UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM
(Mark One)
| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For
the Quarterly Period Ended
| 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:
(Exact name of registrant as specified in its charter)
(State or Other Jurisdiction of Incorporation or Organization) |
(I.R.S. Employer Identification No.) |
| (Address of Principal Executive Offices) | (Zip Code) |
(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.
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).
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 | ☐ |
| ☐ | 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 ☐
As of November 12, 2021, there were shares of the issuer’s common stock outstanding, each with a par value of $0.001 per share.
INTELLINETICS, INC.
Form 10-Q
September 30, 2021
TABLE OF CONTENTS
| 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 (i) 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, and (ii) inflation, labor costs, and the labor markets and their effects on our profitability and our ability to attract and retain talent; | |
| ● | 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
| (unaudited) | ||||||||
| September 30, | December 31, | |||||||
| 2021 | 2020 | |||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash | $ | $ | ||||||
| Accounts receivable, net | ||||||||
| Accounts receivable, unbilled | ||||||||
| Parts and supplies, net | ||||||||
| Other contract assets | ||||||||
| Prepaid expenses and other current assets | ||||||||
| Total current assets | ||||||||
| Property and equipment, net | ||||||||
| Right of use assets | ||||||||
| Intangible assets, net | ||||||||
| Goodwill | ||||||||
| Other assets | ||||||||
| Total assets | $ | $ | ||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Current liabilities: | ||||||||
| Accounts payable | $ | $ | ||||||
| Accrued compensation | ||||||||
| Accrued expenses, other | ||||||||
| Lease liabilities - current | ||||||||
| Deferred revenues | ||||||||
| Deferred compensation | ||||||||
| Earnout liabilities - current | ||||||||
| Accrued interest payable - current | - | |||||||
| Notes payable - current | - | |||||||
| Total current liabilities | ||||||||
| Long-term liabilities: | ||||||||
| Notes payable - net of current portion | ||||||||
| Lease liabilities - net of current portion | ||||||||
| Earnout liabilities - net of current portion | ||||||||
| Total long-term liabilities | ||||||||
| Total liabilities | ||||||||
| Stockholders’ equity: | ||||||||
| Common stock, $ par value, shares authorized; and shares issued and outstanding at September 30, 2021 and December 31, 2020, respectively | ||||||||
| Additional paid-in capital | ||||||||
| Accumulated deficit | ( | ) | ( | ) | ||||
| Total stockholders’ equity | ||||||||
| Total liabilities and stockholders’ equity | $ | $ | ||||||
See Notes to these Condensed Consolidated financial statements
| 5 |
INTELLINETICS, INC. and SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Unaudited)
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Revenues: | ||||||||||||||||
| Sale of software | $ | $ | $ | $ | ||||||||||||
| Software as a service | ||||||||||||||||
| Software maintenance services | ||||||||||||||||
| Professional services | ||||||||||||||||
| Storage and retrieval services | ||||||||||||||||
| Total revenues | ||||||||||||||||
| Cost of revenues: | ||||||||||||||||
| Sale of software | ||||||||||||||||
| Software as a service | ||||||||||||||||
| Software maintenance services | ||||||||||||||||
| Professional services | ||||||||||||||||
| Storage and retrieval services | ||||||||||||||||
| Total cost of revenues | ||||||||||||||||
| Gross profit | ||||||||||||||||
| Operating expenses: | ||||||||||||||||
| General and administrative | ||||||||||||||||
| Change in fair value of earnout liabilities | - | - | - | |||||||||||||
| Significant transaction costs | - | - | - | |||||||||||||
| Sales and marketing | ||||||||||||||||
| Depreciation and amortization | ||||||||||||||||
| Total operating expenses | ||||||||||||||||
| Income (loss) from operations | ( | ) | ||||||||||||||
| Other income (expense) | ||||||||||||||||
| Gain on extinguishment of debt | - | - | ||||||||||||||
| Interest expense, net | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Total other income (expense) | ( | ) | ( | ) | ( | ) | ||||||||||
| Income (loss) before income taxes | ( | ) | ||||||||||||||
| Income tax benefit | - | - | - | |||||||||||||
| Net income (loss) | $ | $ | $ | $ | ( | ) | ||||||||||
| Basic net income (loss) per share: | $ | $ | $ | $ | ( | ) | ||||||||||
| Diluted net income (loss) per share: | $ | $ | $ | $ | ( | ) | ||||||||||
| Weighted average number of common shares outstanding - basic | ||||||||||||||||
| Weighted average number of common shares outstanding - diluted | ||||||||||||||||
See Notes to these Condensed Consolidated financial statements
| 6 |
INTELLINETICS, INC. and SUBSIDIARIES
Condensed Consolidated Statement of Stockholders’ Equity
For the Three and Nine Months Ended September 30, 2021 and 2020
(Unaudited)
| Common Stock | Additional Paid-in | Accumulated | ||||||||||||||||||
| Shares | Amount | Capital | Deficit | Total | ||||||||||||||||
| Balance, June 30, 2020 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Stock Option Compensation | - | - | - | |||||||||||||||||
| Net Income | - | - | - | |||||||||||||||||
| Balance, September 30, 2020 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Balance, June 30, 2021 | ( | ) | ||||||||||||||||||
| Stock Option Compensation | - | - | - | |||||||||||||||||
| Net Income | - | - | - | |||||||||||||||||
| Balance, September 30, 2021 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Common Stock | Additional Paid-in | Accumulated | ||||||||||||||||||
| Shares | Amount | Capital | Deficit | Total | ||||||||||||||||
| Balance, December 31, 2019 | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||||||
| Stock Issued to Directors | - | |||||||||||||||||||
| Stock Option Compensation | - | - | - | |||||||||||||||||
| Stock Issued | - | |||||||||||||||||||
| Stock Issued for Convertible Notes | - | |||||||||||||||||||
| Equity Issuance Costs | - | - | ( | ) | - | ( | ) | |||||||||||||
| Note Offer Warrants | - | - | - | |||||||||||||||||
| Net Loss | - | - | - | ( | ) | ( | ) | |||||||||||||
| Balance, September 30, 2020 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Balance, December 31, 2020 | ( | ) | ||||||||||||||||||
| Stock Issued to Directors | - | |||||||||||||||||||
| Stock Option Compensation | - | - | - | |||||||||||||||||
| Net Income | - | - | - | |||||||||||||||||
| Balance, September 30, 2021 | $ | $ | $ | ( | ) | $ | ||||||||||||||
See Notes to these Condensed Consolidated financial statements
| 7 |
INTELLINETICS, INC. and SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
| For
the Nine Months Ended September 30, | ||||||||
| 2021 | 2020 | |||||||
| Cash flows from operating activities: | ||||||||
| Net income (loss) | $ | $ | ( | ) | ||||
| Adjustments to reconcile net income (loss) to net cash used in operating activities: | ||||||||
| Depreciation and amortization | ||||||||
| Bad debt (recovery) expense | ( | ) | ||||||
| Parts and supplies reserve change | ||||||||
| Amortization of deferred financing costs | ||||||||
| Amortization of beneficial conversion option | - | |||||||
| Amortization of debt discount | ||||||||
| Amortization of right of use asset | ||||||||
| Stock issued for services | ||||||||
| Stock options compensation | ||||||||
| Note conversion stock issue expense | - | |||||||
| Warrant issue expense | - | |||||||
| Interest on converted debt | - | |||||||
| Amortization of original issue discount on notes | - | |||||||
| Gain on extinguishment of debt | ( | ) | ( | ) | ||||
| Change in fair value of earnout liabilities | - | |||||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | ( | ) | ||||||
| Accounts receivable, unbilled | ( | ) | ( | ) | ||||
| Parts and supplies | ||||||||
| Prepaid expenses and other current assets | ( | ) | ( | ) | ||||
| Accounts payable and accrued expenses | ( | ) | ||||||
| Lease liabilities, current and long-term | ( | ) | ( | ) | ||||
| Deferred compensation | - | ( | ) | |||||
| Accrued interest, current and long-term | ||||||||
| Deferred revenues | ||||||||
| Total adjustments | ||||||||
| Net cash provided by (used in) operating activities | ( | ) | ||||||
| Cash flows from investing activities: | ||||||||
| Cash paid to acquire business, net of cash acquired | - | ( | ) | |||||
| Purchases of property and equipment | ( | ) | ( | ) | ||||
| Net cash used in investing activities | ( | ) | ( | ) | ||||
| Cash flows from financing activities: | ||||||||
| Payment of earnout liabilities | ( | ) | - | |||||
| Proceeds from issuance of common stock | - | |||||||
| Offering costs paid on issuance of common stock | - | ( | ) | |||||
| Payment of deferred financing costs | - | ( | ) | |||||
| Proceeds from notes payable | - | |||||||
| Repayment of notes payable | - | ( | ) | |||||
| Repayment of notes payable - related parties | - | ( | ) | |||||
| Net cash (used in) provided by financing activities | ( | ) | ||||||
| Net (decrease) increase in cash | ( | ) | ||||||
| Cash - beginning of period | ||||||||
| Cash - end of period | $ | $ | ||||||
| Supplemental disclosure of cash flow information: | ||||||||
| Cash paid during the period for interest | $ | $ | ||||||
| Cash paid during the period for income taxes | $ | $ | ||||||
| Supplemental disclosure of non-cash financing activities: | ||||||||
| Accrued interest notes payable converted to equity | $ | $ | ||||||
| Accrued interest notes payable related parties converted to equity | - | |||||||
| Discount on notes payable for beneficial conversion feature | - | |||||||
| Discount on notes payable for warrants | - | |||||||
| Notes payable converted to equity | - | |||||||
| Notes payable converted to equity - related parties | - | |||||||
| Right-of-use asset obtained in exchange for operating lease liability | - | |||||||
| Supplemental disclosure of non-cash investing activities relating to business acquisitions: | ||||||||
| Cash | $ | $ | ||||||
| Accounts receivable | - | |||||||
| Accounts receivable, unbilled | - | |||||||
| Parts and supplies | - | |||||||
| Prepaid expenses | - | |||||||
| Other current assets | - | |||||||
| Right of use assets | - | |||||||
| Property and equipment | - | |||||||
| Intangible assets | - | |||||||
| Accounts payable | - | ( | ) | |||||
| Accrued expenses | - | ( | ) | |||||
| Lease liabilities | - | ( | ) | |||||
| Federal and state taxes payable | - | ( | ) | |||||
| Deferred revenues | - | ( | ) | |||||
| Deferred tax liabilities, net | - | ( | ) | |||||
| Net assets acquired in acquisition | - | |||||||
| Total goodwill acquired in acquisition | - | |||||||
| Total purchase price of acquisition | - | |||||||
| Purchase price of business acquisition financed with earnout liability | - | ( | ) | |||||
| Purchase price of business acquisition financed with installment payments | - | ( | ) | |||||
| Cash used in business acquisition | $ | $ | ||||||
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 documents 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 $
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 $ | |
| ● | converting
all of the outstanding principal and accrued interest payable on our then-existing convertible debt in the approximate amount of
$ |
| 9 |
| ● | receiving
$ | |
| ● | obtaining
the loan under the Paycheck Protection Program through PNC Bank in the principal amount of $ |
Overall,
we reduced our outstanding debt by approximately $
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
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, as well as other contract assets which are comprised of employee sales commissions paid in advance of contract periods ending. 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 presents changes in our contract assets during the nine months ended September 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 | ||||||||||||||||
| Nine months ended September 30, 2021 | ||||||||||||||||||||
| Accounts receivable, unbilled | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
| Other contract assets | $ | $ | $ | $ | $ | |||||||||||||||
| Nine months ended September 30, 2020 | ||||||||||||||||||||
| Accounts receivable, unbilled | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
| Other contract assets | $ | $ | $ | $ | $ | |||||||||||||||
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
The following table presents changes in our contract liabilities during the nine months ended September 30, 2021 and 2020:
| Balance
at Beginning of Period | Addition
from acquisition (Note 5) | Billings | Recognized
Revenue | Balance
at End of Period | ||||||||||||||||
| Nine months ended September 30, 2021 | ||||||||||||||||||||
| Deferred revenue | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
| Nine months ended September 30, 2020 | ||||||||||||||||||||
| Deferred revenue | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
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 $
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 to
| 12 |
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.
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 completion 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 nine months ended September 30, 2021 and 2020, our expensed software development costs were $
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.
| 13 |
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 nine months ended September 30, 2021 and 2020 amounted
to $
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 nine months ended September 30, 2021 reported net income, as did the three months ended September 30, 2020, while the nine months ended September 30, 2020 reported a net loss.
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
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
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.
| 14 |
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 September 30, | For the nine months ended September 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Revenues | ||||||||||||||||
| Document Management | $ | $ | $ | $ | ||||||||||||
| Document Conversion | ||||||||||||||||
| Total revenues | $ | $ | $ | $ | ||||||||||||
| Gross profit | ||||||||||||||||
| Document Management | $ | $ | $ | $ | ||||||||||||
| Document Conversion | ||||||||||||||||
| Total gross profit | $ | $ | $ | $ | ||||||||||||
| Capital additions, net | ||||||||||||||||
| Document Management | $ | $ | $ | $ | ||||||||||||
| Document Conversion | ||||||||||||||||
| Total capital additions, net | $ | $ | $ | $ | ||||||||||||
| As of September 30, | As of December 31, | |||||||
| 2021 | 2020 | |||||||
| Total assets | ||||||||
| Document Management | $ | $ | ||||||
| Document Conversion | ||||||||
| Total assets | $ | $ | ||||||
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 $
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 $
| 15 |
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 nine months ended September 30, 2020 | (unaudited) | |||
| September 30, 2020 | ||||
| Total revenues | $ | |||
| Net loss | $ | ( | ) | |
| Basic and diluted net loss per share | $ | ( | ) | |
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 September 30, | For the nine months ended September 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Graphic Sciences: | ||||||||||||||||
| Total revenues | $ | $ | $ | $ | ||||||||||||
| Net income | $ | $ | $ | |||||||||||||
| For the three months ended September 30, | For the nine months ended September 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| CEO Image: | ||||||||||||||||
| Total revenues | $ | $ | $ | $ | ||||||||||||
| Net income | $ | (a) | $ | (a) | $ | (a) | $ | (a) | ||||||||
| (a) |
6. Intangible Assets, Net
At September 30, 2021, intangible assets consisted of the following:
| Estimated | Accumulated | |||||||||||||
| Useful Life | Costs | Amortization | Net | |||||||||||
| Trade names | $ | $ | ( | ) | $ | |||||||||
| Customer contracts | ( | ) | ||||||||||||
| $ | $ | ( | ) | $ | ||||||||||
At December 31, 2020, intangible assets consisted of the following:
| Estimated | Accumulated | |||||||||||||
| Useful Life | Costs | Amortization | Net | |||||||||||
| Trade names | $ | $ | ( | ) | $ | |||||||||
| Customer contracts | ( | ) | ||||||||||||
| $ | $ | ( | ) | $ | ||||||||||
| 16 |
Amortization
expense for the three and nine months ended September 30, 2021 and September 30, 2020, amounted to $
| For the Twelve Months Ending September 30, | Amount | |||
| 2022 | $ | |||
| 2023 | ||||
| 2024 | ||||
| 2025 | ||||
| 2026 | ||||
| Thereafter | ||||
| $ | ||||
7. Fair Value Measurements
Under GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy consists of the following three levels. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Level 2 inputs consist of quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data. Level 3 inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.
The carrying values of cash and equivalents, accounts receivable, accounts payable, accrued expenses, and the PPP loan (prior to forgiveness) approximate fair value because of its short maturity. Management believes that the carrying value of the 2020 Notes approximate fair value given the March 2, 2020 transaction proximity to December 31, 2020 in conjunction with the absence of significant net change in the overall economic environment with regards to availability of credit to Company.
We
have earnout liabilities related to our two 2020 acquisitions which are measured on a recurring basis and recorded at fair value, measured
using probability-weighted analysis and discounted using a rate that appropriately captures the risks associated with the obligation.
The inputs used to calculate the fair value of the earnout liabilities are considered to be Level 3 inputs due to the lack of relevant
market activity and significant management judgment.
The following table provides a summary of the changes in fair value of the earnout liabilities for the three and nine months ended September 30, 2021:
| Three
months ended September 30, 2021 | ||||
| Fair value at June 30, 2021 | $ | |||
| Payment | ||||
| Change in fair value | ||||
| Fair value at September 30, 2021 | $ | |||
| Nine
months ended September 30, 2021 | ||||
| Fair value at December 31, 2020 | $ | |||
| Payment | ( | ) | ||
| Change in fair value | ||||
| Fair value at September 30, 2021 | $ | |||
The fair values of amounts owed are recorded in the current and long-term portions of earnout liabilities in our condensed consolidated balance sheets. Changes in fair value are recorded in change in fair value of earnout liabilities in our condensed consolidated statements of operations.
8. Property and Equipment
Property and equipment are comprised of the following:
| September 30, 2021 | December 31, 2020 | |||||||
| Computer hardware and purchased software | $ | $ | ||||||
| Leasehold improvements | ||||||||
| Furniture and fixtures | ||||||||
| Less: accumulated depreciation | ( | ) | ( | ) | ||||
| Property and equipment, net | $ | $ | ||||||
Total
depreciation expense on our property and equipment for the three and nine months ended September 30, 2021 and 2020 amounted to $
| 17 |
9. Notes Payable – Unrelated Parties
Summary of Notes Payable to Unrelated Parties
The table below summarizes all notes payable at September 30, 2021 and December 31, 2020, respectively, with the exception of related party notes disclosed in Note 10 “Notes Payable - Related Parties.”
| September 30, 2021 | December 31, 2020 | |||||||
| PPP Note (a) | $ | $ | ||||||
| 2020 Notes | ||||||||
| Total notes payable | $ | $ | ||||||
| Less unamortized debt issuance costs | ( | ) | ( | ) | ||||
| Less unamortized debt discount | ( | ) | ( | ) | ||||
| Less current portion | ( | ) | ||||||
| Long-term portion of notes payable | $ | $ | ||||||
| (a) |
Future minimum principal payments of the 2020 Notes are as follows:
| As of September 30, | Amount | |||
| 2023 | $ | |||
| Total | $ | |||
As
of September 30, 2021 and December 31, 2020, accrued interest for these notes payable with the exception of the related party notes in
Note 10, “Notes Payable - Related Parties,” was $
With
respect to all notes outstanding (other than the notes to related parties), interest expense, including the amortization of deferred
financing costs, accrued loan participation fees, original issue discounts, deferred interest and related fees, interest expense related
to warrants issued for the conversion of convertible notes, and the embedded conversion feature for the three and nine months ended September
30, 2021 was $
We have evaluated the terms of our 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 our common stock. We determined that the conversion feature did not meet the definition of a derivative and therefore did not bifurcate the conversion feature and account for it as a separate derivative liability. We evaluated the conversion feature for a beneficial conversion feature. The effective conversion price was compared with 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 we recognized a beneficial conversion feature resulting in a discount on the note payable, upon satisfaction of the contingency. The beneficial conversion features were amortized to interest expense over the life of the respective notes, starting from the date of recognition.
2016-18 Unrelated Party Notes and 2020 Note Conversion
In
2016 through 2018, we issued convertible promissory notes to unrelated parties in an aggregate principal amount of $
| 18 |
2020 Notes
On
March 2, 2020, we sold units, at an offering price of $1,000 per unit, to accredited investors in a private placement offering,
with each unit consisting of $1,000 in 12% Subordinated Notes (“2020 Notes”) and shares of our common stock, for aggregate
gross proceeds of $
PPP Note
On
April 15, 2020, we were issued an unsecured promissory note (“PPP Note”) for the PPP loan through PNC Bank with a principal
amount of $
10. Notes Payable - Related Parties
For
the three and nine months ended September 30, 2021, there was
2016-19 Related Party Notes and 2020 Note Conversion
In
2016 through 2019, we issued convertible promissory notes to related parties, including
11. Deferred Compensation
Pursuant
to an employment agreement, we have accrued incentive compensation totaling $
12. Commitments and Contingencies
From time to time we are involved in legal proceedings, claims and litigation related to employee claims, contractual disputes and taxes in the ordinary course of business. Although we cannot predict the outcome of such matters, currently we have no reason to believe the disposition of any current matter could reasonably be expected to have a material adverse impact on our financial position, results of operations or the ability to carry on any of our business activities.
Employment Agreements
We have entered into employment agreements with three of our key executives, including one of our founders. Under their respective employment agreements, the executives are employed on an “at-will” basis and are bound by typical confidentiality, non-solicitation and non-competition provisions. Deferred compensation for one founder remains outstanding as of September 30, 2021.
| 19 |
Operating Leases
On
Graphic
Sciences also leases and uses an additional temporary storage space in Madison Heights, with a monthly rental payment of $
The following table sets forth the future minimum lease payments under these operating leases:
| For the period ending September 30, | Amount | |||
| 2022 | $ | |||
| 2023 | ||||
| 2024 | ||||
| 2025 | ||||
| 2026 | ||||
| Thereafter | ||||
| $ | ||||
Lease
costs charged to operations for the three months ended September 30, 2021 and 2020 amounted to $
| For the Nine Months Ending September 30, 2021: | ||||
| Operating cash flows from operating leases | $ | |||
| Weighted average remaining lease term – operating leases | ||||
| Weighted average discount rate – operating leases | % | |||
Because these leases do not provide an implicit rate, we use an incremental borrowing rate based on the information available at the lease commencement date in determining the present value of lease payments.
| 20 |
13. Stockholders’ Equity
Common Stock
As of September 30, 2021, shares of common stock were issued and outstanding, shares of common stock were reserved for issuance upon the exercise of outstanding warrants, and shares of common stock were reserved for issuance under our 2015 Equity Incentive Plan, as amended (the “2015 Plan”).
On March 2, 2020, we sold shares of our common stock and certain subordinated notes in a private placement to accredited investors as follows:
| ● |
shares of our common stock at a purchase price of $ per share, for aggregate gross proceeds of $ | |
| ● |
units at a purchase price of $ per unit, with each unit consisting of $ |
In
connection with the private placement offering, we paid the placement agent $
Reverse Stock Split
In
February 2020, upon recommendation and authorization by our Board of Directors, our stockholders holding a majority in interest of the
issued and outstanding shares of our common stock, acting by written consent, adopted an amendment to our Articles of Incorporation to
Effective March 2, 2020, before the Reverse Split and the 25,000,000 Share Amendment became effective, upon recommendation and authorization by the Board of Directors, stockholders holding a majority in interest of the issued and outstanding shares of our common stock, acting by written consent, adopted an amendment to our Articles of Incorporation to increase the authorized number of shares of our common stock to shares (representing shares on a post-split basis) from shares (representing shares on a post-split basis), in order to facilitate the acquisition of Graphic Sciences and certain private placement offerings and note conversions. Thereafter, on March 20, 2020, when the Reverse Split and the 25,000,000 Share Amendment became effective, our authorized capital stock became shares of common stock.
The Reverse Split did not cause an adjustment to the par value of the common stock. Pursuant to the Reverse Split, we adjusted the amounts for shares reserved for issuance upon the exercise of outstanding warrants, outstanding stock options, and shares reserved for the 2015 Plan.
All references to shares of common stock and per share data in the accompanying condensed consolidated financial statements and in these notes related thereto have been adjusted to reflect the Reverse Split for all periods presented.
| 21 |
Warrants
The following sets forth the warrants to purchase our common stock that were outstanding as of September 30, 2021:
| ● | Warrants
to purchase | |
| ● | Warrants
to purchase | |
| ● | Warrants
to purchase | |
| ● | Warrants
to purchase | |
| ● | Warrants
to purchase |
No
warrants were issued during the nine months ended September 30, 2021. Warrants to purchase
| Warrants
Issued March 2, 2020 | ||||
| Risk-free interest rate | % | |||
| Weighted average expected term | ||||
| Expected volatility | % | |||
| Expected dividend yield | % | |||
From time to time, we issue stock options and restricted stock as compensation for services rendered by our directors and employees.
Restricted Stock
On February 15, 2021 and January 2, 2020, we issued shares and shares, respectively, of restricted common stock to our directors as part of their annual compensation plan. The grants of restricted common stock were made outside the 2015 Plan and were not subject to any vesting conditions. Stock compensation of $ was recorded on this issuance of restricted common stock for the nine months ended September 30, 2021. Stock compensation of $ on the issuance of the restricted common stock to directors was recorded for the twelve months ending December 31, 2020.
Stock Options
We did not make any stock option grants during the nine months ended September 30, 2021. The weighted-average grant date fair value of options granted during the nine months ended September 30, 2020 was $. Stock-based compensation for options was $ and $, during the three months ended September 30, 2021 and 2020, respectively, and $ and $, during the nine months ended September 30, 2021 and 2020, respectively.
| Weighted- | ||||||||||||||||
| Weighted- | Average | |||||||||||||||
| Shares | Average | Remaining | Aggregate | |||||||||||||
| Under | Exercise | Contractual | Intrinsic | |||||||||||||
| Option | Price | Life | Value | |||||||||||||
| Outstanding at January 1, 2021 | $ | years | $ | |||||||||||||
| Outstanding at September 30, 2021 | $ | years | $ | |||||||||||||
| Exercisable at September 30, 2021 | $ | years | $ | |||||||||||||
| 22 |
| Weighted- | ||||||||||||||||
| Weighted- | Average | |||||||||||||||
| Shares | Average | Remaining | Aggregate | |||||||||||||
| Under | Exercise | Contractual | Intrinsic | |||||||||||||
| Option | Price | Life | Value | |||||||||||||
| Outstanding at January 1, 2020 | $ | years | $ | |||||||||||||
| Granted | ||||||||||||||||
| Outstanding at September 30, 2020 | $ | years | $ | |||||||||||||
| Exercisable at September 30, 2020 | $ | years | $ | |||||||||||||
As of September 30, 2021 and December 31, 2020, there was $ and $ , respectively, of total unrecognized compensation costs related to stock options granted under our stock option agreements. The unrecognized compensation cost is expected to be recognized over a weighted-average period of . The total fair value of stock options that vested during the nine months ended September 30, 2021 and 2020 was $ and $, respectively.
15. Concentrations
Revenues
from a limited number of customers have accounted for a substantial percentage of our total revenues. During the three months ended September
30, 2021 and 2020, our largest customer, the State of Michigan, accounted for
For
the three months ended September 30, 2021 and 2020, government contracts represented approximately
As
of September 30, 2021, accounts receivable concentrations from our two largest customers were
16. Certain Relationships and Related Transactions
We did not participate in any related person transactions during the three and nine months ended September 30, 2021.
17. Provision For Income Taxes
We file federal and various state income tax returns in the U.S. For the three and nine months ended September 30, 2021 and 2020, we have recognized the minimum amount of state income tax as required by the states in which we are required to file taxes. We are not currently subject to any other federal or state taxes because we have incurred losses since our inception.
Income tax benefit consists of the following federal, deferred components for the nine months ended September 30, 2021 and 2020:
| Nine
months ended September 30, 2021 | Nine
months ended September 30, 2020 | |||||||
| Benefit of net operating losses | $ | $ | ( | ) | ||||
| Other timing differences | ( | ) | ||||||
| Change in valuation
allowance, including $ | ( | ) | ||||||
| Tax benefit | $ | $ | ( | ) | ||||
| 23 |
A
reconciliation is provided below of the U.S. Federal income tax expense at a statutory rate of
| Nine
months ended September 30, 2021 | Nine
months ended September 30, 2020 | |||||||
| U.S. statutory rate | % | % | ||||||
| U.S. Federal income tax at statutory rate | $ | $ | ( | ) | ||||
| Increase (decrease) in income taxes due to: | ||||||||
| Non-taxable PPP loan and accrued interest recovery | ( | ) | ||||||
| Non-deductible earnout expense | ||||||||
| Non-deductible goodwill amortization | ||||||||
| Other differences | ||||||||
| Benefit of acquisition-date purchased deferred tax liability | ( | ) | ||||||
| Other change in valuation allowance | ( | ) | ||||||
| Income tax benefit | $ | $ | ( | ) | ||||
The approximate tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are presented below:
| September 30, 2021 | December 31, 2020 | |||||||
| Deferred tax assets | ||||||||
| Reserves and accruals not currently deductible for tax purposes | $ | $ | ||||||
| Amortizable assets | ||||||||
| Net operating loss carryforwards | ||||||||
| Deferred tax liabilities | ||||||||
| Property and equipment | ( | ) | ( | ) | ||||
| Net Deferred tax assets | ||||||||
| Valuation allowance | ( | ) | ( | ) | ||||
| $ | $ | |||||||
As
of September 30, 2021 and December 31, 2020, we had federal net operating loss carry forwards of approximately $
| 24 |
| ITEM 2 | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion and analysis of our financial conditions and results of operations should be read together with our condensed consolidated financial statements and notes thereto included in Part I, Item 1, “Financial Statements,” of this Quarterly Report on Form 10-Q, and with the condensed consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods. Any forward-looking statements in this discussion and analysis should be read in conjunction with the information set forth in “Note Regarding Forward-Looking Statements” elsewhere herein. In this Quarterly Report, we sometimes refer to the three and nine month periods ended September 30, 2021 as the third quarter 2021 and the nine month period 2021 respectively, and to the three and nine month periods ended September 30, 2020 as the third quarter 2020 and the nine month period 2020.
Company Overview
We are a document services and solutions software company serving both the small-to-medium business and governmental sectors. During 2020, we made two significant business acquisitions that have significantly impacted our financial operations and grown our business operations:
| ● | Graphic Sciences, on March 2, 2020, and | |
| ● | CEO Image, on April 21, 2020. |
For further information about these acquisitions, please see Note 5 to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report.
Our products and services are provided through two reporting segments: Document Management and Document Conversion. Our Document Management segment, which includes our CEO Image acquisition, 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 our 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 documents 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.
Our customers use our software by one of two methods: purchasing our software and installing it onto their own equipment, which we refer to as a “premise” model, or licensing and accessing our platform via the Internet, which we refer to as a “SaaS” or “software as a service” model and also as a “cloud-based” model. Licensing of our software through our SaaS model has become increasingly popular among our customers, especially in light of the increased deployment of remote workforce policies, and is a key ingredient in our revenue growth strategy. Our SaaS products are hosted with Amazon Web Services and Expedient, providing our customers with reliable hosting services that we believe maintain the best industry practices in data security.
We operate a U.S.-based business with concentrated sales to the State of Michigan for our Document Conversion segment with a diverse set of document management software solutions and services. We hold or compete for leading positions regionally in select markets and attribute this leadership to several factors including the strength of our brand name and reputation, our comprehensive offering of innovative solutions, and the quality of our service support. Net growth in sales of software as a service in recent years reflects market demand for these solutions over traditional sales of on-premise software. We expect to continue to benefit from our select niche leader positions, innovative product offering, growing installed base, and the impact of our sales and marketing programs. Examples of these programs include identifying and investing in growth and market penetration opportunities, more effectively pricing our products and services, demonstrating superior value to customers, increasing our sales force effectiveness through improved guidance and measurement, and continuing to optimize our lead generation and lead nurturing processes.
For further information about our consolidated revenue and earnings, please see our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report.
How We Evaluate our Business Performance and Opportunities
There has been no material change during the nine month period 2021 to the major qualitative and quantitative factors we consider in the evaluation of our operating results as set forth in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — How We Evaluate our Business Performance and Opportunities” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020.
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Financial Impact of COVID-19
The spread of the COVID-19 pandemic and developments surrounding this global pandemic have had, and we expect will continue to have, a significant impact on our business, operations, financial condition and results of operations.
For approximately three months beginning in late March 2020, our Graphic Services business operations, which constitute a majority of our professional services revenues, were substantially reduced while the State of Michigan’s stay-at-home order was in effect, during which period we were only able to process work orders deemed “essential” by the State of Michigan. While there has not been a meaningful cancellation of future jobs or current contracts for our Graphic Services business operations, many of our customers have been adversely affected by the pandemic and related business restrictions and certain customers continue to be slow to resume operations to pre-pandemic levels, and certain customers may never fully return. In particular, the State of Michigan, our biggest customer, has not fully resumed normal operations, resulting in a decrease in the volume of work orders for our Document Conversion segment. In addition, we are seeing inconsistent demand in certain other areas of our operations, even though those operations are still currently open for business with mostly remote staff.
In addition, the majority of our Ohio employees are continuing to work remotely. Many of our clients operate in a variety of other states, which had differing time periods in which their operations have been, currently or may in the future be restricted due to COVID-19. Even though we have been able to fully resume our operations, we expect to see continued weakened demand in light of reduced or inconsistent governmental and small-business spending and general economic uncertainty.
Looking ahead, the ongoing impact of COVID-19 on our business continues to evolve and be unpredictable. For example, to the extent the pandemic continues to disrupt economic activity we, like other businesses, are not immune to continued adverse impacts to our business, operations and financial results from decreases in customer spending, the adverse impact on the liquidity of our customers, depressed economic activity, or volatility in capital markets. The extent of the impact will depend on a number of factors, including the duration and severity of the pandemic; the uneven impact to certain industries; vaccination rates; the effect that any governmental vaccine mandates might have on our ability to attract and retain talent; the macroeconomic impact of government measures to contain the spread of the virus and related government stimulus measures. To address the potential impact to our business, we have engaged, and continue to assess and engage, in aggressive efforts to reduce expenses and preserve cash flow in order to address the effects of COVID-19 on our business, operations and results. Additionally, we have instituted safe distancing practices and additional cleaning procedures for all our company offices, as well as established work-from-home policies wherever feasible, in order to prevent or mitigate future outbreaks and disruptions to our business. At the same time, we believe the current environment is accelerating digital transformation and we remain focused on innovating and investing in the services we offer to our customers. Accordingly, the ongoing impact of COVID-19 and the extent of these measures we may implement could have a material impact on our financial results.
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, in addition to COVID-19, that are discussed in Part I, Item IA, “Risk Factors” and in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Uncertainties, Trends, and Risks that can cause Fluctuations in our Operating Results” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020. Due to all these factors and the other risks discussed in this Item 2, our past 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.
Executive Overview of Results
The biggest factors in the changes in our results of operations during the third quarter 2021 compared to the third quarter 2020, and the nine month period 2021 compared to the nine month period 2020 were our acquisitions of Graphic Sciences on March 2, 2020 and, to a much lesser extent, CEO Image on April 21, 2020, and the impact of the COVID-19 stay-at-home orders in Michigan and Ohio during most of the second quarter 2020 which did not fully resume in the third quarter 2020. Our results for the nine month period 2021 include the results of Graphic Sciences and CEO Image operations for the full period, while our nine month period 2020 results include only approximately seven month’s results of Graphic Sciences operations, and five month’s results of CEO Image.
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Below are our key financial results for the third quarter 2021 (consolidated unless otherwise noted):
| ● | Revenues were $3,171,362, representing revenue growth of 26% year over year. | |
| ● | Cost of revenues was $1,255,641. | |
| ● | Operating expenses (excluding cost of revenues) were $1,506,254. | |
| ● | Income from operations was $409,467. | |
| ● | Net income was $296,437 with basic and diluted net income per share of $0.11 and $0.10, respectively. | |
| ● | Operating cash flow was $821,129. | |
| ● | Capital expenditures were $132,513. |
Below are our key financial results for the nine month period 2021 (consolidated unless otherwise noted):
| ● | Revenues were $8,716,227, representing revenue growth of 57% year over year. | |
| ● | Cost of revenues was $3,381,535. | |
| ● | Operating expenses (excluding cost of revenues) were $4,508,774. | |
| ● | Income from operations was $825,918. | |
| ● | Net income was $1,331,656 with basic and diluted net income per share of $0.47 and $0.43, respectively, including $845,083 gain on PPP loan forgiveness. | |
| ● | Operating cash flow was $1,408,249. | |
| ● | Capital expenditures were $532,151. | |
| ● | As of September 30, 2021, we had 135 employees, including 9 part-time employees. |
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Reportable Segments
We have two reportable segments: Document Management and Document Conversion. These reportable segments are discussed above under “Company Overview.”
Results of Operations
Revenues
The following table sets forth our revenues by reportable segment for the periods indicated:
| For the three months ended September 30, | For the nine months ended September 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Revenues | ||||||||||||||||
| Document Management | $ | 792,548 | $ | 780,834 | $ | 2,319,370 | $ | 2,018,208 | ||||||||
| Document Conversion | 2,378,814 | 1,730,448 | 6,396,857 | 3,539,378 | ||||||||||||
| Total revenues | $ | 3,171,362 | $ | 2,511,282 | $ | 8,716,227 | $ | 5,557,586 | ||||||||
| Gross profit | ||||||||||||||||
| Document Management | $ | 673,237 | $ | 605,451 | $ | 1,898,799 | $ | 1,526,283 | ||||||||
| Document Conversion | 1,242,484 | 884,843 | 3,435,893 | 1,880,648 | ||||||||||||
| Total gross profit | $ | 1,915,721 | $ | 1,490,294 | $ | 5,334,692 | $ | 3,406,931 | ||||||||
The following table sets forth our revenues by revenue source for the periods indicated:
| For
the Three Months Ended September 30, | For
the Nine months ended September 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Revenues: | ||||||||||||||||
| Sale of software | $ | 58,799 | $ | 53,767 | $ | 73,971 | $ | 153,999 | ||||||||
| Software as a service | 352,192 | 281,810 | 1,052,072 | 756,497 | ||||||||||||
| Software maintenance services | 336,732 | 340,129 | 1,012,251 | 915,483 | ||||||||||||
| Professional services | 2,165,030 | 1,615,445 | 5,715,273 | 3,221,154 | ||||||||||||
| Storage and retrieval services | 258,629 | 220,131 | 862,660 | 510,453 | ||||||||||||
| Total revenues | 3,171,362 | 2,511,282 | 8,716,227 | 5,557,586 | ||||||||||||
Our total revenues in the third quarter 2021 increased by 660,080, or 26%, over our third quarter 2020 revenues, primarily attributable to growth in professional services and software as a service, as further described below. The increase in total revenues for the nine months ended September 30, 2021 is driven primarily by two factors: 2020 COVID-19 impact and acquisitions. The COVID-19 stay-at-home orders in Michigan and Ohio, which were in place for the majority of the second quarter 2020, significantly affected our professional services revenues for that quarter. We estimate the impact of COVID-19 on our Document Conversion segment to be approximately $655,000 reduced revenue for the second quarter 2020. The remaining increase in total revenues for the nine months ended September 30, 2021 is driven primarily by the acquisition of our Graphic Sciences subsidiary and the associated expansion of our revenues from professional services and the addition of storage and retrieval services. Graphic Sciences, which was acquired towards the end of the first quarter 2020, accounted for $1,843,221 of our revenues in the first quarter 2021 compared to $556,254 in the first quarter 2020, constituting 91% of the increase in revenues. In addition, the CEO Image business line that we acquired after the first quarter 2020 accounted for $132,605 of our first quarter revenues, or 9% of the total increase.
Sale of Software Revenues
Revenues from the sale of software principally consist of sales of additional or upgraded software licenses and applications to existing customers and resellers. Revenues from the sale of software, which are reported as part of our Document Management segment, increased by $5,012, or 9%, in the third quarter 2021 compared to the third quarter 2020, and decreased by $80,028, or 52% during the nine month period 2021 compared to the nine month period 2020.
This decrease was due to timing of large direct sales projects, with unfavorable comparisons to the high project volume the same periods in 2020. We expect the volatility of this revenue line item to continue as the frequency of on-premise software solution sales decreases over time and project timing is unpredictable.
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Software as a Service Revenues
We provide access to our software solutions as a service, accessible through the internet. Our customers typically enter into our software as a service agreement for periods of one year or more. Under these agreements, we generally provide access to the applicable software, data storage and related customer assistance and support. Revenues from the sale of software as a service, which are reported as part of our Document Management segment increased by $70,382, or 25%, in the third quarter 2021 compared to the third quarter 2020 and increased by $295,575, or 39% in the nine month period 2021 compared to the nine month period 2020. This increase was primarily the result of most new customers choosing a cloud-based solution, as well as expanded data storage, user seats, and hosting fees for existing customers.
Software Maintenance Services Revenues
Software maintenance services revenues consist of fees for post-contract customer support services provided to license (premise-based) holders through support and maintenance agreements. 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 renewals of maintenance agreements, which typically run on a year-to-year basis. Revenues from the sale of software maintenance services, which are reported as part of our Document Management segment, decreased by $3,397, or 1%, in the third quarter 2021 compared to the third quarter 2020 and increased by $96,768, or 11%, in the nine month period 2021 compared to the nine month period 2020. This increase was primarily the result of maintenance and support agreements acquired with CEO Image, augmented by expansion of services with existing customers and price increases more than offsetting normal attrition.
Professional Services Revenues
Professional services revenues consist of revenues from document scanning and conversion services, consulting, discovery, training, and advisory services to assist customers with document management needs, as well as repair and maintenance services for customer equipment. These revenues include arrangements that do not involve the sale of software. Revenues from our professional services offerings were enhanced with our acquisition of Graphic Sciences. Of our professional services revenues during the third quarter 2021 and nine month period 2021, $2,120,185 and $5,534,197, respectively, were derived from our Document Conversion operations and $44,845 and $181,076, respectively, were derived from our Document Management operations. Our overall professional services revenues increased by $549,585, or 34%, in the third quarter 2021 compared to the third quarter 2020 and increased by $2,494,119, or 77%, in the nine month period 2021 compared to the nine month period 2020. This increase is largely the net result of two key factors limiting professional service sales during the nine month period 2020: the acquisition of Graphic Sciences late in the first quarter 2021 and the COVID-19 stay-at-home orders. The increase is also due to a solid pipeline and favorable mix of project work during those periods in 2021.
Storage and Retrieval Services Revenues
Graphic Sciences provides document storage and retrieval services to customers, primarily in Michigan. Revenues from storage and retrieval services, which are reported as part of our Document Conversion segment, increased by $38,498, or 17%, in the third quarter 2021 compared to the third quarter 2020 and increased by $352,207, or 69%, during the nine month period 2021 compared to the nine month period 2020. This increase was the result of a contract extension, including improved pricing, with our largest storage and retrieval customer, as well as unusually high project work including shredding of documents approved for destruction, and also the timing of the acquisition of Graphic Sciences in March 2020.
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Costs of Revenues and Gross Profits
The following table sets forth our cost of revenues, by revenue source, for the periods indicated:
| For
the Three Months Ended September 30, | For
the Nine months ended September 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Cost of revenues: | ||||||||||||||||
| Sale of software | 3,691 | - | 10,050 | 40,117 | ||||||||||||
| Software as a service | 73,596 | 65,712 | 241,717 | 209,508 | ||||||||||||
| Software maintenance services | 18,270 | 49,354 | 64,930 | 127,439 | ||||||||||||
| Professional services | 1,042,249 | 841,016 | 2,765,241 | 1,637,308 | ||||||||||||
| Storage and retrieval services | 117,835 | 64,906 | 299,597 | 136,283 | ||||||||||||
| Total cost of revenues | 1,255,641 | 1,020,988 | 3,381,535 | 2,150,655 | ||||||||||||
The following table sets forth our cost of revenues by reportable segment for the periods indicated:
| For the three months ended September 30, | For the nine months ended September 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Cost of revenues by segment | ||||||||||||||||
| Document Management | $ | 119,311 | $ | 175,383 | $ | 420,571 | $ | 491,925 | ||||||||
| Document Conversion | 1,136,330 | 845,605 | 2,960,964 | 1,658,730 | ||||||||||||
| Total revenues | $ | 1,255,641 | $ | 1,020,988 | $ | 3,381,535 | $ | 2,150,655 | ||||||||
Our total cost of revenues during the third quarter 2021 increased by $234,653, or 23%, over third quarter 2020 and increased by $1,230,880, or 57%, during the nine month period 2021 over the nine month period 2020 primarily due to the corresponding increase in revenues for professional services and storage and retrieval services, which were adversely impacted by the stay-at-home orders in effect during third quarter 2020. The increase was also due to the acquisition of Graphic Sciences at the end of the first quarter 2020 and, to a lesser degree, the acquisition of CEO Image in April 2020. Our cost of revenues for our Document Management segment decreased by $56,072, or 32%, in the third quarter 2021 compared to the third quarter 2020 and decreased $71,354, or 15%, in the nine month period 2021 compared to the nine month period 2020 primarily due to more efficient execution of the software maintenance services in that segment. Our cost of revenues for our Document Conversion segment increased by $290,725, or 34%, in the third quarter 2021 compared to the third quarter 2020 and increased by $1,302,234, or 79%, during the nine month period 2021 compared to the nine month period 2020 primarily due to the acquisition of Graphic Sciences at the end of the first quarter 2020.
Our overall gross profit decreased to 61% in the third quarter 2021 from 59% in the third quarter 2020, and was stable at 61% for the nine month period 2021 and 2020. The increase in the mix of professional services revenue drove a decrease in gross margin, but that decrease was offset by strong margin professional services projects as well as margin improvements software-related revenue sources.
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Cost of Software Revenues
Cost of software revenues consists primarily of labor costs of our software engineers and implementation consultants and third-party software licenses that are sold in connection with our core software applications. Cost of software revenues during the third quarter 2021 increased by $3,691, or 100%, from the third quarter 2020, and decreased by $30,067, or 75%, from the nine month period 2020, due to the decrease in revenues and implementations. Our gross margin for software revenues decreased to 94% from 100% in the third quarter 2020 and increased to 86% from 74% in the nine month period 2020. The strong third quarter 2021 and 2020 margins were driven by license expansions and similar favorable changes in the software solution mix with very little costs to deliver the solution, while changes in the software solution mix from the first quarter 2021 to the third quarter 2021 more than offset the opposite changes in the same quarters in 2020 resulting in improved margins year to date.
Cost of Software as a Service
Cost of software as a service, or SaaS, consists primarily of technical support personnel, hosting services, and related costs. Cost of software as a service during the third quarter 2021 increased by $7,884, or 12%, over the third quarter 2020 and increased by $32,209, or 15%, during the nine month period 2021 over the nine month period 2020. This increase in the cost of SaaS was less than the increase in associated SaaS revenues, so our gross margin in the third quarter 2021 increased to 79% compared to 77% in the third quarter 2020 and to 77% in the nine month period 2021 compared to 72% during the nine month period 2020, as a result of more standard projects and scaling of hosting infrastructure.
Cost of Software Maintenance Services
Cost of software maintenance services consists primarily of technical support personnel and related costs. Cost of software maintenance services during the third quarter 2021 decreased by $31,084, or 63%, over the third quarter 2020 and decreased by $62,509, or 49%, in the nine month period 2021 over the nine month period 2020, due primarily to reduced support activity, especially compared to the unusually high support volumes in first and third quarter 2020. As a result, our gross margin for software maintenance services increased to 95% and 94% in the third quarter 2021 and the nine month period 2021 compared to 85% and 86% in the third quarter 2020 and the nine month period 2020, respectively.
Cost of Professional Services
Cost of professional services consists primarily of compensation for employees performing the document conversion services, compensation of our software engineers and implementation consultants and related third-party costs. Cost of professional services during the third quarter 2021 increased by $201,233, or 24%, over the third quarter 2020 and increased in the nine month period 2021 by $1,127,933, or 69%, over the nine month period 2020, following the increased revenue volume primarily due to the acquisition of Graphic Sciences late in the first quarter 2020 and the 2020 COVID-19 stay-at-home orders. As a result, our gross margin for professional services increased to 52% in the third quarter 2021 compared to 48% in the third quarter 2020 and increased to 52% during the nine month period 2021 compared to 49% in the nine month period 2020. Gross margins related to professional services may vary widely, depending upon the nature of the projects completed in a period, driven by the amount of labor it takes to complete a project.
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Cost of Storage and Retrieval Services
Cost of storage and retrieval services consists primarily of compensation for employees performing the document storage and retrieval services, including logistics, provided by Graphic Sciences. Cost of storage and retrieval services increased by $52,929, or 82%, in the third quarter 2021 compared to the third quarter 2020, and increased by $163,314, or 120%, during the nine month period 2021 compared to the nine month period 2020, due to additional labor costs associated with our 2021 warehouse consolidation, which began in the third quarter, as well as costs for additional project work including shredding and the inclusion of storage and retrieval services during the entire period of the first quarter 2021 compared to approximately one full month during the first quarter 2020. Gross margins for our storage and retrieval services, which exclude the cost of facilities rental, maintenance, and related overheads, decreased to 54% in the third quarter 2021 compared to 71% in the third quarter 2020 and decreased to 65% during nine month period 2021 compared to 73% in the nine month period 2020 primarily as a result of increased use of subcontractors for certain projects, including shredding, labor associated with consolidating warehouses in 2021, and expanded services offered to customers.
Operating Expenses
The following table sets forth our operating expenses for the periods indicated:
For the Three Months Ended September 30, | For the Nine months ended September 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Operating expenses: | ||||||||||||||||
| General and administrative | 1,027,932 | 844,186 | 3,125,019 | 2,533,046 | ||||||||||||
| Change in fair value of earnout liabilities | - | - | 77,211 | - | ||||||||||||
| Significant transaction costs | - | 285,462 | - | 636,440 | ||||||||||||
| Sales and marketing | 372,399 | 229,873 | 1,004,305 | 759,024 | ||||||||||||
| Depreciation and amortization | 105,923 | 89,475 | 302,239 | 204,317 | ||||||||||||
| Total operating expenses | 1,506,254 | 1,219,123 | 4,508,774 | 4,132,827 | ||||||||||||
General and Administrative Expenses
General and administrative expenses during the third quarter 2021 increased by $183,746, or 22%, over the third quarter 2020, and increased in the nine month period 2021 by $591,973, or 23%, over the nine month period 2020, principally related to the addition of Graphic Sciences expenses and certain furloughed hourly workers and management salary reductions in 2020. This was primarily reflected in our Document Conversion segment, in which our general and administrative expenses increased to $640,890 and $1,881,246 in the third quarter 2021 and the nine month period 2021, respectively, from $470,855 and $1,154,770 in the third quarter 2020 and the nine month period 2020, respectively. In our Document Management segment, our general and administrative expenses increased slightly to $387,042 in the third quarter 2021 compared to $373,331 in the third quarter 2020, and decreased to $1,243,773 in the nine month period 2021 compared to $1,378,276 in the nine month period 2020, which changes were due to the impacts of reinstated full management salaries increasing those expenses while decreased legal and accounting professional fees and increased sharing of public company costs with the increased Document Conversion segment decreased those expenses in our Document Management segment.
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Change in Fair Value of Earnout Liabilities
Improved gross margin performance at Graphic Science during the first quarter 2021 resulted in an adjustment to fair value of earnout liabilities of $69,950. Improved revenue performance at CEO during the second quarter resulted in an adjustment to fair value of earnout liabilities of $7,261. There were no adjustments to fair value of earnout liabilities during the third quarter 2021 or the nine month period 2020.
Significant Transaction Expenses
There were no significant transaction expenses during the nine month period 2021. The significant transactions expenses during the nine month period 2020 were comprised of investment banker and placement agent success fees, as well as legal and consulting fees, in connection with our acquisition of Graphic Sciences and our financing and debt conversion.
Sales and Marketing Expenses
Sales and marketing expenses during the third quarter 2021 increased by $86,937, or 30%, over the third quarter 2020 and increased by $245,281, or 32%, during the nine month period 2021 over the nine month period 2020. This increase was primarily driven by the inclusion of the sales and marketing expenses Graphic Sciences during all of those periods in 2021 as well as the reinstatement of full sales and marketing salaries as a part of reducing expenses and preserving cash during the initial COVID-19 uncertainty in 2020, as well as adding a sales representative and a partial resumption of travel in 2021, plus adding a director of marketing in the third quarter 2021.
Depreciation and Amortization
Depreciation and amortization during the third quarter 2021 increased by $16,448, or 18%, over the third quarter 2020 and increased by $97,922, or 48%, during the nine month period 2021 over the nine month period 2020 as a result of depreciation on additional assets placed in service, primarily racking associated with the warehouse consolidation, and the addition of Graphic Sciences depreciation for a full year.
Other Items of Income and Expense
Gain on Extinguishment of Debt
The $845,083 gain on extinguishment of debt during the nine month period 2021 reflects the full forgiveness of the principal and interest on our PPP Note by the SBA in January 2021. The $287,426 gain on extinguishment of debt in the during the nine month period 2020 was due to the extinguishment of certain debt as part of conversion of notes payable accounted for using troubled debt restructuring.
Income Tax Benefit
Income tax benefit was $0 during the nine month period 2021 compared to $188,300 during the nine month period 2020. The income tax benefit in the during the nine month period 2020 was driven by the releases of a portion of the valuation allowance for deferred tax liabilities of Graphic Sciences that were no longer due.
Interest Expense, Net
Interest expense decreased by $2,468, or 2%, in the third quarter 2021 as compared to the third quarter 2020, and decreased by $183,379, or 35% during the nine month period 2021 as compared to the nine month period 2020. The decrease resulted primarily from lower interest expense on lower net debt following the March 2020 private placement of securities and note conversion, as well as one-time interest expense associated with accelerating the beneficial conversion option on the notes converted in 2020.
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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. Since 2012, we have raised a total of approximately $18.6 million in cash through issuances of debt and equity securities. As of September 30, 2021, we had $1,829,247 in cash and cash equivalents, net working capital deficit of $7,473, 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 the positive cash flow generated by Graphic Sciences and CEO Image, | |
| ● | 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 million into shares of common stock at a conversion price of $4.00 per share, and | |
| ● | receiving $2.0 million in proceeds from the issuance of 12% subordinated promissory notes due February 29, 2023, which we refer to as the 2020 notes, and | |
| ● | obtaining the PPP loan in the principal amount of $838,700, the principal and interest on which was forgiven in its entirety by the SBA in January 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.
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.
Indebtedness
As of September 30, 2021, our only outstanding long-term indebtedness consisted of the 2020 notes issued to accredited investors on March 2, 2020, with an aggregate outstanding principal balance of $2,000,000 and accrued interest of $0. See Note 9 to our condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report for further information on the 2020 notes.
Capital Expenditures
There were no material commitments for capital expenditures at September 30, 2021 or December 31, 2020.
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Cash Provided by and Used in Operating Activities
Net cash provided by operating activities during the nine month period 2021 was $1,408,249, primarily attributable to net income adjusted for non-cash expenses of $290,063, an increase in operating assets of $344,900 and an increase in operating liabilities of $131,430. Net cash used in operating activities during the nine month period 2020 was $392,155, primarily attributable to the net loss adjusted for non-cash expenses of $1,074,074, a decrease in operating assets of $108,188 and a decrease in operating liabilities of $801,523.
Cash Used by Investing Activities
Net cash used in investing activities in the nine month period 2021 was $532,151, primarily related to purchases of racking property and equipment for the new Sterling Heights, MI warehouse. Net cash used in investing activities in the nine month period 2020 was $4,074,701, primarily related to cash paid to acquire Graphic Sciences and CEO Image.
Cash Used and Provided by Financing Activities
Net cash used by financing activities during the nine month period 2021 amounted to $954,733, due to payment of earnout liabilities. Net cash provided by financing activities for the nine month period 2020 amounted to $5,574,681. The net cash provided by financing activities resulted from new borrowings of $3,008,700, partially offset by $175,924 in financing costs, and the sale of common stock resulting in $2,859,633 in net cash. Notes payable payments amounted to $70,000, which comprised of seller notes which are installment payments for net assets acquired. Notes payable payments to related parties amounted to $47,728.
Critical Accounting Policies and Estimates
The preparation of our condensed consolidated financial statements in accordance GAAP requires us 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 revenue and expenses in the reporting period. We monitor and analyze these items for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the accrual of costs and expenses that are not readily apparent from other sources. Changes in estimates are reflected in reported results for the period in which they become known. The actual results experienced by us may differ materially from our estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected.
Our critical accounting policies and estimates are set forth in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020. There were no material changes to our critical accounting policies and estimates during the third quarter 2021.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable to smaller reporting companies.
ITEM 4. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) at the end of the period covered by this this Quarterly Report.
Based on this evaluation, we concluded that, as of September 30, 2021, our disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed by us in the reports we file or submit under 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 management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
In designing and evaluating our disclosure controls and procedures, management recognizes that any controls system, no matter how well designed and operated, can provide only reasonable assurance of achieving its desired objectives. In addition, the design of disclosure controls and procedures must reflect resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
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Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the period covered by this Quarterly Report that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act).
We regularly review our internal control over financial reporting and, from time to time, we have made changes as we deemed appropriate to maintain and enhance the effectiveness of our internal controls over financial reporting, although these changes do not have a material effect on our overall internal control.
PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 1A. RISK FACTORS.
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. Except as supplemented in Part II, Item 1A, “Risk Factors,” of our Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2021, there have been no material changes to the risk factors set forth in Part I, Item 1A, “Risk Factors,” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULT UPON SENIOR SECURITIES.
None.
ITEM 4. MINE SAFETY DISCLOSURES.
Not Applicable.
ITEM 5. OTHER INFORMATION.
None.
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ITEM 6. EXHIBITS.
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* | Inline XBRL Instance Document (The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.). | |
| 101.SCH* | XBRL Taxonomy Schema. | |
| 101.CAL* | Inline XBRL Taxonomy Extension Calculation Linkbase. | |
| 101.DEF* | Inline XBRL Taxonomy Extension Definition Linkbase. | |
| 101.LAB* | Inline XBRL Taxonomy Extension Label Linkbase. | |
| 101.PRE* | Inline XBRL Taxonomy Extension Presentation Linkbase. | |
| 104 | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) |
* Filed herewith.
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SIGNATURES
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 15, 2021 | |
| By: | /s/ James F. DeSocio | |
| James F. DeSocio | ||
| President and Chief Executive Officer | ||
| Dated: | November 15, 2021 | |
| By: | /s/ Joseph D. Spain | |
| Joseph D. Spain | ||
| Chief Financial Officer | ||
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