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:
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(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 | ||
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 10, 2022, 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, 2022
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 the current global inflation and other economic and market conditions, and their effects on our customers and their capital spending and ability to finance purchases of our products, services, technologies and systems; | |
| ● | our expectation that the shift from an offline to online world will continue to benefit our business; | |
| ● | our ability to integrate our 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, 2021, filed on March 24, 2022, 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, | |||||||
| 2022 | 2021 | |||||||
| 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 | ||||||||
| Notes payable - current | ||||||||
| Total current liabilities | ||||||||
| Long-term liabilities: | ||||||||
| Notes payable - net of current portion | ||||||||
| Notes payable - related party - 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, 2022 and December 31, 2021, 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, | |||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||
| 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 | ||||||||||||||||
| Transaction costs | ||||||||||||||||
| Sales and marketing | ||||||||||||||||
| Depreciation and amortization | ||||||||||||||||
| Total operating expenses | ||||||||||||||||
| Income from operations | ||||||||||||||||
| Other income (expense) | ||||||||||||||||
| Gain on extinguishment of debt | ||||||||||||||||
| Interest expense | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Total other (expense) income, net | ( | ) | ( | ) | ( | ) | ||||||||||
| 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, 2022 and 2021
(Unaudited)
| Common Stock | Additional Paid-in | Accumulated | ||||||||||||||||||
| Shares | Amount | Capital | Deficit | Total | ||||||||||||||||
| Balance, June 30, 2021 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Stock Option Compensation | - | |||||||||||||||||||
| Net Income | - | |||||||||||||||||||
| Balance, September 30, 2021 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Balance, June 30, 2022 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Stock Option Compensation | - | |||||||||||||||||||
| Net Income | - | |||||||||||||||||||
| Balance, September 30, 2022 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Common Stock | Additional Paid-in | Accumulated | ||||||||||||||||||
| Shares | Amount | Capital | Deficit | Total | ||||||||||||||||
| ||||||||||||||||||||
| Balance, December 31, 2020 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Stock Issued to Directors | ||||||||||||||||||||
| Stock Option Compensation | - | |||||||||||||||||||
| Net Income | - | |||||||||||||||||||
| Balance, September 30, 2021 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Balance, December 31, 2021 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Stock Issued to Directors | ||||||||||||||||||||
| Stock Option Compensation | - | |||||||||||||||||||
| Stock Issued | ||||||||||||||||||||
| Equity Issuance Costs | - | ( | ) | ( | ) | |||||||||||||||
| Warrants Issued and Extended | - | |||||||||||||||||||
| Net Loss | - | ( | ) | ( | ) | |||||||||||||||
| Balance, September 30, 2022 | $ | $ | $ | ( | ) | $ | ||||||||||||||
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, | ||||||||
| 2022 | 2021 | |||||||
| Cash flows from operating activities: | ||||||||
| Net (loss) income | $ | ( | ) | $ | ||||
| Adjustments to reconcile net (loss) income to net cash used in operating activities: | ||||||||
| Depreciation and amortization | ||||||||
| Bad debt expense (recovery) | ( | ) | ||||||
| Parts and supplies reserve change | ||||||||
| Amortization of deferred financing costs | ||||||||
| Amortization of debt discount | ||||||||
| Amortization of right of use asset | ||||||||
| Stock issued for services | ||||||||
| Stock option compensation | ||||||||
| 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 operating activities | ||||||||
| Cash flows from investing activities: | ||||||||
| Cash paid to acquire business | ( | ) | ||||||
| Capitalized software | ( | ) | ||||||
| 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 and notes | ( | ) | ||||||
| Proceeds from notes payable | ||||||||
| Proceeds from notes payable - related parties | ||||||||
| Net cash provided by (used in) financing activities | ( | ) | ||||||
| Net increase (decrease) 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: | ||||||||
| Discount on notes payable for warrants | $ | $ | ||||||
| Discount on notes payable - related parties for warrants | ||||||||
| Warrants issued and extended for common stock issuance costs | ||||||||
| Right-of-use asset obtained in exchange for operating lease liability | ||||||||
| Supplemental disclosure of non-cash investing activities relating to business acquisitions: | ||||||||
| Accounts receivable | $ | $ | ||||||
| Prepaid expenses | ||||||||
| Property and equipment | ||||||||
| Intangible assets | ||||||||
| Goodwill | ||||||||
| Accounts payable | ( | ) | ||||||
| Deferred revenues | ( | ) | ||||||
| Net assets acquired in acquisition | ||||||||
| 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., is a Nevada corporation incorporated in 1997, with two wholly-owned subsidiaries: Intellinetics, Inc., an Ohio corporation (“Intellinetics Ohio”), and Graphic Sciences, Inc., a Michigan corporation (“Graphic Sciences”). Intellinetics Ohio was incorporated in 1996, and on February 10, 2012, Intellinetics Ohio became our sole operating subsidiary as a result of a reverse merger and recapitalization. On March 2, 2020, we purchased all the outstanding capital stock of Graphic Sciences.
Our digital transformation products and services are provided through two reporting segments: Document Management and Document Conversion. Our Document Management segment, which includes the Yellow Folder, LLC (“Yellow Folder”) asset acquisition in April 2022 and 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, 2022 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, 2021 filed with the SEC filed on March 24, 2022.
3. 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 inflation and 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, 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 the realizable value deferred taxes and related valuation allowances. Our management monitors these risks and assesses our business and financial risks on a quarterly basis.
| 9 |
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, including applying these policies to our revenues from Yellow Folder. More detail regarding each category of revenue is contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 filed with the SEC filed on March 24, 2022.
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 present changes in our contract assets during the nine months ended September 30, 2022 and 2021:
| Balance at Beginning of Period | Revenue Recognized in Advance of Billings | Billings | Balance at End of Period | |||||||||||||
| Nine months ended September 30, 2022 | ||||||||||||||||
| Accounts receivable, unbilled | $ | $ | $ | ( | ) | $ | ||||||||||
| Nine months ended September 30, 2021 | ||||||||||||||||
| Accounts receivable, unbilled | $ | $ | $ | ( | ) | $ | ||||||||||
| Balance at Beginning of Period | Commissions Paid | Commissions Recognized | Balance at End of Period | |||||||||||||
| Nine months ended September 30, 2022 | ||||||||||||||||
| Other contract assets | $ | $ | $ | ( | ) | $ | ||||||||||
| Nine months ended September 30, 2021 | ||||||||||||||||
| 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 been 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.
| 10 |
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, 2022 and 2021:
| Balance at Beginning of Period | Addition from acquisition (Note 4) | Billings | Recognized Revenue | Balance at End of Period | ||||||||||||||||
| Nine months ended September 30, 2022 | ||||||||||||||||||||
| Contract liabilities: Deferred revenue | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
| Nine months ended September 30, 2021 | ||||||||||||||||||||
| Contract liabilities: 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
| 11 |
Intangible Assets
All intangible assets have finite lives and are stated at cost, net of amortization. Amortization is computed over the useful life of the related assets on a straight-line method.
Goodwill
The carrying value of goodwill is not amortized, but is tested for impairment annually as of December 31, as well as on an interim basis whenever events or changes in circumstances indicate that the carrying amount of a reporting unity may not be recoverable. An impairment charge is recognized for the amount by which the carrying amount exceeds the recorded fair value.
Impairment of Long-Lived Assets
We account for the impairment and disposition of long-lived assets in accordance with ASC 360, “Property, Plant, and Equipment.” We test long-lived assets or asset groups, such as property and equipment, for recoverability when events or changes in circumstances indicate that their carrying amount may not be recoverable.
Circumstances which could trigger a review include, but are not limited to: significant adverse changes in the business climate or legal factors; current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the asset; and a current expectation that the asset will more likely than not be sold or disposed of before the end of its estimated useful life.
Recoverability
is assessed based on comparing the carrying amount of the asset to the aggregate pre-tax undiscounted cash flows expected to result from
the use and eventual disposal of the asset or asset group. Impairment is recognized when the carrying amount is not recoverable and exceeds
the fair value of the asset or asset group. The impairment loss, if any, is measured as the amount by which the carrying amount exceeds
fair value, which for this purpose is based upon the discounted projected future cash flows of the asset or asset group. There was
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, with the exception of acquired contract assets and contract liabilities, which are measured under ASC 606. 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 earn-out 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.
Leases
We determine if an arrangement is a lease at inception. Operating leases in which we are the lessee are included in operating lease right-of-use (“ROU”) assets and operating lease liabilities in the condensed consolidated balance sheets. We do not have any finance leases, as a lessee, and no long-term leases for which we are the lessor.
ROU assets represent the right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the reasonably certain lease term. As our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We use the implicit rate when readily determinable. The operating lease ROU asset also includes any lease payments made and reduced by lease incentives, such as tenant improvement allowances. Our lease terms include options to extend or terminate the lease only when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term.
We account for stock-based payments in accordance with ASC 718, “Compensation - Stock Compensation,” which requires that such equity instruments be measured at their fair values on the grant date. Stock-based payments to employees include grants of stock that are recognized in the condensed consolidated statement of operations based on their fair values at the date of grant.
| 12 |
The grant date fair value of stock option awards is recognized in earnings as stock-based compensation cost over the requisite service period of the award using the straight-line attribution method. We estimate the fair value of the stock option awards using the Black-Scholes-Merton option pricing model. The exercise price of options is specified in the stock option agreements. The expected volatility is based on the historical volatility of our stock for the previous period equal to the expected term of the options. The expected term of options granted is based on the midpoint between the vesting date and the end of the contractual term. The risk-free interest rate is based upon a U.S. Treasury instrument with a life that is similar to the expected term of the options. The expected dividend yield is based upon the yield expected on date of grant to occur over the term of the option.
Software Development Costs
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. Such costs in the amount
of $
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. Such costs in the amount of $
Capitalized
costs are stated at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the related assets
on a straight-line basis, which is three years. At September 30, 2022 and December 31, 2021, our condensed consolidated balance sheets
included $
For
the three and nine months ended September 30, 2022 and 2021, 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, 2022, including interim reporting periods within those annual reporting periods. Early adoption is permitted. We are currently evaluating the impact of the new guidance on our condensed consolidated financial statements and related disclosures.
In October 2021, the FASB issued ASU No. 2021-08, Accounting for Contract Assets and Contract Liabilities from Contracts with Customers (Topic 805). This ASU requires an acquirer in a business combination to recognize and measure contract assets and contract liabilities (deferred revenue) from acquired contracts using the revenue recognition guidance in Topic 606. At the acquisition date, the acquirer applies the revenue model as if it had originated the acquired contracts. The ASU is effective for annual periods beginning after December 15, 2022, including interim periods within those fiscal years, with early adoption permitted. Adoption of the ASU should be applied prospectively. The Company elected to early adopt ASU 2021-08 on a prospective basis during the second quarter of 2022 in connection with the purchase price allocation for the Yellow Folder acquisition (see Note 4).
| 13 |
No other Accounting Standards Updates that have been issued but are not yet effective are expected to have a material effect on our 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, 2022 and 2021 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, 2022 reported net losses, while the three and nine months ended September 30, 2021 reported net income.
We have outstanding warrants and stock options which have not been included in the calculation of diluted net loss per share for the nine months ended September 30, 2022 because to do so would be anti-dilutive. As such, the numerator and the denominator used in computing both basic and diluted net loss per share for each period are the same.
Income Taxes
We file a consolidated federal income tax return with our subsidiaries. The provision for income taxes is computed by applying statutory rates to income before taxes.
Deferred
income taxes are recognized for the tax consequences in future years of temporary differences between the financial reporting and tax
bases of assets and liabilities as of each period-end based on enacted tax laws and statutory rates. Valuation allowances are established
when necessary to reduce deferred tax assets to the amount expected to be realized. A
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 Operating segments are defined
in the criteria established under the ASC 280, “Segment Reporting,” 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, | |||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||
| 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 | $ | $ | $ | $ | ||||||||||||
| September 30, 2022 | December 31, 2021 | |||||||
| Goodwill | ||||||||
| Document Management | $ | $ | ||||||
| Document Conversion | ||||||||
| Total goodwill | $ | $ | ||||||
| September 30, 2022 | December 31, 2021 | |||||||
| 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.
4. Business Combinations
On April 1, 2022, we entered into an asset purchase agreement to acquire substantially all of the assets of Yellow Folder. The acquisition was accounted for in accordance with GAAP and was made to expand our market share in the digital transformation industry and due to synergies of product lines and services between the Companies.
The purchase price has been preliminarily allocated to assets acquired and liabilities assumed based on the estimated fair value of such assets and liabilities at the date of acquisitions as follows:
| Assets acquired: | ||||
| Accounts receivable | $ | |||
| Prepaid expenses | ||||
| Property and equipment | ||||
| Intangible assets (see Note 5) | ||||
| Liabilities assumed: | ||||
| Accounts payable | ||||
| Deferred revenue | ||||
| Total identifiable net assets | ||||
| Purchase price | ||||
| Goodwill - Excess of purchase price over fair value of net assets acquired | $ |
The
purchase price of $
Acquisition
costs which include legal and other professional fees of $
As the Company finalizes the fair value of assets acquired and liabilities assumed, additional purchase price adjustments may be recorded. The finalization of the purchase accounting assessment may result in changes in the valuation of assets acquired and liabilities assumed and may have an impact on the Company’s results of operations and financial position.
| 15 |
The following unaudited pro forma information presents a summary of the condensed consolidated results of operations for the Company as if the acquisition of Yellow Folder had occurred on January 1, 2021.
| For the Three months ended | ||||||||
| (unaudited) | (unaudited) | |||||||
| September 30, 2022 | September 30, 2021 | |||||||
| Total revenues | $ | $ | ||||||
| Net income | $ | $ | ||||||
| Basic net income per share | $ | $ | ||||||
| Diluted net income per share | $ | $ | ||||||
| For the Nine months ended | ||||||||
| (unaudited) | (unaudited) | |||||||
| September 30, 2022 | September 30, 2021 | |||||||
| Total revenues | $ | $ | ||||||
| Net (loss) income | $ | ( | ) | $ | ||||
| Basic net (loss) income per share | $ | ( | ) | $ | ||||
| Diluted net (loss) income per share | $ | ( | ) | $ | ||||
The unaudited pro forma consolidated results are based on our historical financial statements and those of Yellow Folder 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, 2021.
The following tables present the amounts of revenue and earnings of Yellow Folder 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, | |||||||
| 2022 | 2022 | |||||||
| Yellow Folder: | ||||||||
| Total revenues | $ | $ | ||||||
| Net income | $ | $ | ||||||
5. Intangible Assets, Net
At September 30, 2022, intangible assets consisted of the following:
| Estimated | Accumulated | |||||||||||||
| Useful Life | Costs | Amortization | Net | |||||||||||
| Trade names | $ | $ | ( | ) | $ | |||||||||
| Proprietary technology | ( | ) | ||||||||||||
| Customer relationships | ( | ) | ||||||||||||
| $ | $ | ( | ) | $ | ||||||||||
At December 31, 2021, intangible assets consisted of the following:
| Estimated | Accumulated | |||||||||||||
| Useful Life | Costs | Amortization | Net | |||||||||||
| Trade names | $ | $ | ( | ) | $ | |||||||||
| Customer relationships | ( | ) | ||||||||||||
| $ | $ | ( | ) | $ | ||||||||||
| 16 |
Amortization
expense for the three and nine months ended September 30, 2022 and 2021, amounted to $
| For the Twelve Months Ending September 30, | Amount | |||
| 2023 | $ | |||
| 2024 | ||||
| 2025 | ||||
| 2026 | ||||
| 2027 | ||||
| Thereafter | ||||
| $ | ||||
6. 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, and accrued expenses approximate fair value because of its short maturity. Management believes that the carrying value of the 2020 Notes and 2022 Notes approximate fair value given that, while there has been change in the overall economic environment, there has not been significant net 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, 2022:
| Three months ended September 30, 2022 | ||||
| Fair value at July 31, 2022 | $ | |||
| Payment | ||||
| Change in fair value | ||||
| Fair value at September 30, 2022 | $ | |||
| Nine months ended September 30, 2022 | ||||
| Fair value at December 31, 2021 | $ | |||
| Payment | ( | ) | ||
| Change in fair value | ||||
| Fair value at September 30, 2022 | $ | |||
| 17 |
| Three months ended September 30, 2021 | ||||
| Fair value at July 31, 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.
7. Property and Equipment
Property and equipment are comprised of the following:
| September 30, 2022 | December 31, 2021 | |||||||
| 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, 2022 and 2021 amounted to $
| 18 |
Summary of Notes Payable to Unrelated Parties
| September 30, 2022 | December 31, 2021 | |||||||
| 2022 Unrelated Notes | $ | $ | ||||||
| 2020 Notes | ||||||||
| Total notes payable | $ | $ | ||||||
| Less unamortized debt issuance costs | ( | ) | ( | ) | ||||
| Less unamortized debt discount | ( | ) | ( | ) | ||||
| Less current portion, net | ( | ) | ||||||
| Long-term portion of notes payable | $ | $ | ||||||
| As of September 30, | Amount | |||
| 2023 | $ | |||
| 2025 | ||||
| Total | $ | |||
As of September 30, 2022 and December 31, 2021, accrued interest for these notes payable with the exception of the related party notes in Note 9, “Notes Payable - Related Parties,” was $. As of September 30, 2022 and December 31, 2021, unamortized deferred financing costs and unamortized debt discount were reflected within short and long term liabilities on the condensed consolidated balance sheets, netted with the corresponding notes payable balance.
With
respect to all notes outstanding (other than the notes to related parties), interest expense, including the amortization of debt issuance
costs and debt discount, for the three and nine months ended September 30, 2022 and 2021 was $
| 19 |
2022 Unrelated Notes
On April 1, 2022, we sold $ in % Subordinated Notes (“2022 Unrelated Notes”) to unrelated accredited investors. The entire outstanding principal and unpaid interest of the 2022 Notes are due and payable on . Interest on the 2022 Unrelated Notes accrues at the rate of % per annum, payable quarterly in cash, beginning on September 30, 2022. Any accrued but unpaid quarterly installment of interest will accrue interest at the rate of % per annum. Any overdue principal and accrued and unpaid interest at the maturity date will accrue a mandatory default penalty of % of the outstanding principal balance and an interest rate of % per annum from the maturity date until paid in full. We used a portion of the net proceeds from the private placement offering to finance the acquisition of Yellow Folder and the remaining net proceeds for working capital and general corporate purposes.
2020 Notes
On
March 2, 2020, we sold units, at an offering price of $ per unit, to accredited investors in a private placement offering,
with each unit consisting of $
PPP Note
On
April 15, 2020, we were issued an unsecured promissory note (“PPP Note”) under the Paycheck Protection Program through PNC
Bank with a principal amount of $
9. Notes Payable - Related Parties
Summary of Notes Payable to Related Parties
The table below summarizes all notes payable to related parties at September 30, 2022 and December 31, 2021:
| September 30, 2022 | December 31, 2021 | |||||||
| Notes payable – “2022 Related Notes” | $ | $ | ||||||
| Less unamortized debt issuance costs | ( | ) | ||||||
| Less current portion | ||||||||
| Long-term portion of notes payable | $ | $ | ||||||
Future minimum principal payments of the 2022 Notes to related parties are as follows:
| As of September 30, | Amount | |||
| 2025 | $ | |||
| Total | $ | |||
As
of September 30, 2022 and December 31, 2021, accrued interest for these notes payable – related parties was $
With
respect to all notes payable – related parties outstanding, interest expense, including the amortization of debt issuance costs,
for the three and nine months ended September 30, 2022 was $
| 20 |
2022 Related Notes
On
April 1, 2022, we issued 12% Subordinated Notes in an aggregate principal amount of $
10. Deferred Compensation
Pursuant
to an employment agreement, we have accrued incentive cash compensation for one of our founders totaling $
11. 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, 2022.
| 21 |
Operating Leases
On
January 1, 2010, we entered into an agreement to lease
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 nine months ending September 30, | Amount | |||
| 2023 | $ | |||
| 2024 | ||||
| 2025 | ||||
| 2026 | ||||
| 2027 | ||||
| Thereafter | ||||
| $ | ||||
Lease
costs charged to operations for the three months ended September 30, 2022 and 2021 amounted to $
| For the nine months ending September 30, 2022: | ||||
| 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.
| 22 |
12. Stockholders’ Equity
Common Stock
As of September 30, 2022, 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”).
Private Placement 2022
On
April 1, 2022, we entered into a Securities Purchase Agreement with certain accredited investors, pursuant to which we issued and sold
(i) shares of the Company’s Common Stock, at a price of $ per share,
for aggregate gross proceeds of $
We
retained Taglich Brothers, Inc. as the exclusive placement agent for the private placement. In compensation, we paid the placement agent
a cash payment of
Private Placement 2020
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 $
| 23 |
Warrants
The following sets forth the warrants to purchase our common stock that were outstanding as of September 30, 2022:
| ● | Warrants
to purchase | |
| ● | Warrants
to purchase | |
| ● | Warrants
to purchase | |
| ● | Warrants
to purchase | |
| ● | Warrants
to purchase |
Warrants
to purchase
| Warrants Issued April 1, 2022 | ||||
| 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 January 6, 2022 and February 15, 2021, 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 vesting. Stock compensation of $ was recorded on this issuance of restricted common stock for the nine months ended September 30, 2022 and 2021.
Stock Options
On April 14, 2022, we granted employees stock options to purchase shares at an exercise price of $ per share in accordance with the 2015 Plan, with vesting continuing until 2025. The total fair value of $ for these stock options is being recognized over the requisite service period. 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, 2022 was $. The weighted average assumptions that were used in calculating such values during the nine months ended September 30, 2022, as well as the assumptions that were used in calculating such values, were based on estimates at the grant date in the table as follows:
| Grant Date April 1, 2022 | ||||
| Risk-free interest rate | % | |||
| Weighted average expected term | years | |||
| Expected volatility | % | |||
| Expected dividend yield | % | |||
| 24 |
| Weighted- | ||||||||||||||||
| Weighted- | Average | |||||||||||||||
| Shares | Average | Remaining | Aggregate | |||||||||||||
| Under | Exercise | Contractual | Intrinsic | |||||||||||||
| Option | Price | Life | Value | |||||||||||||
| Outstanding at January 1, 2022 | $ | years | $ | |||||||||||||
| Granted | ||||||||||||||||
| Outstanding at September 30, 2022 | $ | years | $ | |||||||||||||
| Exercisable at September 30, 2022 | $ | years | $ | |||||||||||||
| 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 | $ | |||||||||||||
| 25 |
During the three and nine months ended September 30, 2022 and 2021, stock-based compensation for options was $ and $, respectively, and $ and $, respectively.
As of September 30, 2022 and December 31, 2021, 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, 2022 and 2021 was $ and $, respectively.
14. 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, 2022 and 2021, our largest customer, the State of Michigan, accounted for
For
the three months ended September 30, 2022 and 2021, government contracts represented approximately
As
of September 30, 2022, accounts receivable concentrations from our two largest customers were
15. Certain Relationships and Related Transactions
We
retained Taglich Brothers, Inc. as the exclusive placement agent for the private placement offering discussed in Note 8 and Note 12.
In compensation, the Company paid the placement agent a cash payment of
We
retained Taglich Brothers, Inc. on an exclusive basis to render financial advisory and investment banking services to us in connection
with our acquisition of Yellow Folder. Pursuant to an Engagement Agreement, dated May 1, 2020, we paid Taglich Brothers, Inc. a success
fee of $
We did not participate in any related person transactions during the three and nine months ended September 30, 2021.
| 26 |
| 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, 2021. 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, 2022 as the third quarter 2022 and the nine-month period 2022 respectively, and to the three and nine-month periods ended September 30, 2021 as the third quarter 2021 and the nine-month period 2021.
Company Overview
We are a document services and solutions software company serving both the small-to-medium business and governmental sectors. On April 1, 2022, we made a significant business acquisition of Yellow Folder that has significantly impacted our financial operations and grown our business operations. For further information about this acquisition, please see Note 4 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 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 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 and processes who need them by making those documents easy to find and act upon, while also being secure, compliant, and audit-ready. 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 “software as a service” or “SaaS” 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 are consistent with industry best practices in data security and performance.
We operate a U.S.-based business with concentrated sales to the State of Michigan for our Document Conversion segment, complemented by our 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 leadership market positions, innovative product offering, growing customer base, and the impact of our sales and marketing programs. Examples of these programs include identifying and investing in growth and expanded market penetration opportunities, more effective products and services pricing strategies, 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 2022 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, 2021.
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Recent Developments
On September 9, 2022, the Company’s common stock was listed on the NYSE American stock exchange under the symbol “INLX.” Previously, the Company’s common stock was available for quotation on the OTCQB under the same symbol.
Financial Impact of Inflation and Lingering Effects of COVID-19
We are primarily a service business, and we have been affected by general wage inflation in the markets where our employees reside. To the extent possible, we appropriately price our services to reflect these rising costs, along with rigorous general expense management. For some long-term government contracts, however, we are contractually bound to specific pricing over multi-year periods, which inhibits our ability to completely recover our rising labor costs in the short term, particularly in our Document Conversion segment. In addition, wage inflation has also led to a slow-down in our ability to recruit and hire new employees. In 2022, we have experienced more staffing positions remaining open for longer periods, which directly affects our ability to generate revenue, again, especially in our Document Conversion segment. Inflation with respect to the costs of goods and raw materials has had a much smaller effect on our business, although our Document Conversion segment has seen an increase in the costs of its transportation services.
While the general effects of COVID-19 in the United States appear to be abating, we are still experiencing some lingering effects. We continue to experience staffing absences due to new COVID-19 infections, which directly affects our revenue production in our Document Conversion segment. The State of Michigan, our largest customer, has yet to return a majority of its agencies and departments to on-site work, resulting in a continuing decreased volume of work orders for our Document Conversion segment. In particular, we experienced slow-downs in workflow and corresponding revenues during the fourth quarter of 2021 and first quarter 2022 due to the Omicron variant outbreak. Looking ahead, the ongoing impact of COVID-19 on our business continues to evolve and be unpredictable. Our business, financial condition and results of operations could be affected by future outbreaks of COVID-19 generally or in our facilities or among our customers. 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. At the same time, we believe COVID-19 has accelerated digital transformation, particularly among governmental customers, 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 have and are likely to continue to 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 inflation and COVID-19, that are discussed 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, 2021. Due to all these factors and the other risks discussed in Part II, Item 1 of this Quarterly Report, and Part I, Item IA, “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, 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 2022 compared to the third quarter 2021, and the nine-month period 2022 compared to the nine-month period 2021 was our acquisition of Yellow Folder on April 1, 2022. Our results for the third quarter 2022 include the results of Yellow Folder operations for the full period, while our nine-month period 2022 results exclude the first quarter results of Yellow Folder operations. Our 2021 results do not include Yellow Folder operations. Without Yellow Folder, revenues were down $141,591, or 21%, primarily in professional services in our Document Conversion segment, due to lingering challenges in hiring. This shortfall in professional services was partially offset by continued strength in software as a service, which, excluding Yellow Folder, grew 42% year over year for the nine-month period 2022.
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Below are our key financial results for the third quarter 2022 (consolidated unless otherwise noted):
| ● | Revenues were $3,859,627, representing revenue growth of 22% year over year. | |
| ● | Cost of revenues was $1,353,442, an increase of 8% year over year. | |
| ● | Operating expenses (excluding cost of revenues) were $2,048,182, an increase of 36% year over year. | |
| ● | Income from operations was $458,003, compared to $409,467 in third quarter 2021. | |
| ● | Net income was $217,536 with basic and fully diluted net income per share of $0.05, compared to net income was $296,437 in third quarter 2021. |
| ● | Third quarter 2022 included $28,494 of earnout fair value adjustments, compared to $0 for 2021. |
| ● | Cash provide by operations was $1,852,085, compared to cash provided by operations of $821,129 in third quarter 2021. | |
| ● | Capital expenditures were $188,687, compared to $132,513 in third quarter 2021. |
Below are our key financial results for the nine-month period 2022 (consolidated unless otherwise noted):
| ● | Revenues were $9,978,782, representing revenue growth of 14% year over year. | |
| ● | Cost of revenues was $3,651,742, an increase of 8% year over year. | |
| ● | Operating expenses (excluding cost of revenues) were $5,910,261, an increase of 31% year over year. | |
| ● | Income from operations was $416,779, compared to $825,918 for the nine-month period 2021. | |
| ● | Net loss was $176,757 with basic and diluted net loss per share of $0.05, compared to net income of $1,331,656 for the nine-month period 2021. |
| ● | 2021 included other income of $845,083 for forgiveness of the PPP loan and interest. | |
| ● | Nine-month period 2022 included $355,281 of transaction costs. | |
| ● | Nine-month period 2022 included $144,999 of earnout fair value adjustments, compared to $77,211 for 2021. |
| ● | Net cash provided by operating activities was $1,924,734, compared to $1,408,249 for the nine-month period 2021. | |
| ● | Capital expenditures were $458,051, compared to $532,151 for the nine-month period 2021. | |
| ● | As of September 30, 2022, we had 132 employees, including 14 part-time employees, compared to 135 employees, including 9 part-time employees, as of September 30, 2021. |
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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, | |||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||
| Revenues by segment | ||||||||||||||||
| Document Management | $ | 1,693,128 | $ | 792,548 | $ | 4,180,931 | $ | 2,319,370 | ||||||||
| Document Conversion | 2,166,499 | 2,378,814 | 5,797,851 | 6,396,857 | ||||||||||||
| Total revenues | $ | 3,859,627 | $ | 3,171,362 | $ | 9,978,782 | $ | 8,716,227 | ||||||||
| Gross profit by segment | ||||||||||||||||
| Document Management | $ | 1,294,263 | $ | 673,237 | $ | 3,488,947 | $ | 1,898,799 | ||||||||
| Document Conversion | 894,755 | 1,242,484 | 2,838,093 | 3,435,893 | ||||||||||||
| Total gross profit | $ | 2,189,018 | $ | 1,915,721 | $ | 6,327,040 | $ | 5,334,692 | ||||||||
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, | |||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||
| Revenues: | ||||||||||||||||
| Sale of software | $ | 18,390 | $ | 58,779 | $ | 93,986 | $ | 73,971 | ||||||||
| Software as a service | 1,211,407 | 352,192 | 2,801,084 | 1,052,072 | ||||||||||||
| Software maintenance services | 352,892 | 336,732 | 1,033,375 | 1,012,251 | ||||||||||||
| Professional services | 2,007,613 | 2,165,030 | 5,221,326 | 5,715,273 | ||||||||||||
| Storage and retrieval services | 269,325 | 258,629 | 829,011 | 862,660 | ||||||||||||
| Total revenues | $ | 3,859,627 | $ | 3,171,362 | $ | 9,978,782 | $ | 8,716,227 | ||||||||
Our total revenues in the third quarter 2022 increased by 688,265, or 22%, over our third quarter 2021 revenues, driven primarily by the acquisition of Yellow Folder. Yellow Folder added $829,856 revenue for the third quarter 2022. The remaining net decrease in total revenues for the third quarter is attributable to weakness in professional services and storage and retrieval, partially offset by strong growth in software as a service, as further described below. The increase in total revenues for the nine-month period September 30, 2022 is driven by the same factors, plus a further partial offset from growth in sales of software.
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. Yellow Folder does not earn revenue in this category. Revenues from the sale of software, which are reported as part of our Document Management segment, decreased by $40,389, or 69%, the third quarter 2022 compared to the third quarter 2021, and increased by $20,015, or 27% during the nine-month period 2022 compared to the nine-month period 2021.
These period over period changes are due to timing of direct sales projects compared to the same periods in 2021. 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.
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 $859,215, or 244%, in the third quarter 2022 compared to the third quarter 2021 and increased by $1,749,012, or 166% in the nine-month period 2022 compared to the nine-month period 2021. This increase was primarily the result of the Yellow Folder acquisition, which contributed $1,391,295, or 80% of the increase, augmenting the underlying new cloud-based solution sales, as well as expanded data storage, user seats, and hosting fees for existing customers. Excluding Yellow Folder, software as a service sales grew 34% in the nine-month period 2022 compared to the nine-month period 2021.
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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. Yellow Folder does not earn revenue in this category. Revenues from the sale of software maintenance services, which are reported as part of our Document Management segment, increased by $16,160, or 5%, in the third quarter 2022 compared to the third quarter 2021 and increased by $21,124, or 2%, in the nine-month period 2022 compared to the nine-month period 2021. This small increase in these revenues in 2022 compared to the 2021 was driven by expansion of services with existing customers and price increases being partially offset by normal attrition and certain customers migrating their premise solution to our cloud solution, resulting maintenance and support agreements decreasing and software as a service increasing.
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. Of our professional services revenues during the third quarter 2022 and nine-month period 2022, $1,954,034 and $5,079,802, respectively, were derived from our Document Conversion operations and $53,579 and $141,525, respectively, were derived from our Document Management operations. Our overall professional services revenues decreased by $157,417, or 7%, in the third quarter 2022 compared to the third quarter 2021 and decreased by $493,947, or 9%, in the nine-month period 2022 compared to the nine-month period 2021. This decrease is primarily the result initial COVID impacts to customers and staff in our Document Conversion segment in the first quarter 2022, and in the nine-month period 2022 our challenges hiring staff to ramp up production and fulfill the large backlog of project work. The decrease was exacerbated by an unfavorable mix of project work during 2022 to date, relative to 2021. The decrease was partially offset by the contribution of $157,290 revenue from Yellow Folder for the nine-month period 2022.
Storage and Retrieval Services Revenues
We provide 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 $10,696, or 4%, in the third quarter 2022 compared to the third quarter 2021 and decreased by $33,649, or 4%, during the nine-month period 2022 compared to the nine-month period 2021. This decrease was the result of a significant reduction in volume of work from our largest storage and retrieval customer, Rocket Mortgage, due to the significant slowdown in the home mortgage and refinancing industry, as well as unusually high project work in 2021 including shredding of documents approved for destruction. Revenue contributed from the Yellow Folder acquisition partially offset the decrease by $71,639.
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Costs of Revenues and Gross Profits
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, | |||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||
| Cost of revenues by segment | ||||||||||||||||
| Document Management | $ | 265,432 | $ | 119,311 | $ | 691,984 | $ | 420,571 | ||||||||
| Document Conversion | 1,088,010 | 1,136,330 | 2,959,758 | 2,960,964 | ||||||||||||
| Total cost of revenues | $ | 1,353,442 | $ | 1,255,641 | $ | 3,651,742 | $ | 3,381,535 | ||||||||
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, | |||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||
| Cost of revenues: | ||||||||||||||||
| Sale of software | $ | 10,647 | $ | 3,691 | $ | 44,232 | $ | 10,050 | ||||||||
| Software as a service | 207,502 | 73,596 | 489,939 | 241,717 | ||||||||||||
| Software maintenance services | 19,024 | 18,270 | 56,509 | 64,930 | ||||||||||||
| Professional services | 1,028,074 | 1,042,249 | 2,794,783 | 2,765,241 | ||||||||||||
| Storage and retrieval services | 88,195 | 117,835 | 266,279 | 299,597 | ||||||||||||
| Total cost of revenues | $ | 1,353,442 | $ | 1,255,641 | $ | 3,651,742 | $ | 3,381,535 | ||||||||
Our total cost of revenues during the third quarter 2022 increased by $97,801, or 8%, over third quarter 2021 and increased by $270,207, or 8%, during the nine-month period 2022 over the nine-month period 2021. Our cost of revenues for our Document Management segment increased by $146,121, or 122%, in the third quarter 2022 compared to the third quarter 2021 and increased $271,413, or 65%, in the nine-month period 2022 compared to the nine-month period 2021 primarily due to the impact of Yellow Folder in that segment. Our cost of revenues for our Document Conversion segment decreased by $48,320, or 4%, in the third quarter 2022 compared to the third quarter 2021 and decreased by $1,206, or 0%, during the nine-month period 2022 compared to the nine-month period 2021 primarily due to the COVID impact and staffing challenges at Graphic Sciences, including staffing up in the second and third quarter 2022, where costs did not decrease at the same rate as revenues.
Our overall gross profit increased to 65% in the third quarter 2022 from 60% in the third quarter 2021, and increased to 63% for the nine-month period 2022 from 61% in the nine-month period 2021. The increase in the mix of software as a service revenue was the principal driver of the increase, due to the addition of Yellow Folder and overall strong margins in the Document Management segment, partially offset by margin erosion in the Document Conversion segment, driven by unfavorable lower-margin project work relative to 2021 and inflationary pressures.
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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 2022 increased by $6,956, or 188%, from the third quarter 2021, and increased by $34,182, or 340%, from the nine-month period 2021, due to the increase in revenues and implementations. Our gross margin for software revenues decreased to 42% from 94% in the third quarter 2021 and decreased to 53% from 86% the nine-month period 2021. The decrease in margin percent in the third quarter 2022 was driven by unfavorable comparison to a significant margin project in the third quarter 2021, and it was exacerbated by larger percentage swings on small dollar values. Yellow Folder had no impact to this category.
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 2022 increased by $133,906, or 182%, over the third quarter 2021 and increased by $248,222, or 103%, during the nine-month period 2022 over the nine-month period 2021. This increase in the cost of SaaS was less than the increase in associated SaaS revenues, so our gross margin in the third quarter 2022 increased to 83% compared to 79% in the third quarter 2021 and to 83% in the nine-month period 2022 compared to 77% during the nine-month period 2021, as a result of strong margins with and without Yellow Folder, which contributed 86% gross margin.
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 2022 decreased by $754, or 4%, over the third quarter 2021 and decreased by $8,421, or 13%, in the nine-month period 2022 over the nine-month period 2021, due primarily to stable support call activity. As a result, our gross margin for software maintenance services increased to 95% in both the third quarter 2022 and the nine-month period 2022 compared to 95% in the third quarter 2021 and 94% in the nine-month period 2021, 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 2022 increased by $7,430, or 1%, over the third quarter 2021 and increased in the nine-month period 2022 by $51,147, or 2%, over the nine-month period 2021, primarily due to an unfavorable mix of lower-margin projects combined with the staffing challenges in our Document Conversion segment, driven by inflationary pressures. As a result, our gross margins professional services decreased to 48% in the third quarter 2022 compared to 52% in the third quarter 2021 and decreased to 46% during the nine-month period 2022 compared to 52% in the nine-month period 2021. Gross margins related to consulting services may vary widely, depending upon the nature of the consulting project and the amount of labor it takes to complete a project. Yellow Folder partially offset the overall margin erosion with $61,176 costs in the nine-month period 2022 at 61% margin.
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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 primarily by our Michigan operations and to a much lesser extent, Yellow Folder. Cost of storage and retrieval services decreased by $29,640, or 25%, in the third quarter 2022 compared to the third quarter 2021, and decreased by $33,318, or 11%, during the nine-month period 2022 compared to the nine-month period 2021. The decrease was due to additional labor costs in 2021 associated with our 2021 warehouse consolidation, partially offset by general wage inflation, as well as costs decreasing in proportion to revenue project volume. Gross margins for our storage and retrieval services, which exclude the cost of facilities rental, maintenance, and related overheads, increased to 67% in the third quarter 2022 compared to 54% in the third quarter 2021 and increased to 68% during nine-month period 2022 compared to 65% in the nine-month period 2021. Yellow Folder did not have a material impact, contributing costs of $18,287, or 7% of the cost in the third quarter 2022.
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, | |||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||
| Operating expenses: | ||||||||||||||||
| General and administrative | $ | 1,333,285 | $ | 1,027,932 | $ | 3,532,672 | $ | 3,125,019 | ||||||||
| Change in fair value of earnout liabilities | 28,494 | - | 144,999 | 77,211 | ||||||||||||
| Transaction costs | - | - | 355,281 | - | ||||||||||||
| Sales and marketing | 492,540 | 372,399 | 1,374,059 | 1,004,305 | ||||||||||||
| Depreciation and amortization | 193,863 | 105,923 | 503,250 | 302,239 | ||||||||||||
| Total operating expenses | $ | 2,048,182 | $ | 1,506,254 | $ | 5,910,261 | $ | 4,508,774 | ||||||||
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General and Administrative Expenses
General and administrative expenses during the third quarter 2022 increased by $305,353, or 30%, over the third quarter 2021, and increased in the nine-month period 2022 by $407,653, or 13%, over the nine-month period 2021, principally related to the addition of Yellow Folder expenses in the second and third quarters 2022. This was primarily reflected in our Document Management segment, in which our general and administrative expenses increased to $774,951 and $1,852,296 in the third quarter 2022 and the nine-month period 2022, respectively, from $387,042 and $1,243,773 in the third quarter 2021 and the nine-month period 2021, respectively. In our Document Conversion segment, our general and administrative expenses decreased to $558,334 in the third quarter 2022 compared to $640,890 in the third quarter 2021, and decreased to $1,680,376 in the nine-month period 2022 compared to $1,881,246 in the nine-month period 2021.
Change in Fair Value of Earnout Liabilities
Fair value adjustments amounted to $28,494 in the third quarter 2022 and $144,999 for the nine-month period 2022. The fair value adjustments were driven by updated assumptions to reflect the improved performance of both acquisitions against their threshold targets, a reduction of pandemic-related uncertainty, and the decreasing impact of time value of money. For the nine-month period 2021, a total adjustment of $77,211 was derived from improved gross margin performance at Graphic Science during the first quarter 2021, which resulted in an adjustment to fair value of earnout liabilities of $69,950, plus improved revenue performance at CEO Image during the nine-month period 2021, which resulted in an adjustment to fair value of earnout liabilities of $7,261.
Transaction Expenses
The transactions expenses during the nine-month period 2022 were comprised of investment banker success fees, as well as legal and consulting fees, in connection with our acquisition of Yellow Folder and related fundraising activities. There were no transaction expenses during the nine-month period 2021.
Sales and Marketing Expenses
Sales and marketing expenses during the third quarter 2022 increased by $120,141, or 32%, over the third quarter 2021 and increased by $369,754, or 37%, during the nine-month period 2022 over the nine-month period 2021. This increase was primarily driven by the inclusion of the sales and marketing expenses Yellow Folder during the second third quarter 2022, as well as adding two sales representatives.
Depreciation and Amortization
Depreciation and amortization during the third quarter 2022 increased by $87,940, or 83%, over the third quarter 2021 and increased by $201,011, or 67%, during the nine-month period 2022 over the nine-month period 2021 as a result of amortization of new intangible assets related to the Yellow Folder acquisition. The incremental amortization amounted to $73,458 in the second quarter and $146,917 in the nine-month period 2022. Depreciation on the new Yellow Folder assets acquired was a much smaller impact, at $8,687 for the same periods relative to 2021.
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.
Interest Expense, Net
Interest expense increased by $127,437, or 113%, in the third quarter 2022 as compared to the third quarter 2021, and increased by $254,191, or 75% during the nine-month period 2022 as compared to the nine-month period 2021. The increase resulted from incremental interest expense on increased net debt following the April 1, 2022 private placement of securities.
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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, and including our private offering in April 2022, discussed in Recent Developments, we have raised a total of approximately $26.5 million in cash through issuances of debt and equity securities. As of September 30, 2022, we had approximately $3.8 million in cash and cash equivalents, net working capital deficit of $1.5 million, and an accumulated deficit of $22 million. In June 2022, we paid $1,018,333 in earnout liabilities.
In 2022, we engaged in several actions that significantly improved our liquidity and cash flows, including, on April 1, 2022:
| ● | acquiring the positive cash flow generated by Yellow Folder, | |
| ● | receiving aggregate gross proceeds of approximately $5.7 million from the private placement of our common stock (all which was used to acquire Yellow Folder), and | |
| ● | receiving approximately $3.0 million in proceeds from the issuance of 12% subordinated promissory notes due March 30, 2025, which we refer to as the 2022 notes (some of which was used to acquire Yellow Folder). |
Of our existing debt, $2 million is due February 29, 2023 and approximately $3 million is due March 30, 2025. We also may have earnout payments of up to a maximum $833,333 in the second quarter of 2023. Our operating cash flow alone may be insufficient to meet these obligations in full in the first and second quarters of 2023. We have positive operating cash flow, and we believe we could seek additional debt or equity financing on acceptable terms. We believe that our balance sheet and financial statements would support a full or partial refinancing or other appropriate modification of the current promissory notes, such as an extension or conversion to equity. We are confident in our ability to prudently manage our current debt on terms acceptable to us.
Our ability to meet our capital needs in the short term will depend on many factors, including maintaining and enhancing our operating cash flow, successfully managing the transition of our recent acquisition of Yellow Folder, successfully retaining and growing our client base in the midst of global inflation and general economic uncertainty, and managing any 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 and potential financing options, 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.
Our ability to meet our capital needs further into the future will depend primarily on strategically managing the business and successfully retaining our client base.
Indebtedness
As of September 30, 2022, our 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. | |
| ● | The 2022 Notes issued to accredited investors on April 1, 2022, with an aggregate outstanding principal balance of $2,964,500 and accrued interest of $0. |
See Note 8 and Note 9 to our condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report for further information on the 2022 Notes and 2020 Notes.
Capital Expenditures
There were no material commitments for capital expenditures at September 30, 2022.
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Cash Provided by Operating Activities
Net cash provided by operating activities during the nine-month period 2022 was $1,924,734, primarily attributable to the net loss adjusted for non-cash expenses of $1,684,773, a decrease in operating assets of $175,131 and an increase in operating liabilities of $241,587. 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.
Cash Used by Investing Activities
Net cash used in investing activities in the nine-month period 2022 was $6,841,320, primarily $6,383,269 related to cash paid to acquire Yellow Folder, as well as $315,148 in capitalized software. 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.
Cash Provided by Financing Activities
Net cash provided by financing activities during the nine-month period 2022 amounted to $6,940,583, as the result of cash generated from the sale of common stock of $5,740,758 and from new borrowings of $2,964,500, partially offset by issuance costs of $746,342, as well as a further offset of $1,018,333 in earnout liability payments.
Net cash used by financing activities during the nine-month period 2021 amounted to $954,733, due to payment of earnout liabilities.
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, 2021. There were no material changes to our critical accounting policies and estimates during the third quarter 2022.
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 Quarterly Report.
Based on this evaluation, we concluded that, as of September 30, 2022, 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. 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, 2021.
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.
ITEM 6. EXHIBITS.
The following is a list of exhibits filed as part of this Quarterly Report on Form 10-Q.
| Incorporation by reference | ||||||||
| Exhibit No. | Description of Exhibit | Form | Date | 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 14, 2022 | |
| By: | /s/ James F. DeSocio | |
| James F. DeSocio | ||
| President and Chief Executive Officer | ||
| Dated: | November 14, 2022 | |
| By: | /s/ Joseph D. Spain | |
| Joseph D. Spain | ||
| Chief Financial Officer | ||
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