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 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 50%
of the outstanding voting stock of an investee, except when control is not held by the majority owner. We have two subsidiaries: Intellinetics
Ohio and Graphic Sciences. We consider the criteria established under Financial Accounting Standards Board (“FASB”) Accounting
Standard Codification (“ASC”) 810, “Consolidations” in the consolidation process. All significant intercompany
balances and transactions have been eliminated in consolidation.
Use
of Estimates
The
preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions.
Such estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses. By their nature,
these estimates and assumptions are subject to an inherent degree of uncertainty. The impact of COVID-19 has significantly increased
economic and demand uncertainty. Because future events and their effects cannot be determined with precision, actual results could differ
significantly from estimated amounts.
Significant
estimates and assumptions include valuation allowances related to receivables, accounts receivable -unbilled, the recoverability of long-term
assets, depreciable lives of property and equipment, purchase price allocations for acquisitions, fair value for goodwill and intangibles,
the lease liabilities, estimates of fair value deferred taxes and related valuation allowances. Our management monitors these risks and
assesses our business and financial risks on a quarterly basis.
Revenue
Recognition
In
accordance with ASC 606, “Revenue From Contracts With Customers,” we follow a five-step model to assess each contract of
a sale or service to a customer: identify the legally binding contract, identify the performance obligations, determine the transaction
price, allocate the transaction price, and determine whether revenue will be recognized at a point in time or over time. Revenue is recognized
when a performance obligation is satisfied and the customer obtains control of promised goods and services. The amount of revenue recognized
reflects the consideration to which we expect to be entitled to receive in exchange for these goods and services. In addition, ASC 606
requires disclosures of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.
We
categorize revenue as software, software as a service, software maintenance services, professional services, and storage and retrieval
services. We earn the majority of our revenue from the sale of professional services, followed by the sale of software maintenance services
and software as a service. We apply our revenue recognition policies as required in accordance with ASC 606 based on the facts and circumstances
of each category of revenue. More detail regarding each category of revenue is contained in our Annual Report on Form 10-K for the fiscal
year ended December 31, 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 tables present changes in our contract assets during the three months ended March 31, 2022 and 2021:
Schedule of Changes in Contract Assets and Liabilities
| |
Balance at Beginning of Period | | |
Revenue Recognized in Advance of Billings | | |
Billings | | |
Balance at End of Period | |
Three months ended March 31, 2022 | |
| | | |
| | | |
| | | |
| | |
Accounts receivable, unbilled | |
$ | 444,782 | | |
$ | | |
$ | (671,665 | ) | |
$ | 473,986 | |
| |
| | | |
| | | |
| | | |
| | |
Three months ended March 31, 2021 | |
| | | |
| | | |
| | | |
| | |
Accounts receivable, unbilled | |
$ | 523,522 | | |
$ | 466,310 | | |
$ | (643,681 | ) | |
$ | 346,151 | |
|
|
Balance at
Beginning of Period |
|
|
Commissions
Paid |
|
|
Commissions
Recognized |
|
|
Balance at
End of
Period |
|
Three months ended March 31, 2022 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other contract assets |
|
$ |
78,556 |
|
|
$ |
22,136 |
|
|
$ |
(14,089 |
) |
|
$ |
86,603 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31, 2021 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other contract assets |
|
$ |
31,283 |
|
|
$ |
10,064 |
|
|
$ |
(9,225 |
) |
|
$ |
32,122 |
|
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.
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 97% of the remaining performance obligations over the next 12 months,
with the remainder recognized thereafter. As of March 31, 2022, the aggregate amount of the transaction price allocated to remaining
performance obligations for software as a service and software maintenance contracts with a duration greater than one year was $33,547.
As of December 31, 2021, the aggregate amount of the transaction price allocated to remaining performance obligations for software as
a service and software maintenance contracts with a duration greater than one year was $16,835. This does not include revenue related
to performance obligations that are part of a contract whose original expected duration is one year or less.
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. The Company recorded an allowance of $24,000 at March 31, 2022 and December 31, 2021.
Property
and Equipment
Property,
equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization. Depreciation and amortization
is computed over the estimated useful lives of the related assets on a straight-line basis. Furniture and fixtures, computer hardware
and purchased software are depreciated over three to seven years. Leasehold improvements are amortized over the life of the lease or
the asset, whichever is shorter, generally seven to ten years. Upon retirement or other disposition of these assets, the cost and related
accumulated depreciation and amortization of these assets are removed from the accounts and the resulting gains and losses are reflected
in the results of operations.
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 no
impairment of long-lived assets in the
three month periods ended 2022 or 2021.
Purchase
Accounting Related Fair Value Measurements
We
allocate the purchase price, including contingent consideration, of our acquisitions to the assets and liabilities acquired, including
identifiable intangible assets, based on their respective fair values at the date of acquisition. Such fair market value assessments
are primarily based on third-party valuations using assumptions developed by management that require significant judgments and estimates
that can change materially as additional information becomes available. The purchase price allocated to intangibles is based on unobservable
factors, including but not limited to, projected revenues, expenses, customer attrition rates, a weighted average cost of capital, among
others. The weighted average cost of capital uses a market participant’s cost of equity and after-tax cost of debt and reflects
the risks inherent in the cash flows. The approach to valuing the initial contingent consideration associated with the purchase price
also uses similar unobservable factors such as projected revenues and expenses over the term of the contingent 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.
Stock-Based
Compensation
We
account for stock-based payments to employees in accordance with ASC 718, “Compensation - Stock Compensation.” 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.
We account for stock-based payments to non-employees
in accordance with ASC 718, “Compensation - Stock Compensation,” which requires that such equity instruments be measured
at their fair values on the grant date.
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. No such costs were capitalized
during the periods presented in this report.
In
accordance with ASC 350-40, “Internal-Use Software,” we capitalize purchase and implementation costs of internal use software.
Once an application has reached development stage, internal and external costs, if direct and incremental, are capitalized until the
software is substantially complete and ready for its intended use. Capitalization ceases upon completion of all substantial testing.
We also capitalize costs related to specific upgrades and enhancements when it is probable that the expenditure will result in additional
functionality. Such costs in the amount of $29,397
were capitalized during the first quarter 2022.
No such costs were capitalized during the first quarter 2021. Such 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 March 31, 2022 and December 31, 2020,
our condensed consolidated balance sheets included $64,509
and $38,305,
respectively, in other long-term assets.
For
the three months ended March 31, 2022 and 2021, our expensed software development costs were $62,751 and $102,195, respectively.
Recently
Issued Accounting Pronouncements Not Yet Effective
Financial
Instruments – Credit Losses
In
June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which requires entities to measure
all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable
and supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial
assets measured at amortized cost. ASC 2016-16 is effective for annual reporting periods beginning after December 15, 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.
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 months ended March 31, 2022 and 2021 amounted to $448
and $675, respectively.
(Loss)
Earnings Per Share
Basic
income or loss per share is computed by dividing net income or loss by the weighted average number of shares of common stock outstanding
during the period. Diluted income or loss per share is computed by dividing net income or loss by the diluted weighted average number
of shares of common stock outstanding during the period. The diluted weighted average number of shares gives effect to all dilutive potential
common shares outstanding during the period using the treasury stock method. Diluted earnings per share exclude all diluted potential
shares if their effect is anti-dilutive, including warrants or options which are out-of-the-money and for those periods with a net loss.
The three months ended March 31, 2022 reported a net loss, while the three months ended March 31, 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 three
months ended March 31, 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 100% valuation allowance has been established on
deferred tax assets at March 31, 2022 and December 31, 2021, due to the uncertainty of our ability to realize future taxable income.
We
account for uncertainty in income taxes in our financial statements as required under ASC 740, “Income Taxes.” The standard
prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. The standard also provides guidance on de-recognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition accounting. Management determined there were no material uncertain positions
taken by us in our tax returns.
Segment
Information
Operating
segments are defined in the criteria established under the 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 two operating segments: Document Management and Document
Conversion. These segments contain individual business components that have been combined on the basis of common management, customers,
solutions offered, service processes and other economic characteristics. We currently have no intersegment sales. We evaluate the performance
of our segments based on gross profits.
The
Document Management Segment provides cloud-based and premise-based content services software. Its modular suite of solutions complements
existing operating and accounting systems to serve a mission-critical role for organizations to make content secure, compliant, and process-ready.
This segment conducts its primary operations in the United States. Markets served include highly regulated, risk and compliance-intensive
markets in healthcare, K-12 education, public safety, other public sector, risk management, financial services, and others. Solutions
are sold both directly to end-users and through resellers.
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:
Schedule of Segment Information
| |
Three months
ended March 31, 2022 | | |
Three months
ended March 31, 2021 | |
Revenues | |
| | | |
| | |
Document Management | |
$ | 914,950 | | |
$ | 735,818 | |
Document Conversion | |
| 1,788,562 | | |
| 1,899,401 | |
Total revenues | |
$ | 2,703,512 | | |
$ | 2,635,219 | |
| |
| | | |
| | |
Gross profit | |
| | | |
| | |
Document Management | |
$ | 734,906 | | |
$ | 587,500 | |
Document Conversion | |
| 896,931 | | |
| 1,017,404 | |
Total gross profit | |
$ | 1,631,837 | | |
$ | 1,604,904 | |
| |
| | | |
| | |
Capital additions, net | |
| | | |
| | |
Document Management | |
$ | 1,687 | | |
$ | 38,117 | |
Document Conversion | |
| 54,356 | | |
| 193,582 | |
Total capital additions, net | |
$ | 56,043 | | |
$ | 231,699 | |
| |
March 31, 2022 | | |
December 31, 2021 | |
Goodwill | |
| | | |
| | |
Document Management | |
$ | 522,711 | | |
$ | 522,711 | |
Document Conversion | |
| 1,800,176 | | |
| 1,800,176 | |
Total goodwill | |
$ | 2,322,887 | | |
$ | 2,322,887 | |
| |
March 31, 2022 | | |
December 31, 2021 | |
Total assets | |
| | | |
| | |
Document Management | |
$ | 2,303,195 | | |
$ | 2,233,419 | |
Document Conversion | |
| 9,686,847 | | |
| 9,728,713 | |
Total assets | |
$ | 12,000,042 | | |
$ | 11,962,132 | |
Statement
of Cash Flows
For
purposes of reporting cash flows, cash includes cash on hand and demand deposits held by banks.
4.
Intangible
Assets, Net
At
March 31, 2022, intangible assets consisted of the following:
Schedule of Intangible Assets
| |
Estimated | |
| | |
Accumulated | | |
| |
| |
Useful Life | |
Costs | | |
Amortization | | |
Net | |
Trade names | |
10 years | |
$ | 119,000 | | |
$ | (24,792 | ) | |
$ | 94,208 | |
Customer contracts | |
5-8 years | |
| 1,242,000 | | |
| (421,831 | ) | |
| 820,169 | |
| |
| |
$ | 1,361,000 | | |
$ | (446,623 | ) | |
$ | 914,377 | |
At
December 31, 2021, intangible assets consisted of the following:
| |
Estimated | |
| | |
Accumulated | | |
| |
| |
Useful Life | |
Costs | | |
Amortization | | |
Net | |
Trade names | |
10 years | |
$ | 119,000 | | |
$ | (21,817 | ) | |
$ | 97,183 | |
Customer contracts | |
5-8 years | |
| 1,242,000 | | |
| (370,687 | ) | |
| 871,313 | |
| |
| |
$ | 1,361,000 | | |
$ | (392,504 | ) | |
$ | 968,496 | |
Amortization
expense for the three months ended March 31, 2022 and 2021 amounted to $54,119. The following table represents future amortization expense
for intangible assets subject to amortization.
Schedule of Amortization Expense for Intangible Assets
For the Twelve Months Ending March 31, | |
Amount | |
2023 | |
$ | 216,475 | |
2024 | |
| 216,475 | |
2025 | |
| 216,475 | |
2026 | |
| 179,292 | |
2027 | |
| 32,275 | |
Thereafter | |
| 53,385 | |
Intangible assets | |
$ | 914,377 | |
5.
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 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. Key unobservable inputs include revenue growth rates, which ranged from 0% to 7%,
and volatility rates, which were 20% for gross profits. An increase in future revenues and gross profits may result in a higher estimated
fair value while a decrease in future revenues and gross profits may result in a lower estimated fair value of the earnout liabilities.
The
following table provides a summary of the changes in fair value of the earnout liabilities for the three months ended March 31, 2022
and 2021:
Summary of Changes in Fair Value of Earnout Liabilities
| |
March 31, 2022 | |
Fair value at December 31, 2021 | |
$ | 1,630,681 | |
Change in fair value | |
| 64,204 | |
Fair value at March 31, 2022 | |
$ | 1,694,885 | |
| |
March 31, 2021 | |
Fair value at December 31, 2020 | |
$ | 2,444,000 | |
Change in fair value | |
| 69,950 | |
Fair value at March 31, 2021 | |
$ | 2,513,950 | |
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.
6.
Property
and Equipment
Property
and equipment are comprised of the following:
Schedule of Property and Equipment
| |
March 31, 2022 | | |
December 31, 2021 | |
Computer hardware and purchased software | |
$ | 1,510,080 | | |
$ | 1,494,918 | |
Leasehold improvements | |
| 336,111 | | |
| 295,230 | |
Furniture and fixtures | |
| 71,325 | | |
| 71,325 | |
Property and equipment,
gross | |
| 1,917,516 | | |
| 1,861,473 | |
Less: accumulated depreciation | |
| (829,684 | ) | |
| (769,693 | ) |
Property and equipment, net | |
$ | 1,087,832 | | |
$ | 1,091,780 | |
Total
depreciation expense on our property and equipment for the three months ended March 31, 2022 and 2021 amounted to $59,991 and $40,765,
respectively.
7.
Notes Payable
Summary
of Notes Payable to Unrelated Parties
The
table below summarizes all notes payable at March 31, 2022 and December 31, 2021, respectively.
Schedule of Notes Payable to Unrelated Parties
| |
March 31, 2022 | | |
December 31, 2021 | |
Notes payable – “2020 Notes” | |
$ | 2,000,000 | | |
$ | 2,000,000 | |
Less unamortized debt issuance costs | |
| (95,094 | ) | |
| (121,029 | ) |
Less unamortized debt discount | |
| (97,778 | ) | |
| (124,444 | |
Less current portion | |
| (1,807,128 | ) | |
| - | |
Long-term portion of notes payable | |
$ | - | | |
$ | 1,754,527 | |
Future
minimum principal payments of the 2020 Notes are as follows:
Schedule
of Future Minimum Principal Payments of Notes Payable
As of March 31, | |
Amount | |
2023 | |
$ | 2,000,000 | |
Total | |
$ | 2,000,000 | |
As
of March 31, 2022 and December 31, 2021, accrued interest for these notes payable was $0. As of March 31, 2022, unamortized deferred
financing costs and unamortized debt discount were reflected within short term liabilities on the condensed consolidated balance sheets.
As of December 31, 2021, unamortized deferred financing costs and unamortized debt discount were reflected within long term liabilities
on the condensed consolidated balance sheets.
With
respect to all notes outstanding, for the three months ended March 31, 2022 and 2021, interest expense, including the amortization of
debt issuance costs and debt discount, was $112,601 and $113,044, respectively.
2020
Notes
On
March 2, 2020, we sold 2,000 units, at an offering price of $1,000 per unit, to accredited investors in a private placement offering,
with each unit consisting of $1,000 in 12% Subordinated Notes (“2020 Notes”) and 40 shares of our common stock, for aggregate
gross proceeds of $2,000,000. The entire outstanding principal and accrued interest of
the 2020 Notes are due and payable on February 28, 2023. Interest on the 2020 Notes accrues at the rate of 12% per annum, payable quarterly
in cash, beginning on June 30, 2020. Any accrued but unpaid quarterly installment of interest will accrue interest at the rate of 14.0%
per annum. Any overdue principal and accrued and unpaid interest at the maturity date will accrue a mandatory default penalty of 20%
of the outstanding principal balance and an interest rate of 14% 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 acquisitions of Graphic Sciences and CEO Image and the remaining
net proceeds for working capital and general corporate purposes. We recognized a debt discount of $320,000 for the 80,000 shares issued
in conjunction with the units. The amortization of the debt discount, which will be recognized over the life of the 2020 Notes as interest
expense, was $26,666 and $26,667, respectively, for the three months ended March 31, 2022 and 2021.
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 $838,700. The term of the PPP Note Payable was two years, with an interest rate of 1.0% per annum deferred
for the first six months. We received notice on January 20, 2021 that the Small Business Administration had forgiven the full amount
of principal and interest of the PPP Note, and we have recognized a gain on extinguishment of debt of $845,083 for the three months ended
March 31, 2021.
8.
Deferred
Compensation
Pursuant
to an employment agreement, we have accrued incentive cash compensation for one of our founders totaling $80,662 as of March 31, 2022
and $100,828 as of December 31, 2021. During the three months ended March 31, 2022, we paid $20,166 in deferred incentive compensation,
which amount was reflected as a reduction in our deferred compensation liability. We made no deferred incentive compensation payments
during the three months ended March 31, 2021.
9.
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 March 31, 2022.
Operating
Leases
On
January 1, 2010, we entered into an agreement to lease 6,000 rentable square feet of office space in Columbus, Ohio. The lease commenced
on January 1, 2010 and, pursuant to a lease extension dated September 18, 2021, the lease expires on December 31, 2028. The monthly rental
payment is $4,638, with gradually higher annual increases each January up to $5,850 for the final year.
Our
subsidiary, Graphic Sciences, uses 36,000 square feet of leased space in Madison Heights, Michigan as its main facility. Graphic Sciences
uses about 20,000 square feet for its records storage services, with the remainder of the space used for production, sales, and administration.
The monthly rental payment is $41,508, with gradually higher annual increases each September up to $45,828 for the final year, and with
a lease term continuing until August 31, 2026. Graphic Sciences also leases and uses a separate 37,000 square foot building in Sterling
Heights, Michigan for document storage, except approximately 5,000 square feet for production, and a satellite office in Traverse City,
Michigan for production. The monthly Sterling Heights rental payment is $20,452, with gradually higher annual increases each May up to
$24,171 for the final year, and with a lease term continuing to April 30, 2028. The monthly Traverse City rental payment is $4,500, with
a lease term continuing until January 31, 2024. Graphic Sciences also leases and uses four leased vehicles for logistics. The monthly
rental payments for these vehicles total $2,618, with lease terms continuing until October 31, 2024.
Graphic
Sciences also leases and uses an additional temporary storage space in Madison Heights, with a monthly rental payment of $1,605 and a
lease term on a month-to-month basis. We have made an accounting policy election to not record a right-of-use asset and lease liability
for short-term leases, which are defined as leases with a lease term of 12 months or less. Instead, the lease payments are recognized
as rent expense in the general and administrative expenses on the statement of operations. For each of the above listed leases, management
has determined it will utilize the base rental period and have not considered any renewal periods.
The
following table sets forth the future minimum lease payments under these operating leases:
Schedule of Future Rental Payments for Operating Leases
For the Three Months Ending March 31, | |
Amount | |
2023 | |
$ | 935,024 | |
2024 | |
| 924,598 | |
2025 | |
| 875,314 | |
2026 | |
| 885,260 | |
2027 | |
| 578,184 | |
Thereafter | |
| 435,103 | |
Total | |
$ | 4,633,483 | |
Lease
costs charged to operations for the three months ended March 31, 2022 and 2021 amounted to $243,301 and $238,075, respectively. Included
in the lease costs for the three months ended March 31, 2022 and 2021 were short-term lease costs of $4,814 and $39,105, respectively.
The following table sets forth additional information pertaining to our leases:
Schedule of Operating Lease Costs
For the Three Months Ending March 31, 2022: | |
| |
Operating cash flows from operating leases | |
$ | 151,032 | |
Weighted average remaining lease term – operating leases | |
| 5.1 years | |
Weighted average discount rate – operating leases | |
| 7.01 | % |
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.
10.
Stockholders’
Equity
Common
Stock
As
of March 31, 2022, 2,831,169 shares
of common stock were issued and outstanding, 131,700
shares of common stock were reserved for
issuance upon the exercise of outstanding warrants, and 497,330
shares of common stock were reserved for issuance
under our 2015 Equity Incentive Plan, as amended (the “2015 Plan”).
On
March 2, 2020, we sold 955,000 shares of our common stock and certain subordinated notes in a private placement to accredited investors
as follows:
|
● |
875,000
shares of our common stock at a purchase price of $4.00 per share, for aggregate gross proceeds of $3,500,000, and |
|
|
|
|
● |
2,000
units at a purchase price of $1,000 per unit, with each unit consisting of $1,000 in 12% Subordinated Notes and 40 shares of our
common stock, for aggregate gross proceeds of $2,000,000. |
In
connection with the private placement offering, we paid the placement agent $440,000 in cash, equal to 8% of the gross proceeds of the
offering, along with 95,500 warrants to purchase shares of our common stock and reimbursement for the placement agent’s reasonable
out of pocket expenses, FINRA filing fees and related legal fees. The warrants are exercisable at an exercise price at $4.00 per share
for a period of five years after issuance, contain customary cashless exercise provisions and anti-dilution protection and are entitled
to limited piggyback registration rights. Underwriting expense of $236,761 and debt issuance costs of $135,291 were recorded for the
issuance of the March 2, 2020 warrants, utilizing the Black-Scholes valuation model. The fair value of warrants issued was determined
to be $3.90. Underwriting expense of $307,867 and debt issuance costs of $175,924 was recorded for the placement agent cash fee and other
related legal fees. For the three months ended March 31, 2022 and 2021, interest expense of $25,935 was recorded as amortization of the
debt issuance costs for this private placement offering.
Warrants
The
following sets forth the warrants to purchase our common stock that were outstanding as of March 31, 2022:
|
● |
Warrants
to purchase 3,000 shares of common stock at an exercise price of $15.00 per share exercisable until September 21, 2022, issued to
certain 5% stockholders. |
|
|
|
|
● |
Warrants
to purchase 17,200 shares of common stock at an exercise price of $12.50 per share exercisable until between November 17, 2022 and
November 30, 2022, issued to the placement agent in connection with private placements of our convertible promissory notes. |
|
|
|
|
● |
Warrants
to purchase 16,000 shares of common stock at an exercise price of $9.00 per share exercisable until between September 20, 2023 and
September 26, 2023, issued to the placement agent in connection with private placements of our convertible promissory notes. |
|
|
|
|
● |
Warrants
to purchase 95,500 shares of common stock at an exercise price of $4.00 per share exercisable until March 2, 2025, issued to the
placement agent in connection with private placements of our convertible promissory notes. |
No
warrants were issued during the three months ended March 31, 2022 or 2021.
11.
Stock-Based
Compensation
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 8,097 shares and 12,207 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 $57,500 was recorded on the issuance of the common stock for the three months ended March 31, 2022
and 2021.
Stock
Options
We
did not make any stock option grants during the three months ended March 31, 2022 or 2021. Stock-based compensation for options was $22,960
and $23,098 during the three months ended March 31, 2022 and 2021, respectively.
A
summary of stock option activity during the three months ended March 31, 2022 and 2021 is as follows:
Schedule of Stock Option Activity
| |
| | |
| | |
Weighted- | |
| |
| |
| | |
Weighted- | | |
Average | |
| |
| |
Shares | | |
Average | | |
Remaining | |
Aggregate | |
| |
Under | | |
Exercise | | |
Contractual | |
Intrinsic | |
| |
Option | | |
Price | | |
Life | |
Value | |
Outstanding at January 1, 2022 | |
| 144,860 | | |
$ | 5.61 | | |
8 years | |
$ | 19,200 | |
| |
| | | |
| | | |
| |
| | |
Outstanding at March 31, 2022 | |
| 144,860 | | |
$ | 5.61 | | |
8 years | |
$ | 19,200 | |
| |
| | | |
| | | |
| |
| | |
Exercisable at March 31, 2022 | |
| 68,335 | | |
$ | 7.32 | | |
7 years | |
$ | 19,200 | |
| |
| | |
| | |
Weighted- | |
| |
| |
| | |
Weighted- | | |
Average | |
| |
| |
Shares | | |
Average | | |
Remaining | |
Aggregate | |
| |
Under | | |
Exercise | | |
Contractual | |
Intrinsic | |
| |
Option | | |
Price | | |
Life | |
Value | |
Outstanding at January 1, 2021 | |
| 145,360 | | |
$ | 5.61 | | |
9 years | |
$ | 19,200 | |
| |
| | | |
| | | |
| |
| | |
Outstanding at March 31, 2021 | |
| 145,360 | | |
$ | 5.61 | | |
9 years | |
$ | 19,200 | |
| |
| | | |
| | | |
| |
| | |
Exercisable at March 31, 2021 | |
| 41,560 | | |
$ | 9.34 | | |
8 years | |
$ | 19,200 | |
As
of March 31, 2022 and December 31, 2021, there was $207,660 and $230,620, 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 two years. The total fair value of stock options that vested during the three months ended March 31, 2022 and 2021 was $10,238
and $10,800, respectively.
12.
Concentrations
Revenues
from a limited number of customers have accounted for a substantial percentage of our total revenues. During the three months ended March
31, 2022 and 2021, our two largest customers, the State of Michigan, and Rocket Mortgage, both direct clients, accounted for 40% and
10%, and 46% and 11%, respectively, of our total revenues.
For
the three months ended March 31, 2022 and 2021, government contracts represented approximately 60% and 64% of our net revenues, respectively.
A significant portion of our sales to resellers represent ultimate sales to government agencies.
As
of March 31, 2022, accounts receivable concentrations from our three largest customers were 43%, 10%, and 9% of our gross accounts receivable,
respectively by customer. As of March 31, 2021, accounts receivable concentrations from our two largest customers were 40% and 17% of
gross accounts receivable, respectively by customer. Accounts receivable balances from our two largest customers at March 31, 2022 have
been partially collected.
13.
Certain Relationships
and Related Transactions
We
did not participate in any related person transactions during the three-month period ended March 31, 2022 or 2021.
14.
Provision
For Income Taxes
The
Company files income tax returns in the U.S. Federal jurisdiction and various state jurisdictions. For the three months ended March 31,
2022 and 2021, we have recognized the minimum amount of state income tax as required by the states in which we are required to file taxes.
We are not currently subject to further federal or state tax since we have incurred losses since our inception.
A
reconciliation is provided below of the U.S. Federal income tax expense at a statutory rate of 21% for the three months ended March 31,
2022 and 2021:
Summary
of Reconciliation of Income Tax Expense
| |
March 31, 2022 | | |
March 31, 2021 | |
U.S. statutory rate | |
| 21 | % | |
| 21 | % |
U.S. Federal income tax at statutory rate | |
$ | (4,226 | ) | |
$ | 177,030 | ) |
Increase (decrease) in income taxes due to: | |
| | | |
| | |
Non-taxable PPP loan and accrued interest recovery | |
| - | | |
| (176,190 | ) |
Non-deductible earnout expense | |
| 11,220 | | |
| 14,700 | |
Non-deductible goodwill amortization | |
| 9,989 | | |
| 10,080 | |
Other differences | |
| 93 | | |
| 1,380 | |
Other change in valuation allowance | |
| (17,076 | ) | |
| (27,000 | ) |
Income tax benefit | |
$ | - | | |
$ | - | |
The
approximate tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are
presented below:
Summary
of Deferred Tax Assets and Liabilities
| |
March 31, 2022 | | |
December 31, 2021 | |
Deferred tax assets | |
| | | |
| | |
Reserves and accruals not currently deductible for tax purposes | |
$ | 47,622 | | |
$ | 50,558 | |
Amortizable assets | |
| 33,950 | | |
| 32,615 | |
Net operating loss carryforwards | |
| 3,926,322 | | |
| 3,942,488 | |
Deferred tax assets | |
| 4,007,894 | | |
| 4,025,661 | |
Deferred tax liabilities | |
| | | |
| | |
Property and equipment | |
| (224,792 | ) | |
| (225,484 | ) |
Net Deferred tax assets | |
| 3,783,102 | | |
| 3,800,177 | |
Valuation allowance | |
| (3,783,102 | ) | |
| (3,800,177 | ) |
Deferred
tax assets and liabilities | |
$ | - | | |
$ | - | |
As
of March 31, 2022 and December 31, 2021, we had federal net operating loss carry forwards of approximately $18,685,000 and $18,762,000,
respectively, which can be used to offset future federal income tax. A portion of the federal and state net operating loss carry forwards
expire at various dates through 2040,
and a portion of the net operating loss carry forwards have an indefinite carry forward period. We recorded a valuation allowance against
all of our deferred tax assets as of both December 31, 2021, and December 31, 2020. We intend to continue maintaining a full valuation
allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances.
Release of the valuation allowance would result in the recognition of certain deferred tax assets and a decrease to income tax expense
for the period the release is recorded. However, the exact timing and amount of the valuation allowance release are subject to change
on the basis of the level of profitability that we are able to actually achieve.
15.
Subsequent Events
Incentive
Stock Option Issuance
On
April 14, 2022, we issued incentive stock option awards to purchase an aggregate of 220,587
shares, with an exercise price of $6.08
per share, to seven members of our executive
and management teams, subject to three-year
vesting and in accordance with the terms and conditions of our 2015 Equity Incentive Plan. Stock compensation of approximately $1.2
million will be recorded over the vesting
period.
Private
Securities Offering
On
April 1, 2022, we entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with certain accredited
investors, pursuant to which we issued and sold (i) 1,242,588 shares of the Company’s
Common Stock, at a price of $4.62 per share, for aggregate gross proceeds of $ 5,740,756
and (ii) $2,964,500 in 12% Subordinated Notes (“Notes”), for aggregate gross proceeds
of $8,705,256 for the combined private placement pursuant to the Securities Purchase Agreement (the “Offering”).
We used a portion of the net proceeds of the Offering to finance the acquisition of Yellow Folder described below, and intend
to use the remaining net proceeds for working capital and general corporate purposes, including potentially debt reduction and other
future acquisitions.
The
principal amount of the Notes, together with any accrued and unpaid interest thereon, become due and payable on March 30, 2025.
Interest on the Notes will accrue at the rate of 12% per annum, payable quarterly in cash, beginning on June 30, 2022 and the entire
outstanding principal and accrued but unpaid interest due on the Notes is payable on the maturity date. Any accrued but unpaid quarterly
installment of interest shall accrue interest at the rate of 14.0% per annum. Any overdue principal and accrued and unpaid interest at
the Maturity Date shall accrue a mandatory default penalty of 20% of the outstanding principal balance and an interest rate of 14% per
annum from the maturity date until paid in full.
The
Company retained Taglich Brothers, Inc. as the exclusive placement agent for the private placement offering of the Securities Purchase
Agreement. In compensation, the Company paid the placement agent a cash payment of 8% of the gross proceeds of the offering, along with
warrants to purchase shares of Company common stock, an extension of its existing warrants, and reimbursement for the placement agent’s
reasonable out of pocket expenses, FINRA filing fees and related legal fees. On April 1, 2022, the Company paid the placement agent cash
in the amount of $696,420 and issued the placement agent warrants to purchase 124,258 shares at an exercise price at $4.62 per share,
which are exercisable for a period of five years after issuance, contain customary cashless exercise provisions and anti-dilution protection
and are entitled to limited piggyback registration rights. In addition, we agreed to extend the expiration date of all currently outstanding
warrants previously issued to the placement agent and/or its assignees to March 30, 2027.
Acquisition
of Yellow Folder, LLC
On
April 1, 2022, the Company acquired substantially all of the assets of Yellow Folder, LLC, a Texas limited liability company (“Yellow
Folder”). Located in Dallas, Yellow Folder is a document solutions company that specializes
in the K-12 education market.
The
acquisition was consummated pursuant to an Asset Purchase Agreement, dated as of April 1, 2022 (the “Purchase Agreement”).
The purchase price for Yellow Folder consisted of approximately $6.5 million in cash, on a cash-free, debt-free basis, with a preliminary
working capital negative adjustment of $116,731, which remains subject to a post-closing net working capital true-up adjustment.
The
Company incurred $70,051
of related acquisition costs in the three months ended March 31, 2022 which are reflected in transaction costs in the Condensed
Consolidated Statement of Operations. The Company expects to report Yellow Folder as part of its Document Management segment during
fiscal year 2022. The acquisition qualifies as a business combination and will be accounted for using the acquisition method of
accounting.
As
a result of limited access to Yellow Folder information required to prepare initial accounting, together with the limited time since
the acquisition date and the effort required to conform the financial statements to the Company’s practices and policies, the initial
accounting for the business combination is incomplete at the time of this filing. As a result, the Company is unable to provide the amounts
recognized as of the Yellow Folder acquisition date for the major classes of assets acquired and liabilities assumed, pre-acquisition
contingencies and goodwill. Also, the Company is unable to provide proforma revenues and earnings of the combined entity. This information
will be included in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2022.