INLX 10-K
Intellinetics, Inc. (INLX)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM
(Mark One)
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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DOCUMENTS INCORPORATED BY REFERENCE
TABLE oF CONTENTS
| i |
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K and the documents incorporated into this report by reference contain, and we may from time to time make, forward-looking statements. From time to time in the future, 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 fact, 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, but are not limited to, 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 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 expectation that the shift from an offline to online world will continue to benefit our business; | |
| ● | our markets, including our market position and our market share; | |
| ● | our ability to integrate our two recent acquisitions and any future acquisitions, grow their businesses and obtain the expected financial and operational benefits from those businesses; | |
| ● | the effects of fluctuations in sales on our business, revenues, expenses, net income, earnings per share, margins, profitability, cash flow, capital expenditures, liquidity, financial condition and results of operations; | |
| ● | our products, services, technologies and systems, including their quality and performance in absolute terms and as compared to competitive alternatives, their benefits to our customers and their ability to meet our customers’ requirements, and our ability to successfully develop and market new products, services, technologies and systems; | |
| ● | our markets, including our market position and our market share; | |
| ● | our ability to successfully develop, operate, grow and diversify our operations and businesses; | |
| ● | our business plans, strategies, goals and objectives, and our ability to successfully achieve them; | |
| ● | the sufficiency of our capital resources, including our cash and cash equivalents, funds generated from operations, availability of 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; | |
| ● | 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, goals, targets, strategies, hopes, beliefs, 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 “Risk Factors” as well as other risks, uncertainties and factors discussed elsewhere in this 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 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 Annual 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. |
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PART I
ITEM 1. BUSINESS
Company Overview
Intellinetics, formerly known as GlobalWise Investments, Inc. is a Nevada holding company incorporated in 1997, with two wholly-owned subsidiaries: (i) Intellinetics, Ohio, an Ohio corporation and (ii) Graphic Sciences, a Michigan corporation. Intellinetics Ohio was incorporated in 1996, and on February 10, 2012, Intellinetics Ohio became the sole operating subsidiary of Intellinetics as a result of a reverse merger and recapitalization. On March 2, 2020, Intellinetics purchased Graphic Sciences, Inc.
We are a document services and software solutions company serving both the small-to-medium business and governmental sectors with their digital transformation and process automation initiatives. During 2020, we made two significant business acquisitions that have significantly impacted our financial operations and grown our business operations:
| ● | Graphic Sciences, on March 2, 2020, and | |
| ● | CEO Image, on April 21, 2020. |
For further information about these acquisitions, please see Note 5 to our consolidated financial statements included in Item 8, Part I, Item 1 of this Annual Report.
Our products and services are provided through two reporting segments: Document Management and Document Conversion. Our Document Management segment, which includes our CEO Image acquisition, consists primarily of solutions involving our software platform, allowing customers to capture and manage their documents across operations such as scanned hard-copy documents and digital documents including those from Microsoft Office 365, digital images, audio, video and emails. Our Document Conversion segment, which includes and primarily consists of our Graphic Sciences acquisition, provides digital transformation assistance to customers converting documents from one medium to another, predominantly paper to digital, potentially 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.
Software and Services
Document Management
Our flagship software platform suite is IntelliCloud™, reflecting our focus, and the market’s focus, on growth via cloud-based content management and process automation. Our Document Management business also generates software-related professional services that include installation, integration, training, and consulting services, as well as ongoing software maintenance and customer support.
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The IntelliCloud™ suite of software is comprised of stand-alone and integrated modules that include:
| ● | Image Processing: includes image processing modules used for capturing, transforming and managing images of paper documents, including support of distributed and high-volume capture, optical character recognition; | |
| ● | Records Management: addresses needs relating to retention of content through automation and policies, ensuring legal, regulatory and industry compliance for our clients; | |
| ● | Workflow: supports business processes, routing content electronically for assigning work tasks and approvals, and creating related audit trails, notifications, and escalations; and | |
| ● | Extended Components: includes document composition and e-forms (via third party OEM integration partnership), search, content and web analytics (via third party data visualization and advanced OCR engine partnerships), email and information archiving, packaged application integration, and advanced capture for invoice processing, and accounts payable lifecycle automation. |
Document Conversion
We convert images from paper to digital, paper to microfilm, microfiche to microfilm, and micrographics to digital for business and federal, county, and municipal governments. Our Document Conversion business also provides its clients with long-term paper and microfilm storage and retrieval options.
The primary Document Conversion offerings are:
| ● | Digital Scanning Services. These services include paper scanning, newspaper and microfilm scanning, microfiche scanning, aperture card scanning, drawing scanning, and book scanning. Most government files must be retained for long terms or permanently, making such clients a prime candidate for digital conversion. There are four production categories for these services, consisting of document prep, scanning, indexing, and delivery. | |
| ● | Business Process Outsourcing (BPO). BPO contracts provide ongoing outsourcing of customer processes such as mail room activities, where we pick up customer mail from the post office, open it, sort it, scan it, and upload it to the appropriate customer system. | |
| ● | Microfilm and Microfiche. We provide microfilming/microfiche conversion to digital, converting scanned images to microfilm or microfiche, and microfilm/microfiche preservation and duplication. | |
| ● | Box Storage Services. We provide physical document storage and retrieval services for our clients. | |
| ● | Scanning Equipment, Software and Repair. We sell and service document image software, document scanners, and microfilm scanners, readers and printers. This is a smaller, slowly declining part of our Document Conversion business. |
Marketing and Sales
We have a multi-channel sales model that directs our sales efforts through direct sales and through intermediaries, such as independent software vendors, resellers and referral partners. Our Document Management and Document Conversion segments each use direct and reseller channels for sales. We have developed partner-specific marketing programs with channel partners. We believe that our channel partner strategy improvements have increased the competitive strength of our platform of products. In addition, we have established a set of business solutions templates for specific vertical markets that provide base software configurations which we believe will facilitate our delivery and installation of software to our customers in both our direct and reseller channels. We believe that these advancements, in the aggregate, will allow us to license and sell our products to a targeted customer base, shortening our sales cycle, making margins more consistent, and allowing us to expand our sales through existing and new reseller partnerships and direct customers. We continue to devote significant efforts, in both development and marketing, in enhancing all channels to market.
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Competition and Market Position
The market for our products is competitive, and we expect that competition will continue to intensify as the document solutions markets evolve and potentially consolidate. We believe that the trend toward electronic document management, and particularly cloud solutions, was accelerated by the COVID-19 pandemic.
We believe the primary competitors of our Document Management segment are DocuWare, Square 9, M-files, On-Base, FileBound, and Laserfiche, who also serve small-to-medium business (SMB) and governmental sectors. The principal competitive factors affecting the market for our document conversion services include: (i) vendor and product reputation; (ii) product quality, performance and price; (iii) the availability of software products on multiple platforms; (iv) product scalability; (v) product integration with other enterprise applications; (vi) software functionality and features; (vii) software ease of use; (viii) the quality of professional services, customer support services and training; and (ix) the ability to address specific customer business problems. We believe that the relative importance of each of these factors depends upon the concerns and needs of each specific customer.
We believe the competitors of our Document Conversion segment vary from small, niche entities to larger entities, including Iron Mountain. The principal competitive factors affecting the market for our software products and services include: (i) vendor and services reputation and (ii) services quality, performance and price. We believe that the relative importance of each of these factors depends upon the concerns and needs of each specific customer, and that, for our current and prospective customers, maintaining secure control over the customers’ information is highly valued.
We believe that the consolidated Company has advantages over our competitors in the small-to-medium business market, and particularly organizations in highly regulated, risk and compliance-intensive markets, such as state and local government, non-clinical health care, and K-12 education. In our view, we will remain competitive by remaining a focused niche provider with product offerings aligned with buyer-specific requirements. We anticipate that we will benefit from five specific advantages already in place:
| ● | Turnkey cloud or premise document workflow and document conversion solutions targeting specific industry customers with benchmark value-to-price ratio; | |
| ● | Rigorous quality review process and maintenance of customer data confidentiality in document conversions; | |
| ● | Modular solution packaging and rapid customer activation model; | |
| ● | Integrated on-demand solutions library as standard platform feature; and | |
| ● | Expanded software integration tools that make it easier for independent software vendors to integrate and sell IntelliCloud software capabilities into their customer base. |
We believe, with these competitive strengths, that we are well positioned as a cloud-based managed document services provider for the small-to-medium business and governmental sectors.
Customers
Document Management
For 2021, the two largest customers of our Document Management segment accounted for approximately 10% and 4%, respectively, of the segment’s revenues for that period. For 2020, the two largest customers of our Document Management segment accounted for approximately 6% and 4%, respectively, of the segment’s revenues for that period.
For the years ended December 31, 2021, and 2020, government contracts represented approximately 30% and 37%, respectively, of the Document Management segment’s net revenues, including a significant portion of the segment’s sales to resellers which represent ultimate sales to government agencies. Due to their dependence on state, local and federal budgets, government contracts carry short terms, typically 12 months. Since our inception, our contracts with government customers have generally renewed on the original terms and conditions upon expiration.
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Document Conversion
Our Document Conversion segment has significant customer concentration with the State of Michigan. Graphic Sciences’ contract with the State of Michigan is for five years from June 1, 2018 to May 30, 2023 with a provision for two, one-year extensions. The contract is issued to Graphic Sciences through the Michigan Department of Management and Budget, Enterprise Procurement and managed through the Department of Management and Budget, Records Management Services Division (RMS).
The contract provides local and state government agencies access to digital and micrographic conversion services. These agencies have the option to perform these conversion services internally or go out to bid if they so choose. Typically, they elect to have these services outsourced to Graphic Sciences through RMS, which eliminates the bidding process.
All Michigan agencies and departments are able to use the services and prices provided under this contract. Mechanically, the work we perform is invoiced to RMS and the end user is invoiced through the State of Michigan accounting system. We do not invoice the end user directly when entities utilize this contract facility, and we have a single point of contact for managing billing and receipt. The state in effect acts as a reseller of our services to the other agencies and makes a mark-up of what is charged. For 2021, the State of Michigan represented approximately 64% of our Document Conversion segment’s net revenues, and 47% of the total consolidated revenues. For 2020, the State of Michigan represented approximately 71% of our Document Conversion segment’s net revenues, and 47% of the total consolidated revenues.
Intellectual Property
Our software and most of the underlying technologies are built on a Microsoft.Net framework. We rely on a combination of copyright, trademark laws, non-disclosure agreements and other contractual provisions to establish and maintain our proprietary intellectual property rights.
Customers license the right to use our software products on a non-exclusive basis. We grant to third parties rights in our intellectual property that allow them to market certain of our products on a non-exclusive or limited-scope exclusive basis for a particular application of the product or to a particular geographic area.
While we believe that our intellectual property as a whole is valuable and our ability to maintain and protect our intellectual property rights is important to our success, we also believe that our business as a whole is not materially dependent on any particular trademark, license, or other intellectual property right.
Software Development
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. We discuss our accounting for such costs, and when we expense or capitalize, in more detail below in “Critical Accounting Policies and Estimates.”
Government Regulation
We are subject to federal, state and local laws and regulations affecting our business. Other than government procurement rules affecting sales to governmental customers, we do not believe that we are subject to any special governmental regulations or approval requirements affecting our products or services. Complying with the regulations and requirements applicable to our business does not entail a significant cost or burden. We believe that we are in compliance in all material respects with all applicable governmental regulations.
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Human Capital
As of March 21, 2021, we employed a total of 104 individuals; all but 11 are full-time employees. Graphic Sciences employs 81 individuals, comprised of 75 full-time and 6 part-time employees, all located in Michigan. Graphic Sciences also utilizes temporary employees, through various agencies, to provide labor for variable project work. Intellinetics Ohio employs 23 individuals, comprised of 17 full-time and 5 part-time employees, primarily located in Ohio. As a combined company, 14 of our employees work in administration and management, 19 of our employees work in software sales, maintenance and support, and software development, and 71 of our employees work in document services and storage operations.
We consider the integrity, experience, dedication, creativity, and team-oriented nature of our employees to be an essential driver of our business and a key to our future prospects. Personal relationships with our existing customers are an important part of our business, and our customers have come to rely on the personal service and knowledge of our workforce across all functional areas. To attract and retain qualified applicants to our company and retain our employees, we offer total benefits packages consisting of base salary or hourly wage (depending on position), a comprehensive benefits package, and equity compensation for certain employees. Annual cash bonuses are based on our profitability, achievement of targets and level of responsibility. When selecting talent, we consider education, experience, diversity, and the likelihood that a candidate will espouse our values of integrity, collaboration, dedication, creativity, and superior customer service.
We are committed to fostering a diverse and inclusive workforce that attracts and retains exceptional talent. In addition, we pride ourselves on an open culture that respects co-workers, values employees’ health and well-being and fosters professional development. We support employee growth and development in a variety of ways including with training opportunities and an overall strategy of promotion from within. Our management conducts annual employee engagement surveys and, for supervisors and above, annual individual employee assessments with an emphasis on individual development for each employee.
We remain focused on protecting the health and safety of our employees with respect to COVID-19. In April of 2020, we instituted safe distancing practices and additional cleaning procedures for all company offices and facilities, and our offices in Michigan and Ohio were reconfigured to maintain physical distancing. Wherever feasible, we have encouraged employees to work from home. To date, our employees who work in software sales, maintenance and support, and software development continue to work remotely. Our remote working arrangements have not significantly affected our ability to maintain critical business operations.
We believe that relations with our employees are good. None of our employees are represented by a labor union, and we do not have collective bargaining arrangements with any of our employees. In addition, as of March 21, 2021, we engaged four independent contractors.
Executive Officers and Board of Directors
On December 31, 2021, our executive officers and directors included the following:
| Name | Age | Title | ||
| James F. DeSocio | 66 | President, Chief Executive Officer, and Director | ||
| Matthew L. Chretien | 54 | Chief Strategy Officer, Chief Technology Officer, Secretary, and Director | ||
| Joseph D. Spain | 54 | Chief Financial Officer, Treasurer | ||
| William M. Cooke | 60 | Director, Chairman of the Board | ||
| Rye D’Orazio | 67 | Director | ||
| Sophie Pibouin | 54 | Director | ||
| Roger Kahn | 52 | Director |
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James F. DeSocio, President, Chief Executive Officer, and Director. Mr. DeSocio joined Intellinetics on September 25, 2017. Prior to joining Intellinetics, Mr. DeSocio served as Chief Revenue Officer at Relayware, LLC, a global provider of Partner Relationship Management solutions, from January 2015 to September 2017. From January 2013 to November 2014, Mr. DeSocio served as Executive Vice President of Operations for XRS Corporation, a fleet management software solutions provider. From October 2007 to September 2012, Mr. DeSocio served as Executive Vice President of Sales and Business Development for Antenna Software, Inc., a business mobility solutions provider. Mr. DeSocio has extensive experience in sales, marketing, international operations, mergers and acquisitions.
Matthew L. Chretien, Chief Strategy Officer, Chief Technology Officer, Director. Mr. Chretien is a co-founder of Intellinetics and has served as Secretary since December 19, 2017, Chief Strategy Officer since September 25, 2017, and Chief Technology Officer since September 2011. Mr. Chretien previously served as Intellinetics’ President and Chief Executive Officer from July 2013 to September 2017, and from January 1999 to September 2011; Executive Vice President from September 2011 to July 2013; Chief Financial Officer from September 2011 to September 2012; Treasurer from September 2011 to December 2016; and Vice President from 1996 until 1999. Prior to joining Intellinetics, Mr. Chretien served as the field sales engineer for Unison Industries, a manufacturer of aircraft ignition systems.
Joseph D. Spain, Chief Financial Officer and Treasurer. Mr. Spain joined Intellinetics on October 31, 2016 and was appointed as its Chief Financial Officer on December 1, 2016. Prior to joining Intellinetics, Mr. Spain worked from September 2014 to October 2016 for nChannel, Inc., a software solutions provider for the small-to-medium business retail sector, ultimately serving as Chief Financial Officer of the company. From July 1995 to June 2014, Mr. Spain worked for Mettler-Toledo International, Inc., a global provider of measurement and precision instruments, ultimately serving as Vice President of Finance & Controller for one of the company’s operating units.
William M. Cooke, Director. Mr. Cooke was appointed as a member and chairman of our board of directors in October 2021. Mr. Cooke joined Taglich Brothers, Inc., a New York-based full-service brokerage firm that specializes in placing and investing in private equity transactions for small public companies, in 2012 and participates in sourcing, evaluating, and executing new investments as well as monitoring existing investments. Prior to joining Taglich Brothers, he was a Managing Director of Glenwood Capital LLC from 2010 to 2012, where he advised middle-market clients on capital raising and mergers and acquisitions. From 2001 to 2009, he sourced, evaluated and executed mezzanine transactions for The Gladstone Companies and BHC Interim Funding II, L.P. Before entering the private equity industry, Mr. Cooke served as a securities analyst primarily covering the automotive and industrial sectors for ABN AMRO Incorporated and McDonald and Company Securities, Inc. Bill received his Bachelor of Arts degree from Michigan State University and Master of Business Administration degree from the University of Michigan. He is a Chartered Financial Analyst and a member of the Board of DecisonPoint Systems, Inc., Unique Fabricating, Inc., Racing & Performance Holdings, LLC and a former member of the board of directors of APR, LLC.
Rye D’Orazio, Director. Mr. D’Orazio has served as a director of Intellinetics since 2006. Mr. D’Orazio has been a partner at Ray & Barney Group since 2001. From 1995 to 2000, Mr. D’Orazio served as Vice President of Professional Services at Compucom. From 1985 to 1995, Mr. D’Orazio was a partner at NCGroup, which he founded. From 1982 to 1995, Mr. D’Orazio was employed as the Vice President of Professional Services at Triangle Systems, and from 1977 to 1982, Mr. D’Orazio was employed as a systems engineer at Electronic Data Systems.
Sophie Pibouin, Director. Ms. Pibouin was appointed as a member of our board of directors on March 20, 2015. Ms. Pibouin is currently employed by Progress Software as the VP Sales North America. Prior to that she was Head of Sales, U.S. for Resulticks. From 2014 to June 2019 Ms. Pibouin served as the worldwide Sales Leader of the IBM Watson marketing brand. Prior to that, Ms. Pibouin served as Chief Operating Officer, from 2012 to 2014, for SDL, PLC, a global provider of customer experience management software and solutions, having previously worked as a General Manager from 2010 to 2012. From 2006 to 2009, she served as Chief Operating Officer at Chronicle Solutions, Inc., a security software company. From 1990 to 2004, she worked for CA, Inc. (formerly Computer Associates), in a variety of positions including ultimately as Senior Vice President/GM for the Mid-Atlantic Region. She graduated with Honors as a Bachelor in International Commerce from the University of Flaubert in Rouen, France.
Roger Kahn, Director. Mr. Kahn was appointed as a member of our board of directors on October 5, 2017. Mr. Kahn has served as President and Chief Executive Officer of Bridgeline Digital, Inc. (“Bridgeline”), a web content management solutions provider, since May 2016. Mr. Kahn previously served as Co-Interim Chief Executive Officer and President of Bridgeline from December 2015 to May 2016, and as Chief Operating Officer from August 2015 to May 2016. From 2008 to September 2016, Mr. Kahn was a partner at Great Land Holdings, a resort development company. Mr. Kahn received his Ph.D. in Computer Science and Artificial Intelligence from the University of Chicago.
Available Information
Our Annual Reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”), are available free of charge via our website (www.intellinetics.com) as soon as reasonably practicable after they are filed with, or furnished, to the SEC.
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ITEM 1A. RISK FACTORS
Our business and future operating results may be affected by many risks, uncertainties and other factors, including those set forth below and those contained elsewhere in this report. If any of the following risks were to occur, our business, affairs, assets, financial condition, results of operations, cash flows and prospects could be materially and adversely affected. When we say that something could have a material adverse effect on us or on our business, we mean that it could have one or more of these effects.
In addition to the other information contained in this report, the following risk factors should be considered carefully in evaluating our company. Our business, financial condition, liquidity or results of operations could be materially adversely affected by any of these risks.
Risks Relating to Our Business
General inflation and increases in the minimum wage and general labor costs, could adversely affect our business, financial condition and results of operations.
Labor is a significant portion of our cost structure and is subject to many external factors, including minimum wage laws, prevailing wage rates, unemployment levels, health insurance costs and other insurance costs and changes in employment and labor legislation or other workplace regulation. From time to time, legislative proposals are made to increase the federal minimum wage in the United States, as well as the minimum wage in Michigan and Ohio and municipalities, and to reform entitlement programs, such as health insurance and paid leave programs. On April 27, 2021, President Biden issued an Executive Order, effective January 30, 2022, requiring certain federal contractors to pay a $15 minimum wage to workers who work on federal contracts and to adjust that rate annually according to the consumer price index. While we do not currently have any federal contracts and are not directly affected by the Executive Order, the Executive Order will mostly likely significantly contribute to the overall increase in prevailing wage rates and increase in current general levels of inflation. Further, the Executive Order may influence other state and municipal jurisdictions to increase their statutory minimum wage. As minimum wage rates increase or related laws and regulations change, we will need to increase not only the wage rates of our minimum wage employees, but also the wages paid to our other hourly or salaried employees. Increases in the cost of our labor could have an adverse effect on our business, financial condition and results of operations, or if we fail to pay such higher wages we could suffer increased employee turnover. Increases in labor costs generally could force us to increase prices for other customers, which could adversely impact our sales. For some customers with multi-year fixed pricing contracts, increases in the minimum wage could decrease our profit margins or result in losses and could have a material adverse effect on our business, financial condition and results of operations.
We have been and could continue to be negatively impacted by the novel coronavirus pandemic (COVID-19) and related governmental actions and orders and market effects.
The coronavirus pandemic (COVID-19) and related economic downturn continues to pose various and interrelated risks to our customers, our employees, our vendors and the communities in which we operate, which have all negatively impacted, and may continue to negatively impact, our business. From March 24, 2020 to current, customers have responded with varying levels of project postponements, particularly in our document conversion segment, which generally requires picking up boxes from customer sites. Our level of customer engagement in document conversion has varied with the ebb and flow of the initial virus and the subsequent variants and outbreaks. The State of Michigan, our largest customer, has yet to return a majority of its agencies and departments to on site work. In addition, our business, financial condition and results of operations could be materially adversely affected by future outbreaks of COVID-19 generally or in our facilities. We are also likely to be impacted further by decreased customer demand and/or subscription terminations as a result of a reduction in customer spending (especially customers that are state and local governmental entities) or as a result of government-imposed restrictions on businesses. In particular, governmental budget reductions in the State of Michigan, our largest customer, may have a material adverse effect on our business. If the pandemic or its recovery continues to reduce customer’s budgets and restrict business operations, the pandemic may have a material adverse effect on our business, results of operations, financial condition and cash flows and adversely impact the trading price of our common stock.
Any significant reduction in the sales efforts or cooperative efforts from our partners could materially impact our revenues.
We rely on close cooperation with our resellers for sales and product development as well as for the optimization of opportunities that arise in our competitive environment. In particular, the success of our reseller program is entirely dependent upon our relationships with resellers of multi-functional devices, which are currently being purchased by current and potential customers in our target markets. Our success will depend, in part, upon our ability to maintain access to existing channels of distribution and to gain access to new channels if and when they develop. We may not be able to retain a sufficient number of our existing partners or develop a sufficient number of future partners. We are unable to predict the extent to which our partners will be successful in marketing and licensing our products. A reduction in partner cooperation or sales efforts, or a decline in the number of channels, could materially reduce revenues.
If we are unable to continue to attract new customers and increase market awareness of our company and solutions, our revenue growth could be slower than we expect or could decline.
We believe that our future growth depends in part upon increasing our customer base. Our ability to achieve significant growth in revenue in the future will depend, in part, upon continually attracting new customers and obtaining subscription renewals to our solutions from those customers. Market awareness of our capabilities and solutions is essential to our ability to generate new leads for expanding our business and our continued growth. If we fail to sufficiently invest in our marketing programs or they are unsuccessful in attracting new customers by creating market awareness of our company and solutions, our business may be harmed.
If our existing customers fail to renew their support agreements, or if customers do not license updated products on terms favorable to us, our revenues could be adversely affected.
We currently derive a significant portion of our overall revenues from maintenance services and software subscriptions, and we depend on our installed customer base for future revenue from maintenance services and software subscriptions and licenses of updated products. The IT industry generally has been experiencing increasing pricing pressure from customers when purchasing or renewing support agreements. Moreover, the trend towards consolidation in certain industries that we serve, such as financial services, could result in a reduction of the software under agreement and put pressure on our maintenance and support terms with customers who have merged. Given this environment, there can be no assurance that our current customers will renew their maintenance agreements or agree to the same terms when they renew, which could result in our reducing or losing maintenance fees. If our existing customers fail to renew their maintenance agreements, or if we are unable to generate additional maintenance fees through the licensing of updated products to existing or new customers, our business and future operating results could be adversely affected.
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Reduced IT or enterprise software spending may adversely impact our business.
Our business depends on the overall demand for IT and enterprise software spend and on the economic health of our current and prospective customers. Any meaningful reduction in IT or enterprise software spending or weakness in the economic health of our current and prospective customers could harm our business in a number of ways, including longer sales cycles and lower prices for our solutions.
Current and future competitors could have a significant impact on our ability to generate future revenues and profits.
The markets for our products are intensely competitive, and are subject to rapid technological change and other pressures created by changes in our industry. The convergence of many technologies has resulted in unforeseen competitors arising from companies that were traditionally not viewed as threats to our marketplace. We expect competition to increase and intensify in the future as the pace of technological change and adaptation quickens, and as additional companies enter our markets, including those competitors who offer similar products and services to ours, but offer them through a different form of delivery. Numerous releases of competitive products have occurred in recent history and are expected to continue in the future. We may not be able to compete effectively with current competitors and potential entrants into our marketplace. We could lose market share if our current or prospective competitors: (i) introduce new competitive products, (ii) add new functionality to existing products, (iii) acquire competitive products, (iv) reduce prices, or (v) form strategic alliances with other companies. If other businesses were to engage in aggressive pricing policies with respect to competing products, or if the dynamics in our marketplace resulted in increased bargaining power by the consumers of our products and services, we would need to lower the prices we charge for the products we offer. This could result in lower revenues or reduced margins, either of which could materially and adversely affect our business and operating results. Additionally, if prospective consumers choose other methods of document solutions delivery, different from those that we offer, our business and operating results could also be materially and adversely affected.
Consolidation in the industry, particularly by large, well-capitalized companies, could place pressure on our operating margins which could, in turn, have a material adverse effect on our business.
Acquisitions by large, well-capitalized technology companies have changed the marketplace for our goods and services by replacing competitors that are comparable in size to our company with companies that have more resources at their disposal to compete with us in the marketplace. In addition, other large corporations with considerable financial resources either have products that compete with the products we offer, or have the ability to encroach on our competitive position within our marketplace. These companies have considerable financial resources, channel influence, and broad geographic reach; thus, they can engage in competition with our products and services on the basis of sales price, marketing, services, or support. They also have the ability to introduce items that compete with our maturing products and services. The threat posed by larger competitors and their ability to use their better economies of scale to sell competing products and services at a lower cost may materially reduce the profit margins we earn on the goods and services we provide to the marketplace. Any material reduction in our profit margin may have a material adverse effect on the operations or finances of our business, which could hinder our ability to raise capital in the public markets at opportune times for strategic acquisitions or general operational purposes, which may prevent effective strategic growth or improved economies of scale or put us at a disadvantage to our better-capitalized competitors.
We must manage our internal resources during periods of company growth, or our operating results could be adversely affected.
The document solutions market has continued to evolve at a rapid pace. If we are successful with our growth plans, any growth will place significant strains on our administrative and operational resources, and increase demands on our internal systems, procedures and controls. Our administrative infrastructure, systems, procedures and controls may not adequately support our operations. In addition, our management may not be able to achieve a rapid, effective execution of the product and business initiatives necessary to successfully implement our operational and competitive strategy. If we are unable to manage growth effectively, our operating results will likely suffer which may, in turn, adversely affect our business.
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We may be unable to acquire other businesses, technologies or companies or engage in other strategic transactions, and we may not be able to successfully realize the benefits of and may be exposed to a variety of risks from any such strategic transactions.
The acquisitions of Graphic Sciences and CEO Imaging Systems, Inc., both in 2020, were our first strategic business acquisitions. As part of our growth strategy, we also expect to continue to evaluate and consider potential strategic transactions, including business combinations, acquisitions and strategic alliances, to enhance our existing businesses and to develop new products and services. At any given time, we may be engaged in discussions or negotiations with respect to one or more of these types of transactions, and any of these transactions could be material to our financial condition and results of operations. However, we do not know if we will be able to identify any future opportunities that we believe will be beneficial for us. Even if we are able to identify an appropriate business opportunity, we may not be able to successfully consummate the transaction, and even if we do consummate such a transaction we may be unable to obtain the benefits or avoid the difficulties and risks of such transaction.
Any future acquisition involves risks commonly encountered in business relationships, including:
| ● | difficulties in assimilating and integrating the operations, personnel, systems, technologies, finance and accounting functions, internal controls, business policies, and products and services of the acquired business; | |
| ● | technologies, products or businesses that we acquire may not achieve expected levels of revenue, profitability, benefits or productivity; | |
| ● | we may not be able to achieve the expected synergies from an acquisition, or it may take longer than expected to achieve those synergies; | |
| ● | unexpected costs and liabilities and unknown risks associated with the acquisition; | |
| ● | diversion of management’s time and resources away from our daily operations; | |
| ● | risks of entering markets in which we have no or limited direct prior experience; | |
| ● | potential need for restructuring operations or reductions in workforce, which may result in substantial charges to our operations; | |
| ● | incurring future impairment charges related to diminished fair value of businesses acquired as compared to the price we paid for them; and | |
| ● | issuing potentially dilutive equity securities, or incurring debt or contingent liabilities, which could harm our financial condition. |
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We cannot assure you that we will make any additional acquisitions, or that any future acquisitions will be successful, will assist us in the accomplishment of our business strategy, or will generate sufficient revenues to offset the associated costs and other adverse effects or will otherwise result in us receiving the intended benefits of the acquisition. In addition, we cannot assure you that any future acquisition of new businesses or technology will lead to the successful development of new or enhanced customer relationships, products, and services, or that any new or enhanced products and services, if developed, will achieve market acceptance or prove to be profitable.
Risks Related to Product Development
We need to continue to develop new technologically-advanced products that successfully integrate with the software products and enhancements used by our customers.
Our success depends upon our ability to design, develop, test, market, license, and support new software products and enhancements of current products on a timely basis in response to both competitive threats and marketplace demands. Recent examples of significant trends in the software industry include cloud computing, mobility, social media, networking, browser, and software as a service. In addition, software products and enhancements must remain compatible with standard platforms and file formats. Often, we must integrate software licensed or acquired from third parties with our proprietary software to create or improve our products. If we are unable to achieve a successful integration with third-party software, we may not be successful in developing and marketing our new software products and enhancements. If we are unable to successfully integrate third-party software to develop new software products and enhancements to existing products, or to complete products currently under development which we license or acquire from third parties, our operating results will materially suffer. In addition, if the integrated or new products or enhancements do not achieve acceptance by the marketplace, our operating results will materially suffer. Also, if new industry standards emerge that we do not anticipate or adapt to, our software products could be rendered obsolete and, as a result, our business and operating results, as well as our ability to compete in the marketplace, would be materially harmed.
If our products and services do not gain market acceptance, our operating results may be negatively affected.
We intend to pursue our strategy of growing the capabilities of our document solutions software offerings through our proprietary research and the development of new product offerings. In response to customer demand, it is important to our success that we continue: (i) to enhance our products, and (ii) to seek to set the standard for document solutions capabilities in the small-to-medium market. The primary market for our software and services is rapidly evolving, due to the nature of the rapidly changing software industry, which means that the level of acceptance of products and services that have been released recently or that are planned for future release by the marketplace is not certain. If the markets for our products and services fail to develop, develop more slowly than expected or become subject to increased competition, our business may suffer. As a result, we may be unable to: (i) successfully market our current products and services, (ii) develop new software products, services and enhancements to current products and services, (iii) complete customer installations on a timely basis, or (iv) complete products and services currently under development. In addition, increased competition could put significant pricing pressures on our products, which could negatively impact our margins and profitability. If our products and services are not accepted by our customers or by other businesses in the marketplace, our business and operating results will be materially affected.
Our investment in our current research and development efforts may not provide a sufficient, timely return.
The development of document solutions software products is a costly, complex, and time-consuming process, and the investment in document solutions software product development often involves a long wait until a return is achieved on such an investment. When cash is available, we make and will continue to make significant investments in software research and development and related product opportunities. Investments in new technology and processes are inherently speculative. Commercial success depends on many factors including the degree of innovation of the products developed through our research and development efforts, sufficient support from our strategic partners, and effective distribution and marketing. Accelerated product introductions and short product life cycles require high levels of expenditures for research and development. These expenditures may adversely affect our operating results if they are not offset by increased revenues. We believe that we must continue to dedicate a significant amount of resources to our research and development efforts in order to maintain our competitive position. However, significant revenues from new product and service investments may not be achieved for a number of years, if at all. Moreover, new products and services may not be profitable, and even if they are profitable, operating margins for new products and businesses may not be as high as the margins we have experienced for our current or historical products and services.
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Product development is a long, expensive, and uncertain process, and we may terminate one or more of our development programs.
We may determine that certain product candidates or programs do not have sufficient potential to warrant the continued allocation of resources. Accordingly, we may elect to terminate one or more of our programs for such product candidates. If we terminate a product in development in which we have invested significant resources, our prospects may suffer, as we will have expended resources on a project that does not provide a return on our investment and we may have missed the opportunity to have allocated those resources to potentially more productive uses, and this may negatively impact our business operating results or financial condition.
Our products may contain defects that could harm our reputation, be costly to correct, delay revenues, and expose us to litigation.
Our products are highly complex and sophisticated and, from time to time, may contain design defects or software errors that are difficult to detect and correct. Errors may be found in new software products or improvements to existing products after delivery to our customers. If these defects are discovered, we may not be able to successfully correct such defects in a timely manner. In addition, despite the tests we conduct on all of our products, we may not be able to fully simulate the environment in which our products will operate and, as a result, we may be unable to adequately detect the design defects or software errors which may become apparent only after the products are installed in an end-user’s network. The occurrence of errors and failures in our products could result in the delay or the denial of market acceptance of our products, and alleviating such errors and failures may require us to make significant expenditure of our resources. The harm to our reputation resulting from product errors and failures may be materially damaging. Because we regularly provide a warranty with our products, the financial impact of fulfilling warranty obligations may be significant in the future. Our agreements with our strategic partners and end-users typically contain provisions designed to limit our exposure to claims. These agreements regularly contain terms such as the exclusion of all implied warranties and the limitation of the availability of consequential or incidental damages. However, such provisions may not effectively protect us against claims and the attendant liabilities and costs associated with such claims. Accordingly, any such claim could negatively affect our business, operating results or financial condition.
The use of open-source software in our products may expose us to the risk of having to disclose the source code to our product, rendering our software no longer proprietary and reducing or eliminating its value.
Certain open-source software is licensed pursuant to license agreements that require a user who distributes the open-source software as a component of the user’s software to disclose publicly part or all of the source code to the user’s software. This effectively renders what was previously proprietary software open-source software. As competition in our markets increases, we must strive to be cost-effective in our product development activities. Many features we may wish to add to our products in the future may be available as open-source software, and our development team may wish to make use of this software to reduce development costs and speed up the development process. While we carefully monitor the use of all open-source software and try to ensure that no open-source software is used in such a way as to require us to disclose the source code to the related product, such use could inadvertently occur. Additionally, if a third party has incorporated certain types of open-source software into its software but has failed to disclose the presence of such open-source software, and we embed that third-party software into one or more of our products, we could, under certain circumstances, be required to disclose the source code to our product. This could have a material adverse effect on our business.
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The loss of licenses to use third-party software or the lack of support or enhancement of such software could adversely affect our business.
We currently depend upon a limited number of third-party software products. If such software products were not available, we might experience delays or increased costs in the development of our products. In certain instances, we rely on software products that we license from third parties, including software that is integrated with internally-developed software, and which is used in our products to perform key functions. These third-party software licenses may not continue to be available to us on commercially reasonable terms, and the related software may not continue to be appropriately supported, maintained, or enhanced by the licensors. The loss by us of the license to use, or the inability by licensors to support, maintain, and enhance any of such software, could result in increased costs or in delays or reductions in product shipments until equivalent software is developed or licensed and integrated with internally-developed software. Such increased costs or delays or reductions in product shipments could adversely affect our business.
Financial Risks
We need to continue to maintain an effective system of internal controls, in order to be able to report our financial results accurately and timely and prevent fraud.
Effective internal control is necessary for us to provide reliable financial reports and prevent fraud. We maintain a small accounting and reporting staff, concentrated in a few individuals. Any future weaknesses in our internal controls and procedures over financial reporting could result in material misstatements in our consolidated financial statements not being prevented or detected. We may experience difficulties or delays in completing remediation or may not be able to successfully remediate material weaknesses at all. Any material weakness or unsuccessful remediation could affect our ability to file periodic reports on a timely basis and investor confidence in the accuracy and completeness of our consolidated financial statements, which in turn could harm our business and have an adverse effect on our stock price and our ability to raise additional funds.
We may not be able to generate sufficient cash to service any indebtedness or contingent transaction consideration that we may incur from time to time, which could force us to sell assets, cease operations, or take other detrimental actions for our business.
Our ability to make scheduled payments on or to refinance any debt or contingent transaction obligations that we have or may incur depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and to certain financial, business, and other factors beyond our control. We currently have $2 million in principal amount of debt maturing in February of 2023. In addition, we have operated with a history of losses. For 2021, we had a net income of $1.4 million. For 2020, we had a net loss of $2.2 million, including a change in fair value of earnout liabilities of $1.6 million. We have an accumulated deficit of $21.6 million as of December 31, 2021. Our ability to meet our capital needs in the future will depend on many factors, including maintaining and enhancing our operating cash flow, successfully managing the transition of our recent acquisitions of Graphic Sciences and CEO Imaging Systems, Inc., successfully retaining and growing our client base in the midst of general economic uncertainty, and managing the continuing effects of the COVID-19 pandemic on our business. We cannot ensure that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on any indebtedness or the contingent transaction consideration.
If our cash flows and capital resources are at any time insufficient to fund our obligations, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital, restructure or refinance our indebtedness, or reduce or cease operations. There can be no assurance that additional capital or debt financing will be available to us at any time. Even if additional capital is available, we may not be able to obtain debt or equity financing on terms favorable to us. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to reduce or curtail our operations.
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The terms of our promissory notes will restrict our financing flexibility.
The terms of promissory notes we issued in 2020 contain standard negative covenants customary for transactions of this type. These negative covenants may preclude or restrict our ability to effect future debt and convertible debt financings without the prior approval of holders of the previous notes. The events of default are also customary for transactions of this type, including default in timely payment of principal or interest, failure to observe or perform any covenant or agreement contained in the convertible note and other transaction documents, the commencement of bankruptcy or insolvency proceedings, and failure to timely file Exchange Act filings.
If our estimates or judgments relating to our critical accounting policies are based on assumptions that change or prove to be incorrect, our operating results could fall below expectations of securities analysts and investors,
resulting in a decline in our stock price.
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, as provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates” in this Annual Report on Form 10-K, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our operating results may be adversely affected if our assumptions change or if actual circumstances differ from those in our assumptions, which could cause our operating results to fall below the expectations of securities analysts and investors, resulting in a decline in our stock price. Significant assumptions and estimates used in preparing our consolidated financial statements include those related to revenue recognition, deferred contract costs and commission expense, accounting for business combination, troubled debt restructuring and stock compensation.
The loss of a major customer or the failure to collect a large account receivable could negatively affect our results of operations and financial condition.
Revenues from a limited number of customers have accounted for a substantial percentage of our total revenues. Our two largest clients account for approximately 47% and 9%, and 47% and 8%, of our revenues for the years ending December 31, 2021 and 2020, respectively. For the years ended December 31, 2021, and 2020, government contracts represented approximately 62% and 64% of our net revenues, respectively. The loss of one of our clients or the loss of a meaningful percentage of government contracts could materially affect our business and operating results.
A significant downturn in our business may not be immediately reflected in our operating results because of the way we recognize revenue.
We recognize revenue from subscription agreements ratably over the terms of these agreements, which are typically one year. As a result, a significant portion of the revenue we report in each quarter is generated from customer agreements entered into during previous periods, which is reflected as deferred revenue on our balance sheet. Consequently, a decline in new or renewed subscriptions, or a downgrade of renewed subscriptions to less-expensive editions, in any one quarter may not be fully reflected in our revenue in that quarter, and may negatively affect our revenue in future quarters. If contracts having significant value expire and are not renewed or replaced at the beginning of a quarter or are downgraded, our revenue may decline significantly in that quarter and subsequent quarters.
Legal and Regulatory Risks
Our contracts with government clients subject us to risks including early termination, audits, investigations, sanctions, and penalties.
A significant portion of our revenues comes from contracts with state and local governments, and their respective agencies, which may terminate most of these contracts at any time, without cause. As discussed above, government contracts constitute a significant portion of our total revenues. At this time, governments and their agencies are operating under increased pressure to reduce spending. Contracts at the state and local levels are subject to government funding authorizations. Additionally, government contracts are generally subject to audits and investigations that could result in various civil and criminal penalties and administrative sanctions, including termination of contracts, refund of a portion of fees received, forfeiture of profits, suspension of payments, fines and suspensions, or debarment from future government business.
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We are subject to the reporting requirements of federal securities laws, causing us to make significant compliance-related expenditures that may divert resources from other projects, thus impairing its ability to grow.
We are subject to the information and reporting requirements of the Exchange Act, and other federal securities laws, including the Sarbanes-Oxley Act. The costs of preparing and filing annual and quarterly reports, proxy statements and other information with the Commission and furnishing audited reports to stockholders causes our expenses to be higher than most other similarly-sized companies that are privately held. As a public company, we expect these rules and regulations to continue to keep our compliance costs high in 2022 and beyond, and to make certain activities more time-consuming and costly. As a public company, we also expect that these rules and regulations may make it more difficult and expensive for us to obtain director and officer liability insurance in the future, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers.
The elimination of monetary liability against our directors, officers, agents and employees under Nevada law, and the existence of indemnification rights to such persons, may result in substantial expenditures by us and may discourage lawsuits against our directors, officers, agents and employees.
Our articles of incorporation and bylaws contain provisions permitting us to eliminate the personal liability of our directors, officers, agents and employees to the Company and our stockholders for damages for breach of fiduciary duty to the extent provided by Nevada law. We may also have contractual indemnification obligations under our employment agreements with our officers. The foregoing indemnification obligations could result in our incurring substantial expenditures to cover the cost of settlement or damage awards against directors, officers, agents and employees, which we may be unable to recoup. These provisions and resultant costs may also discourage our Company from bringing a lawsuit against certain individuals for breaches of their fiduciary duties, and may similarly discourage the filing of derivative litigation by our stockholders against our directors, officers, agents and employees even though such actions, if successful, might otherwise benefit us and our stockholders.
Security breaches may harm our business.
Any security breaches, unauthorized access, unauthorized usage, virus or similar breach or disruption could result in loss of confidential information, damage to our reputation, early termination of our contracts, litigation, regulatory investigations or other liabilities. Our clients may use our products and services to handle personally identifiable information, sensitive personal information, protected health information, or information that is otherwise confidential. If our security measures or those of our third-party data centers are breached as a result of third-party action, employee error, malfeasance or otherwise and, as a result, someone obtains unauthorized access to customer data, our reputation could be damaged, our business may suffer and we could incur significant liability.
The United States has laws and regulations relating to data privacy, security, and retention and transmission of information. We have certain measures to protect our information systems against unauthorized access and disclosure of our confidential information and confidential information belonging to our customers. We have policies and procedures in place dealing with data security and records retention. However, there is no assurance that the security measures we have put in place will be effective in every case.
There has been an increase in the number of private privacy-related lawsuits filed against companies in recent years. There has also been an increase in the incidence of data breaches in public companies operating in the US, resulting in unfavorable publicity and high amounts of damages against the breached companies, including the cost of obtaining credit monitoring services for all persons whose information was compromised. In addition, we are unable to predict what additional legislation or regulation in the area of privacy of personal information could be enacted and what effect that could have on our operations and business. Concerns about our practices with regard to the collection, use, disclosure, or security of personal information or other privacy-related matters, even if unfounded and even if we are in compliance with applicable laws, could damage our reputation and harm our business.
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Breaches, or perceived breaches, in security could result in a negative impact for us and for our customers, potentially affecting our business, assets, revenues, brand, and reputation, and resulting in penalties, fines, litigation, and other potential liabilities, in each case depending upon the nature of the information disclosed. These risks to our business may increase as we expand the number of products and services we offer.
We may become involved in litigation that may materially adversely affect us.
From time to time in the ordinary course of our business, we may become involved in various legal proceedings, including commercial, product liability, employment, class action, and other litigation and claims, as well as governmental and other regulatory investigations and proceedings. We provide business management solutions that we believe are critical to the operations of our customers’ businesses and provide benefits that may be difficult to quantify. Any failure of a customer’s system installed by us or of the services offered by us could result in a claim for substantial damages against us, regardless of our responsibility for the failure. Although we attempt to limit our contractual liability for damages resulting from negligent acts, errors, mistakes, or omissions in rendering our services, we cannot assure you that the limitations on liability we include in our agreements will be enforceable in all cases, or that those limitations on liability will otherwise protect us from liability for damages. There can be no assurance that any insurance coverage we may have in place will be adequate or that current coverages will remain available at acceptable costs. Such matters can be time-consuming, divert management’s attention and resources, and cause us to incur significant expenses. Furthermore, because litigation is inherently unpredictable, the results of any such actions may have a material adverse effect on our business, operating results, or financial condition.
Any claim that we infringe on a third party’s intellectual property could materially increase costs and materially harm our ability to generate future revenues and profits.
Claims of infringement are becoming increasingly common as the software industry develops and as related legal protections, including patents are applied to software products. Although we are not aware of any infringement on the rights of third parties, third parties may assert infringement claims against us in the future. Although most of our technology is proprietary in nature, we do include certain third-party software in our products. In these cases, this software is licensed from the entity holding the intellectual property rights. Although we believe that we have secured proper licenses for all third-party software that is integrated into our products, third parties may assert infringement claims against us in the future. The third parties making these assertions and claims may include non-practicing entities (known as “patent trolls”) whose business model is to obtain patent-licensing revenues from operating companies, such as ours. Any such assertion, regardless of merit, may result in litigation or may require us to obtain a license for the intellectual property rights of third parties. Such licenses may not be available, or they may not be available on reasonable terms. In addition, such litigation could be time-consuming, disruptive to our ability to generate revenues or enter into new market opportunities, and may result in significantly increased costs as a result of our defense against those claims or our attempt to license the intellectual property rights or rework our products to avoid infringement of third-party rights to ensure they comply with judicial decisions. Our agreements with our partners and end-users typically contain provisions that require us to indemnify them, with certain limitations on the total amount of such indemnification, for damages sustained by them as a result of any infringement claims involving our products. Any of the foregoing results of an infringement claim could have a significant adverse impact on our business and operating results, as well as our ability to generate future revenues and profits.
Risks Relating to Our Common Stock
We may have to issue additional securities at prices which may result in substantial dilution to our stockholders.
If we raise additional funds through the sale of equity or convertible debt, our current stockholders’ percentage ownership will be reduced. In addition, these transactions may dilute the value of ordinary shares outstanding. We may have to issue securities that may have rights, preferences, and privileges senior to our common stock. We cannot provide assurance that we will be able to raise additional funds on terms acceptable to us, if at all. If future financing is not available or is not available on acceptable terms, we may not be able to fund our future needs, which would have a material adverse effect on our business plans, prospects, results of operations, and financial condition.
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Shares of our common stock that have not been registered under the Securities Act, regardless of whether such shares are restricted or unrestricted, are subject to resale restrictions imposed by Rule 144.
Pursuant to Rule 144 of the Securities Act of 1933, as amended (the “Securities Act”), a “shell company” is defined as a company that has no or nominal operations, and either no or nominal assets, assets consisting solely of cash and cash equivalents, or assets consisting of any amount of cash and cash equivalents and nominal other assets. As such, we were a shell company pursuant to Rule 144 prior to 2012. Even though we are no longer a shell company, investors may be reluctant to invest in our securities because securities of a former shell company may not be as freely tradable as securities of companies that are not former “shell companies.” In addition, since we are a former shell company, shareholders with restricted securities cannot rely upon Rule 144 for sales of restricted securities in the event that we are not current in our filing obligations under the Exchange Act.
Our shares are quoted on the OTCQB and are subject to limited trading, a high degree of volatility, and liquidity risk.
Our common stock is currently quoted on the OTCQB. Shares of our common stock have had very limited and sporadic trading in the past. As such, we believe our stock price to be more volatile and the share liquidity characteristics to be of higher risk than if we were listed on one of the national exchanges. Due to this volatility, our stock price as quoted by the OTCQB may not reflect an actual or perceived value of our common stock. In the past, several days have passed between trades in our common stock, meaning that at any given time, there may be few or no investors interested in purchasing our common stock at or near ask prices. This limited trading, volatility, and liquidity risk is attributable to the fact that we are a small company relatively unknown to stock analysts, brokers, and institutional or other investors. Finally, if our stock were no longer quoted on the OTCQB, the ability to trade our stock would become even more limited and investors might not be able to sell their shares. Consequently, investors must be prepared to bear the economic risk of holding the securities for an indefinite period of time. There is no assurance that a more active market for our common stock will develop or be sustained, which limits the liquidity of our common stock, and could have a material adverse effect on the price of our common stock and our ability to raise capital.
The market price of our common stock may limit the appeal of certain alternative compensation structures that we might offer to the high-quality employees we seek to attract and retain.
If the market price of our common stock performs poorly, such performance may adversely affect our ability to retain or attract critical personnel. For example, if we were to offer options to purchase shares of our common stock as part of an employee’s compensation package, the attractiveness of such a compensation package would be highly dependent upon the performance of our common stock.
In addition, any changes made to any of our compensation practices which are made necessary by governmental regulations or competitive pressures could adversely affect our ability to retain and motivate existing personnel and recruit new personnel. For example, any limit to total compensation which may be prescribed by the government, or any significant increases in personal income tax levels in the United States, may hurt our ability to attract or retain our executive officers or other employees whose efforts are vital to our success.
Shares eligible for future sale may adversely affect the market price of our common stock.
From time to time, certain of our stockholders may be eligible to sell all or some of their shares of common stock by means of ordinary brokerage transactions in the open market pursuant to Rule 144 of the Securities Act, subject to certain limitations. Any substantial sale of our common stock pursuant to Rule 144 may have an adverse effect on the market price of our common stock.
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The price of our common stock may fluctuate significantly and lead to losses by stockholders.
The common stock of public companies can experience extreme price and volume fluctuations. These fluctuations often have been unrelated or out of proportion to the operating performance of such companies. We expect our stock price to be similarly volatile. These broad market fluctuations may continue and could harm our stock price. Any negative change in the public’s perception of the prospects of our business or companies in our industry could also depress our stock price, regardless of our actual results. Factors affecting the trading price of our common stock may include:
| ● | Variations in operating results; | |
| ● | Announcements of technological innovations, new products or product enhancements, strategic alliances, or significant agreements by us or by competitors; | |
| ● | Recruitment or departure of key personnel; | |
| ● | Litigation, legislation, regulation, or technological developments that adversely affect our business; and | |
| ● | Market conditions in our industry, the industries of our customers, and the economy as a whole. |
Further, the stock market in general, and securities of smaller companies in particular, can experience extreme price and volume fluctuations. Continued market fluctuations could result in extreme volatility in the price of our common stock, which could cause a decline in the value of our common stock. You should also be aware that price volatility might be worse if the trading volume of our common stock is low. Occasionally, periods of volatility in the market price of a company’s securities may lead to the institution of securities class action litigation against a company. Due to the volatility of our stock price, we may be the target of such securities litigation in the future. Such legal action could result in substantial costs to defend our interests and a diversion of management’s attention and resources, each of which would have a material adverse effect on our business and operating results.
FINRA sales practice requirements may limit a shareholder’s ability to buy and sell our stock.
The Financial Industry Regulatory Authority has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds for believing that the investment is suitable for that customer. Prior to recommending speculative, low-priced securities to their non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial status, tax status, investment objectives, and other information. Under interpretations of these rules, FINRA believes that there is a high probability that speculative, low-priced securities will not be suitable for at least some customers. The FINRA requirements make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit your ability to buy and sell our stock and have an adverse effect on the market for our shares.
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We do not expect to pay any dividends on our common stock for the foreseeable future.
We do not anticipate that we will pay any cash dividends to holders of our common stock in the foreseeable future. Instead, we plan to retain any earnings to maintain and expand our existing operations. The declaration, payment, and amount of any future dividends, if any, will be made at the discretion of our board of directors, and will depend upon, among other things, the results of our operations, cash flows and financial condition, operating and capital requirements, and other factors that the board of directors considers relevant. We currently are subject to loan covenants that would require consent from our lenders in order to pay any dividends prior to repayment of certain outstanding loans. In addition, any future credit facilities we enter into may contain terms prohibiting or limiting the amount of dividends that may be declared or paid on our common stock.
General Risks
Global economic conditions and uncertainty are likely to adversely affect our operating results or financing in ways that are hard to predict or to defend against.
Our overall performance depends on economic conditions. The United States’ and world economies are currently suffering from uncertainty, inflation, volatility, disruption, and other adverse conditions, primarily caused by global sanctions on Russia and the current outbreak of and containment strategies for the coronavirus disease (COVID-19), and those conditions will continue to adversely impact the business community and financial markets for some time. Moreover, instability in the global economy affects countries, including the United States, with varying levels of severity, which makes the impact on our business complex and unpredictable. During adverse economic conditions, many customers delay or reduce technology purchases. Contract negotiations are likely to become more protracted, or conditions could result in reductions in sales of our products, longer sales cycles, pressure on our margins, difficulties in collection of accounts receivable or delayed payments, increased default risks associated with our accounts receivable, slower adoption of new technologies, and increased price competition. In addition, a curtailment of the United States and global credit markets could adversely impact our ability to complete sales of our products and services, including maintenance and support renewals. Any of these prolonged events, are likely to cause a curtailment in government or corporate spending and delay or decrease customer purchases, and adversely affect our business, financial condition, and results of operations.
Businesses and industries throughout the world are very tightly connected to each other. Thus, financial developments seemingly unrelated to us or to our industry may adversely affect us over the course of time. For example, credit contraction in financial markets may hurt our ability to access credit in the event that we require significant access to credit for other reasons. Similarly, volatility in our stock price could hurt our ability to raise capital for the financing of acquisitions or other reasons. Any of these events, or any other events caused by the current turmoil in domestic or international financial markets, may have a material adverse effect on our business, operating results, and financial condition.
Any disruption of service at data centers that house our equipment and deliver our solutions could harm our business.
Our users expect to be able to access our solutions 24-hours a day, seven-days a week, without interruption. We have computing and communications hardware operations located in data centers owned and operated by third parties. We do not control the operation of these data centers and we are therefore vulnerable to any security breaches, power outages or other issues the data centers experience. We expect that we will experience interruptions, delays and outages in service and availability from time to time.
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The owners of our data centers have no obligation to renew agreements with us on commercially reasonable terms, or at all. If we are unable to renew these agreements on commercially reasonable terms, we may be required to move to new data centers, and we may incur significant costs and possible service interruption in connection with doing so.
These data centers are vulnerable to damage or interruption from human error, malicious acts, earthquakes, hurricanes, tornados, floods, fires, war, terrorist attacks, power losses, hardware failures, systems failures, telecommunications failures and similar events. The occurrence of a natural disaster or an act of terrorism, vandalism or other misconduct, or a decision to close the data centers without adequate notice or other unanticipated problems could result in lengthy interruptions in availability of our solutions.
Any changes in third-party service levels at our data centers or any errors, defects, disruptions or other performance problems with our solutions could harm our reputation and may damage our customers’ businesses. Interruptions in availability of our solutions might reduce our revenue, cause us to issue credits to customers, subject us to potential liability, and cause customers to terminate their subscriptions or decide not to renew their subscriptions with us.
If we are not able to attract and retain top employees, our ability to compete may be harmed.
Our performance is substantially dependent on the performance of our executive officers and key employees. The loss of the services of any of our executive officers or other key employees could significantly harm our business. Our success is also highly dependent upon our continuing ability to identify, hire, train, retain, and motivate highly-qualified management, technical, sales, and marketing personnel. In particular, the recruitment of top software developers and experienced salespeople remains critical to our success. Competition for such people is intense, substantial, and continuous, especially in the current environment of labor shortage, and we may not be able to attract, integrate, or retain highly-qualified technical, sales, or managerial personnel in the future. In addition, in our effort to attract and retain critical personnel, we may experience increased compensation costs that are not offset by either improved productivity or higher prices for our products or services.
Our products rely on the stability of infrastructure software that, if not stable, could negatively impact the effectiveness or reliability of our products, resulting in harm to our reputation and business.
Our development of internet and intranet applications depends and will continue to depend on the stability, functionality, and scalability of the infrastructure software of the underlying internet and intranet. If weaknesses in such infrastructure exist, we may not be able to correct or compensate for such weaknesses. If we are unable to address weaknesses resulting from problems in the infrastructure software such that our products do not meet customer needs or expectations, our reputation and, consequently, our business may be significantly harmed.
In addition, our business and operations are highly automated, and a disruption or failure of our systems may delay our ability to complete sales and to provide services. A major disaster or other catastrophic event that results in the destruction or disruption of any of our critical business or information technology systems could severely affect our ability to conduct normal business operations, which may materially and adversely affect our future operating results.
Failure to protect our intellectual property could harm our ability to compete effectively.
We are highly dependent on our ability to protect our proprietary technology. We rely on a combination of intellectual property laws, trademark laws, as well as non-disclosure agreements and other contractual provisions to establish and maintain our proprietary rights. We intend to protect our rights vigorously; however, there can be no assurance that these measures will be successful. Enforcement of our intellectual property rights may be difficult or cost prohibitive. While U.S. copyright laws may provide meaningful protection against unauthorized duplication of software, software piracy has been, and is expected to be, a persistent problem for the software industry, and piracy of our products represents a loss of revenue to us. Certain of our license arrangements may require us to make a limited confidential disclosure of portions of the source code for our products, or to place such source code into escrow for the protection of another party. Although we will take considerable precautions, unauthorized third parties, including our competitors, may be able to: (i) copy certain portions of our products, or (ii) reverse engineer or obtain and use information that we regard as proprietary. Also, our competitors could independently develop technologies that are perceived to be substantially equivalent or superior to our technologies. Our competitive position may be adversely affected by our possible inability to effectively protect our intellectual property.
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ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
We lease an office facility measuring approximately 6,000 square feet in Columbus, Ohio, for our headquarters, chief executive offices, and conducting the operations of Intellinetics Ohio. 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 owns and operates an extensive collection of the specialized equipment necessary for scanning images or converting microfilm to digital images. Graphic Sciences’ logistics department includes a fleet of four leased vehicles for pickup and delivery of client materials. Graphic Sciences also has the ability to provide on-site capture operations for clients needing such services.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we are subject to ordinary routine litigation and claims incidental to our business. We are not currently involved in any legal proceedings that we believe to be material.
ITEM 4. MINE SAFETY DISCLOSURE
Not applicable.
Part II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is available for quotation on the OTCQB Venture Market under the symbol “INLX.” As such, any over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission and may not necessarily represent actual transactions.
Holders
As of March 21, 2022 we had 75 stockholders of record. Such number of record stockholders does not include additional stockholders or other beneficial owners whose shares are held in street or nominee name by banks, brokerage firms, and other institutions on their behalf.
Dividends
Dividends may be declared and paid out of legally available funds at the discretion of our board of directors (“Board of Directors,” or “Board”). No dividends on our common stock were paid in either of the two most recent fiscal years, and we do not anticipate paying dividends on our common stock in the foreseeable future. The timing, amount and form of dividends, if any, will depend on, among other things, our results of operations, financial condition, cash requirements and other factors deemed relevant by our Board of Directors. We currently intend to utilize all available funds to develop our business.
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Unregistered Securities Issuances in Fiscal Year 2021
There have been no unregistered securities issuances in Fiscal Year 2021 that have not previously been disclosed in Current Reports on 8-K or Forms 10-Q.
Issuer Purchase of Securities
None.
ITEM 6. [RESERVED]
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following management’s discussion and analysis of financial conditions and results of operations for the fiscal years ended December 31, 2021, and 2020 should be read in conjunction with our consolidated financial statements and the notes to those consolidated financial statements that are included elsewhere in this Annual Report on Form 10-K. In this Annual Report, we sometimes refer to the twelve month period ended December 31, 2021 as 2021, and to the twelve month period ended December 31, 2020 as 2020.
We caution you that any forward-looking statements included in this section are not guarantees of future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond our control, which may influence the accuracy of the statements and the projections upon which the statements are based. Factors that may affect our results include, but are not limited to, the risk factors that are included in Part I, Item 1A of this report.
Company Overview
We are a document services and software solutions company serving both the small-to-medium business and governmental sectors with their digital transformation and process automation initiatives. During 2020, we made two significant business acquisitions that have significantly impacted our financial operations and grown our business operations:
| ● | Graphic Sciences, on March 2, 2020, and | |
| ● | CEO Image, on April 21, 2020. |
For further information about these acquisitions, please see Note 5 to our consolidated financial statements included in Item 8, Part I, Item 1 of this Annual Report.
Our products and services are provided through two reporting segments: Document Management and Document Conversion. Our Document Management segment, which includes our CEO Image acquisition, consists primarily of solutions involving our software platform, allowing customers to capture and manage their documents across operations such as scanned hard-copy documents and digital documents including those from Microsoft Office 365, digital images, audio, video and emails. Our Document Conversion segment, which includes and primarily consists of our Graphic Sciences acquisition, provides assistance to customers as a part of their overall document strategy to convert documents from one medium to another, predominantly paper to digital, including migration to our software solutions, as well as long-term storage and retrieval services. Our solutions create value for customers by making it easy to connect business-critical documents to the people 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.
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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.
How We Evaluate our Business Performance and Opportunities
The major qualitative and quantitative factors we consider in the evaluation of our operating results include the following:
| ● | With respect to our Document Management segment, including the solutions recently acquired from CEO Image, our current strategy is to focus on cloud-based delivery of our software products. Historically, our revenues have mostly resulted from premise-based software licensing revenue and professional services revenue. Our observation of industry trends leads us to anticipate that cloud-based delivery will become our principal software business and a primary source of revenues for us, and we are seeing our customers migrate to cloud-based services. When we evaluate our results, we assess whether our cloud-based software revenues are increasing, relative to prior periods and relative to other sources of revenue. | |
| ● | With respect to our Document Conversion segment, our strategy is to maintain and grow our core document conversion, storage, and retrieval business, while simultaneously leveraging our software products and services to provide more attractive total digital transformation solutions for the customers of our Document Conversion segment. Accordingly, when we evaluate our results for Document Conversion, we will assess whether our revenues increase with respect to the segment’s services, relative to prior periods, but we will also be assessing whether Document Conversion customers begin to make purchases of other products or services. | |
| ● | We are focused upon sales of our document services and software solutions through resellers and directly to our customers, with a further focus on select vertical markets. We assess whether our sales resulting from relationships with resellers are increasing, relative to prior periods and relative to direct sales to customers, and whether reseller or direct efforts offer the best opportunities for growth in our targeted vertical markets. | |
| ● | Our customer engagements often involve the development and licensing of customer-specific document solutions and related consulting and software maintenance services or tailoring a document conversion program to meet customer requirements. When analyzing whether to undertake a particular customer engagement, we often consider the following factors as part of our overall strategy to grow the business: (i) the profit margins the project may yield, and (ii) whether the project would help to develop new product and service features that we could integrate into our suite of products, resulting in an overall product portfolio that better aligns with the needs of our target customers. | |
| ● | Our software sales cycle averages 1-2 months; however, large projects can be longer, lasting 3-6 months. When a software project begins, we generally perform pre-installation assessment, project scoping, and implementation consulting. On the other hand, our document conversion services typically contain a very short sales cycle, but we can have a backlog of work orders not yet processed. Therefore, when we plan our business and evaluate our results, we consider the revenue we expect to recognize from projects in our late-stage software pipeline and in our document conversion services backlog queue. | |
| ● | We monitor our costs and capital needs to ensure efficiency as well as an adequate level of support for our business plan. | |
| ● | While we are constantly focused on organic growth, we also continually monitor potential acquisitions of complementary solutions and expertise that are consistent with our core business. We look for acquisitions that can add value for our customers and are expected to be accretive to our financial performance. |
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Executive Overview of Results
The biggest factors in the changes in our results of operations during 2021 compared to 2020 were our acquisitions of Graphic Sciences on March 2, 2020 and, to a much lesser extent, CEO Image on April 21, 2020, and the impact of the COVID-19 stay-at-home orders in Michigan and Ohio during most of the second quarter 2020 which did not fully resume in the third quarter 2020. Our results for 2021 include the results of Graphic Sciences and CEO Image operations for the full period, while our twelve month period 2020 include only approximately ten month’s results of Graphic Sciences operations, and eight month’s results of CEO Image. We faced challenges in the fourth quarter 2021 due to the Omicron variant of COVID-19 and general inflationary pressures, but this did not outweigh our strong performance for 2021 year-over-year.
Below are our key financial results for 2021 (consolidated unless otherwise noted):
| ● | Revenues were $11,460,265, representing revenue growth of 39% year over year. |
| ● | Cost of revenues was $4,517,283. |
| ● | Operating expenses (excluding cost of revenues) were $5,977,994. |
| ● | Income from operations was $964,988. |
| ● | Net income was $1,357,951 with basic and diluted net income per share of $0.48 and $0.44, respectively, including $845,083 gain on PPP loan forgiveness. |
| ● | Operating cash flow was $1,389,966. |
| ● | Capital expenditures were $590,485. |
| ● | As of December 31, 2021, we had 114 employees, including 13 part-time employees. |
Financial Impact of COVID-19
The spread of the COVID-19 pandemic and developments surrounding this global pandemic have had, and we expect will continue to have, a significant impact on our business, operations, financial condition and results of operations.
For approximately three months beginning in late March 2020, our Graphic Sciences business operations, which constitute a majority of our professional services revenues, were substantially reduced while the State of Michigan’s stay-at-home order was in effect, during which period we were only able to process work orders deemed “essential” by the State of Michigan. Since the initial shutdowns, our level of customer engagement in Document Conversion has varied with the ebb and flow of the initial virus and the subsequent variants and outbreaks. In particular, we experienced slow-downs in workflow and corresponding revenues during the fourth quarter of 2021 due to the Omicron variant outbreak. 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 decrease in the volume of work orders for our Document Conversion segment. We are seeing inconsistent demand in certain other areas of our operations, even though those operations are still currently open for business with mostly remote staff.
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Looking ahead, the ongoing impact of COVID-19 on our business continues to evolve and be unpredictable. The majority of our Ohio employees continue to work remotely. Many of our clients operate in a variety of other states, which had differing time periods in which their operations have been, currently or may in the future be restricted due to COVID-19. Our business, financial condition and results of operations could be affected by future outbreaks of COVID-19 generally or in our facilities. We are also likely to be impacted further by decreased customer demand and/or subscription terminations as a result of a reduction in customer spending (especially customers that are state and local governmental entities) or as a result of government-imposed restrictions on businesses. In particular, governmental budget reductions in the State of Michigan, our largest customer, may have a material adverse effect on our business. The extent of the impact will depend on a number of factors, including the duration and severity of the outbreak(s); the uneven impact to certain industries; vaccination rates; the effect that any governmental vaccine mandates might have on our ability to attract and retain talent; the macroeconomic impact of government measures to contain the spread of the virus and related government stimulus measures. To address the potential impact to our business, we have engaged, and continue to assess and engage, in aggressive efforts to reduce expenses and preserve cash flow in order to address the effects of COVID-19 on our business, operations and results. Additionally, we have instituted safe distancing practices and additional cleaning procedures for all our company offices, as well as established work-from-home policies wherever feasible, in order to prevent or mitigate future outbreaks and disruptions to our business. At the same time, we believe the current environment is accelerating digital transformation and we remain focused on innovating and investing in the services we offer to our customers. Accordingly, the ongoing impact of COVID-19 and the extent of these measures we may implement have and are likely to continue to have a material impact on our financial results.
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 years ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Revenues | ||||||||
| Document Management | $ | 3,089,669 | $ | 2,816,848 | ||||
| Document Conversion | 8,370,596 | 5,436,543 | ||||||
| Total revenues | $ | 11,460,265 | $ | 8,253,391 | ||||
| Gross profit | ||||||||
| Document Management | $ | 2,542,135 | $ | 2,160,807 | ||||
| Document Conversion | 4,400,847 | 2,829,931 | ||||||
| Total gross profit | $ | 6,942,982 | $ | 4,990,738 | ||||
The following table sets forth our revenues by revenue source for the periods indicated:
| For the years ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Revenues: | ||||||||
| Sale of software | $ | 78,450 | $ | 194,787 | ||||
| Software as a service | 1,441,683 | 1,055,016 | ||||||
| Software maintenance services | 1,350,470 | 1,257,446 | ||||||
| Professional services | 7,468,716 | 5,007,617 | ||||||
| Storage and retrieval services | 1,120,946 | 738,525 | ||||||
| Total revenues | $ | 11,460,265 | $ | 8,253,391 | ||||
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The increase in total revenues for 2021 is driven primarily by two factors: 2020 COVID-19 impact and acquisitions. The COVID-19 stay-at-home orders in Michigan and Ohio, which were in place for the majority of the second quarter 2020, significantly affected our professional services revenues for that quarter. We estimate the impact of COVID-19 on our Document Conversion segment to be approximately $655,000 reduced revenue for the second quarter 2020. The remaining increase in total revenues for 2021 is driven primarily by the acquisition of our Graphic Sciences subsidiary and the associated expansion of our revenues from professional services and the addition of storage and retrieval services. Graphic Sciences, which was acquired towards the end of the first quarter 2020, accounted for $1,843,221 of our revenues in the first quarter 2021 compared to $556,254 in the first quarter 2020, constituting 91% of the increase in revenues. In addition, the CEO Image business line that we acquired after the first quarter 2020 accounted for $132,605 of our first quarter revenues, or 9% of the total increase.
Sale of Software Revenues
Revenues from the sale of software principally consist of sales of additional or upgraded software licenses and applications to existing customers and resellers. Revenues from the sale of software, which are reported as part of our Document Management segment decreased by $116,337, or 60% during 2021 compared to 2020.
This decrease was due to timing of large direct sales projects, with unfavorable comparisons to the high project volume the same periods in 2020. We expect the volatility of this revenue line item to continue as project timing is unpredictable and we expect the frequency of on-premise software solution sales to decrease over time.
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 $386,667, or 37% in 2021 compared to 2020. This increase was primarily the result of most new customers choosing a cloud-based solution, as well as expanded data storage, user seats, and hosting fees for existing customers.
Software Maintenance Services Revenues
Software maintenance services revenues consist of fees for post-contract customer support services provided to license (premise-based) holders through support and maintenance agreements. These agreements allow our customers to receive technical support, enhancements and upgrades to new versions of our software products when and if available. A substantial portion of these revenues were generated from renewals of maintenance agreements, which typically run on a year-to-year basis. Revenues from the sale of software maintenance services, which are reported as part of our Document Management segment, increased by $93,024, or 7%, in 2021 compared to 2020. This increase was primarily the result of maintenance and support agreements acquired with CEO Image, augmented by expansion of services with existing customers and price increases more than offsetting normal attrition.
Professional Services Revenues
Professional services revenues consist of revenues from document scanning and conversion services, consulting, discovery, training, and advisory services to assist customers with document management needs, as well as repair and maintenance services for customer equipment. These revenues include arrangements that do not involve the sale of software. Revenues from our professional services offerings were significantly enhanced with our acquisition of Graphic Sciences. Of our professional services revenues during 2021, $7,249,650 was derived from our Document Conversion operations and $219,066 was derived from our Document Management operations. Our overall professional services revenues increased by $2,461,099, or 49%, in 2021 compared to 2020. This increase is largely the net result of two key factors limiting professional service sales during 2020: the acquisition of Graphic Sciences late in the first quarter 2021 and the COVID-19 stay-at-home orders. The increase is also due to a solid pipeline and favorable mix of project work during 2021.
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Storage and Retrieval Services Revenues
Graphic Sciences provides document storage and retrieval services to customers, primarily in Michigan. Revenues from storage and retrieval services, which are reported as part of our Document Conversion segment, increased by $382,421, or 52%, during 2021 compared to 2020. This increase was the result of a contract extension, including improved pricing, with our largest storage and retrieval customer, as well as unusually high project work including shredding of documents approved for destruction, and also the timing of the acquisition of Graphic Sciences in March 2020.
Costs of Revenues and Gross Profits
The following table sets forth our cost of revenues, by revenue source, for the periods indicated:
| For the years ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Cost of revenues: | ||||||||
| Sale of software | $ | 14,828 | $ | 56,664 | ||||
| Software as a service | 333,001 | 273,368 | ||||||
| Software maintenance services | 81,641 | 159,122 | ||||||
| Professional services | 3,709,348 | 2,553,053 | ||||||
| Storage and retrieval services | 378,465 | 220,446 | ||||||
| Total cost of revenues | $ | 4,517,283 | $ | 3,262,653 | ||||
The following table sets forth our cost of revenues by reportable segment for the periods indicated:
| For the years ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Cost of revenues by segment | ||||||||
| Document Management | $ | 547,534 | $ | 656,041 | ||||
| Document Conversion | 3,969,749 | 2,606,612 | ||||||
| Total cost of revenues | $ | 4,517,283 | $ | 3,262,653 | ||||
Our total cost of revenues increased by $1,254,630, or 38%, during 2021 over 2020 primarily due to the corresponding increase in revenues for professional services and storage and retrieval services. The increase was also due to the acquisition of Graphic Sciences at the end of the first quarter 2020 and the 2020 COVID-19 stay-at-home orders, plus to a lesser degree, the acquisition of CEO Image in April 2020. Our cost of revenues for our Document Management segment decreased $108,507, or 17%, in 2021 compared to 2020 primarily due to more efficient execution of the software maintenance services in that segment as well as generally more standardized solutions sales. Our cost of revenues for our Document Conversion segment increased by $1,363,137, or 52%, during 2021 compared to 2020 due to the acquisition of Graphic Sciences at the end of the first quarter 2020 and corresponding sales growth in that segment.
Our overall gross profit increased to 61% for 2021 from 60% for 2020. Strong margin professional services projects as well as margin improvements software-related revenue sources were partially offset by an increase in the mix of professional services revenue driving a decrease in gross margin.
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. During 2021, cost of software revenues decreased by $41,836, or 74%, from 2020, due to the decrease in revenues and implementations. Our gross margin for software revenues increased to 81% from 71% in 2020. The improved 2021 margins were driven by license expansions and similar favorable solutions with lesser costs to deliver the solution.
| 26 |
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 increased by $59,633, or 22%, during 2021 over 2020. This increase in the cost of SaaS was less than the increase in associated SaaS revenues, so our gross margin increased to 77% in 2021 compared to 74% during 2020, as a result of more standard projects and scaling of hosting infrastructure.
Cost of Software Maintenance Services
Cost of software maintenance services consists primarily of technical support personnel and related costs. Cost of software maintenance services decreased by $77,481, or 49%, in 2021 over 2020, due primarily to reduced support activity, especially compared to the unusually high support volumes in first and third quarter 2020. As a result, our gross margin for software maintenance services increased to 94% in 2021 compared to 87% in 2020.
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 increased in 2021 by $1,156,295, or 45%, over 2020, following the increased revenue volume primarily due to the acquisition of Graphic Sciences late in the first quarter 2020 and the 2020 COVID-19 stay-at-home orders. As a result, our gross margin for professional services increased to 50% during 2021 compared to 49% in 2020. Gross margins related to professional services may vary widely, depending upon the nature of the projects completed in a period, driven by the amount of labor it takes to complete a project.
Cost of Storage and Retrieval Services
Cost of storage and retrieval services consists primarily of compensation for employees performing the document storage and retrieval services, including logistics, provided by Graphic Sciences. Cost of storage and retrieval services increased by $158,019, or 72%, during 2021 compared to 2020, due to additional labor costs associated with our 2021 warehouse consolidation, which began in the third quarter, as well as costs for additional project work including shredding and the inclusion of storage and retrieval services during the entire period of the first quarter 2021 compared to approximately one full month during the first quarter 2020. Gross margins for our storage and retrieval services, which exclude the cost of facilities rental, maintenance, and related overheads, decreased to 66% during twelve month period 2021 compared to 70% in 2020 primarily as a result of increased use of subcontractors for certain projects, including shredding, labor associated with consolidating warehouses in 2021, and expanded services offered to customers.
Operating Expenses
The following table sets forth our operating expenses for the periods indicated:
For the years ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Operating expenses: | ||||||||
| General and administrative | $ | 4,044,296 | $ | 3,499,440 | ||||
| Change in fair value of earnout liabilities | 141,414 | 1,554,800 | ||||||
| Significant transaction costs | - | 636,440 | ||||||
| Sales and marketing | 1,378,352 | 1,041,367 | ||||||
| Depreciation and amortization | 413,932 | 296,935 | ||||||
| Total operating expenses | $ | 5,977,994 | $ | 7,028,982 | ||||
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General and Administrative Expenses
General and administrative expenses increased in 2021 by $544,856, or 16%, over 2020, principally related to the full year addition of Graphic Sciences expenses combined with the impact of certain furloughed hourly workers and management salary reductions in 2020. This was primarily reflected in our Document Conversion segment, in which our general and administrative expenses increased to $2,434,279 in 2021 from $1,990,342 in 2020. In our Document Management segment, our general and administrative expenses decreased to $1,610,017 in 2021 compared to $1,818,184 in 2020. Overall increases were due to the impacts of full year of Graphic Sciences and CEO plus reinstated full management salaries in 2021, partially offset by decreased legal and accounting professional fees. Increased sharing of public company costs with the increased Document Conversion segment decreased those expenses in our Document Management segment.
Change in Fair Value of Earnout Liabilities
Improved gross margin performance at Graphic Science during the first quarter 2021 resulted in an adjustment to fair value of earnout liabilities of $69,950. Improved revenue performance at CEO during the second quarter resulted in an adjustment to fair value of earnout liabilities of $7,261. Further improvements in actual and forecast gross margin and revenue performance drove an adjustment in fair value of during the fourth quarter of $53,426 and $10,777 for Graphic Sciences and CEO, respectively, totaling $141,414 for 2021. Adjustments to fair value of earnout liabilities were $1,554,800 during 2020, comprised of $1,423,800 for Graphic Sciences and $131,000 for CEO Image. The fair value adjustments were driven by updated assumptions to reflect the improved performance of both acquisitions against their threshold targets and a reduction of pandemic-related uncertainty.
Significant Transaction Expenses
There were no significant transaction expenses during 2021. The significant transactions expenses during 2020 were comprised of investment banker and placement agent success fees, as well as legal and consulting fees, in connection with our acquisition of Graphic Sciences and our financing and debt conversion.
Sales and Marketing Expenses
Sales and marketing expenses increased by $336,985, or 32%, during 2021 over 2020. This increase was primarily driven by the inclusion of the sales and marketing expenses Graphic Sciences during all of those periods in 2021 as well as the reinstatement of full sales and marketing salaries as a part of reducing expenses and preserving cash during the initial COVID-19 uncertainty in 2020, as well as adding two sales representatives during the year and a partial resumption of travel in 2021, plus adding a director of marketing in the third quarter 2021. For 2021, the sales and marketing expenses related to Document Management and Document Conversion segments were $591,106 and $787,246. For 2020, the sales and marketing expenses related to Document Management and Document Conversion segments were $584,470 and 456,897. The relative increase in Document Conversion is driven by the two additional sales reps and shared general marketing expenses.
Depreciation and Amortization
Depreciation and amortization increased by $116,997, or 39%, during 2021 over 2020 as a result of depreciation on additional assets placed in service, primarily racking associated with the warehouse consolidation, and the addition of Graphic Sciences depreciation for a full year.
Other Items of Income and Expense
Gain on Extinguishment of Debt
The $845,083 gain on extinguishment of debt during 2021 reflects the full forgiveness of the principal and interest on our PPP Note by the SBA in January 2021. The $287,426 gain on extinguishment of debt in the during 2020 was due to the extinguishment of certain debt as part of conversion of notes payable accounted for using troubled debt restructuring.
| 28 |
Income Tax Benefit
Income tax benefit was $0 during 2021 compared to $188,300 during 2020. The benefit was driven by the releases of a portion of the valuation allowance in March 2020 for deferred tax liabilities of Graphic Sciences that were no longer due.
Interest Expense
Interest expense was $452,120 during 2021 as compared with $637,683 during 2020, representing a decrease of $185,563 or 29%. The decrease resulted primarily from lower interest expense on lower net debt following the March 2020 private placement of securities and note conversion, as well as one-time interest expense associated with accelerating the beneficial conversion option on the notes converted in 2020.
Liquidity and Capital Resources
We have financed our operations primarily through a combination of cash on hand, cash generated from operations, borrowings from third parties and related parties, and proceeds from private sales of equity. Since 2012, we have raised a total of approximately $18.6 million in cash through issuances of debt and equity securities. As of December 31, 2021, we had $1,752,630 in cash and cash equivalents, net working capital of $126,944, and an accumulated deficit of approximately $21.6 million. In June 2021, we paid $954,733 in annual earnout liabilities.
In 2020, we engaged in several actions that significantly improved our liquidity and cash flows, including:
| ● | acquiring the positive cash flow generated by Graphic Sciences and CEO Image, | |
| ● | receiving aggregate gross proceeds of $3.5 million from the private placement of our common stock, | |
| ● | converting all of the outstanding principal and accrued interest payable on our then-existing convertible debt in the approximate amount of $6 million into shares of common stock at a conversion price of $4.00 per share, and | |
| ● | receiving $2.0 million in proceeds from the issuance of 12% subordinated promissory notes due February 29, 2023, which we refer to as the 2020 notes, and | |
| ● | obtaining the PPP loan in the principal amount of $838,700, the principal and interest on which was forgiven in its entirety by the SBA in January 2021. |
Overall, we reduced our outstanding debt by approximately $3 million during 2020 and have not incurred any new debt in 2021.
Our existing $2 million of debt is due February 29, 2023. We also may have earnout payments of up to a maximum of $1,018,333 in the second quarter of 2022 and $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 acquisitions of Graphic Sciences and CEO Image, successfully retaining and growing our client base in the midst of general economic uncertainty, and managing the continuing effects of the COVID-19 pandemic on our business.
Based on our current plans and assumptions, we believe our capital resources, including our cash and cash equivalents, along with funds expected to be generated from our operations 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 December 31, 2021, our only outstanding long-term indebtedness consisted of the 2020 notes issued to accredited investors on March 2, 2020, with an aggregate outstanding principal balance of $2,000,000 and accrued interest of $0.
| 29 |
Capital Expenditures
There were no material commitments for capital expenditures at December 31, 2021.
Cash Provided by Operating Activities.
From our inception, we have generated revenues from the sales, implementation, subscriptions, and maintenance of our internally generated software applications, as well as significantly increased revenues from document conversion services beginning in 2020. Our uses of cash from operating activities include compensation and related costs, hardware costs, rent for our corporate offices, hosting fees for our cloud-based software services, other general corporate expenditures, and travel costs to client sites.
Our plan is to increase our sales and market share by implementing a targeted marketing approach to select vertical markets, an expanded network of resellers through which we expect to sell our expanded software product portfolio, as well as continue to enhance our direct selling results. We expect our operations to continue to require additional capital in order to implement direct marketing campaigns and leads management, reseller training and on-boarding, and to develop additional software integration and customization capabilities. Although management believes that we may have access to additional capital resources, there are currently no commitments in place for new financing, and there is no assurance that we will be able to obtain funds on commercially acceptable terms, if at all.
Net cash provided by operating activities during 2021 was $1,389,966, primarily attributable to net income adjusted for non-cash expenses of $703,883, an increase in operating assets of $393,404 and an decrease in operating liabilities of $278,464. Net cash provided by operating activities during 2020 was $124,988, primarily attributable to the net loss adjusted for non-cash expenses of $2,945,569, a decrease in operating assets of $388,507 and a decrease in operating liabilities of $1,008,887.
Cash Used in Investing Activities.
Net cash used in investing activities in 2021 was $590,485, primarily related to purchases of racking property and equipment for the new Sterling Heights, MI warehouse. Net cash used in investing activities in 2020 was $4,095,952, primarily related to cash paid to acquire Graphic Sciences and CEO Image.
Cash Provided and Used in Financing Activities.
Cash provided and used by financing activities primarily consist of net proceeds from issuance or repayments of debt, new issuance of equity, or payment of contingent consideration in the form of earnout liabilities.
Net cash used by financing activities during 2021 amounted to $954,733, due to payment of earnout liabilities. Net cash provided by financing activities for 2020 amounted to $5,474,681. The net cash provided by financing activities resulted from new borrowings of $3,008,700, partially offset by $175,924 in financing costs, and the sale of common stock resulting in $2,859,633 in net cash. Notes payable payments amounted to $170,000, which comprised of seller notes which are installment payments for net assets acquired. Notes payable payments to related parties amounted to $47,728.
Critical Accounting Policies and Estimates
These critical accounting policies and estimates by our management should be read in conjunction with Note 4 Summary of Significant Accounting Policies to the Consolidated Financial Statements.
The preparation of consolidated financial statements in accordance U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses in the reporting period. We regularly make estimates and assumptions that affect the reported amounts of assets and liabilities. 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.
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The actual results experienced by us may differ materially and adversely 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.
We consider the following accounting policies and estimates to be both those most important to the portrayal of our financial condition and those that require the most subjective judgment:
| ● | Revenue Recognition | |
| ● | Business Acquisition, Goodwill and Intangibles, including Contingent Liability—Earnout | |
| ● | Accounts Receivable, Unbilled | |
| ● | Deferred Revenues | |
| ● | Accounting for Costs of Computer Software to be Sold, Leased or Marketed and Accounting for Internal Use Software | |
| ● | Accounting Stock-Based Compensation |
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.
Our contracts with customers often contain multiple performance obligations. For these contracts, we account for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations on a relative standalone selling price (“SSP”) basis. We determine the SSP based on an observable standalone selling price when it is available, as well as other factors, including, the price charged to customers, our discounting practices, and our overall pricing objectives, while maximizing observable inputs. In situations where pricing is highly variable or uncertain, we estimate the SSP using a residual approach.
Revenue from on-premises licenses is recognized upfront upon transfer of control of the software, which occurs at delivery, or when the license term commences, if later. We recognize revenue from maintenance contracts ratably over the service period. Cloud services revenue is recognized ratably over the cloud service term. Training, professional services, and storage and retrieval services are provided either on a time and material basis, in which revenues are recognized as services are delivered, or over a contractual term, in which revenues are recognized ratably. With respect to contracts that include customer acceptance provisions, we recognize revenue upon customer acceptance. Our policy is to record revenues net of any applicable sales, use or excise taxes.
Payment terms and conditions vary by contract type, although our terms generally include a requirement of payment within 30 to 60 days. We assess whether payment terms are customary or extended in accordance with normal practice relative to the market in which the sale is occurring. In instances where the timing of revenue recognition differs from the timing of payment, we have determined our contracts do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing.
We generally do not offer rights of return or any other incentives such as concessions, product rotation, or price protection and, therefore, do not provide for or make estimates of rights of return and similar incentives.
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We establish allowances for doubtful accounts when available information causes us to believe that credit loss is probable.
Business Acquisition, Goodwill and Intangibles Assets, including Contingent Liability—Earnout
We have allocated the purchase price to assets acquired and liabilities assumed based on the estimated fair value of such assets and liabilities at the date of acquisition. We estimate a fair value of any earnout which would be owed to the seller based on the terms of the earnout and record this liability at the acquisition date. Fair value was based on future projections of metrics such as revenue or profit over the earnout period and valuation techniques that utilize expected volatility, threshold probability, and discounting of future payments. Evaluating the fair value involves a high degree of assumptions used within the valuation models, in particular, forecasts of projected revenues or margins. Changes in these assumptions could have a significant impact on the fair value of the earnout liabilities.
The carrying value of goodwill is not amortized, but it 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 unit may not be recoverable. An impairment charge is recognized for the amount by which the carrying amount exceeds the recorded fair value. 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.
As of December 31, 2021 and 2020, we recorded a change in fair value of earnout liabilities for both Graphic Sciences and CEO Image. The assumptions were updated to reflect the improved performance of both acquisitions against their threshold targets, the passage of time, and, for December 2020, a reduction of uncertainty driven by the pandemic.
Accounts Receivable, Unbilled
We recognize professional services revenue over time as the services are delivered using an input or output method (e.g., labor hours incurred as a percentage of total labor hours budgeted, images scanned, or similar milestones), as appropriate for the contract, provided all other revenue recognition criteria are met. When our revenue recognition policies recognize revenue that has not yet been billed, we record those contract asset amounts in accounts receivable, unbilled.
Deferred Revenues
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.
Accounting for Costs of Computer Software to be Sold, Leased or Marketed and Accounting for Internal Use Software
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 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.
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Stock-Based Compensation
We maintain one stock-based compensation plan. 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 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 are recorded at their fair value 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable to smaller reporting companies.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
(1) Consolidated Financial Statements.
(2) Consolidated Financial Statement Schedules.
Consolidated Financial Statement Schedules have been omitted because they are either not required or not applicable, or because the information required to be presented is included in the consolidated financial statements or the notes thereto included in this report.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors
Intellinetics, Inc. and Subsidiaries
Columbus, Ohio
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Intellinetics, Inc. and Subsidiaries (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the years then ended, and related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Evaluation of the Fair Value of Earnout Liabilities Related to Business Acquisitions
Description of the Matter
As discussed in Note 7 to the consolidated financial statements, the Company makes certain assumptions and judgment in determining fair value measurements for business acquisitions. During 2020, the Company consummated two business acquisitions. The acquisitions resulted in the recognition of earnout liabilities totaling $889,200, subsequently revalued at $2,444,000 at December 31, 2020. During 2021, the Company paid out $954,733 and recorded a change in fair value of $141,414. The remaining earnout liability amounted to $1,630,681 at December 31, 2021.
We identified the evaluation of the fair value of the earnout liabilities related to the acquired businesses as a critical audit matter. Evaluating the fair value involved a high degree of assumptions used within the valuation models including forecasts of projected revenues and volatility rates. In addition, changes in these assumptions could have a significant impact on the fair value of the earnout liabilities.
| F-1 |
How We Addressed the Matter in Our Audit
We obtained an understanding and evaluated the design of internal control over the Company’s process for determining the fair value of earnout liabilities related to the business acquisitions, specifically related to the determination of the key assumptions. We evaluated the forecasts of projected revenues and customer attrition rate assumptions used by the Company by comparing the assumptions to the acquirees’ historical performance. We evaluated certain forecasts of projected revenues used by the Company to value the earnout liabilities using retrospective analysis as well as historical performance and qualitative factors used in forward looking forecast.
| /s/
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| We have served as the Company’s auditor since 2012. | |
| March 24, 2022 |
| F-2 |
INTELLINETICS, INC. and SUBSIDIARIES
Consolidated Balance Sheets
| December 31, | December 31, | |||||||
| 2021 | 2020 | |||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash | $ | $ | ||||||
| Accounts receivable, net | ||||||||
| Accounts receivable, unbilled | ||||||||
| Parts and supplies, net | ||||||||
| Other contract assets | ||||||||
| Prepaid expenses and other current assets | ||||||||
| Total current assets | ||||||||
| Property and equipment, net | ||||||||
| Right of use assets | ||||||||
| Intangible assets, net | ||||||||
| Goodwill | ||||||||
| Other assets | ||||||||
| Total assets | $ | $ | ||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Current liabilities: | ||||||||
| Accounts payable | $ | $ | ||||||
| Accrued compensation | ||||||||
| Accrued expenses, other | ||||||||
| Lease liabilities - current | ||||||||
| Deferred revenues | ||||||||
| Deferred compensation | ||||||||
| Earnout liabilities - current | ||||||||
| Accrued interest payable - current | - | |||||||
| Notes payable - current | - | |||||||
| Total current liabilities | ||||||||
| Long-term liabilities: | ||||||||
| Notes payable - net of current portion | ||||||||
| Lease liabilities - net of current portion | ||||||||
| Earnout liabilities - net of current portion | ||||||||
| Total long-term liabilities | ||||||||
| Total liabilities | ||||||||
| Stockholders’ equity: | ||||||||
| Common stock, $ par value, shares authorized; and shares issued and outstanding at December 31, 2021 and 2020, respectively | ||||||||
| Additional paid-in capital | ||||||||
| Accumulated deficit | ( | ) | ( | ) | ||||
| Total stockholders’ equity | ||||||||
| Total liabilities and stockholders’ equity | $ | $ | ||||||
See Notes to these consolidated financial statements
| F-3 |
INTELLINETICS, INC. and SUBSIDIARIES
Consolidated Statements of Operations
| Years Ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Revenues: | ||||||||
| Sale of software | $ | $ | ||||||
| Software as a service | ||||||||
| Software maintenance services | ||||||||
| Professional services | ||||||||
| Storage and retrieval services | ||||||||
| Total revenues | ||||||||
| Cost of revenues: | ||||||||
| Sale of software | ||||||||
| Software as a service | ||||||||
| Software maintenance services | ||||||||
| Professional services | ||||||||
| Storage and retrieval services | ||||||||
| Total cost of revenues | ||||||||
| Gross profit | ||||||||
| Operating expenses: | ||||||||
| General and administrative | ||||||||
| Change in fair value of earnout liabilities | ||||||||
| Significant transaction costs | - | |||||||
| Sales and marketing | ||||||||
| Depreciation and amortization | ||||||||
| Total operating expenses | ||||||||
| Income (loss) from operations | ( | ) | ||||||
| Other income (expense) | ||||||||
| Gain on extinguishment of debt | ||||||||
| Interest expense, net | ( | ) | ( | ) | ||||
| Total other income (expense), 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 consolidated financial statements
| F-4 |
INTELLINETICS, INC. and SUBSIDIARIES
Consolidated Statement of Stockholders’ Equity
Years Ended December 31, 2021 and 2020
| Common Stock | Additional Paid-in | Accumulated | ||||||||||||||||||
| Shares | Amount | Capital | Deficit | Total | ||||||||||||||||
| Balance, December 31, 2019 | $ | $ | $ | ( | ) | $ | ( | ) | ||||||||||||
| Stock Issued to Directors | - | |||||||||||||||||||
| Stock Option Compensation | - | - | - | |||||||||||||||||
| Stock Issued | - | |||||||||||||||||||
| Stock Issued for Convertible Notes | - | |||||||||||||||||||
| Equity Issuance Costs | - | - | ( | ) | - | ( | ) | |||||||||||||
| Note Offer Warrants | - | - | - | |||||||||||||||||
| Net Loss | - | - | - | ( | ) | ( | ) | |||||||||||||
| Balance, December 31, 2020 | $ | $ | $ | ( | ) | $ | ||||||||||||||
| Stock Issued to Directors | $ | - | ||||||||||||||||||
| Stock Option Compensation | - | - | - | |||||||||||||||||
| Net Income | - | - | - | |||||||||||||||||
| Balance, December 31, 2021 | $ | $ | $ | ( | ) | $ | ||||||||||||||
See Notes to these Consolidated financial statements
| F-5 |
INTELLINETICS, INC. and SUBSIDIARIES
Consolidated Statements of Cash Flows
| Years Ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Cash flows from operating activities: | ||||||||
| Net income (loss) | $ | $ | ( | ) | ||||
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | ||||||||
| Depreciation and amortization | ||||||||
| Bad debt (recovery) expense | ( | ) | ||||||
| Parts and supplies reserve change | ||||||||
| Amortization of deferred financing costs | ||||||||
| Amortization of beneficial conversion option | - | |||||||
| Amortization of debt discount | ||||||||
| Amortization of right of use asset | ||||||||
| Stock issued for services | ||||||||
| Stock options compensation | ||||||||
| Note conversion stock issue expense | - | |||||||
| Warrant issue expense | - | |||||||
| Interest on converted debt | - | |||||||
| Amortization of original issue discount on notes | - | |||||||
| Gain on extinguishment of debt | ( | ) | ( | ) | ||||
| Change in fair value of earnout liabilities | ||||||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | ( | ) | ||||||
| Accounts receivable, unbilled | ( | ) | ||||||
| Parts and supplies | ( | ) | ||||||
| Prepaid expenses and other current assets | ( | ) | ||||||
| Accounts payable and accrued expenses | ( | ) | ||||||
| Lease liabilities, current and long-term | ( | ) | ( | ) | ||||
| Deferred compensation | - | ( | ) | |||||
| Accrued interest, current and long-term | ||||||||
| Deferred revenues | ||||||||
| Total adjustments | ||||||||
| Net cash provided by operating activities | ||||||||
| Cash flows from investing activities: | ||||||||
| Cash paid to acquire business, net of cash acquired | - | ( | ) | |||||
| Purchases of property and equipment | ( | ) | ( | ) | ||||
| Net cash used in investing activities | ( | ) | ( | ) | ||||
| Cash flows from financing activities: | ||||||||
| Payment of earnout liabilities | ( | ) | - | |||||
| Proceeds from issuance of common stock | - | |||||||
| Offering costs paid on issuance of common stock | - | ( | ) | |||||
| Payment of deferred financing costs | - | ( | ) | |||||
| Proceeds from notes payable | - | |||||||
| Repayment of notes payable | - | ( | ) | |||||
| Repayment of notes payable - related parties | - | ( | ) | |||||
| Net cash (used in) provided by financing activities | ( | ) | ||||||
| Net (decrease) increase in cash | ( | ) | ||||||
| Cash - beginning of period | ||||||||
| Cash - end of period | $ | $ | ||||||
| Supplemental disclosure of cash flow information: | ||||||||
| Cash paid during the period for interest | $ | $ | ||||||
| Cash paid during the period for income taxes | ||||||||
| Supplemental disclosure of non-cash financing activities: | ||||||||
| Accrued interest notes payable converted to equity | $ | $ | ||||||
| Accrued interest notes payable related parties converted to equity | - | |||||||
| Discount on notes payable for beneficial conversion feature | - | |||||||
| Discount on notes payable for warrants | - | |||||||
| Notes payable converted to equity | - | |||||||
| Notes payable converted to equity - related parties | - | |||||||
| Right-of-use asset obtained in exchange for operating lease liability | - | |||||||
| Supplemental disclosure of non-cash investing activities relating to business acquisitions: | ||||||||
| Cash | $ | $ | ||||||
| Accounts receivable | - | |||||||
| Accounts receivable, unbilled | - | |||||||
| Parts and supplies | - | |||||||
| Prepaid expenses | - | |||||||
| Other current assets | - | |||||||
| Right of use assets | - | |||||||
| Property and equipment | - | |||||||
| Intangible assets | - | |||||||
| Accounts payable | - | ( | ) | |||||
| Accrued expenses | - | ( | ) | |||||
| Lease liabilities | - | ( | ) | |||||
| Federal and state taxes payable | - | ( | ) | |||||
| Deferred revenues | - | ( | ) | |||||
| Deferred tax liabilities, net | - | ( | ) | |||||
| Net assets acquired in acquisition | - | |||||||
| Total goodwill acquired in acquisition | - | |||||||
| Total purchase price of acquisition | - | |||||||
| Purchase price of business acquisition financed with earnout liability | - | ( | ) | |||||
| Purchase price of business acquisition financed with installment payments | - | ( | ) | |||||
| Cash used in business acquisition | $ | $ | ||||||
See Notes to these consolidated financial statements
| F-6 |
INTELLINETICS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
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 audited consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”). We have evaluated subsequent events through the issuance of this Form 10-K.
3. Corporate Actions
On
March 20, 2020, we effected a
4. Summary of Significant Accounting Policies
Principles of Consolidation
The
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 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 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.
a) Sale of software
Revenues included in this classification typically include sales of licenses with professional services to new customers, additional software licenses to existing customers, and sales of software with or without services to our resellers (See section j) - Reseller Agreements, below. Our software licenses are functional intellectual property and typically provide customers with the right to use our software in perpetuity as it exists when made available to the customer. We recognize revenue from software licenses at a point in time upon delivery, provided all other revenue recognition criteria are met.
| F-7 |
b) Sale of software as a service
Sale of software as a service (“SaaS”) consists of revenues from arrangements that provide customers the use of our software applications, as a service, typically billed on a monthly or annual basis. Advance billings of these services are not recorded to the extent that the term of the arrangement has not commenced and payment has not been received. Revenue on these services is recognized over the contract period.
c) Sale of software maintenance services
Software maintenance services revenues consist of revenues derived from arrangements that provide post-contract support (“PCS”), including software support and bug fixes, to our software license holders. Advance billings of PCS are not recorded to the extent that the term of the PCS has not commenced and payment has not been received. PCS are considered distinct services. However, these distinct services are considered a single performance obligation consisting of a series of services that are substantially the same and have the same pattern of transfer to the customer. These revenues are recognized over the term of the maintenance contract.
d) Sale of professional services
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. We recognize professional services revenue over time as the services are delivered using an input or output method (e.g., labor hours incurred as a percentage of total labor hours budgeted, images scanned, or similar milestones), as appropriate for the contract, provided all other revenue recognition criteria are met.
e) Sale of storage and retrieval services
Sale of document storage and retrieval services consist principally of secured warehouse storage of customer documents, which are typically retained for many years, as well as retrieval per agreement terms and certified destruction if desired. We recognize revenue from document storage and retrieval services over the term of the contract for storage and for the retrieval and destructions components, as the services are delivered. Customers are generally billed monthly based upon contractually agreed-upon terms.
f) Arrangements with multiple performance obligations
In addition to selling software licenses, software as a service, software maintenance services, professional services, and storage and retrieval services on a stand-alone basis, a portion of our contracts include multiple performance obligations. For contracts with multiple performance obligations, we allocate the transaction price of the contract to each distinct performance obligation, on a relative basis using its standalone selling price. We determine the standalone selling price based on the price charged for the deliverable when sold separately.
g) 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 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 consolidated balance sheets.
| F-8 |
The following table presents changes in our contract assets during the years ended December 31, 2021, and 2020:
| Balance at Beginning of Period | Addition from acquisition (Note 5) | Revenue Recognized in Advance of Billings | Billings | Balance at End of Period | ||||||||||||||||
| Year ended December 31, 2021 | ||||||||||||||||||||
| Accounts receivable, unbilled | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
| Other contract assets | $ | $ | $ | $ | $ | |||||||||||||||
| Year ended December 31, 2020 | ||||||||||||||||||||
| Accounts receivable, unbilled | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
| Other contract assets | $ | $ | $ | $ | $ | |||||||||||||||
h) Deferred revenue
Amounts that have been invoiced are recognized in accounts receivable, deferred revenue or revenue, depending on whether the revenue recognition criteria have been met. Deferred revenue represents amounts billed for which revenue has not yet be recognized. Deferred revenues typically relate to maintenance and software as a service agreements which have been paid for by customers prior to the performance of those services, and payments received for professional services and license arrangements and software as a service performance obligations that have been deferred until fulfilled under our revenue recognition policy.
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 years ended December 31, 2021 and 2020:
| Balance at Beginning of Period | Addition from acquisition (Note 5) | Billings | Recognized Revenue | Balance at End of Period | ||||||||||||||||
| Year ended December 31, 2021 | ||||||||||||||||||||
| Contract liabilities: Deferred revenue | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
| Year ended December 31, 2020 | ||||||||||||||||||||
| Contract liabilities: Deferred revenue | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
i) Rights of return and customer acceptance
We do not generally offer variable consideration, financing components, rights of return or any other incentives such as concessions, product rotation, or price protection and, therefore, does not provide for or make estimates of rights of return and similar incentives. Our contracts with customers generally do not include customer acceptance clauses.
j) Reseller agreements
We execute certain sales contracts through resellers. We recognize revenues relating to sales through resellers when all the recognition criteria have been met including passing of control. In addition, we assess the credit-worthiness of each reseller, and if the reseller is undercapitalized or in financial difficulty, any revenues expected to emanate from such resellers are deferred and recognized only when cash is received and all other revenue recognition criteria are met.
| F-9 |
k) Contract costs
We capitalize the incremental costs of obtaining a contract with a customer. We have determined that certain sales commissions meet the requirement to be capitalized, and we amortize these costs on a consistent basis with the pattern of transfer of the goods and services in the contract. Total capitalized costs to obtain contracts are included in other contract assets on our consolidated balance sheets.
l) Sales taxes
Sales taxes charged to and collected from customers as part of our sales transactions are excluded from revenues, as well as the determination of transaction price for contracts with multiple performance obligations, and recorded as a liability to the applicable governmental taxing authority.
m) Disaggregation of revenue
We provide disaggregation of revenue based on product groupings in our consolidated statements of operations as we believes this best depicts how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors. Revenues from contracts are primarily within the United States. International revenues were not material to the consolidated financial statements for the years ended December 31, 2021 and 2020.
n) Significant financing component
Our customers typically do not pay in advance for goods or services to be transferred in excess of one year. As such, it is not necessary to determine if we benefit from the time value of money and should record a component of interest income related to the upfront payment due to the practical expedient of ASC 606-10-32-18.
Concentrations of Credit Risk
We maintain our cash with high credit quality financial institutions. At times, our cash and cash equivalents may be uninsured or in deposit accounts that exceed the Federal Deposit Insurance Corporation insurance limit.
The
number of customers that comprise our customer base, along with the different industries, governmental entities and geographic regions,
in which our customers operate, limits concentrations of credit risk with respect to accounts receivable, with the exception of the State
of Michigan. In the years ended December 31, 2021 and 2020, our sales to the State of Michigan totaled approximately
We
do not generally require collateral or other security to support customer receivables; however, we may require customers to provide
retainers, up-front deposits or irrevocable letters-of-credit when considered necessary to mitigate credit risks. We have established
an allowance for doubtful accounts based upon facts surrounding the credit risk of specific customers and past collections history. Credit
losses have been within management’s expectations. At December 31, 2021 and 2020, our allowance for doubtful accounts was $
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 $
| F-10 |
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
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 tests long-lived assets or asset groups, such as property and equipment, for recoverability when events or changes in circumstances indicate that their carrying amount may not be recoverable.
Circumstances which could trigger a review include, but are not limited to: significant adverse changes in the business climate or legal factors; current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the asset; and a current expectation that the asset will more likely than not be sold or disposed of before the end of its estimated useful life.
Recoverability
is assessed based on comparing the carrying amount of the asset to the aggregate pre-tax undiscounted cash flows expected to result from
the use and eventual disposal of the asset or asset group. Impairment is recognized when the carrying amount is not recoverable and exceeds
the fair value of the asset or asset group. The impairment loss, if any, is measured as the amount by which the carrying amount exceeds
fair value, which for this purpose is based upon the discounted projected future cash flows of the asset or asset group. 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. Such fair market value assessments are primarily based on third-party valuations using assumptions developed by management that require significant judgments and estimates that can change materially as additional information becomes available. The purchase price allocated to intangibles is based on unobservable factors, including but not limited to, projected revenues, expenses, customer attrition rates, a weighted average cost of capital, among others. The weighted average cost of capital uses a market participant’s cost of equity and after-tax cost of debt and reflects the risks inherent in the cash flows. The approach to valuing the initial contingent consideration associated with the purchase price also uses similar unobservable factors such as projected revenues and expenses over the term of the contingent earnout period, discounted for the period over which the initial contingent consideration is measured, and volatility rates. We finalize the purchase price allocation once certain initial accounting valuation estimates are finalized, and no later than 12 months following the acquisition date.
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 consolidated balance sheets. We do not have any finance leases, as a lessee, and no long-term leases for which we are the lessor.
| F-11 |
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 to employees in accordance with ASC 718, “Compensation - Stock Compensation.” Stock-based payments to employees include grants of stock that are recognized in the consolidated statement of operations based on their fair values at the date of grant.
We account for stock-based payments to non-employees in accordance with ASC 718, “Compensation - Stock Compensation,” which requires that such equity instruments are recorded 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 $
For
the years ended December 31, 2021, and 2020, our expensed software development costs were $
| F-12 |
Recently Issued Accounting Pronouncements Not Yet Effective
Financial Instruments – Credit Losses
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost. ASC 2016-16 is effective for annual reporting periods beginning after December 15, 2023, including interim reporting periods within those annual reporting periods. Early adoption is permitted. We are currently evaluating the impact of the new guidance on its consolidated financial statements and related disclosures.
Reference Rate Reform
In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting” which provides optional relief through specific exceptions and practical expedients for transitioning away from reference rates that are expected to be discontinued. The relief generally applies to eligible modifications of contractual terms that change (or have the potential to change) the amount or timing of contractual cash flows related to replacement of a reference rate. The relief allows such modifications to be accounted for as continuations of existing contracts without additional analysis. The optional relief is available from March 2020 through December 31, 2022. We do not anticipate any impact on our business from this standard.
No other Accounting Standards Updates that have been issued but are not yet effective are expected to have a material effect on our future consolidated financial statements.
Advertising
We
expense the cost of advertising as incurred. Advertising expense for the years ended December 31, 2021 and 2020 amounted to $
Basic income or loss per share is computed by dividing net income or loss by the weighted average number of shares of common stock outstanding during the period. Diluted income or loss per share is computed by dividing net income or loss by the diluted weighted average number of shares of common stock outstanding during the period. The diluted weighted average number of shares gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method. Diluted earnings per share exclude all diluted potential shares if their effect is anti-dilutive, including warrants or options which are out-of-the-money and for those periods with a net loss. We reported a net income for 2021 and a net loss for 2020.
Income Taxes
Intellinetics and its subsidiaries file a consolidated federal income tax return. The provision for income taxes is computed by applying statutory rates to income before taxes.
Deferred
income taxes are recognized for the tax consequences in future years of temporary differences between the financial reporting and tax
bases of assets and liabilities as of each period-end based on enacted tax laws and statutory rates. Valuation allowances are established
when necessary to reduce deferred tax assets to the amount expected to be realized. A
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.
| F-13 |
Segment Information
Operating
segments are defined in the criteria established under the FASB ASC 280 as components of public entities that engage in business
activities from which they may earn revenues and incur expenses for which separate financial information is available and which is evaluated
regularly by our chief operating decision maker (“CODM”) in deciding how to assess performance and allocate resources. Our
CODM assesses performance and allocates resources based on
The Document Management Segment provides cloud-based and premise-based content services software. Its modular suite of solutions complements existing operating and accounting systems to serve a mission-critical role for organizations to make content secure, compliant, and process-ready. This segment conducts its primary operations in the United States. Markets served include highly regulated, risk and compliance-intensive markets in healthcare, K-12 education, public safety, other public sector, risk management, financial services, and others. Solutions are sold both directly to end-users and through resellers.
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:
| Year ended December 31, 2021 | Year ended December 31, 2020 | |||||||
| Revenues | ||||||||
| Document Management | $ | $ | ||||||
| Document Conversion | ||||||||
| Total revenues | $ | $ | ||||||
| Gross profit | ||||||||
| Document Management | $ | $ | ||||||
| Document Conversion | ||||||||
| Total gross profit | $ | $ | ||||||
| Capital additions, net | ||||||||
| Document Management | $ | $ | ||||||
| Document Conversion | ||||||||
| Total capital additions, net | $ | $ | ||||||
| December 31, 2021 | December 31, 2020 | |||||||
| Goodwill | ||||||||
| Document Management | $ | $ | ||||||
| Document Conversion | ||||||||
| Total goodwill | $ | $ | ||||||
| December 31, 2021 | December 31, 2020 | |||||||
| Total assets | ||||||||
| Document Management | $ | $ | ||||||
| Document Conversion | ||||||||
| Total assets | $ | $ | ||||||
Statement of Cash Flows
For purposes of reporting cash flows, cash includes cash on hand and demand deposits held by banks.
Reclassifications
Certain amounts reported in prior filings of the consolidated financial statements have been reclassified to conform to current presentation.
| F-14 |
5. Business Acquisitions
On
March 2, 2020, we acquired all of the issued and outstanding stock of Graphic Sciences. The purchase price paid for Graphic Sciences
was $
On
April 21, 2020, we acquired substantially all of the assets of CEO Image. The purchase price paid for the assets of CEO Image consisted
of $
The purchase price was 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:
| Total 2020 | March 2, 2020 | April 21, 2020 | ||||||||||
| Assets acquired: | ||||||||||||
| Cash | $ | $ | $ | |||||||||
| Accounts receivable | ||||||||||||
| Accounts receivable, unbilled | - | |||||||||||
| Parts and supplies | - | |||||||||||
| Prepaid expenses | - | |||||||||||
| Other current assets | - | |||||||||||
| Right of use assets | - | |||||||||||
| Property and equipment | ||||||||||||
| Intangible assets (see Note 6) | ||||||||||||
| Liabilities assumed: | ||||||||||||
| Accounts payable | ||||||||||||
| Accrued expenses | ||||||||||||
| Lease liabilities | - | |||||||||||
| Federal and state taxes payable | - | |||||||||||
| Deferred revenue | ||||||||||||
| Deferred tax liabilities - Net | - | |||||||||||
| Total identifiable net assets/(liabilities) | ( | ) | ||||||||||
| Purchase price | ||||||||||||
| Goodwill - Excess of purchase price over fair value of net assets acquired | $ | $ | $ | |||||||||
| F-16 |
Acquisition
costs which include legal and other professional fees of approximately $
The following unaudited pro forma information presents a summary of our consolidated results of operations, as if the acquisitions of Graphic Sciences and CEO Image had occurred on January 1, 2020.
| For the year ended December 31, 2020 | (unaudited) | |||
December 31, 2020 | ||||
| Total revenues | $ | |||
| Net loss | $ | ( | ) | |
| Basic and diluted net loss per share | $ | ( | ) | |
The unaudited pro forma consolidated results are based on our historical financial statements and those of Graphic Sciences and CEO Image and do not necessarily indicate the results of operations that would have resulted had the acquisition actually been completed at the beginning of the applicable period presented. The pro forma financial information assumes that the companies were combined as of January 1, 2020.
The following tables present the amounts of revenue and earnings of the acquirees since the acquisition date included in the consolidated income statement for the reporting period.
| Year ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| Graphic Sciences: | ||||||||
| Total revenues | $ | $ | ||||||
| Net income | $ | $ | ||||||
| Year ended December 31, | ||||||||
| 2021 | 2020 | |||||||
| CEO Image: | ||||||||
| Total revenues | $ | $ | ||||||
| Net income | $ | (a) | $ | (a) | ||||
| (a) |
6. Intangible Assets, Net
At December 31, 2021, intangible assets consisted of the following:
| Estimated | Accumulated | |||||||||||||||
| Useful Life | Costs | Amortization | Net | |||||||||||||
| Trade names | $ | $ | ( | ) | $ | |||||||||||
| Customer contracts | ( | ) | ||||||||||||||
| $ | $ | ( | ) | $ | ||||||||||||
At December 31, 2020, intangible assets consisted of the following:
| Estimated | Accumulated | |||||||||||||||
| Useful Life | Costs | Amortization | Net | |||||||||||||
| Trade names | $ | $ | ( | ) | $ | |||||||||||
| Customer contracts | ( | ) | ||||||||||||||
| $ | $ | ( | ) | $ | ||||||||||||
| F-17 |
Amortization
expense for the years ended December 31, 2021 and 2020, amounted to $
| For the Years Ending December 31, | Amount | |||
| 2022 | $ | |||
| 2023 | ||||
| 2024 | ||||
| 2025 | ||||
| 2026 | ||||
| Thereafter | ||||
| $ | ||||
7. Fair Value Measurements
Under GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy consists of the following three levels. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Level 2 inputs consist of quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data. Level 3 inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.
The carrying values of cash and equivalents, accounts receivable, accounts payable, accrued expenses, and the PPP loan (prior to forgiveness) approximate fair value because of its short maturity. Management believes that the carrying value of the 2020 Notes approximate fair value given the March 2, 2020 transaction proximity to December 31, 2020 in conjunction with the absence of significant net change in the overall economic environment with regards to availability of credit to Company.
We
have earnout liabilities related to our two 2020 acquisitions which are measured on a recurring basis and recorded at fair value, measured
using probability-weighted analysis and discounted using a rate that appropriately captures the risks associated with the obligation.
The inputs used to calculate the fair value of the earnout liabilities are considered to be Level 3 inputs due to the lack of relevant
market activity and significant management judgment.
The following table provides a summary of the changes in fair value of the earnout liabilities for the years ended December 31, 2021 and 2020:
Year ended December 31, 2021 | ||||
| Fair value at January 1, 2021 | $ | |||
| Payment | ( | ) | ||
| Change in fair value | ||||
| Fair value at December 31, 2021 | $ | |||
Year ended December 31, 2020 | ||||
| Fair value at January 1, 2020 | $ | |||
| Additions | ||||
| Change in fair value | ||||
| Fair value at December 31, 2020 | $ | |||
| F-18 |
The fair values of amounts owed are recorded in the current and long-term portions of earnout liabilities in our consolidated balance sheets. Changes in fair value are recorded in change in fair value of earnout liabilities in our consolidated statements of operations.
8. Property and Equipment
Property and equipment are comprised of the following:
| December 31, 2021 | December 31, 2020 | |||||||
| Computer hardware and purchased software | $ | $ | ||||||
| Leasehold improvements | ||||||||
| Furniture and fixtures | ||||||||
| Less: accumulated depreciation | ( | ) | ( | ) | ||||
| Property and equipment, net | $ | $ | ||||||
Total
depreciation expense on our property and equipment for the years ended December 31, 2021 and 2020 amounted to $
9. Notes Payable – Unrelated Parties
Summary of Notes Payable to Unrelated Parties
The table below summarizes all notes payable at December 31, 2021 and 2020, respectively. See also Note 10 “Notes Payable - Related Parties.”
December 31, 2021 | December 31, 2020 | |||||||
| PPP Note (a) | $ | $ | ||||||
| 2020 Notes | ||||||||
| Total notes payable | $ | $ | ||||||
| Less unamortized debt issuance costs | ( | ) | ( | ) | ||||
| Less unamortized debt discount | ( | ) | ( | ) | ||||
| Less current portion | ( | ) | ||||||
| Long-term portion of notes payable | $ | $ | ||||||
| (a) |
Future minimum principal payments of the 2020 Notes are as follows:
| As of December 31, | Amount | |||
| 2023 | $ | |||
| Total | $ | |||
As
of December 31, 2021 and 2020, accrued interest for these notes payable with the exception of the related party notes in Note 10,
“Notes Payable - Related Parties,” was $
With
respect to all notes outstanding (other than the notes to related parties), interest expense, including the amortization of debt issuance
costs and debt discount for the years ended December 31, 2021 and 2020 was $
We have evaluated the terms of our convertible notes payable in accordance with ASC 815 – 40, “Derivatives and Hedging - Contracts in Entity’s Own Stock” and determined that the underlying common stock is indexed to our common stock. We determined that the conversion feature did not meet the definition of a derivative and therefore did not bifurcate the conversion feature and account for it as a separate derivative liability. We evaluated the conversion feature for a beneficial conversion feature. The effective conversion price was compared with the market price on the date of each note. If the conversion price was deemed to be less than the market value of the underlying common stock at the inception of the note, then we recognized a beneficial conversion feature resulting in a discount on the note payable, upon satisfaction of the contingency. The beneficial conversion features were amortized to interest expense over the life of the respective notes, starting from the date of recognition.
| F-19 |
2016-18 Unrelated Party Notes and 2020 Note Conversion
In 2016 through 2018, we issued convertible promissory notes to unrelated parties in an aggregate principal amount of $3,535,000. On March 2, 2020, we entered into amendments to these convertible promissory notes, as well as amendments to convertible promissory notes with related parties (see note 10), that permitted us to convert all of the outstanding principal and accrued and unpaid interest payable on all outstanding convertible promissory notes into shares of common stock at a reduced conversion rate equal to the purchase price of our common stock issued in the contemporaneous private placement offering. Pursuant thereto, we converted all of the outstanding principal and accrued and unpaid interest payable with respect to all convertible promissory notes, with related parties and with unrelated parties, into a total of shares of our common stock at a conversion rate of $ per share. Taglich Brothers, Inc. acted as the exclusive placement agent for the note conversion and received compensation (relating to the conversion of both the related and the unrelated notes) of shares of our common stock, based on a fee valued at $ per share.
2020 Notes
On
March 2, 2020, we sold units, at an offering price of $1,000 per unit,
to accredited investors in a private placement offering, with each unit consisting of $1,000 in 12% Subordinated Notes (“2020 Notes”)
and shares of our common stock, for aggregate gross
proceeds of $
PPP Note
On
April 15, 2020, we were issued an unsecured promissory note (“PPP Note”) for the PPP loan through PNC Bank with a principal
amount of $
10. Notes Payable - Related Parties
For
the year ended December 31, 2021, there was no
interest expense in connection with notes payable
– related parties. For the year ended December 31, 2020, interest expense in connection with notes payable – related
parties was $
2016-19 Related Party Notes and 2020 Note Conversion
In
2016 through 2019, we issued convertible promissory notes to related parties, including
| F-20 |
11. Deferred Compensation
Pursuant
to an employment agreement, we have accrued incentive compensation totaling $
12. Commitments and Contingencies
From time to time we are involved in legal proceedings, claims and litigation related to employee claims, contractual disputes and taxes in the ordinary course of business. Although we cannot predict the outcome of such matters, currently we have no reason to believe the disposition of any current matter could reasonably be expected to have a material adverse impact on our financial position, results of operations or the ability to carry on any of our business activities.
Employment Agreements
We have entered into employment agreements with three of our key executives, including one of our founders. Under their respective employment agreements, the executives are employed on an “at-will” basis and are bound by typical confidentiality, non-solicitation and non-competition provisions. Deferred compensation for one founder remains outstanding as of December 31, 2021.
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 period Ending December 31, | Amount | |||
| 2022 | $ | |||
| 2023 | ||||
| 2024 | ||||
| 2025 | ||||
| 2026 | ||||
| Thereafter | ||||
| $ | ||||
| F-21 |
Lease
costs charged to operations for the years ended December 31, 2021 and 2020 amounted to $
| For the Year Ending December 31, | 2021 | 2020 | ||||||
| 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.
13. Stockholders’ Equity
Description of Authorized Capital
We are authorized to issue up to shares of common stock with $par value. The holders of our common stock are entitled to one vote per share. The holders of common stock are entitled to receive ratably such dividends, if any, as may be declared by the Board of Directors out of legally available funds. However, the current policy of the Board of Directors is to retain earnings, if any, for the operation and expansion of the business. Upon liquidation, dissolution or winding-up of Intellinetics, the holders of common stock are entitled to share ratably in all assets legally available for distribution.
Common Stock
As of December 31, 2021, shares of common stock were issued and outstanding, shares of common stock were reserved for issuance upon the exercise of outstanding warrants, and shares of common stock were reserved for issuance under our 2015 Equity Incentive Plan, as amended (the “2015 Plan”).
On March 2, 2020, we sold shares of our common stock and certain subordinated notes in a private placement to accredited investors as follows:
| ● |
shares of our common stock at a purchase price of $ per share, for aggregate gross proceeds of $ | |
| ● |
units at a purchase price of $ per unit, with each unit consisting of $ |
In
connection with the private placement offering, we paid the placement agent $
| F-22 |
Reverse Stock Split
In
February 2020, upon recommendation and authorization by our Board of Directors, our stockholders holding a majority in interest of the
issued and outstanding shares of our common stock, acting by written consent, adopted an amendment to our Articles of Incorporation to
Effective March 2, 2020, before the Reverse Split and the Share Amendment became effective, upon recommendation and authorization by the Board of Directors, stockholders holding a majority in interest of the issued and outstanding shares of our common stock, acting by written consent, adopted an amendment to our Articles of Incorporation to increase the authorized number of shares of our common stock to shares (representing shares on a post-split basis) from shares (representing shares on a post-split basis), in order to facilitate the acquisition of Graphic Sciences and certain private placement offerings and note conversions. Thereafter, on March 20, 2020, when the Reverse Split and the Share Amendment became effective, our authorized capital stock became shares of common stock.
The Reverse Split did not cause an adjustment to the par value of the common stock. Pursuant to the Reverse Split, we adjusted the amounts for shares reserved for issuance upon the exercise of outstanding warrants, outstanding stock options, and shares reserved for the 2015 Plan.
All references to shares of common stock and per share data in the accompanying consolidated financial statements and in these notes related thereto have been adjusted to reflect the Reverse Split for all periods presented.
Warrants
The following sets forth the warrants to purchase our common stock that were outstanding as of December 31, 2021:
| ● | Warrants
to purchase | |
| ● | Warrants
to purchase | |
| ● | Warrants
to purchase | |
| ● | Warrants
to purchase |
No
warrants were issued during 2021. Warrants to purchase
| Warrants Issued March 2, 2020 | ||||
| Risk-free interest rate | % | |||
| Weighted average expected term | ||||
| Expected volatility | % | |||
| Expected dividend yield | % | |||
| F-23 |
From time to time, we issue stock options and restricted stock as compensation for services rendered by our directors and employees.
Restricted Stock
On February 15, 2021 and January 2, 2020, we issued shares and shares, respectively, of restricted common stock to our directors as part of their annual compensation plan. The grants of restricted common stock were made outside the 2015 Plan and were not subject to any vesting conditions. Stock compensation of $was recorded for the years ended December 31, 2021 and 2020.
Stock Options
We did not make any stock option grants during 2021. The weighted-average grant date fair value of options granted during 2020 was $. Stock-based compensation for options was $and $, during the years ended December 31, 2021 and 2020, respectively.
| Weighted- | ||||||||||||||||
| Weighted- | Average | |||||||||||||||
| Shares | Average | Remaining | Aggregate | |||||||||||||
| Under | Exercise | Contractual | Intrinsic | |||||||||||||
| Option | Price | Life | Value | |||||||||||||
| Outstanding at January 1, 2021 | $ | years | $ | |||||||||||||
| Forfeited and expired | ( | ) | ||||||||||||||
| Outstanding at December 31, 2021 | $ | years | $ | |||||||||||||
| Exercisable at December 31, 2021 | $ | years | $ | |||||||||||||
| Weighted- | ||||||||||||||||
| Weighted- | Average | |||||||||||||||
| Shares | Average | Remaining | Aggregate | |||||||||||||
| Under | Exercise | Contractual | Intrinsic | |||||||||||||
| Option | Price | Life | Value | |||||||||||||
| Outstanding at January 1, 2020 | $ | years | ||||||||||||||
| Granted | ||||||||||||||||
| Forfeited and expired | ( | ) | ||||||||||||||
| Outstanding at December 31, 2020 | $ | years | $ | |||||||||||||
| Exercisable at December 31, 2020 | $ | years | $ | |||||||||||||
As of December 31, 2021 and 2020, there was $and $, respectively, of total unrecognized compensation costs related to stock options granted under our stock option agreements. The unrecognized compensation cost is expected to be recognized over a weighted-average period of . The total fair value of stock options that vested during the years ended December 31, 2021, and 2020 was $and $, respectively.
Issues of Stock-Based Compensation
| Grant date | Shares granted (canceled) | Exercise price | Date fully vested | Fair value | ||||||||||||
| February 10, 2016 | $ | $ | ||||||||||||||
| December 6, 2016 | ||||||||||||||||
| September 25, 2017 | ||||||||||||||||
| September 25, 2017 | ||||||||||||||||
| January 30, 2019 | ||||||||||||||||
| March 11, 2019 | ( | ) | - | |||||||||||||
| March 11, 2019 | (1) | |||||||||||||||
| March 11, 2019 | ||||||||||||||||
| September 2, 2020 | ||||||||||||||||
| (1) |
| F-24 |
| April 30, | January 1, | February 10, | ||||||||||
| 2015 Grant | 2016 Grant | 2016 Grant | ||||||||||
| Risk-free interest rate | % | % | % | |||||||||
| Weighted average expected term | years | years | years | |||||||||
| Expected volatility | % | % | % | |||||||||
| Expected dividend yield | % | % | % | |||||||||
| December 6, | September 25, | January 30, | ||||||||||
| 2016 Grant | 2017 Grant | 2019 Grant | ||||||||||
| Risk-free interest rate | % | % | % | |||||||||
| Weighted average expected term | years | years | years | |||||||||
| Expected volatility | % | % | % | |||||||||
| Expected dividend yield | % | % | % | |||||||||
| March 11, | September 2, | |||||||
| 2019 Grant | 2020 Grant | |||||||
| Risk-free interest rate | % | % | ||||||
| Weighted average expected term | years | years | ||||||
| Expected volatility | % | % | ||||||
| Expected dividend yield | % | % | ||||||
| F-25 |
15. Concentrations
Revenues
from a limited number of customers have accounted for a substantial percentage of our total revenues. During the years ended December
31, 2021 and 2020, our largest customer, the State of Michigan, accounted for
For
the years ended December 31, 2021, and 2020, government contracts represented approximately
As
of December 31, 2021, accounts receivable concentrations from our two largest customers were
16. Provision For Income Taxes
We file income tax returns in the U.S. Federal jurisdiction and various state jurisdictions. For the years ended December 31, 2021, and 2020, we have recognized the minimum amount of state income tax as required by the states in which we are required to file taxes. We are not currently subject to further federal or state tax since we have incurred losses since our inception.
Income tax benefit consists of the following Federal, deferred components for the years ended December 31, 2021 and 2020:
December 31, 2021 | December 31, 2020 | |||||||
| Use of (benefit of) net operating losses | $ | $ | ( | ) | ||||
| Other timing differences | ( | ) | ||||||
| Change in valuation allowance, including $ | ( | ) | ( | ) | ||||
| Tax benefit | $ | $ | ( | ) | ||||
A reconciliation is provided below of the U.S. Federal income tax expense at a statutory rate of 21% for the years ended December 31, 2021 and 2020:
| December 31, 2021 | December 31, 2020 | |||||||
| U.S. statutory rate | % | % | ||||||
| U.S. Federal income tax at statutory rate | $ | $ | ( | ) | ||||
| Increase (decrease) in income taxes due to: | ||||||||
| Non-deductible earnout expense | ||||||||
| Non-deductible goodwill amortization | ||||||||
| Other differences | ||||||||
| Non-taxable PPP loan and interest recovery | ( | ) | - | |||||
| Benefit of acquisition-date purchased deferred tax liability | ( | ) | ||||||
| Other change in valuation allowance | ||||||||
| Income tax benefit | $ | $ | ( | ) | ||||
| F-26 |
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are presented below:
December 31, 2021 | December 31, 2020 | |||||||
| Deferred tax assets | ||||||||
| Reserves and accruals not currently deductible for tax purposes | $ | $ | ||||||
| Amortizable assets | ||||||||
| Net operating loss carryforwards | ||||||||
| Deferred tax liabilities | ||||||||
| Property and equipment | ( | ) | ( | ) | ||||
| Net Deferred tax assets | ||||||||
| Valuation allowance | ( | ) | ( | ) | ||||
| $ | $ | |||||||
As
of December 31, 2021 and 2020, we had federal net operating loss carry forwards of approximately $
17. Certain Relationships and Related Transactions
Certain Relationships and Related Transactions
The following is a summary of the related person transactions that Intellinetics has participated in at any time during the reporting period.
Notes Payable – Related Parties
See Note 10 for a summary of notes issued to related parties and the subsequent conversion of such related party notes into shares of our common stock on March 2, 2020.
2020 Private Placement
The
following related persons participated as investors a private placement of our securities, on the same terms as
all other investors participating in the offering.
| Name of Investor | Relationship to Intellinetics | Number of Shares Purchased | Date of Transaction | |||||||
| Michael N. Taglich | ||||||||||
| Robert F. Taglich | ||||||||||
| Robert C. Schroeder | ||||||||||
| James F. DeSocio | ||||||||||
| Joseph D. Spain | ||||||||||
Promoters and Certain Control Persons
| F-27 |
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 Graphic Sciences. Pursuant to an Engagement Agreement, dated April 15, 2019, we paid Taglich Brothers, Inc. a
success fee of $
We
retained Taglich Brothers, Inc., as the exclusive placement agent for the 2020 private placement, as described above, pursuant to a Placement
Agent Agreement. In connection with the 2020 private placement, we paid Taglich Brothers, Inc. $
We
retained Taglich Brothers, Inc. as the exclusive placement agent for the 2020 note conversion, as described above in Note 10 (Notes
Payable – Related Parties), pursuant to the Placement Agent Agreement. In connection with the 2020 note conversion, we issued shares of common stock to Taglich Brothers, Inc.,
which, based on the conversion price of $
18. Subsequent Events
Issuance of Restricted Common Stock to Directors
On
January 6, 2022, we issued new Shares of restricted common stock to
our directors in accordance with our director compensation policy. Stock compensation of $
| F-28 |
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain “disclosure controls and procedures” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act that are designed to ensure that information required to be disclosed by us in 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 our management, including our principal executive officer and principal financial office, and Board of Directors, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable assurance of achieving the desired objectives, and we necessarily are required to apply our judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures.
Our management, including our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2021 and concluded that our disclosure controls and procedures were effective as of December 31, 2021.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation and fair presentation of consolidated financial statements for external purposes, in accordance with generally accepted accounting principles. The effectiveness of any system of internal control over financial reporting is subject to inherent limitations and therefore, may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness of future periods are subject to the risk that the controls may become inadequate due to change in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
| 34 |
Our management, including our principal executive officer and principal financial officer, conducted an evaluation of the effectiveness of our internal control over financial reporting using the criteria set forth by the committee of Sponsoring Organization of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013).
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim consolidated financial statements will not be prevented or detected on a timely basis.
Based on our evaluation, our principal executive officer and principal financial officer concluded that, as of December 31, 2021, our disclosure controls and procedures were effective as required under Rules 13a-15(e) and 15d-15(e) under the Exchange Act and we did maintain effective internal control over financial reporting, based on criteria issued by COSO.
This report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this report.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rules 13a-13(f) and 15d-15(f) under the Exchange Act) that occurred during our fourth fiscal quarter of the fiscal year ended December 31, 2021, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
Not applicable
ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTION.
Not applicable.
Part III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Incorporated by reference to our definitive Proxy Statement for the 2022 Annual Meeting of Stockholders, which will be filed with the SEC no later than 120 days after December 31, 2021.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference to our definitive Proxy Statement for the 2022 Annual Meeting of Stockholders, which will be filed with the SEC no later than 120 days after December 31, 2021.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Incorporated by reference to our definitive Proxy Statement for the 2022 Annual Meeting of Stockholders, which will be filed with the SEC no later than 120 days after December 31, 2021.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Incorporated by reference to our definitive Proxy Statement for the 2022 Annual Meeting of Stockholders, which will be filed with the SEC no later than 120 days after December 31, 2021.
| 35 |
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Incorporated by reference to our definitive Proxy Statement for the 2022 Annual Meeting of Stockholders, which will be filed with the SEC no later than 120 days after December 31, 2021.
Part IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Reference is made to the Index to Financial Statements beginning on Page F-1 hereof.
Financial Statement Schedules.
(a) Documents Filed as Part of Report
(1) Financial Statements.
(3) Exhibits.
The exhibits listed on the accompanying Exhibit Index are filed or incorporated by reference as part of this report and such Exhibit Index is incorporated by reference.
| 36 |
Signatures
Pursuant to the requirements of Section 13 or 15(d) 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, on March 24, 2022.
| Intellinetics, Inc. | ||
| By: | /s/ James F. DeSocio | |
| James F. DeSocio | ||
| President, Chief Executive Officer and Director | ||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 24, 2022.
| Name | Title | |
| President, Chief Executive Officer, and Director | ||
| /s/ James F. DeSocio | (Principal Executive Officer) | |
| James F. DeSocio | ||
| Chief Financial Officer and Treasurer | ||
| /s/ Joseph D. Spain | (Principal Financial and Accounting Officer) | |
| Joseph D. Spain | ||
| /s/ Matthew L. Chretien | Chief Strategy Officer, Chief Technology Officer, Secretary, and Director | |
| Matthew L. Chretien | ||
| /s/ Rye D’Orazio | Director | |
| Rye D’Orazio | ||
| /s/ Roger Kahn | Director | |
| Roger Kahn | ||
| /s/ William M. Cooke | Chairman of the Board, and Director | |
| William M. Cooke | ||
| /s/ Sophie Pibouin | Director | |
| Sophie Pibouin |
| 37 |
EXHIBIT INDEX
| 38 |
| + | Filed herewith: |
| 39 |