Notes
to Condensed Consolidated Financial Statements
1.
|
Business
Organization and Nature of Operations
|
Intellinetics,
Inc., formerly known as GlobalWise Investments, Inc., (“Intellinetics”), is a Nevada corporation incorporated in 1997,
with two subsidiaries: (i) Intellinetics, Inc., an Ohio corporation that is wholly-owned by the Company (“Intellinetics
Ohio), and (ii) Graphic Sciences, Inc., a Michigan corporation that is also wholly-owned by the Company (“Graphic Sciences”).
Intellinetics Ohio was incorporated in 1996, and on February 10, 2012, Intellinetics Ohio became the sole operating subsidiary
of the Company as a result of a reverse merger and recapitalization. On March 2, 2020, the Company purchased all the outstanding
capital stock of Graphic Sciences.
The
Company is a document management company, providing comprehensive document solutions, software, and services to its customers
in both the public and private sectors. The Company’s software platform allows customers to capture and manage all documents
across operations such as scanned hard-copy documents and all digital documents including those from Microsoft Office 365, digital
images, audio, video and emails. The Company’s suite of document services includes indexing, conversion, and physical document
storage and retrieval. The Company’s comprehensive solutions create value for customers by making it easy to connect business-critical
documents to the processes they drive by making them easy to find, secure and compliant with its customers’ audit requirements.
The
accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States generally
accepted accounting principles (“U.S. GAAP”). The Company has evaluated subsequent events through the issuance of
this Form 10-Q.
The
financial statements presented in this Quarterly Report on Form 10-Q are unaudited. However, in the opinion of management, such
Financial Statements include all adjustments, consisting solely of normal recurring adjustments, necessary to present fairly the
financial position, results of operations and cash flows for the periods presented in conformity with U.S. GAAP applicable to
interim periods.
Operating
results for the interim periods presented are not necessarily indicative of the results that may be expected for the current fiscal
year ending December 31, 2020.
3.
|
Liquidity
and Management’s Plans
|
Through
September 30, 2020, the Company had incurred an accumulated deficit since its inception of $21,568,960. At September 30, 2020,
the Company had a cash balance of $1,511,990. Since inception, the Company’s operations have primarily been funded through
a combination of gross profits, government-sponsored loans, and the sale of both equity and debt securities.
As
part of its overall strategic plan to increase the Company’s revenues, improve liquidity, and move the Company towards profitability,
the Company acquired Graphic Sciences on March 2, 2020, and CEO Imaging Systems, Inc. (“CEO Image”) on April 21, 2020.
Additionally, proceeds from issuance of shares, including conversion of convertible debt, and issuance of new debt on March
2, 2020 enabled the company to restructure its balance sheet and reduce its overall debt burden by approximately $3 million.
The
Company’s business plan is to increase our sales and market share by focusing on a targeted marketing approach to select
vertical markets, maximizing cross selling opportunities within the newly expanded customer base of the consolidated company,
enhancing our direct selling results, and continuing to develop a network of select resellers through which we expect to sell
our expanded document management solutions. We expect that these initiatives will require us to continue our efforts towards direct
marketing campaigns and leads management, reseller on-boarding, and to develop additional software integration and customization
capabilities, all of which may require additional capital. We also plan to continually monitor opportunities to make strategic
acquisitions that will strengthen or complement our product and services offerings, bring more solutions to our customers, and
increase revenues and liquidity. Since the COVID-19 crisis began, the Company has been working proactively to preserve cash,
including a temporary furlough at Graphic Sciences until the Michigan stay-at-home order was lifted, a reduction in management
compensation through June 2020, and the receipt of a loan through the Paycheck Protection Program (“PPP”) in April
2020 amounting to $838,700. Currently, we believe that we comply with the program requirements and that the entire amount will
be forgiven, but will not have assurance on the amount forgiven until our forgiveness application is accepted by the Small Business
Administration.
Our ability to meet our capital needs in the future will depend
on many factors, including maintaining and enhancing our operating cash flow, successfully managing the transition of our recent
acquisitions of Graphic Sciences and CEO Image, successfully retaining and growing our client base in the midst of general economic
uncertainty, managing the effects of the COVID-19 pandemic on our business, and obtaining forgiveness of our PPP loan. We will
need to successfully manage our revenues to support potential future earnout commitments for previous transactions and current
debt service commitments, and our future cash resources and capital requirements may vary materially from those now planned. Our
ability to obtain additional capital or debt financing on favorable terms, if needed, would likely be adversely affected by our
history of operating losses. Prior to this quarter, management has historically assessed that there was substantial doubt regarding
our ability to continue as a going concern. These conditions raise substantial doubt over the Company’s ability to meet all
of its obligations over the twelve months following the date of this Report. However, management has evaluated these conditions
and believes, based on its current plans and expectations, that we will be able to meet those obligations, although there is no
assurance.
Based
on our plans and assumptions as of the date of this report, we believe our capital resources, including our cash and cash equivalents,
along with funds expected to be generated from our operations, will be sufficient to meet our anticipated cash needs, including
for working capital, earnout liability payments for previous transactions, capital spending, and debt service commitments, for
at least the next 12 months. However, any projections of future cash needs and cash flows are subject to substantial risks and
uncertainties, such as our history of operating losses, the current COVID-19 pandemic, as well as general overall economic conditions.
See “Cautionary Note Regarding Forward-Looking Statements” above in this report and the risk factors included in Part
II, Item IA of this Report, Part II, Item 1A of our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2020, and
June 30, 2020, and filed on May 15, 2020, and August 14, 2020, respectively, and the risk factors that are included in Part I,
Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2019, filed on March 30, 2020.
The
Company’s condensed consolidated financial statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should it be
unable to continue as a going concern.
On
March 20, 2020, the Company effected a one-for-fifty (1-for-50) reverse stock split of the Company’s common stock. All share
and per share amounts herein have been adjusted to reflect the reverse stock split.
5.
|
Summary
of Significant Accounting Policies
|
Principles
of Consolidation
The
financial statements include the accounts of Intellinetics and the accounts of all the subsidiaries in which a controlling interest
is held by the Company. Under U.S. GAAP, consolidation is generally required for investments of more than 50% of the outstanding
voting stock of an investee, except when control is not held by the majority owner. The Company’s subsidiaries include:
Intellinetics Ohio and Graphic Sciences. The Company considers the criteria established under Financial Accounting Standards Board
(“FASB”) Accounting Standard Codification (“ASC”) Topic 810, “Consolidations” in its consolidation
process. All significant intercompany balances and transactions have been eliminated in consolidation.
Use
of Estimates
The
preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates
and assumptions. Such estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and
expenses. Actual results could differ from estimated amounts.
Significant
estimates and assumptions include valuation allowances related to receivables, accounts receivable -unbilled, allowance for obsolescence
or slow-moving parts and supplies inventory, the recoverability of long-term assets, depreciable lives of property and equipment,
purchase price allocations for acquisitions, fair value for goodwill and intangibles, the lease liabilities, estimates of fair
value deferred taxes and related valuation allowances. The Company’s management monitors these risks and assesses its business
and financial risks on a quarterly basis.
Revenue
Recognition
In
accordance with ASC 606, the Company follows 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. Specific revenue recognition policies apply to 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 the Company’s 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.
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 the Company’s
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 the Company’s 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, 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.
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, the Company allocates the transaction price of the contract to each distinct performance
obligation, on a relative basis using its standalone selling price. The Company determines 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 condensed consolidated balance sheets. Our contract liabilities consisted of
deferred (unearned) revenue, which is generally related to software as a service or software maintenance contracts. We classify
deferred revenue as current based on the timing of when we expect to recognize revenue, which are disclosed on the condensed consolidated
balance sheets.
The
following table present changes in our contract assets and liabilities during the nine months ended September 30, 2020 and 2019:
|
|
Balance
at
Beginning of Period
|
|
|
Addition
from
acquisition
(Note 6)
|
|
|
Revenue
Recognized in
Advance of
Billings
|
|
|
Billings
|
|
|
Balance
at
End of
Period
|
|
Nine months
ended September 30, 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
assets: Accounts receivable, unbilled
|
|
$
|
23,371
|
|
|
$
|
276,023
|
|
|
$
|
602,692
|
|
|
$
|
(398,444
|
)
|
|
$
|
503,642
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months
ended September 30, 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
assets: Accounts receivable, unbilled
|
|
$
|
65,118
|
|
|
$
|
-
|
|
|
$
|
133,505
|
|
|
$
|
(163,271
|
)
|
|
$
|
35,352
|
|
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 96% of the remaining performance obligations over the
next 12 months, with the remainder recognized thereafter. As of September 30, 2020, the aggregate amount of the transaction price
allocated to remaining performance obligations for software as a service and software maintenance contracts with a duration greater
than one year was $43,337. As of December 31, 2019, the aggregate amount of the transaction price allocated to remaining performance
obligations for software as a service and software maintenance contracts with a duration greater than one year was $69,381. This
does not include revenue related to performance obligations that are part of a contract whose original expected duration is one
year or less.
|
|
Balance
at
Beginning
of Period
|
|
|
Addition
from
acquisition
(Note 6)
|
|
|
Billings
|
|
|
Recognized
Revenue
|
|
|
Balance
at
End of
Period
|
|
Nine months
ended September 30, 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
liabilities: Deferred revenue
|
|
$
|
754,073
|
|
|
$
|
198,659
|
|
|
$
|
2,215,742
|
|
|
$
|
(2,146,222
|
)
|
|
$
|
1,022,252
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months
ended September 30, 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
liabilities: Deferred revenue
|
|
$
|
723,619
|
|
|
$
|
-
|
|
|
$
|
2,010,090
|
|
|
$
|
(2,060,993
|
)
|
|
$
|
672,716
|
|
i)
Rights of return and customer acceptance
The
Company does 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
The
Company executes certain sales contracts through resellers. The Company recognizes revenues relating to sales through resellers
when all the recognition criteria have been met including passing of control. In addition, the Company assesses 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.
k)
Contract costs
The
Company capitalizes 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 were immaterial during the periods presented and
are included in other current and long-term assets on our consolidated balance sheets.
l)
Sales taxes
Sales
taxes charged to and collected from customers as part of the Company’s 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
The
Company provides disaggregation of revenue based on product groupings in our consolidated statements of operations as it 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 condensed consolidated
financial statements for the nine months ended September 30, 2020 and 2019.
n)
Significant financing component
The
Company’s 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 the Company benefits 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
The
Company maintains its cash with high credit quality financial institutions. At times, the Company’s 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 the Company’s customer base, along with the different industries, governmental entities
and geographic regions, in which the Company’s customers operate, limits concentrations of credit risk with respect to accounts
receivable, with the exception of the State of Michigan. In the nine months ended September 30, 2020, the Company’s sales
to the State of Michigan totaled approximately 43% of revenues. The Company expects revenues from the State of Michigan
to be a slightly higher percentage of total revenues in future periods. The Company is not aware of any losses by Graphic
Sciences resulting from nonpayment by the State of Michigan.
The
Company does not generally require collateral or other security to support customer receivables; however, the Company may require
its customers to provide retainers, up-front deposits or irrevocable letters-of-credit when considered necessary to mitigate credit
risks. The Company has 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 September 30, 2020
and December 31, 2019, the Company’s allowance for doubtful accounts was $59,706 and $35,733, respectively.
Parts
and Supplies
Parts
and supplies are valued at the lower of cost or net realizable value. Costs are determined using the first-in, first-out method.
Parts and supplies are used for scanning and document conversion services. A provision for potentially obsolete or slow-moving
parts and supplies inventory is made based on parts and supplies levels, future sales forecasted and management’s judgment
of potentially obsolete parts and supplies. The Company recorded an allowance of $10,500 at September 30, 2020 and there was no
allowance recorded as of September 30, 2019.
Property
and Equipment
Property,
equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization. Depreciation and amortization
is computed over the estimated useful lives of the related assets on a straight-line basis. Furniture and fixtures, computer hardware
and purchased software are depreciated over three to seven years. Leasehold improvements are amortized over the life of the lease
or the asset, whichever is shorter, generally seven to ten years. Upon retirement or other disposition of these assets, the cost
and related accumulated depreciation and amortization of these assets are removed from the accounts and the resulting gains and
losses are reflected in the results of operations.
Intangible
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
The
Company accounts for the impairment and disposition of long-lived assets in accordance with ASC 360, “Property, Plant, and
Equipment.” The Company 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 were no impairment of long lived assets in the periods ended September 30, 2020 or 2019.
Stock-Based
Compensation
The
Company accounts 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.
The
Company accounts 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. The Company estimates 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 the Company’s 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
The
Company designs, develops, tests, markets, licenses, and supports new software products and enhancements of current products.
The Company continuously monitors its 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,” the Company
expenses 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 the Company’s 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,” the Company capitalizes purchase and implementation costs of
internal use software. Once an application has reached development stage, internal and external costs, if direct and incremental,
are capitalized until the software is substantially complete and ready for its intended use. Capitalization ceases upon complete
of all substantial testing. The Company also capitalize costs related to specific upgrades and enhancements when it is probable
that the expenditure will result in additional functionality. No such costs were capitalized during the periods presented in this
report.
For
the three and nine months ended September 30, 2020 and 2019, our expensed software development costs were $60,085 and $228,834,
respectively, and $101,885 and $349,111, respectively.
Recent
Accounting Pronouncements
Intangibles
– Goodwill and Other – Internal-Use Software
In
August 2018, the FASB issued ASU 2018-15, which addresses a customer’s accounting for implementation costs incurred in a
cloud computing arrangement that is a service contract. Under the new guidance, customers will apply the same criteria for capitalizing
implementation costs as they would for an arrangement that has a software license. ASC 2018-15 was effective for the Company beginning
in its first quarter of 2020. The Company has concluded that the impact on its condensed consolidated financial statements and
related disclosures is not material.
Fair
Value
In
August 2018, the FASB issued ASU 2018-13, which is guidance that changes the fair value measurement disclosure requirements of
ASC 820. ASU 2018-13 was effective for the Company beginning in its first quarter of 2020. The Company has concluded that the
impact on its condensed consolidated financial statements and related disclosures is not material.
Leases
In
February 2016, the FASB issued ASU No. 2016-02, Leases (“ASC 842”) (“ASU 2016-02”), which modified lease
accounting for both lessees and lessors to increase transparency and comparability by recognizing lease assets and lease liabilities
by lessees for those leases classified as operating leases under previous accounting standards and disclosing key information
about leasing arrangements. ASU 2016-02 was effective for the Company beginning in its first quarter of 2019. On January 1, 2019,
the Company recorded a lease liability of $143,761 and a net right-of-use asset of $138,549 using the required modified retrospective
approach. On March 2, 2020, the Company recorded a lease liability of $2,947,684 and a net right-of-use asset of $2,885,619 using
the required modified retrospective approach for the newly acquired subsidiary, Graphic Sciences. In adopting ASC 842, the Company
elected to utilize the available package of practical expedients permitted under the transition guidance within the new standard,
which does not require the reassessment of the following: i) whether existing or expired arrangements are or contain a lease,
ii) the lease classification of existing or expired leases, and iii) whether previous initial costs would qualify as capitalization
under the new lease standard.
Recently
Issued Accounting Pronouncements Not Yet Effective
Financial
Instruments – Credit Losses
In
June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which requires entities
to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current
conditions, and reasonable and supportable forecasts. This replaces the existing incurred loss model and is applicable to the
measurement of credit losses on financial assets measured at amortized cost. ASC 2016-16 is effective for annual reporting periods
beginning after December 15, 2023, including interim reporting periods within those annual reporting periods. Early adoption is
permitted. The Company is currently evaluating the impact of the new guidance on its condensed consolidated financial statements
and related disclosures.
Reference
Rate Reform
In
March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate
Reform on Financial Reporting” which provides optional relief through specific exceptions and practical expedients for transitioning
away from reference rates that are expected to be discontinued. The relief generally applies to eligible modifications of contractual
terms that change (or have the potential to change) the amount or timing of contractual cash flows related to replacement of a
reference rate. The relief allows such modifications to be accounted for as continuations of existing contracts without additional
analysis. The optional relief is available from March 2020 through December 31, 2022. The Company is currently evaluating the
impact of this ASU.
Income
Taxes
In
December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes”
which removes certain exceptions related to intra-period tax allocations and deferred tax accounting on outside basis differences
in foreign subsidiaries and equity method investments. Additionally, it provides other simplifying measures for the accounting
for income taxes. The new standard is effective for fiscal years beginning after December 15, 2021 with early adoption permitted.
The Company is currently evaluating the impact of this ASU.
Equity
Securities, Equity Method Investments and Certain Derivatives
In
January 2020, the FASB issued ASU 2020-01, “Clarifying the Interactions Between Topic 321, Topic 323, and Topic 815.”
This ASU clarifies the interaction between accounting standards related to equity securities, equity method investments and certain
derivatives. The effective date of the standard will be for annual periods beginning after December 15, 2020, and interim periods
within those fiscal years. The Company is currently evaluating the impact of the adoption of the new standard on its condensed
consolidated financial statements and related disclosures.
Lease
Accounting and COVID-19
In April 2020, the FASB issued a question-and-answer document to
address stakeholder questions on the application of the lease accounting guidance for lease concessions related to the effects
of the COVID-19 pandemic. The guidance will allow concessions related to the timing of payments, where the total consideration
has not changed, to not be accounted for as lease modifications. Instead, any such concessions can be accounted for as if no change
was made to the contract or as variable lease payments. The Company is currently assessing the impact of the question-and-answer
document on its condensed consolidated financial statements.
All
other Accounting Standards Updates issued but not yet effective are not expected to have a material effect on the Company’s
future condensed consolidated financial statements.
Advertising
The
Company expenses the cost of advertising as incurred. Advertising expense for the three and nine months ended September 30, 2020
and 2019 amounted to $1,651 and 5,331, respectively, $1,028 and $3,084, respectively.
Earnings
(Loss) Per Share
Basic income or loss per share is computed
by dividing net income or loss by the weighted average number of shares of common stock outstanding during the period.
Diluted income or loss per share is computed by dividing net income or loss by the diluted weighted average number of shares
of common stock outstanding during the period. The diluted weighted average number of shares gives effect to all dilutive potential
common shares outstanding during the period using the treasure 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. For the three months ended September 30, 2020, all applicable options and warrants were out-of-the-money. The nine
months ended September 30, 2020 and the three and nine months ended September 30, 2019 reported a net loss.
Income
Taxes
The
Company 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 100% valuation allowance
has been established on deferred tax assets at September 30, 2020 and December 31, 2019, due to the uncertainty of our ability
to realize future taxable income. For the nine months ended September 30, 2020 the Company recovered a net $179,400 of its valuation
allowance in conjunction with the consolidation of the net deferred tax liability of its wholly owned subsidiary, Graphic Sciences.
The
Company accounts for uncertainty in income taxes in its 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 the Company in its tax returns.
Segment
Information
Operating segments are defined in the criteria
established under ASC 280, “Segment Reporting,” as components of public entities that engage in business activities
from which they may earn revenues and incur expenses for which separate financial information is available and which is evaluated
regularly by the Company’s chief operating decision maker (“CODM”) in deciding how to assess performance and
allocate resources. The Company’s CODM assesses performance and allocates resources based on two operating segments: Document
Management and Document Conversion. These segments contain individual business components that have been combined on the basis
of common management, customers, solutions offered, service processes and other economic characteristics. The Company currently
has no intersegment sales. The Company evaluates the segments’ performance based on gross profits.
The
Document Management Segment provides cloud-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:
|
|
Three
months ended
September 30, 2020
|
|
|
Three
months ended
September 30, 2019
|
|
Revenues
|
|
|
|
|
|
|
|
|
Document
Management
|
|
$
|
780,834
|
|
|
$
|
738,957
|
|
Document
Conversion
|
|
|
1,730,448
|
|
|
|
16,611
|
|
Total
revenues
|
|
$
|
2,511,282
|
|
|
$
|
755,568
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
|
|
|
|
|
|
Document
Management
|
|
$
|
605,451
|
|
|
$
|
610,998
|
|
Document
Conversion
|
|
|
884,843
|
|
|
|
(3,120
|
)
|
Total
gross profit
|
|
$
|
1,490,294
|
|
|
$
|
607,878
|
|
|
|
|
|
|
|
|
|
|
Capital
additions, net
|
|
|
|
|
|
|
|
|
Document
Management
|
|
$
|
-
|
|
|
$
|
-
|
|
Document
Conversion
|
|
|
33,676
|
|
|
|
-
|
|
Total
capital additions, net
|
|
$
|
33,676
|
|
|
$
|
-
|
|
|
|
Nine
months ended
September 30, 2020
|
|
|
Nine
months ended
September 30, 2019
|
|
Revenues
|
|
|
|
|
|
|
|
|
Document
Management
|
|
$
|
2,018,208
|
|
|
$
|
1,879,187
|
|
Document
Conversion
|
|
|
3,539,378
|
|
|
|
32,374
|
|
Total
revenues
|
|
$
|
5,557,586
|
|
|
$
|
1,911,561
|
|
|
|
|
|
|
|
|
|
|
Gross
profit
|
|
|
|
|
|
|
|
|
Document
Management
|
|
$
|
1,526,283
|
|
|
$
|
1,506,071
|
|
Document
Conversion
|
|
|
1,880,648
|
|
|
|
(14,769
|
)
|
Total
gross profit
|
|
$
|
3,406,931
|
|
|
$
|
1,491,302
|
|
|
|
|
|
|
|
|
|
|
Capital
additions, net
|
|
|
|
|
|
|
|
|
Document
Management
|
|
$
|
7,911
|
|
|
$
|
-
|
|
Document
Conversion
|
|
|
51,205
|
|
|
|
5,489
|
|
Total
capital additions, net
|
|
$
|
59,116
|
|
|
$
|
5,489
|
|
|
|
September
30, 2020
|
|
|
December
31, 2019
|
|
Total
assets
|
|
|
|
|
|
|
|
|
Document
Management
|
|
$
|
1,825,343
|
|
|
$
|
986,574
|
|
Document
Conversion
|
|
|
4,995,089
|
|
|
|
-
|
|
Corporate
|
|
|
3,561,977
|
|
|
|
-
|
|
Total
assets
|
|
$
|
10,382,409
|
|
|
$
|
986,574
|
|
Statement
of Cash Flows
For
purposes of reporting cash flows, cash includes cash on hand and demand deposits held by banks.
Reclassifications
Certain
amounts reported in prior filings of the condensed consolidated financial statements have been reclassified to conform
to current presentation.
On
March 2, 2020, the Company entered into a stock purchase agreement to acquire all of the issued and outstanding stock of Graphic
Sciences. The acquisition was accounted for in accordance with GAAP and was made to expand the Company’s market share in
the document management industry and due to synergies of product lines and services between the Companies.
On
April 21, 2020, the Company entered into an asset purchase agreement to acquire substantially all of the assets of CEO Image.
The acquisition was accounted for in accordance with GAAP and was made to expand the Company’s market share in the document
management industry and due to synergies of product lines and services between the Companies.
The
purchase price has been preliminarily allocated to assets acquired and liabilities assumed based on the estimated fair value of
such assets and liabilities at the date of acquisitions as follows:
|
|
Total
|
|
|
March
2, 2020
|
|
|
April
21, 2020
|
|
Assets
acquired:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
17,269
|
|
|
$
|
17,269
|
|
|
$
|
-
|
|
Accounts
receivable
|
|
|
1,122,737
|
|
|
|
1,071,770
|
|
|
|
50,967
|
|
Accounts
receivable, unbilled
|
|
|
276,023
|
|
|
|
276,023
|
|
|
|
-
|
|
Parts
and supplies
|
|
|
91,396
|
|
|
|
91,396
|
|
|
|
-
|
|
Prepaid
expenses
|
|
|
73,116
|
|
|
|
73,116
|
|
|
|
-
|
|
Other
current assets
|
|
|
5,954
|
|
|
|
5,954
|
|
|
|
-
|
|
Right
of use assets
|
|
|
2,885,618
|
|
|
|
2,885,618
|
|
|
|
-
|
|
Property
and equipment
|
|
|
735,885
|
|
|
|
732,372
|
|
|
|
3,513
|
|
Intangible
assets (see Note 7)
|
|
|
1,361,000
|
|
|
|
1,230,000
|
|
|
|
131,000
|
|
|
|
|
6,568,998
|
|
|
|
6,383,518
|
|
|
|
185,480
|
|
Liabilities
assumed:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
|
168,749
|
|
|
|
129,622
|
|
|
|
39,127
|
|
Accrued
expenses
|
|
|
162,426
|
|
|
|
155,949
|
|
|
|
6,477
|
|
Lease
liabilities
|
|
|
2,947,684
|
|
|
|
2,947,684
|
|
|
|
-
|
|
Federal
and state taxes payable
|
|
|
168,900
|
|
|
|
168,900
|
|
|
|
-
|
|
Deferred
revenue
|
|
|
198,659
|
|
|
|
39,186
|
|
|
|
159,473
|
|
Deferred
tax liabilities - Net
|
|
|
149,900
|
|
|
|
149,900
|
|
|
|
-
|
|
|
|
|
3,796,318
|
|
|
|
3,591,241
|
|
|
|
205,077
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
identifiable net assets/(liabilities)
|
|
|
2,772,680
|
|
|
|
2,792,277
|
|
|
|
(19,597
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase price
|
|
|
5,095,567
|
|
|
|
4,592,453
|
|
|
|
503,114
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill
- Excess of purchase price over fair value of net assets acquired
|
|
$
|
2,322,887
|
|
|
$
|
1,800,176
|
|
|
$
|
522,711
|
|
The
purchase price of Graphic Sciences was financed with a $686,200 seller earnout liability and $3,906,253 was paid in cash. Goodwill
in the amount of $1,800,176 was recognized in the acquisition of Graphic Sciences and is attributable to the cash flows of the
business derived from the potential of the Company to outperform the market due to its existing relationship and other synergies
created within the Company.
The
purchase price of CEO Image was partially financed with a $203,000 seller earnout liability and $170,000 in installment payments.
$128,832 was paid in cash at the closing. On August 3, 2020, $1,282 was paid for a net working capital adjustment and $70,000
was paid, along with accrued interest, in installment payments. The remaining Seller note of $100,000 is included in notes payable
– current. Goodwill in the amount of $522,711 was recognized in the acquisition of CEO Image and is attributable to the
cash flows of the business derived from the potential of the Company to outperform the market due to its existing relationship
and other synergies created within the Company.
Acquisition
costs which include legal and other professional fees of approximately $636,440 were expensed as nonrecurring transaction costs
and are included in Significant transaction costs in the accompanying condensed consolidated statement of operations.
The
earnout arrangement for Graphic Sciences requires the Company to pay the seller up to $833,000 annually for a three year period
based on a gross profit level achieved by Graphic Sciences on an annual basis, resulting in a max payout to the seller over a
three year period of $2,500,000, as defined. Management estimated a fair value of the earnout liability of $686,200 which would
be owed to the seller based on the terms of the earnout, and accordingly, recorded this liability at the acquisition date in accordance
with GAAP. The fair value was based on projections of future gross profit over a three year period and valuation techniques that
utilized expected volatility, threshold probability, and discounting of future payments.
The
earnout arrangement for CEO Image requires the Company to pay the seller up to $185,000 annually for a two year period
based on a sales revenue level achieved by certain customers of CEO Image on an annual basis, resulting in a max payout to the
seller over a two year period of $370,000, as defined. Management estimated a fair value of the earnout of $203,000 which would
be owed to the seller based on the terms of the earnout, and accordingly, recorded this liability at the acquisition date in accordance
with GAAP. The fair value was based on projections of future revenue over a two year period and valuation techniques that utilized
expected volatility, threshold probability, and discounting of future payments.
As
the Company finalizes the fair value of assets acquired and liabilities assumed, additional purchase price adjustments may be
recorded. The finalization of the purchase accounting assessment may result in changes in the valuation of assets acquired and
liabilities assumed and may have an impact on the Company’s results of operations and financial position.
The
following unaudited pro forma information presents a summary of the consolidated results of operations for the Company as if the
acquisitions of Graphic Sciences and CEO Image had occurred on January 1, 2019.
|
|
For
the Three months ended
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
|
September
30, 2020
|
|
|
September
30, 2019
|
|
Total
revenues
|
|
$
|
2,511,282
|
|
|
$
|
2,931,250
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
155,673
|
|
|
$
|
(324,174
|
)
|
|
|
|
|
|
|
|
|
|
Basic
and diluted net income (loss) per share
|
|
$
|
0.06
|
|
|
$
|
(0.12
|
)
|
|
|
For
the Nine months ended
|
|
|
|
(unaudited)
|
|
|
(unaudited)
|
|
|
|
September
30, 2020
|
|
|
September
30, 2019
|
|
Total
revenues
|
|
$
|
6,990,549
|
|
|
$
|
7,716,421
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(566,082
|
)
|
|
$
|
(1,031,326
|
)
|
|
|
|
|
|
|
|
|
|
Basic
and diluted net loss per share
|
|
$
|
(0.20
|
)
|
|
$
|
(0.37
|
)
|
The
unaudited pro forma consolidated results are based on the Company’s historical financial statements and those of Graphic
Sciences and CEO Image and do not necessarily indicate the results of operations that would have resulted had the acquisition
actually been completed at the beginning of the applicable period presented. The pro forma financial information assumes that
the companies were combined as of January 1, 2019.
The following table presents the amounts
of revenue and earnings of the acquirees since the acquisition date included in the condensed consolidated income statement for
the reporting period.
For the three months ended September 30, 2020
|
|
Graphic Sciences
|
|
|
CEO Image
|
|
Total revenues
|
|
$
|
1,660,775
|
|
|
$
|
155,414
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
239,555
|
|
|
$
|
(a)
|
|
For
the nine months ended September 30, 2020
|
|
Graphic
Sciences
|
|
|
CEO
Image
|
|
Total
revenues
|
|
$
|
3,409,193
|
|
|
$
|
219,934
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
380,881
|
|
|
$
|
(a)
|
|
|
(a)
|
Total earnings
from the CEO Image acquisition is impracticable to disclose as the operations were merged with existing operations and not
accounted for separately.
|
7.
|
Intangible
Assets, Net
|
At
September 30, 2020, intangible assets consisted of the following:
|
|
Estimated
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
Useful
Life
|
|
Costs
|
|
|
Amortization
|
|
|
Net
|
|
Trade
names
|
|
10
years
|
|
$
|
119,000
|
|
|
$
|
(6,942
|
)
|
|
$
|
112,058
|
|
Customer
contracts
|
|
5-8
years
|
|
|
1,242,000
|
|
|
|
(114,968
|
)
|
|
|
1,127,032
|
|
|
|
|
|
$
|
1,361,000
|
|
|
$
|
(121,910
|
)
|
|
$
|
1,239,090
|
|
Amortization
expense for the three and nine months ended September 30, 2020, amounted to $54,119 and $121,910, respectively. The following
table represents future amortization expense for intangible assets subject to amortization.
For
the Nine Months Ending September 30,
|
|
Amount
|
|
2021
|
|
$
|
216,475
|
|
2022
|
|
|
216,475
|
|
2023
|
|
|
216,475
|
|
2024
|
|
|
216,475
|
|
2025
|
|
|
205,558
|
|
Thereafter
|
|
|
167,632
|
|
|
|
$
|
1,239,090
|
|
8.
|
Fair
Value Measurements
|
Under
U.S. 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 included in U.S. GAAP gives the highest
priority to Level 1 inputs, which consist of unadjusted quoted prices for identical instruments in active markets. Level 2 inputs
consist of quoted prices for similar instruments. Level 3 valuations are derived from inputs that are significant and unobservable,
and these valuations have the lowest priority.
Management
believes that the carrying values of cash and equivalents, accounts receivable, accounts payable, accrued expenses, and the 2019
Related Notes approximate fair value because of their short maturity. Management believes that the carrying value of the 2020
Notes approximates fair value given the March 2, 2020 transaction proximity to September 30, 2020.
The
table below reflects all other notes payable at December 31, 2019.
|
|
|
|
December
31, 2019
|
|
|
|
|
|
Fair
Value
|
|
2016
Unrelated Notes
|
|
(a)
|
|
$
|
942,256
|
|
2017
Unrelated Notes
|
|
(a)
|
|
|
2,011,859
|
|
2018
Unrelated Notes
|
|
(a)
|
|
|
1,028,792
|
|
Total
|
|
|
|
$
|
3,982,907
|
|
|
|
|
|
December
31, 2019
|
|
|
|
|
|
Fair
Value
|
|
2016
Related Notes
|
|
(a)
|
|
$
|
405,784
|
|
2017
Related Notes
|
|
(a)
|
|
|
445,810
|
|
2018
Related Notes
|
|
(a)
|
|
|
457,241
|
|
Total
|
|
|
|
$
|
1,308,835
|
|
|
(a)
|
The
fair value was based upon Level 2 inputs. See Note 10 for additional information about the Company’s 2016, 2017, and
2018 Unrelated Notes. See Note 11 for additional information about the Company’s 2016, 2017, and 2018 Related Notes.
|
Management
believes that the carrying value of the earnout liabilities approximates fair value given the March 2, 2020 and April 21, 2020
transactions proximity to September 30, 2020. Fair value of the earnout liabilities is based upon Level 3 inputs, using significant
unobservable inputs for the period ended.
9.
|
Property
and Equipment
|
Property
and equipment are comprised of the following:
|
|
September
30, 2020
|
|
|
December
31, 2019
|
|
Computer
hardware and purchased software
|
|
$
|
998,007
|
|
|
$
|
259,959
|
|
Leasehold
improvements
|
|
|
275,106
|
|
|
|
221,666
|
|
Furniture
and fixtures
|
|
|
82,056
|
|
|
|
82,056
|
|
|
|
|
1,355,169
|
|
|
|
563,681
|
|
Less:
accumulated depreciation and amortization
|
|
|
(639,169
|
)
|
|
|
(556,762
|
)
|
Property
and equipment, net
|
|
$
|
716,000
|
|
|
$
|
6,919
|
|
Total
depreciation expense on the Company’s property and equipment for the three and nine months ended September 30, 2020 and
2019 amounted to $35,357 and $82,407, respectively, and $1,901 and $5,908, respectively.
Summary
of Notes Payable
The
table below reflects all notes payable at September 30, 2020 and December 31, 2019, respectively, with the exception of related
party notes disclosed in Note 11 - Notes Payable - Related Parties.
|
|
September
30, 2020
|
|
|
December
31, 2019
|
|
Seller
Notes Payable
|
|
$
|
100,000
|
|
|
$
|
-
|
|
PPP
Note Payable
|
|
|
838,700
|
|
|
|
-
|
|
2020
Notes
|
|
|
2,000,000
|
|
|
|
-
|
|
2018
Unrelated Notes
|
|
|
-
|
|
|
|
900,000
|
|
2017
Unrelated Notes
|
|
|
-
|
|
|
|
1,760,000
|
|
2016
Unrelated Notes, net of beneficial conversion feature of $50,703
|
|
|
-
|
|
|
|
824,297
|
|
Total
notes payable
|
|
$
|
2,938,700
|
|
|
$
|
3,484,297
|
|
Less
unamortized debt issuance costs
|
|
|
(250,702
|
)
|
|
|
(144,334
|
)
|
Less
unamortized debt discount
|
|
|
(257,778
|
)
|
|
|
-
|
|
Less
current portion
|
|
|
(612,539
|
)
|
|
|
3,339,963
|
|
Long-term
portion of notes payable
|
|
$
|
1,817,681
|
|
|
$
|
-
|
|
Future
minimum principal payments of these notes payable as described in this Note 10 are as follows:
As
of September 30,
|
|
Amount
|
|
2021
|
|
$
|
612,539
|
|
2022
|
|
|
326,161
|
|
2023
|
|
|
2,000,000
|
|
Total
|
|
$
|
2,938,700
|
|
As
of September 30, 2020 and December 31, 2019, accrued interest for these notes payable with the exception of the related party
notes in Note 11 - Notes Payable - Related Parties, was $4,505 and $918,307, respectively. As of September 30, 2020, unamortized
deferred financing costs and unamortized debt discount were reflected within long term liabilities on the condensed consolidated
balance sheets. As of December 31, 2019, unamortized deferred financing costs were $144,334, and was reflected within current
liabilities on the consolidated balance sheets.
With
respect to all notes outstanding (other than the notes to related parties), for the three and nine months ended September 30,
2020 and 2019, interest expense, including the amortization of deferred financing costs, accrued loan participation fees, original
issue discounts, deferred interest and related fees, interest expense related to warrants issued for the conversion of convertible
notes, and the embedded conversion feature was $115,498 and $433,783, respectively, and $186,198 and $544,639, respectively.
Seller
Notes Payable
On
April 21, 2020, the Company entered into an asset purchase agreement under which the Company agreed to pay a principal amount
of $170,000 (“Seller Notes Payable”) as further discussed in Note 6. The terms of the Seller Notes Payable are approximately
three and six months, with $70,000 plus accrued interest paid August 3, 2020 and $100,000 plus accrued interest
due November 1, 2020. The Seller Notes Payable bear an interest rate of 1.5% per annum.
Paycheck
Protection Program Note Payable
On
April 15, 2020, the Company entered into an unsecured promissory note (“PPP Note Payable”) under the Paycheck Protection
Program (the “PPP”), through PNC Bank with a principal amount of $838,700. The term of the PPP Note Payable is two
years, with an interest rate of 1.0% per annum, which shall be deferred for the first six months of the term of the loan. PPP
loan recipients can be granted forgiveness for all or a portion of loans granted under the PPP, based on the use of loan proceeds
for payroll costs and mortgage interest, rent or utility costs and the maintenance of employee and compensation levels. No assurance
is provided that the Company will obtain forgiveness of the PPP Note Payable in whole or in part.
2020
Note Issuance
On
March 2, 2020, the Company issued and sold 2,000 units (“Units”) to certain accredited investors in a private offering,
with each Unit consisting of $1,000 in 12% Subordinated Notes (“2020 Notes”) and 40 shares of common stock, for aggregate
gross proceeds of $2,000,000 in Units. The entire outstanding principal and accrued
interest of the 2020 Notes are due and payable on February 28, 2023. Interest on the 2020 Notes accrues at the rate of 12% per
annum, payable quarterly in cash, beginning on June 30, 2020. Any accrued but unpaid quarterly installment of interest shall accrue
interest at the rate of 14.0% per annum. Any overdue principal and accrued and unpaid interest at the maturity date shall accrue
a mandatory default penalty of 20% of the outstanding principal balance and an interest rate of 14% per annum from the maturity
date until paid in full. The Company used a portion of the net proceeds of the offering to finance the acquisition of Graphic
Sciences and CEO Image and using the remaining net proceeds for working capital and general corporate purposes. The Company recognized
a debt discount of $320,000 for the 80,000 shares issued in conjunction with the Units. The amortization of the debt discount
will be recognized over the life of the 2020 Notes as interest expense, and was $26,667 and $62,222, respectively, for the three
and nine months ended September 30, 2020.
2020
Note Conversion
On
March 2, 2020, the Company entered into amendments to all of its then-outstanding convertible promissory notes, which were issued
by the Company to various related and unrelated investors in 2016, 2017, and 2018. The Note Amendments permitted the Company to
convert all of the then-outstanding principal and accrued and unpaid interest payable with respect to the 2016-2018 Notes into
shares of Common Stock upon the same terms as such private placement. Pursuant to the Note Amendments, on March 2, 2020, the Company
converted all of the then-outstanding principal and accrued and unpaid interest payable with respect to the 2016-2018 Notes into
the aggregate amount of 1,433,689 shares of Common Stock at a conversion price of $4.00 per share. Taglich Brothers, Inc. acted
as the exclusive placement agent for the Note Conversion, and earned fees in the form of 35,250 shares of Common Stock at a price
of $4.00 per share (with such fees relating to the conversion of both the related and unrelated notes).
2018
Notes
On
September 20 and September 26, 2018, the Company issued convertible promissory notes in an aggregate amount of $900,000 (“2018
Unrelated Notes”) to unrelated accredited investors (the “2018 Note Investors”). Placement agent and escrow
agent fees of $106,740 were paid out of the cash proceeds. The 2018 Unrelated Notes matured on December 31, 2020, and bore interest
at an annual rate of interest of 8% until maturity, with interest of 8% payable quarterly beginning January 2, 2019. The 2018
Note Investors had the right, in their sole discretion, to convert the 2018 Unrelated Notes into shares of Company common stock
under certain circumstances at a conversion rate of $6.50 per share. These notes were further amended and converted into equity
on March 2, 2020, as described further below in this note, see “2020 Note Conversion.”
2017
Notes
On
November 17 and November 30, 2017, the Company issued convertible promissory notes in an aggregate amount of $1,760,000 (“2017
Unrelated Notes”) to unrelated accredited investors (the “2017 Note Investors”). Placement agent and escrow
agent fees of $174,810 were paid out of the cash proceeds. The 2017 Unrelated Notes had an original maturity date of November
30, 2019. On September 14, 2018, the 2017 Unrelated Notes were amended to mature on December 31, 2020. The amendment was accounted
for as a troubled debt restructuring with the future undiscounted cash flows being greater than the carrying value of the debt
prior to extension. No gain was recorded on the amendment, and a new effective interest rate on the 2017 Unrelated Notes was established
based on the carrying value of the debt and the revised future cash flows. The 2017 Unrelated Notes bore interest at an annual
rate of interest of 8% until maturity, with interest of 8% payable quarterly beginning July 1, 2018. The 2017 Note Investors had
the right, in their sole discretion, to convert the 2017 Unrelated Notes into shares of Company common stock under certain circumstances
at a conversion rate of $10.00 per share. These notes were further amended and converted into equity on March 2, 2020, as described
further below in this note, see “2020 Note Conversion.”
2016
Notes
The
Company issued convertible promissory notes on December 30, 2016 in an aggregate amount of $315,000, and on January 6, 2017 and
January 31, 2017 in an aggregate amount of $560,000 (collectively, the “2016 Unrelated Notes”), to unrelated accredited
investors (the “2016 Note Investors”). Placement agent and escrow agent fees of $100,255 in the aggregate for those
issuances, were paid out of the cash proceeds of those issuances. The 2016 Unrelated Notes bore interest at an annual rate of
interest of 12% until maturity, with partial interest of 6% payable quarterly, and an original maturity date of December 31, 2018.
The 2016 Note Investors had the right, in their sole discretion, to convert the 2016 Unrelated Notes into shares of Company common
stock at a conversion rate of $32.50 per share. On September 17, 2018, the 2016 Unrelated Notes were amended to mature on December
31, 2020, and bore interest at an annual rate of interest of 10% until maturity, with partial interest of 5% payable quarterly.
With the amendment, the 2016 Note Investors had the right, in their sole discretion, to convert the 2016 Unrelated Notes into
shares of Company common stock at a conversion rate of $20.00 per share. The amendment was accounted for as a troubled debt restructuring
with the future undiscounted cash flows being greater than the carrying value of the debt prior to extension. No gain was recorded
on the amendment, and a new effective interest rate on the 2016 Unrelated Notes was established based on the carrying value of
the debt and the revised future cash flows. The Company recognized an initial beneficial conversion feature in the amount of $369,677,
plus a fair value adjustment of $56,661 under the troubled debt restructuring accounting. Interest expense recognized on the amortization
of the beneficial conversion feature of the 2016 Unrelated Notes was $0 and $50,703, and $12,675 and $38,027, for the three and
nine months ended September 30, 2020 and 2019, respectively. These notes were further amended and converted into equity on March
2, 2020, as described further below in this note, see “2020 Note Conversion.”
The
Company has evaluated the terms of its 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 the Company’s
common stock. The Company 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. The Company 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 the Company 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.
11.
|
Notes
Payable - Related Parties
|
Summary
of Related Notes
The
table below reflects the notes payable to related parties at September 30, 2020 and December 31, 2019, respectively:
|
|
September
30, 2020
|
|
|
December
31, 2019
|
|
2019
Related Notes
|
|
$
|
-
|
|
|
$
|
397,728
|
|
2018
Related Notes
|
|
|
-
|
|
|
|
400,000
|
|
2017
Related Notes
|
|
|
-
|
|
|
|
390,000
|
|
2016
Related Notes, net of beneficial conversion feature of $20,015
|
|
|
-
|
|
|
|
354,985
|
|
Total
notes payable - related party
|
|
$
|
-
|
|
|
$
|
1,542,713
|
|
Unamortized
original issue discount and debt issuance costs
|
|
|
-
|
|
|
|
(75,313
|
)
|
Less
current portion
|
|
|
-
|
|
|
|
(1,467,400
|
)
|
Long-term
portion of notes payable-related party
|
|
$
|
-
|
|
|
$
|
-
|
|
As
of December 31, 2019, accrued interest for these notes payable – related parties amounted to $294,191, and on the condensed
consolidated balance sheets was reflected within current liabilities as of December 31, 2019.
For
the three and nine months ended September 30, 2020 and 2019, interest expense in connection with notes payable – related
parties was $0 and $88,941, respectively, and $58,958 and $173,011, respectively.
2020
Note Conversion
On
March 2, 2020, the Company entered into amendments to all of its currently outstanding Convertible Promissory Notes, which were
issued by the Company to various related and unrelated investors in 2016, 2017, and 2018. The Note Amendments permitted the Company
to convert all of the then-outstanding principal and accrued and unpaid interest payable with respect to the 2016-2018 Notes into
shares of Common Stock upon the same terms as such private placement. Pursuant to the Note Amendments, on March 2, 2020, the Company
converted all of the then-outstanding principal and accrued and unpaid interest payable with respect to the 2016-2018 Notes into
the aggregate amount of 1,433,689 shares of Common Stock at a conversion price of $4.00 per share. Taglich Brothers, Inc. acted
as the exclusive placement agent for the Note Conversion, and earned fees in the form of 35,250 shares of Common Stock at a price
of $4.00 per share (with such fees relating to the conversion of both the related and unrelated notes).
2019
Notes
On
November 15, 2019, the Company issued promissory notes in an aggregate principal amount of $397,728 (the “2019 Related Notes”)
to Robert Taglich and Michael Taglich (each holding more than 5% beneficial interest in the Company’s Shares). The notes
included an original issue discount of $47,728. Interest expense recognized on the amortization of the original discount was $11,932,
for the twelve months ended December 31, 2019. The notes bore no interest in addition to the original issue discount, which was
12%, and matured on May 15, 2020. If the 2019 Related Notes had not been either fully repaid by the Company or converted into
Company shares or other securities by the maturity date, then the 2019 Related Notes would have accrued interest at the annual
rate of 12% from the maturity date until the date of repayment. The Company used the proceeds of the 2019 Related Notes for working
capital, general corporate purposes, and debt repayment. On March 2, 2020, $350,000 of such notes were converted into equity in
connection with a private placement of common stock at a conversion price of $4.00 per share. On May 15, 2020, the remaining balance
of $47,728 was repaid by the Company in cash.
2018
Notes
On
September 26, 2018, the Company issued convertible promissory notes in an aggregate amount of $400,000 (the “2018 Related
Notes”) to accredited investors, including Robert Taglich and Michael Taglich (each holding more than a 5% beneficial interest
in the Company’s shares). The 2018 Related Notes matured on December 31, 2020, and bore interest at an annual rate of 8%
until maturity, with interest payable quarterly beginning January 2, 2019. The 2018 Related Note investors had the right, in their
sole discretion, to convert the 2018 Related Notes into shares of Company common stock under certain circumstances at a conversion
rate of $6.50 per share. These notes were further amended and converted into equity on March 2, 2020, as described further below
in this note, see “2020 Note Conversion.”
2017
Notes
On
September 21, 2017, the Company issued convertible promissory notes in an aggregate principal amount of $154,640 (the “2017
Bridge Notes”) to Robert Taglich and Michael Taglich (each holding more than a 5% beneficial interest in the Company’s
shares). The 2017 Bridge Notes included an original issue discount of $4,640. Interest expense recognized on the amortization
of the original discount was $889 for the twelve months ended December 31, 2017. The 2017 Bridge Notes bore interest at an annual
rate of 8% beginning March 21, 2018 until maturity on September 21, 2018. The effective interest rate was 7% for the term of the
2017 Bridge Notes. The 2017 Bridge Note investors had the right, in their sole discretion, to convert the 2017 Bridge Notes into
securities to be issued by the Company in a private placement of equity, equity equivalents, convertible debt or debt financing.
In conjunction with the issue of the 2016 Bridge Notes, 3,000 warrants were issued to the 2017 Bridge Note investors. The warrants
have an exercise price equal to $15.00 per share and contain a cashless exercise provision. All warrants are immediately exercisable
and are exercisable for five years from issuance. The Company recognized debt issuance costs, recorded as a debt discount, on
the issue of the warrants in the amount of $38,836. Interest expense recognized on the amortization of the debt discount was $38,836
for the twelve months ended December 31, 2017. On November 30, 2017, principal in the amount of $150,000 of the 2017 Bridge Notes
was converted by the 2017 Bridge Note investors into the 2017 Related Notes, described below.
On
November 17, 2017, the Company issued convertible promissory notes in an aggregate amount of $390,000 (the “2017 Related
Notes”) to accredited investors, including Robert Taglich and Michael Taglich (each holding more than a 5% beneficial interest
in the Company’s shares) and James DeSocio (President, Chief Executive Officer and Director), in exchange for the conversion
of $150,000 principal amount under the 2017 Bridge Notes and the receipt of $240,000 cash. The 2017 Related Notes were initially
scheduled to mature on November 30, 2019. On September 14, 2018, the 2017 Related Notes were amended to mature on December 31,
2020. The amendment was accounted for as a troubled debt restructuring with the future undiscounted cash flows being greater than
the carrying value of the debt prior to extension. No gain was recorded, and a new effective interest rate was established based
on the carrying value of the debt and the revised future cash flows. The 2017 Related Notes bore interest at an annual rate of
8% until maturity, with interest payable quarterly beginning July 1, 2018. The 2017 Related Note investors had the right, in their
sole discretion, to convert the 2017 Related Notes into shares of Company common stock under certain circumstances at a conversion
rate of $10.00 per share. These notes were further amended and converted into equity on March 2, 2020, as described further below
in this note, see “2020 Note Conversion.”
2016
Notes
On
December 30, 2016, the Company issued convertible promissory notes in an aggregate amount of $375,000 (the “2016 Related
Notes”) to accredited investors (the “2016 Related Note Investors”), including Robert Taglich and Michael Taglich
(each holding more than 5% beneficial interest in the Company’s shares) and Robert Schroeder (a director of the Company).
The 2016 Related Notes bore interest at an annual rate of interest of 12% until maturity, with partial interest of 6% payable
quarterly, and an initial maturity date of December 31, 2018. The 2016 Related Note Investors had a right, in their sole discretion,
to convert the 2016 Related Notes into shares of Company common stock at a conversion rate of $32.50 per share. On September 17,
2018, the 2016 Related Notes were amended to mature on December 31, 2020, and to bear interest at an annual rate of interest of
10% until maturity, with partial interest of 5% payable quarterly. With the amendment, the 2016 Related Note Investors had the
right, in their sole discretion, to convert the 2016 Related Notes into shares at a conversion rate of $20.00 per share. The amendment
was accounted for as a troubled debt restructuring with the future undiscounted cash flows being greater than the carrying value
of the debt prior to extension. No gain was recorded on the amendment, and a new effective interest rate on the 2016 Related Notes
was established based on the carrying value of the debt and the revised future cash flows. The Company recognized an initial beneficial
conversion feature in the amount of $144,231, plus a fair value adjustment of $24,710 under the troubled debt restructuring accounting.
Interest expense recognized on the amortization of the beneficial conversion feature of the 2016 Related Notes was $0 and $20,015,
and $5,004 and $15,011, for the three and nine months ended September 30, 2020 and 2019, respectively. These notes were further
amended and converted into equity on March 2, 2020, as described further below in this note, see “2020 Note Conversion.”
12.
|
Deferred
Compensation
|
Pursuant
to the Company’s employment agreements with the founders, the founders have earned incentive compensation totaling $100,828
and $117,166 in cash, as of September 30, 2020 and December 31, 2019, respectively, which payment obligation has been deferred
by the Company until it reasonably believes it has sufficient cash to make the payment. Following the retirement of founder A.
Michael Chretien on December 8, 2017, the Company made bi-weekly payments of $1,846 until his portion of the deferred compensation
had been paid, which occurred in May, 2020. For the three and nine months ended September 30, 2020 and 2019, the Company paid
$0 and $16,338, respectively, and $11,077 and $35,077, respectively, which is reflected as a reduction in the deferred compensation
liability.
13.
|
Commitments
and Contingencies
|
Employment
Agreements
The
Company has entered into employment agreements with three of its key executives. Under their respective agreements, the executives
serve at will and are bound by typical confidentiality, non-solicitation and non-competition provisions. Deferred compensation
for a founder of the Company, as disclosed in Note 12 above, is still outstanding as of December 31, 2019.
Operating
Leases
On
January 1, 2010, the Company entered into an agreement to lease 6,000 rentable square feet of office space in Columbus, Ohio.
The lease commenced on January 1, 2010 and, pursuant to a lease extension dated August 9, 2016, the lease expires on December
31, 2021.
Our
subsidiary, Graphic Sciences, uses 36,000 square feet of leased space in Madison Heights 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 $40,694, with increases annually in September up to $45,828 for the final year,
with a lease term continuing until August 31, 2026.
Graphic
Sciences also leases and uses a separate 20,000 square foot building for document storage in Highland Park, MI, a satellite office
in Traverse City, MI for production, and additional temporary storage space in Madison Heights, MI. The monthly Highland Park
rental payment is $10,417, with increases annually in September up to $11,250 for the final year, with a lease term continuing
until September 30, 2021. The monthly Traverse City rental payment is $4,500, with a lease term continuing until January 31, 2024.
The monthly additional Madison Heights rental payment is $6,348, with an initial lease term until July 31, 2020 and a month-to-month
arrangement thereafter.
Graphic
Sciences also leases and uses four leased vehicles for logistics. The monthly rental payments for these vehicles total $2,618,
with lease terms continuing until October 31, 2024.
Future
minimum lease payments under these operating leases are as follows:
For
the Twelve Months Ending September 30,
|
|
Amount
|
|
2021
|
|
$
|
774,230
|
|
2022
|
|
|
607,808
|
|
2023
|
|
|
593,781
|
|
2024
|
|
|
564,589
|
|
2025
|
|
|
541,481
|
|
Thereafter
|
|
|
504,111
|
|
|
|
$
|
3,586,000
|
|
Lease
costs charged to operations for the three and nine months ended September 30, 2020 and 2019 amounted to $216,561 and $505,072,
respectively, and $12,814 and $38,441, respectively. Additional information pertaining to the Company’s lease are as follows:
For
the Nine Months Ending September 30, 2020:
|
|
|
|
Operating
cash flows from operating leases
|
|
$
|
315,377
|
|
Weighted
average remaining lease term – operating leases
|
|
|
5.4
years
|
|
Weighted
average discount rate – operating leases
|
|
|
8.0
|
%
|
Description
of Authorized Capital
The
Company is authorized to issue up to 25,000,000 shares of common stock with $0.001 par value. The holders of the Company’s
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 the Company, the holders of common stock are entitled to share ratably in all assets of the Company that are legally available
for distribution.
Reverse
Stock Split
Effective
February 27, 2020, upon recommendation and authorization by the Board of Directors, stockholders holding a majority in interest
of the issued and outstanding shares of Common Stock, acting by written consent, adopted an amendment to the Company’s Articles
of Incorporation to (i) effectuate the Reverse Split at a ratio of one-for-fifty (1-for-50) and (ii) reduce the number of authorized
shares of Common Stock of the Company as of the effective date of such amendment to 25,000,000 shares. On March 3, 2020, the Company
filed the Reverse Split Amendment, which became effective on March 20, 2020. On March 1, 2020, upon recommendation and authorization
by the Board of Directors, stockholders holding a majority in interest of the issued and outstanding shares of Common Stock of
the Company, acting by written consent, adopted an amendment to the Company’s Articles of Incorporation to increase the
authorized number of shares of Common Stock to 160,000,000 shares (representing 3,200,000 on a post-split basis) from 75,000,000
shares (representing 1,500,000 on a post-split basis), in order to facilitate the acquisition of Graphic Sciences, the 2020 private
placement of equity and debt, and the 2020 Note Conversion. On March 2, 2020, the Company filed the Shares Increase Amendment,
which was effective immediately upon filing.
The
reverse stock split did not cause an adjustment to par value of the common stock. As a result of the reverse stock split, the
Company also adjusted the share amounts for shares reserved for issuance upon the exercise of outstanding warrants, outstanding
stock options, and shares reserved for the 2015 Plan. All disclosures of common shares and per share data in the accompanying
financial statements related notes have been adjusted to reflect the reverse stock split for all periods presented. The September
30, 2019 balances of common stock and additional paid in capital were adjusted to $371 and $14,433,183, from previously reported
amounts of $31,528 and $14,371,648, respectively. The December 31, 2019 balances of common stock and additional paid in
capital were adjusted to $371 and $12,419,437, from previously reported amounts of $31,528 and $14,388,280, respectively.
Issuance
of Restricted Common Stock to Directors
On
January 2, 2020 and January 7, 2019, the Company issued 16,429 and 10,454 shares, respectively, of restricted common stock to
directors of the Company as part of an annual compensation plan for directors. The grant of shares was not subject to vesting.
Stock compensation of $57,500 was recorded on the issuance of the common stock for the nine months ended September 30, 2020 and
2019.
Issuance
of Warrants
Between
December 30, 2016 and January 31, 2017, the Company issued convertible promissory notes, the 2016 Unrelated Notes and the 2016
Related Notes (collectively, the “2016 Notes”), in an aggregate amount of $1,250,000 to certain accredited investors,
including related parties, in private placements. The Company retained Taglich Brothers, Inc. as the exclusive placement agent
for the private placement offering of the 2016 Notes. In January 2017, in compensation for the placement agent’s services
in the private placement offering of the 2016 Notes, the Company paid the placement agent a cash payment of $100,000, equal to
8% of the gross proceeds of the offering, along with warrants to purchase 3,077 shares of Company common stock, and the reimbursement
for the placement agent’s reasonable out of pocket expenses, FINRA filing fees and related legal fees. The warrants issued
to the placement agent contained an exercise price at $37.50 per share, are exercisable for a period of five years after issuance,
contain customary cashless exercise provisions and anti-dilution protection and, pursuant to piggyback registration rights, the
underlying shares were registered in the Company’s a Registration Statement on Form S-1 declared effective in February 2018.
Of the warrants issued to the placement agent, 1,699 warrants were issued in conjunction with proceeds raised in December 2016,
and underwriting expense of $65,243 was recorded for the issuance of these warrants, utilizing the Black-Scholes valuation model
to value the warrants issued. The remaining 1,378 warrants were issued in conjunction with proceeds raised in January 2017, and
underwriting expense of $52,951 was recorded for the issuance of these warrants, utilizing the Black-Scholes valuation model.
The fair value of warrants issued was determined to be $38.50.
On
September 21, 2017, the Company issued warrants to purchase 3,000 shares of Company common stock to Robert Taglich and Michael
Taglich (each holding more than a 5% beneficial interest in the Company’s shares) in connection with the 2017 Bridge Notes.
The warrants are exercisable at an exercise price of $15.00 per share, contain a cashless exercise provision, antidilution protection
and are exercisable for five years after issuance. A debt discount of $38,837 was recorded for the issuance of these warrants,
utilizing the Black-Scholes valuation model. The 2017 Bridge Notes were converted into the 2017 Related Notes in November 2017.
The fair value of warrants issued was determined to be $13.00 utilizing the Black-Scholes valuation model.
Between
November 17 and November 30, 2017, the Company issued convertible promissory notes, the 2017 Unrelated Notes and the 2017 Related
Notes (collectively, the “2017 Notes”), in an aggregate amount of $2,150,000 to certain accredited investors, including
related parties, in private placements. The Company retained Taglich Brothers, Inc. as the exclusive placement agent for the private
placement offering of the 2017 Notes. In compensation for the placement agent’s services in the private placement offering
of the 2017 Notes, the Company paid the placement agent a cash payment of 8% of the gross proceeds of the offering, along with
warrants to purchase shares of Company common stock, and the reimbursement for the placement agent’s reasonable out of pocket
expenses, FINRA filing fees and related legal fees. On November 17, 2017, the Company paid the placement agent cash in the amount
of $172,000 and issued the placement agent warrants to purchase 7,080 shares at an exercise price at $12.50 per share, which are
exercisable for a period of five years after issuance, contain customary cashless exercise provisions and anti-dilution protection
and were entitled to piggyback registration rights that were exercised in connection with the Company’s Registration Statement
on Form S-1 declared effective in February 2018. On November 30, 2017, the Company issued the placement agent warrants to purchase
10,120 shares at an exercise price at $12.50 per share, which are exercisable for a period of five years after issuance, contain
customary cashless exercise provisions and anti-dilution protection and are entitled to registration rights that were exercised
in connection with the Company’s Registration Statement on Form S-1 declared effective in February 2018. Debt issuance costs
of $126,603 was recorded for the issuance of the November 17 and November 30, 2017 warrants, utilizing the Black-Scholes valuation
model. The fair value of warrants issued was determined to be $8.50 and $6.50 for the November 17 and November 30 warrants, respectively.
For the three and nine months ended September 30, 2020 and 2019, interest expense of $0 and $14,726, respectively, and $22,089
and $66,267, respectively, was recorded as amortization of the debt issuance costs.
Between
September 20 and September 26, 2018, the Company issued convertible promissory notes, the 2018 Unrelated Notes and the 2018 Related
Notes (collectively, the “2018 Notes”), in an aggregate amount of $1,300,000 to certain accredited investors, including
related parties, in private placements. The Company retained Taglich Brothers, Inc. as the exclusive placement agent for the private
placement offering of the 2018 Notes. In compensation, the Company paid the placement agent a cash payment of 8% of the gross
proceeds of the offering, along with warrants to purchase shares of Company common stock, and reimbursement for the placement
agent’s reasonable out of pocket expenses, FINRA filing fees and related legal fees. On September 20, 2018, the Company
paid the placement agent cash in the amount of $40,000 and issued the placement agent warrants to purchase 6,153 shares at an
exercise price at $9.00 per share, which are exercisable for a period of five years after issuance, contain customary cashless
exercise provisions and anti-dilution protection and are entitled to limited piggyback registration rights. On September 26, 2018,
the Company paid the placement agent cash in the amount of $64,000 and issued the placement agent warrants to purchase 9,846 shares
at an exercise price at $9.00 per share, which are exercisable for a period of five years after issuance, contain customary cashless
exercise provisions and anti-dilution protection and are entitled to limited piggyback registration rights. Debt issuance costs
of $64,348 was recorded for the issuance of the September 20 and September 26, 2018 warrants, utilizing the Black-Scholes valuation
model. The fair value of warrants issued was determined to be $5.00 and $3.50 for the September 20 and September 26 warrants,
respectively. For the nine months ended September 30, 2020 and 2019, interest expense of $0 and $14,458, respectively, and $21,688
and $65,063, respectively, was recorded as amortization of the debt issuance costs.
On
March 2, 2020, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with
certain accredited investors, pursuant to which the Company issued and sold (i) 875,000 shares of the Company’s Common Stock,
at a price of $4.00 per share, for aggregate gross proceeds of $3,500,000 and (ii) 2,000 units (“Units”), with each
Unit consisting of $1,000 in 12% Subordinated Notes and 40 shares, for aggregate gross proceeds of $2,000,000 in Units and $5,500,000
for the combined private placement pursuant to the Securities Purchase Agreement. The
Company issued 955,000 new shares of Common Stock for the Offering. The Company retained Taglich Brothers, Inc. as the exclusive
placement agent for the private placement offering of the Securities Purchase Agreement. In compensation, the Company paid the
placement agent a cash payment of 8% of the gross proceeds of the offering, along with warrants to purchase shares of Company
common stock, and reimbursement for the placement agent’s reasonable out of pocket expenses, FINRA filing fees and related
legal fees. On March 2, 2020, the Company paid the placement agent cash in the amount of $440,000 and issued the placement agent
warrants to purchase 95,500 shares at an exercise price at $4.00 per share, which are exercisable for a period of five years after
issuance, contain customary cashless exercise provisions and anti-dilution protection and are entitled to limited piggyback registration
rights. Underwriting expense of $236,761 and debt issuance costs of $135,291 was recorded for the issuance of the March 2, 2020
warrants, utilizing the Black-Scholes valuation model. The fair value of warrants issued was determined to be $3.90. Underwriting
expense of $307,867 and debt issuance costs of $175,924 was recorded for the placement agent cash fee and other related legal
fees. For the three and nine months ended September 30, 2020, interest expense of $25,935 and $60,514, respectively, was recorded
as amortization of the debt issuance costs.
The
estimated values of warrants, as well as the assumptions that were used in calculating such values were based on estimates at
the issuance date as follows:
|
|
Placement
Agent
December 30,
2016
|
|
|
Bridge
Noteholders
September 21,
2017
|
|
Risk-free
interest rate
|
|
|
1.93
|
%
|
|
|
1.89
|
%
|
Weighted average
expected term
|
|
|
5
years
|
|
|
|
5
years
|
|
Expected
volatility
|
|
|
123.07
|
%
|
|
|
130.80
|
%
|
Expected
dividend yield
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
|
|
Placement
Agent
November 17,
2017
|
|
|
Placement
Agent
November 30,
2017
|
|
Risk-free
interest rate
|
|
|
2.06
|
%
|
|
|
2.14
|
%
|
Weighted average
expected term
|
|
|
5
years
|
|
|
|
5
years
|
|
Expected
volatility
|
|
|
129.87
|
%
|
|
|
129.34
|
%
|
Expected
dividend yield
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
|
|
Placement
Agent
September 20,
2018
|
|
|
Placement
Agent
September 26,
2018
|
|
Risk-free
interest rate
|
|
|
2.96
|
%
|
|
|
2.96
|
%
|
Weighted average
expected term
|
|
|
5
years
|
|
|
|
5
years
|
|
Expected
volatility
|
|
|
122.52
|
%
|
|
|
122.92
|
%
|
Expected
dividend yield
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
|
|
Placement
Agent
March 2, 2020
|
|
Risk-free
interest rate
|
|
|
0.88
|
%
|
Weighted average
expected term
|
|
|
5
years
|
|
Expected
volatility
|
|
|
130.12
|
%
|
Expected
dividend yield
|
|
|
0.00
|
%
|
Shares
Issued and Outstanding and Shares Reserved for Exercise of Warrants, Convertible Notes, and the 2015 Plan
The
Company had 2,810,865 Shares issued and outstanding, 230,032 Shares reserved for issuance upon the exercise of outstanding warrants,
and 197,330 Shares reserved for issuance under the 2015 Plan, as of September 30, 2020.
15.
|
Stock-Based
Compensation
|
On
April 30, 2015, the Company entered into a Non-qualified Stock Option Agreement with Sophie Pibouin, a director of the Company,
in accordance with the 2015 Plan. The agreement granted options to purchase 2,560 shares prior to the expiration date of April
29, 2025 at an exercise price of $37.50. The options granted vested on a graded scale over a period of time through October 31,
2015.
On
January 1, 2016, the Company granted employees stock options to purchase 5,000 shares at an exercise price of $45.00 per share
in accordance with the 2015 Plan. The options were fully vested as of January 1, 2019. The total fair value of $196,250 for these
stock options was recognized by the Company over the requisite service period.
On
February 10, 2016, the Company granted employees stock options to purchase 4,200 shares at an exercise price of $48.00 per share
in accordance with the 2015 Plan. The options were fully vested as of February 10, 2020. The total fair value of $174,748 for
these stock options is being recognized by the Company over the requisite service period.
On
December 6, 2016, the Company granted one employee stock options to purchase 2,000 shares at an exercise price of $38.00 per share
in accordance with the 2015 Plan, with vesting continuing until December 2020. The total fair value of $63,937 for these stock
options is being recognized by the Company over the requisite service period.
On
September 25, 2017, the Company granted an employee stock options to purchase 15,000 shares at an exercise price of $15.00 per
share and 10,000 shares at an exercise price of $19.00 per share, in accordance with the 2015 Plan. The options were fully vested
as of September 25, 2019. The total fair value of $321,011 for these stock options was recognized by the Company over the requisite
service period.
On
January 30, 2019, the Company entered into a Non-qualified Stock Option Agreement with an individual consultant to the Company,
in accordance with the 2015 Plan. The agreement granted options to purchase 250 shares prior to the expiration date of December
31, 2025 at an exercise price of $45.00. The options granted were 100% vested as of the grant date.
On
March 11, 2019, the Company canceled previously granted stock options to employees in the following amounts: 3,000 shares at an
exercise price of $45.00 per share; 3,200 shares at an exercise price of $48.00 per share; 2,000 shares at an exercise price of
$38.00 per share; 15,000 shares at an exercise price of $15.00 per share; and 10,000 shares at an exercise price of $19.00 per
share. On March 11, 2019, the Company replaced those canceled stock options exercisable for a total of 33,200 shares with virtually
identical stock options at an exercise price of $6.50 per share in accordance with the 2015 Plan. The incremental fair value of
$24,898 for these stock options is being recognized by the Company over the requisite service periods, which range by tranche
from fully vested at issuance through vesting by December 2020.
On
March 11, 2019, the Company granted employees stock options to purchase 10,100 shares at an exercise price of $6.50 per share
in accordance with the 2015 Plan, with vesting continuing until 2023. The total fair value of $44,591 for these stock options
is being recognized by the Company over the requisite service period.
On
September 2, 2020, the Company granted employees stock options to purchase 99,000 shares, including 37,500 shares of performance-based
options, at an exercise price of $4.00 per share in accordance with the 2015 Plan, with vesting continuing until 2024. The
total fair value of $327,181 for these stock options is being recognized by the Company over the requisite service period.
The
weighted average estimated values of director and employee stock option grants, as well as the weighted average assumptions that
were used in calculating such values during the nine months ended September 30, 2020 and 2019, were based on estimates at the
date of grant as follows:
|
|
April
30,
|
|
|
January
1,
|
|
|
February
10,
|
|
|
|
2015
Grant
|
|
|
2016
Grant
|
|
|
2016
Grant
|
|
Risk-free
interest rate
|
|
|
1.43
|
%
|
|
|
1.76
|
%
|
|
|
1.15
|
%
|
Weighted average
expected term
|
|
|
5
years
|
|
|
|
5
years
|
|
|
|
5
years
|
|
Expected
volatility
|
|
|
143.10
|
%
|
|
|
134.18
|
%
|
|
|
132.97
|
%
|
Expected
dividend yield
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
|
|
December
6,
|
|
|
September
25,
|
|
|
January
30,
|
|
|
|
2016
Grant
|
|
|
2017
Grant
|
|
|
2019
Grant
|
|
Risk-free
interest rate
|
|
|
1.84
|
%
|
|
|
1.85
|
%
|
|
|
2.54
|
%
|
Weighted average
expected term
|
|
|
5
years
|
|
|
|
5
years
|
|
|
|
5
years
|
|
Expected
volatility
|
|
|
123.82
|
%
|
|
|
130.79
|
%
|
|
|
115.80
|
%
|
Expected
dividend yield
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
|
|
March
11,
|
|
|
September
2,
|
|
|
|
2019
Grant
|
|
|
2020
Grant
|
|
Risk-free
interest rate
|
|
|
2.44
|
%
|
|
|
0.26
|
%
|
Weighted average
expected term
|
|
|
5
years
|
|
|
|
5
years
|
|
Expected
volatility
|
|
|
116.46
|
%
|
|
|
121.33
|
%
|
Expected
dividend yield
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
A
summary of stock option activity during the nine months ended September 30, 2020 and 2019 is as follows:
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
Average
|
|
|
|
|
|
Shares
|
|
|
Average
|
|
|
Remaining
|
|
Aggregate
|
|
|
|
Under
|
|
|
Exercise
|
|
|
Contractual
|
|
Intrinsic
|
|
|
|
Option
|
|
|
Price
|
|
|
Life
|
|
Value
|
|
Outstanding
at January 1, 2020
|
|
|
46,860
|
|
|
$
|
9.02
|
|
|
9
years
|
|
|
19,200
|
|
Granted
|
|
|
99,000
|
|
|
|
4.00
|
|
|
|
|
|
|
|
Outstanding
at September 30, 2020
|
|
|
145,860
|
|
|
$
|
5.61
|
|
|
9
years
|
|
$
|
19,200
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at September 30, 2020
|
|
|
38,785
|
|
|
$
|
9.54
|
|
|
8
years
|
|
$
|
19,200
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
Average
|
|
|
|
|
|
Shares
|
|
|
Average
|
|
|
Remaining
|
|
Aggregate
|
|
|
|
Under
|
|
|
Exercise
|
|
|
Contractual
|
|
Intrinsic
|
|
|
|
Option
|
|
|
Price
|
|
|
Life
|
|
Value
|
|
Outstanding
at January 1, 2019
|
|
|
36,760
|
|
|
$
|
25.04
|
|
|
8
years
|
|
|
79,200
|
|
Granted
|
|
|
43,550
|
|
|
|
6.72
|
|
|
|
|
|
|
|
Forfeited
and expired
|
|
|
(33,450
|
)
|
|
|
43.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at September 30, 2019
|
|
|
46,860
|
|
|
$
|
9.02
|
|
|
9
years
|
|
$
|
19,200
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at September 30, 2019
|
|
|
34,960
|
|
|
$
|
9.87
|
|
|
9
years
|
|
$
|
19,200
|
|
The
weighted-average grant date fair value of options granted during the nine months ended September 30, 2020 was $3.30. The weighted-average
grant date fair value of options granted during the nine months ended September 30, 2019 was $4.49.
As
of September 30, 2020, and December 31, 2019, there was $350,462 and $56,012, 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 four years. The total fair value of stock options that vested during the nine months
ended September 30, 2020 and 2019 was $14,963 and $105,785, respectively.
Revenues
from the Company’s services to a limited number of customers have accounted for a substantial percentage of the Company’s
total revenues. For the three months ended September 30, 2020, the Company’s two largest customers, State of Michigan (“Michigan”),
a direct customer, and Quicken Loans, a direct customer, accounted for approximately 47% and 8%, respectively, of the Company’s
total revenue for that period. For the three months ended September 30, 2019, the Company’s two largest customers, Avenu
Insight & Analytics, formerly known as ACS Wagers or Xerox, a reseller, and Milwaukee Police Department, a direct customer,
accounted for approximately 12% and 11%, respectively, of the Company’s total revenue for that period. For the nine months
ended September 30, 2020, the Company’s two largest customers, Michigan and Quicken Loans accounted for approximately 43%
and 8%, respectively, of the Company’s total revenues for that period. For the nine months ended September 30, 2019, the
Company’s two largest customers, Loffler Companies, Inc., a reseller, and Careworks, a direct customer, each accounted for
approximately 12% of the Company’s total revenues for that period.
For
the three months ended September 30, 2020 and 2019, government contracts represented approximately 65% and 43% of the Company’s
total revenues, respectively. For the nine months ended September 30, 2020 and 2019 government contracts represented approximately
61% and 41%, respectively, of the Company’s total revenue.
As
of September 30, 2020, accounts receivable concentrations from the Company’s two largest customers were 54% and 12% of gross
accounts receivable, respectively, and as of September 30, 2019, accounts receivable concentrations from the Company’s three
largest customers were 23%, 20%, and 13% of gross accounts receivable, respectively. Accounts receivable balances form the Company’s
two largest customers at September 30, 2020 have been partially collected.
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 11 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 securities by the Company, on the same terms as all
other investors participating in the offering. The Company issued and sold (i) shares of common stock, at a price of $4.00 per
share and (ii) units, with each unit consisting of $1,000 in 12% subordinated notes and 40 shares.
The principal amount of the 12% subordinated notes, together with any accrued and unpaid interest thereon, become due and
payable on February 28, 2023.