NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. | Summary of Significant Accounting Policies |
Organization and Business
WaveDancer, Inc. (“WaveDancer”), formerly known as Information Analysis Incorporated (“IAI”), is engaged in providing professional services to U.S. government agencies to modernize information technology services, in selling and supporting third-party software, primarily Adobe products, to U.S. government agencies, and, with our December, 2021 acquisition of Gray Matters, Inc. (“GMI” or “Gray Matters”), in providing a blockchain enabled supply chain management software solution. With the acquisition of GMI, we began implementing a strategy to expand our offerings well beyond systems modernization services and sales of third-party software. We manage our business as a single operating unit and in one reportable segment.
The accompanying unaudited condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates continuity of operations, realization of assets, and satisfaction of liabilities in the ordinary course of business. The propriety of using the going-concern basis is dependent upon, among other things, the achievement of future profitable operations, the ability to generate sufficient cash from operations and potential other funding sources, in addition to cash on-hand, to meet its obligations as they become due. On June 30, 2022, the Company had working capital of approximately $1.0 million, including cash and cash equivalents of $0.6 million, generated operating losses in 2022 and at June 30, 2022 had an accumulated deficit of $17.0 million. The Company intends to continue to pursue organic growth in revenue and profitability, and, at least in the near term, growth via acquisition. To implement this strategy, we have hired staff and implemented processes that are needed to identify, execute, and integrate acquisitions, and manage the Company post-acquisition. In addition, Gray Matters is an early-stage company that has required investments in sales, marketing, and engineering. While we intend to prioritize acquisition targets that are immediately accretive to operating cash flow, the Company will require additional capital to support its strategy. As discussed in Note 12 below, in August, 2022 the Company sold 1,562,506 unregistered shares of its common stock in a private offering at a price of $1.20 per share from which it raised aggregate gross proceeds of $1,875,000 and on July 8, 2022, the Company entered into a Common Stock Purchase Agreement with B. Riley Principal Capital II, LLC, by which it intends to raise additional capital thhrough an equity line of credit. Management believes that these actions will enable the Company to continue as a going concern through at least 12 months from the date these unaudited condensed consolidated financial statements are available to be issued.
Unaudited Interim Condensed Consolidated Financial Statements
The accompanying unaudited condensed consolidated financial statements (“financial statements”) have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions for Form 10-Q and Article 8-03 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, the financial statements include all adjustments necessary (which are of a normal and recurring nature) for the fair and not misleading presentation of the results of the interim periods presented. These unaudited interim condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements for the year ended December 31, 2021 included in the Annual Report on Form 10-K filed by the Company with the SEC on April 12, 2022 (the “Annual Report”), as amended. The accompanying December 31, 2021, balance sheet was derived from the audited financial statements included in the Annual Report. The results of operations for any interim periods are not necessarily indicative of the results of operations for any other interim period or for a full fiscal year.
The condensed consolidated financial statements as of June 30, 2022, and for the six-month period ended June 30, 2022 include the accounts of WaveDancer and its consolidated subsidiaries (collectively, the “Company”, “we” or “our”). All significant intercompany transactions and balances have been eliminated in consolidation.
There have been no changes in the Company’s significant accounting policies as of June 30, 2022, as compared to the significant accounting policies disclosed in Note 1, "Summary of Significant Accounting Policies" in the Company's Annual Report.
Use of Estimates
Preparation of condensed consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates due to uncertainties, including the effects of COVID-19. On an ongoing basis, we evaluate our estimates, including those related to the allowance for credit losses; fair values of financial instruments, intangible assets, and goodwill; useful lives of intangible assets and property and equipment; the valuation of stock-based compensation, the valuation of deferred tax assets and liabilities; and contingent liabilities, among others. We base our estimates on assumptions, both historical and forward looking, that are believed to be reasonable, and the results of which form the basis for making judgments about the carrying values of assets and liabilities.
Reclassification
Beginning with the three months ended March 31, 2022, our condensed consolidated statement of cash flows presents separately the amortization of the right-of-use operating lease asset as a non-cash adjustment from net income and the change in the operating lease liability due to cash payments as a change in operating assets and liabilities. Previously, the net of these amounts was reported as a change in operating assets and liabilities. Amounts on the condensed consolidated statement of cash flows for the six months ended June 30, 2021, have been reclassified to conform to the current year presentation.
WaveDancer, Inc. | Form 10-Q June 30, 2022 |
Income Taxes
Deferred tax assets and liabilities are computed based on the difference between the financial statement and tax basis of assets and liabilities and are measured by applying enacted tax rates and laws for the taxable years in which those differences are expected to reverse. In addition, a valuation allowance is required to be recognized if it is believed more likely than not that a deferred tax asset will not be fully realized. Authoritative guidance prescribes a recognition threshold of more likely than not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those positions to be recognized in the financial statements. The Company has analyzed its income tax positions using the criteria required by GAAP and concluded that as of June 30, 2022, and December 31, 2021, it has no material uncertain tax positions and no interest or penalties have been accrued.
Concentration of Credit Risk
During the three months ended June 30, 2022, the Company’s prime contracts with U.S. government agencies represented 43.3% of revenue, subcontracts under federal procurements represented 52.7% of revenue and 81.3% of gross profit, and 4.0% of revenue came from commercial and local government contracts. The terms of these contracts and subcontracts vary from single transactions to five years. Two prime contracts with U.S. government agencies represented 24.8% and 13.1% of revenue, respectively, and two subcontracts under federal procurements represented 22.3%, and 12.2% of revenue, respectively. Revenue from one prime contractor under which the Company has multiple subcontracts represented 29.8% of the Company’s revenue and 50.5% of the Company’s gross profit in aggregate.
During the three months ended June 30, 2021, the Company’s prime contracts with U.S. government agencies represented 27.0% of revenue, subcontracts under federal procurements represented 69.0% of revenue and 95.0% of gross profit, and 4.0% of revenue came from commercial and local government contracts. The terms of these contracts and subcontracts vary from single transactions to five years. Within this group of prime contracts with U.S. government agencies, one software sales contract generated 19.1% of the Company’s revenue. Two subcontracts under federal procurements generated 28.8% and 10.5% of the Company’s revenue, respectively, and all subcontracts under one of those prime contractors collectively generated 37.0% of the Company’s revenue and 70.0% of its gross profit.
During the six months ended June 30, 2022, the Company’s prime contracts with U.S. government agencies represented 39.6% of revenue, subcontracts under federal procurements represented 57.8% of revenue, and 2.6% of revenue came from commercial and local government contracts. Two prime contracts with U.S. government agencies represented 14.6% and 11.4% of revenue, respectively, and two subcontracts under federal procurements represented 24.2%, and 13.8% of revenue, respectively. Revenue from one prime contractor under which the Company has multiple subcontracts represented 33.1% of the Company’s revenue and 65.8% of the Company’s gross profit in aggregate.
During the six months ended June 30, 2021, the Company’s prime contracts with U.S. government agencies represented 32.9% of revenue, subcontracts under federal procurements represented 64.2% of revenue, and 2.9% of revenue came from commercial and local government contracts. One prime contract with a U.S. government agency represented 11.1% of revenue and one subcontract under a federal procurement represented 33.4% of revenue. Revenue from one prime contractor under which the Company has multiple subcontracts represented 42.2% of the Company’s revenue and 66.5% of the Company’s gross profit in aggregate.
The Company sold third-party software and maintenance contracts under agreements with one major supplier, accounting for 34.1% and 79.9% of total revenue during the three months ended June 30, 2022 and 2021, respectively, and 32.6% and 28.7% of total revenue during the six months ended June 30, 2022 and 2021, respectively.
As of June 30, 2022, the Company’s accounts receivable included receivables from two prime contracts with U.S. government agencies that represented 29.8% and 14.0% of the Company’s outstanding accounts receivable, respectively, and one subcontract under a federal procurement that represented 26.9% of the Company’s outstanding accounts receivable. Receivables from one prime contractor under which the Company has multiple subcontracts represented 32.8% of the Company’s outstanding accounts receivable in aggregate.
As of June 30, 2021, the Company’s accounts receivable balances related to two subcontracts under federal procurements represented 17.2% and 13.0% of the Company’s outstanding accounts receivable, respectively, and additional receivables from one prime contractor under which the Company has multiple subcontracts represented 52.7% of the Company’s outstanding accounts receivable in aggregate.
WaveDancer, Inc. | Form 10-Q June 30, 2022 |
COVID-19 Update
While we have not experienced a significant adverse impact on our business from the pandemic as of June 30, 2022, the extent to which it will impact our business and operations will depend on future developments that are uncertain. We continue to monitor the impact of the COVID-19 pandemic on our customers, partners, employees and service providers.
Note 2. | Revenue from Contracts with Customers |
Nature of Products and Services
We generate revenue from the sales of information technology professional services, sales of third-party software licenses and implementation and training services, sales of third-party support and maintenance contracts based on those software products, and incentive payments received from third-party software suppliers for facilitating sales directly between that supplier and a customer introduced by the Company. In addition, with the GMI acquisition, we expanded our offerings to include licensing and implementation services for proprietary blockchain-based SCM software. We sell through our direct relationships with end customers and under subcontractor arrangements.
Professional services are offered through several arrangements – through time and materials arrangements, fixed-price-per-unit arrangements, fixed-price arrangements, or combinations of these arrangements within individual contracts. Revenue under time and materials arrangements is recognized over time in the period the hours are worked or the expenses are incurred, as control of the benefits of the work is deemed to have passed to the customer as the work is performed. Revenue under fixed-price-per-unit arrangements is recognized at a point in time when delivery of units has occurred and units are accepted by the customer or are reasonably expected to be accepted. Generally, revenue under fixed-price arrangements and mixed arrangements is recognized either over time or at a point in time based on the allocation of transaction pricing to each identified performance obligation as control of each is transferred to the customer. For fixed-price arrangements under which documentary evidence of acceptance or receipt of deliverables is not present or withheld by the customer, the Company recognizes revenue when it has the right to invoice the customer. For fixed-price arrangements for which the Company is paid a fixed fee to make itself available to support a customer, with no predetermined deliverables to which transaction prices can be estimated or allocated, revenue is recognized ratably over time.
Third-party software licenses are classified as enterprise server-based software licenses or desktop software licenses, and desktop licenses are further classified by the type of customer and whether the licenses are bulk licenses or individual licenses. The Company’s obligations as the seller for each class differ based on its reseller agreements and whether its customers are government or non-government customers. Revenue from enterprise server-based sales to either government or non-government customers is usually recognized in full at a point in time based on when the customer gains use of the full benefit of the licenses, after the licenses are implemented. If the transaction prices of the performance obligations related to implementation and customer support for the individual contract is material, these obligations are recognized separately over time, as performed. Revenue for desktop software licenses for government customers is usually recognized on a gross basis at a point in time, based on when the customer’s administrative contact gains training in and beneficial use of the administrative portal. Revenue for bulk desktop software licenses for non-government customers is usually recognized on a gross basis at a point in time, based on when the customer’s administrative contact gains training in and beneficial use of the administrative portal. For desktop software licenses sold on an individual license basis to non-government customers, where the Company has no obligation to the customer after the third-party makes delivery of the licenses, the Company has determined it is acting as an agent, and the Company recognizes revenue upon delivery of the licenses only for the net of the selling price and its contract costs.
Third-party support and maintenance contracts for enterprise server-based software include a performance obligation under the Company’s reseller agreements for it to be the first line of support (direct support) and second line of support (intermediary between customer and manufacturer) to the customer. Because of the support performance obligations, and because the amount of support is not estimable, the Company recognizes revenue ratably over time as it makes itself available to provide the support.
Incentive payments are received under reseller agreements with software manufacturers and suppliers where the Company introduces and courts a customer, but the sale occurs directly between the customer and the supplier or between the customer and the manufacturer. Since the transfer of control of the licenses cannot be measured from outside of these transactions, revenue is recognized when payment from the manufacturer or supplier is received.
WaveDancer, Inc. | Form 10-Q June 30, 2022 |
Disaggregation of Revenue from Contracts with Customers
| | Three months ended June 30, | |
| | 2022 | | | 2021 | |
Contract Type | | Amount | | | Percentage | | | Amount | | | Percentage | |
Services time & materials | | $ | 2,153,537 | | | | 49.9 | % | | $ | 2,847,962 | | | | 60.2 | % |
Services fixed price over time | | | 51,154 | | | | 1.2 | % | | | 416,751 | | | | 8.8 | % |
Firm fixed price | | | 566,862 | | | | 13.1 | % | | | - | | | | - | |
Services combination | | | 21,080 | | | | 0.5 | % | | | 49,401 | | | | 1.1 | % |
Services fixed price per unit | | | 52,061 | | | | 1.2 | % | | | 14,160 | | | | 0.3 | % |
Third-party software | | | 1,423,770 | | | | 33.0 | % | | | 1,317,514 | | | | 27.8 | % |
Software support & maintenance | | | 48,918 | | | | 1.1 | % | | | 85,336 | | | | 1.8 | % |
Incentive payments | | | - | | | | 0.0 | % | | | 837 | | | | 0.0 | % |
Total revenue | | $ | 4,317,382 | | | | 100.0 | % | | $ | 4,731,961 | | | | 100.0 | % |
| | Six months ended June 30, | |
| | 2022 | | | 2021 | |
Contract Type | | Amount | | | Percentage | | | Amount | | | Percentage | |
Services time & materials | | $ | 4,066,533 | | | | 55.6 | % | | $ | 4,814,091 | | | | 59.1 | % |
Services fixed price over time | | | 102,308 | | | | 1.4 | % | | | 433,551 | | | | 5.3 | % |
Firm fixed price | | | 566,862 | | | | 7.8 | % | | | - | | | | - | |
Services combination | | | 30,080 | | | | 0.4 | % | | | 459,271 | | | | 5.6 | % |
Services fixed price per unit | | | 145,601 | | | | 2.0 | % | | | 60,620 | | | | 0.7 | % |
Third-party software | | | 2,286,808 | | | | 31.3 | % | | | 2,238,209 | | | | 27.5 | % |
Software support & maintenance | | | 98,087 | | | | 1.3 | % | | | 102,275 | | | | 1.3 | % |
Incentive payments | | | 16,615 | | | | 0.2 | % | | | 43,524 | | | | 0.5 | % |
Total revenue | | $ | 7,312,894 | | | | 100.0 | % | | $ | 8,151,541 | | | | 100.0 | % |
Contract Balances
Accounts Receivable
Trade accounts receivable are recorded at the billable amount where the Company has the unconditional right to bill, net of allowances for doubtful accounts. The allowance for doubtful accounts is based on the Company’s assessment of the collectability of accounts. Management regularly reviews the adequacy of the allowance for doubtful accounts by considering the age of each outstanding invoice, each customer's expected ability to pay and collection history, when applicable, to determine whether a specific allowance is appropriate. Accounts receivable deemed uncollectible are charged against the allowance for doubtful accounts when identified. There were no such allowances recognized as of June 30, 2022 and December 31, 2021.
Accounts receivable as of June 30, 2022 and December 31, 2021, consist of the following:
| | June 30, 2022 | | | December 31, 2021 | |
Billed federal government | | $ | 3,560,883 | | | $ | 1,594,473 | |
Billed commercial | | | 22,253 | | | | - | |
Unbilled receivables | | | - | | | | 70,389 | |
Accounts receivable | | $ | 3,583,136 | | | $ | 1,664,862 | |
WaveDancer, Inc. | Form 10-Q June 30, 2022 |
Billed receivables from the federal government include amounts due from both prime contracts and subcontracts where the federal government is the end customer.
Contract Assets
Contract assets consist of assets resulting when revenue recognized exceeds the amount billed or billable to the customer due to allocation of transaction price, and of amounts withheld from payment of invoices as a financing component of a contract. There were no amounts recorded to contract assets as of June 30, 2022 or December 31, 2021. Changes in contract assets balances in the six months ended June 30, 2021, were as follows:
Balance as of December 31, 2020 | | $ | 210,688 | |
Contract assets added | | | 131,923 | |
Balance as of March 31, 2021 | | | 342,611 | |
Contract assets added | | | 134,657 | |
Balance as of June 30, 2021 | | $ | 477,268 | |
Contract Liabilities
Contract liabilities consist of amounts that have been invoiced and for which the Company has the right to bill, but that have not been recognized as revenue because the related goods or services have not been transferred. Changes in contracts liabilities balances in the three months and six months ended June 30, 2022 and 2021, are as follows:
Balance as of December 31, 2021 | | $ | 186,835 | |
Contract liabilities added | | | 19,280 | |
Revenue recognized | | | (56,423 | ) |
Balance as of March 31, 2022 | | | 149,692 | |
Contract liabilities added | | | 87,612 | |
Revenue recognized | | | (71,461 | ) |
Balance as of June 30, 2022 | | $ | 165,843 | |
| | | | |
| | | | |
Balance as of December 31, 2020 | | $ | 946,884 | |
Contract liabilities added | | | 93,934 | |
Revenue recognized | | | (585,322 | ) |
Balance as of March 31, 2021 | | | 455,496 | |
Contract liabilities added | | | 4,815 | |
Revenue recognized | | | (354,427 | ) |
Balance as of June 30, 2021 | | $ | 105,884 | |
Revenues recognized during the three months ended June 30, 2022 and 2021, from the balances as of December 31, 2021 and 2020, were $55,168 and $352,969, respectively. Revenues recognized during the six months ended June 30, 2022 and 2021, from the balances as of December 31, 2021 and 2020, were $111,591 and $845,463, respectively.
Costs to Obtain or Fulfill a Contract
When applicable, the Company recognizes an asset related to the costs incurred to obtain a contract only if it expects to recover those costs and it would not have incurred those costs if the contract had not been obtained. The Company recognizes an asset from the costs incurred to fulfill a contract if the costs (i) are specifically identifiable to a contract, (ii) enhance resources that will be used in satisfying performance obligations in future and (iii) are expected to be recovered. There were no such assets as of June 30, 2022 and December 31, 2021. When incurred, these costs are amortized ratably over the periods of the contracts to which those costs apply.
WaveDancer, Inc. | Form 10-Q June 30, 2022 |
Deferred Costs of Revenue
Deferred costs of revenue consist of the costs of third-party support and maintenance contracts for enterprise server-based software. These costs are reported under the prepaid expenses and other current assets caption on the Company’s condensed consolidated balance sheets. The Company recognizes these direct costs ratably over time as it makes itself available to provide its performance obligation for software support, commensurate with its recognition of revenue. Changes in deferred costs of revenue balances in the three and six months ended June 30, 2022 and 2021, are as follows:
Balance as of December 31, 2021 | | $ | 154,218 | |
Deferred costs added | | | 2,800 | |
Deferred costs expensed | | | (55,362 | ) |
Balance as of March 31, 2022 | | | 101,656 | |
Deferred costs expensed | | | (53,434 | ) |
Balance as of June 30, 2022 | | $ | 48,222 | |
| | | | |
Balance as of December 31, 2020 | | $ | 89,068 | |
Deferred costs added | | | 17,406 | |
Deferred costs expensed | | | (75,223 | ) |
Balance as of March 31, 2021 | | | 31,251 | |
Deferred costs added | | | 11,188 | |
Deferred costs expensed | | | (16,681 | ) |
Balance as of June 30, 2021 | | $ | 25,758 | |
The Company has two significant operating leases, one for its headquarters offices in Fairfax, Virginia and one for additional office space in Annapolis, Maryland. The leases both commenced in 2021 and have original lease terms ranging from 37 to 67 months and rental rates escalate by approximately 2.5% annually under both leases. The Company determines if an arrangement is a lease at inception. Operating leases are included in right-of-use operating lease assets and operating lease liabilities in the Company’s condensed consolidated balance sheets as of June 30, 2022 and December 31, 2021.
As of June 30, 2022 and December 31, 2021, the Company does not have any sales-type or direct financing leases.
The Company’s operating lease asset represents its right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Operating lease assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. Since the lease does not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The operating lease asset also includes any lease payments made and excludes lease incentives. Lease expense for lease payments is recognized on a straight-line basis over the lease term. The Company’s lease agreement includes rental payments escalating annually for inflation at a fixed rate. These payments are included in the initial measurement of the operating lease liability and operating lease asset. The Company does not have any rental payments which are based on a change in an index or a rate that can be considered variable lease payments, which would be expensed as incurred.
The Company’s lease agreements do not contain any material residual value guarantees or material restrictions or covenants.
The Company does not sublease any real estate to third parties.
As of June 30, 2022, our two operating leases had a weighted average remaining lease term of 40 months and a weighted average discount rate of 5.0%. Future lease payments under operating leases as of June 30, 2022, were as follows:
Remainder of 2022 | | $ | 112,643 | |
2023 | | | 228,862 | |
2024 | | | 174,721 | |
2025 | | | 74,804 | |
2026 | | | 70,220 | |
Total lease payments | | | 661,250 | |
Less: discount | | | (55,934 | ) |
Present value of lease liabilities | | $ | 605,316 | |
WaveDancer, Inc. | Form 10-Q June 30, 2022 |
The total expense incurred related to its operating leases was $54,460 and $26,122 for the three months ended June 30, 2022 and 2021, respectively, and $110,720 and $52,244 for the six months ended June 30, 2022 and 2021, respectively, and is included in selling, general and administrative expenses on the condensed consolidated statements of operations.
Note 4. | Fair Value Measurements |
The Company defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:
| • | Level 1—Quoted prices in active markets for identical assets or liabilities; |
| • | Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and |
| • | Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. |
The following table represents the fair value hierarchy for the Company’s financial instruments measured at fair value on a recurring basis as of June 30, 2022 and December 31, 2021:
| | June 30, 2022 | |
| | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
Cash equivalents: | | | | | | | | | | | | | | | | |
Money market funds | | $ | 51,413 | | | $ | - | | | $ | - | | | $ | 51,413 | |
Other liabilities: | | | | | | | | | | | | | | | | |
Fair value of contingent consideration | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
| | December 31, 2021 | |
| | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
Cash equivalents: | | | | | | | | | | | | | | | | |
Money market funds | | $ | 1,600,663 | | | $ | - | | | $ | - | | | $ | 1,660,663 | |
Other liabilities: | | | | | | | | | | | | | | | | |
Fair value of contingent consideration | | $ | - | | | $ | - | | | $ | 930,000 | | | $ | 930,000 | |
The following table is a roll-forward of the Level 3 fair value measurements.
Fair value of contingent consideration: | | | | |
December 31, 2021 | | $ | 930,000 | |
Change in fair value | | | 12,609 | |
March 31, 2022 | | | 942,609 | |
Change in fair value | | | (942,609 | ) |
June 30, 2022 | | $ | - | |
There were no unrealized gains or losses included in income for the three or six months ended June 30, 2022.
WaveDancer, Inc. |
Form 10-Q June 30, 2022 |
Tellenger, Inc.
On April 7, 2021, the Company purchased all of the issued and outstanding shares of stock of Tellenger, Inc. (“Tellenger”). Tellenger is primarily engaged in providing professional services related to cybersecurity, cloud computing, and data analytics. Tellenger’s customers include U.S. government agencies, either as a prime contractor or sub-contractor, as well as several national not-for-profit organizations. The purchase price of $2,515,357 was paid with $2,315,357 of cash and 68,264 shares of Company common shares valued at $200,000 as of the transaction closing date. The value of the shares was determined by the closing price as of the transaction date. Goodwill is attributable to human capital related intangible assets like the value of the acquired assembled workforce and strategic and enterprise related intangible assets including growth opportunities that are not reportable separately from goodwill. Goodwill also arises from recognizing deferred tax liabilities from intangible assets that are amortizable for financial reporting but not for income tax purposes. The transaction did not result in a step-up in tax basis and neither the intangible assets nor goodwill recorded for financial reporting purposes results in deductible amortization for tax purposes. The purchase price for Tellenger has been allocated as follows:
| | Useful Lives (years) | | | Amounts | | Valuation Methodology |
Cash | | | | | | $ | 81,473 | | |
Accounts receivable | | | | | | | 611,471 | | |
Other current assets | | | | | | | 6,338 | | |
Intangible assets with estimated useful lives: | | | | | | |
Customer relationships | | | 8 | | | | 1,090,000 | | Replacement cost and relief from royalty |
Non-compete agreements | | | 3 | | | | 120,000 | | Multi-period excess earnings |
Intangible assets with indefinite lives: | | | | | | | | | |
Trade names | | | | | | | 280,000 | | |
Goodwill | | | | | | | 785,000 | | |
Total assets acquired | | | | | | | 2,974,282 | | |
Current liabilities | | | | | | | (458,925 | ) | |
Net assets acquired | | | | | | $ | 2,515,357 | | |
Gray Matters, Inc.
On December 10, 2021, the Company purchased all the issued and outstanding shares of Gray Matters. Gray Matters provides supply chain management software designed to aggregate customer data into a single, interconnected, blockchain secured framework. The purchase price of $11,005,100 comprises the following:
Net cash consideration | | $ | 7,240,100 | |
Buyer common stock | | | 1,500,000 | |
Fair value of deferred consideration | | | 1,335,000 | |
Fair value of contingent consideration | | | 930,000 | |
Total | | $ | 11,005,100 | |
Common stock consideration consisted of 436,481 shares of WaveDancer common stock valued at $1,500,000 as of the transaction closing date. The deferred consideration of $1,335,000 is the estimated present value as of the closing date of the $1,500,000 cash payment due to the selling shareholder of GMI (the “Seller”) on the second anniversary of the acquisition. We applied a discount rate of 6% reflecting our recent secured borrowing rate adjusted to include a premium for the unsecured status of the deferred consideration liability. Accretion of the liability will be recorded as interest expense. For the six months ended June 30, 2022, we recorded $19,319 of interest expense.
Contingent consideration was estimated as of the acquisition date using a probability weighted average of possible outcomes, discounted to its net present value as of the acquisition date. We identified the set of possible outcomes and assigned probabilities to each by applying management judgment to the assumptions underlying the projections of 2022 revenue and gross profit. Under the terms of the purchase agreement, the Seller is eligible to receive from zero up to $4,000,000 of additional consideration, payable in cash, based on the amounts of revenue and gross profit achieved by GMI during the period from the acquisition date through December 31, 2022. We estimated that the outcomes to apply a probability weighting to range from $500,000 to $1,500,000, with an outcome of $1,000,000 given the highest probability weighting. The undiscounted probability weighted outcome was determined to be $1,000,000 and was discounted back to its present value of $930,000 as of December 31, 2021. We applied a discount rate of 6% reflecting our recent secured borrowing rate adjusted to include a premium for the unsecured status of the contingent consideration liability. The contingent consideration liability will be remeasured at fair value at the end of each reporting period and reported in the consolidated statements of operations until the liability is settled.
WaveDancer, Inc. | Form 10-Q June 30, 2022 |
We remeasured the contingent consideration liability as of June 30, 2022 and determined that the undiscounted probability weighted outcome had decreased to zero and we reduced the liability amount accordingly and recognized $942,609 of income, as shown in Note 4.
The deferred consideration liability is included in other liabilities on the condensed consolidated balance sheets and totals $1,374,137 and $1,335,000 as of June 30, 2022 and December 31, 2021, respectively.
Goodwill is attributable to human capital related intangible assets like the value of the acquired assembled workforce and strategic and enterprise related intangible assets including growth opportunities that are not reportable separately from goodwill. Goodwill also arises from recognizing deferred tax liabilities from recording in the purchase accounting intangible assets that are amortizable for financial reporting but not for income tax purposes. The transaction did not result in a step-up in tax basis and the Company will carry over the legacy tax basis of $0 for all intangibles. Neither the intangible assets nor goodwill recorded for financial reporting purposes will generate deductible amortization for tax purposes.
The purchase price for GMI has been allocated as follows:
| | Useful Lives (years) | | | Amounts | | Valuation Methodology |
Cash | | | | | | $ | 20,235 | | |
Fixed assets | | | | | | | 8,902 | | |
Intangible assets with estimated useful lives: | | | | | | |
Technology | | | 5 | | | | 2,900,000 | | Replacement cost and relief from royalty |
Customer relationships | | | 6 | | | | 3,860,000 | | Multi-period excess earnings |
Goodwill | | | | | | | 4,560,099 | | |
Total assets acquired | | | | | | | 11,349,236 | | |
Current liabilities | | | | | | | (344,136 | ) | |
Net assets acquired | | | | | | $ | 11,005,100 | | |
Supplemental Combined Pro Forma Information
The following unaudited pro forma financial information presents combined results of operations for the periods presented as if the acquisitions of both Tellenger and Gray Matters had been completed on January 1, 2021. The pro forma information includes adjustments to amortization expense for the intangible assets acquired.
The pro forma data are for informational purposes only and are not necessarily indicative of the consolidated results of operations of the combined business had the acquisitions of both Tellenger and Gray Matters occurred on January 1, 2021, or the results of future operations of the combined business. For instance, planned or expected operational synergies following the acquisition are not reflected in the pro forma information. Consequently, actual results will differ from the unaudited pro forma information presented below.
| | Three months ended June 30, | | | Six months ended June 30, | |
| | | | | | | | | | | | | | | | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Revenues | | $ | 4,317,382 | | | $ | 4,800,099 | | | $ | 7,312,894 | | | $ | 9,377,504 | |
Net loss | | $ | (1,525,442 | ) | | $ | (748,862 | ) | | $ | (3,603,749 | ) | | $ | (1,326,256 | ) |
16
WaveDancer, Inc. |
Form 10-Q June 30, 2022 |
Note 6. | Goodwill and Intangible Assets |
Information regarding our intangible assets and goodwill is as follows:
| | Weighted Average Useful Life (Years) | | | December 31, 2021 | | | Additions | | | June 30, 2022 | |
Intangible assets with estimated useful lives | | | | | | | | | | | | | | | | |
Technology | | | 5.0 | | | $ | 2,900,000 | | | $ | - | | | $ | 2,900,000 | |
Customer relationships | | | 6.4 | | | | 4,950,000 | | | | - | | | | 4,950,000 | |
Non-compete agreements | | | 3.0 | | | | 120,000 | | | | - | | | | 120,000 | |
Accumulated amortization | | | | | | | (201,032 | ) | | | (699,786 | ) | | | (900,818 | ) |
Sub-total | | | | | | | 7,768,968 | | | | (699,786 | ) | | | 7,069,182 | |
Intangible assets with indefinite lives | | | | | | | | | | | | | | | | |
Trade names | | Indefinite | | | | 280,000 | | | | - | | | | 280,000 | |
Net identifiable intangible assets | | | | | | $ | 8,048,968 | | | $ | (699,786 | ) | | $ | 7,349,182 | |
| | | | | | | | | | | | | | | | |
Goodwill | | Indefinite | | | $ | 7,585,269 | | | $ | - | | | $ | 7,585,269 | |
There was no impairment charge to intangible assets or goodwill for the six months ended June 30, 2022 or 2021.
As of June 30, 2022, expected amortization expense relating to purchased intangible assets for each of the next five years and thereafter is as follows:
Remainder of 2022 | | $ | 699,786 | |
2023 | | | 1,399,572 | |
2024 | | | 1,369,635 | |
2025 | | | 1,359,576 | |
2026 | | | 1,326,854 | |
Thereafter | | | 913,759 | |
Total | | $ | 7,069,182 | |
Note 7. | Stock-Based Compensation |
We have three stock-based compensation plans. The 2006 Stock Incentive Plan was adopted in 2006 (“2006 Plan”) and had options granted under it through April 12, 2016. The 2016 Stock Incentive Plan was adopted in 2016 (“2016 Plan”) and had options granted under it through November 15, 2021. On October 11, 2021, the Board of Directors approved the 2021 Stock Incentive Plan (“2021 Plan”) and on December 2, 2021, our shareholders approved the 2021 Plan.
The Company recognizes compensation costs only for those shares expected to vest on a straight-line basis over the requisite service period of the awards. There were no option awards granted in the three months ended June 30, 2022. Fair values of option awards granted in the three months ended June 30, 2021 and the six months ended June 30, 2022 and 2021, were estimated using the Black-Scholes option pricing model under the following assumptions:
| | Three months ended June 30, | | | Six Months ended June 30, | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Risk-free interest rate | | | n/a | | | 0.77% | - | 0.87% | | | 1.91% | - | 2.41% | | | 0.46% | - | 0.92% | |
Dividend yield | | | n/a | | | | 0% | | | | | 0% | | | | | 0% | | |
Expected term (years) | | | n/a | | | | 5.00 | | | | 5.75 | - | 6.00 | | | | 5.00 | | |
Expected volatility | | | n/a | | | 47.1% | - | 47.7% | | | 45.8% | - | 46.1% | | | 47.1% | - | 92.6% | |
WaveDancer, Inc. | Form 10-Q June 30, 2022 |
Determining the assumptions for the expected term and volatility requires management to exercise significant judgment. The expected term represents the weighted-average period that options granted are expected to be outstanding giving consideration to vesting schedules. Since the Company does not have an extended history of actual exercises, the Company has estimated the expected term using a simplified method which calculates the expected term as the average of the time-to-vesting and the contractual life of the awards. Given the limited public market for the Company’s stock, the Company has elected to estimate its expected volatility by benchmarking its volatility to that of several public company issuers that operate within its market segment. The guideline companies’ volatility was increased by a size adjustment premium to compensate for the difference in size between the guideline companies and the Company in its calculation.
There were no option awards granted in the three months ended June 30, 2022, and 127,500 options with grant date fair values totaling $152,150 were granted during the three months ended June 30, 2021. There were 912,000 options with grant date fair values totaling $2,074,670, and 272,500 options with grant date fair values totaling $329,050 granted during the six months ended June 30, 2022 and 2021, respectively. There were 52,000 and 360,000 options exercised during the three months ended June 30, 2022 and 2021, respectively. There were 157,000 options and 385,000 options exercised during the six months ended June 30, 2022 and 2021, respectively. As of June 30, 2022, there was $2,433,633 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the stock incentive plans. That cost is expected to be recognized over a weighted-average period of 10 months.
Total compensation expense related to these plans was $529,565 and $111,862 for the three months ended June 30, 2022 and 2021, respectively, and $841,741 and $139,573 for the six months ended June 30, 2022 and 2021, respectively, and is included in selling, general and administrative expenses on the condensed consolidated statements of operations.
Note 8. | Revolving Line of Credit and Notes Payable |
On April 16, 2021, the Company entered a revolving line of credit with Summit Community Bank (“Summit”) that provided for on-demand or short-term borrowings of up to $1,000,000 at a variable interest rate equal to the greater of 3.25% or the prime rate as published in The Wall Street Journal, and subject to a borrowing base calculated using outstanding accounts receivable. Borrowings under the line of credit are secured by the assets of the Company. The line expired on April 16, 2022. As of March 31, 2022 and December 31 2021, there was no outstanding balance under this line of credit and there were no borrowings or repayments during the six months ended June 30, 2022.
The Company previously had a revolving line of credit with another bank (“prior LOC”) providing for demand or short-term borrowings of up to $1,000,000 at an interest rate of the greater of 4.0% or LIBOR +3.5%. The prior LOC originally was due to expire on July 31, 2021 and was secured by the assets of the Company. The Summit line of credit was used to pay off the prior LOC and it was closed on May 3, 2021.
On April 16, 2021, we entered into a $1 million term loan agreement with Summit Community Bank. The term of the loan was two years with monthly installments comprising a fixed principal amount plus interest accruing at a fixed rate of 4.89%. The loan was collateralized by a security interest in substantially all the assets of the Company. On December 30, 2021, we fully repaid the outstanding balance of the loan.
To provide additional net working capital support, the Company borrowed $150,000 from the sellers of Tellenger for a period of 90 days from the closing date of April 7, 2021, without interest accumulation. The sellers were repaid in July 2021.
Note 9. | Private Offerings of Common Stock |
In March 2021, the Company sold 330,666 unregistered shares of its common stock in a private offering at a price of $1.50 per share from which it raised aggregate gross proceeds of $495,999.
On August 26, 2021, the Company sold 1,400,000 units at a price of $2.00 per unit, each unit consisting of one unregistered share of common stock and one warrant exercisable at $3.00 for one share of common stock, in a private offering from which it raised aggregate gross proceeds of $2,800,000. The warrants expire on August 31, 2026. 1,400,000 shares of common stock issuable upon exercise of warrants in connection with the offering have been reserved for issuance. The warrants are classified as equity.
On December 10, 2021, the Company sold 3,289,526 units at a price of $3.04 in a private offering from which it raised $10,000,000 resulting in the issuance of a like number of shares of common stock and Series A warrants exercisable for 657,933 shares of common stock. The warrants are exercisable at a price of $4.50 per share, with the warrants exercisable from January 1, 2023 through December 31, 2026. If the shares underlying the warrants are not registered when the warrants become exercisable, the warrants can be exercised on a cashless basis. The warrants are subject to mandatory exercise if, commencing January 1, 2024, the volume weighted average price per share for 10 consecutive trading days equals or exceeds $12.50. The warrants are classified as equity.
WaveDancer, Inc. | Form 10-Q June 30, 2022 |
The total offering costs associated with the sales of unregistered shares of common stock in 2021 were not material.
During the three- and six-month periods ended June 30, 2022, the Company’s effective tax rate was 12.52% and 20.76%, respectively. The Company records income taxes using an estimated annual effective tax rate for interim reporting. The primary factors contributing to the difference between the federal statutory rate and the Company’s effective tax rate for the three- and six-month periods ended June 30, 2022 were state taxes, changes in valuation allowance, and permanent items. A partial valuation allowance was recorded as a discrete item during the three-month period ended June 30, 2022 decreasing the tax benefit by $303. During the three- and six-month periods ended June 30, 2021, the Company’s effective tax rate was 0%. The primary factors contributing to the difference between the statutory tax rate and the effective tax rate for the three- and six-month periods ended June 30, 2021, is primarily driven by the presence of a full valuation allowance in all jurisdictions.
Note 11. | (Loss) Income Per Share |
Basic loss per share excludes dilution and is computed by dividing loss available to common shareholders by the weighted-average number of shares outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock, except for periods when the Company reports a net loss because the inclusion of such items would be antidilutive. The antidilutive effect of 711,537 shares from stock options and 146,269 shares from warrants were excluded from diluted shares for the three months ended June 30, 2022, and the antidilutive effect of 713,035 shares from stock options and 239,779 shares from warrants were excluded from diluted shares for the six months ended June 30, 2022. The dilutive effect of outstanding options and warrants is reflected in earnings per share by use of the treasury stock method. No shares were excluded from diluted shares for the three- and six-month periods ended June 30, 2021.
The following is a reconciliation of the amounts used in calculating basic and diluted net (loss) income per common share:
| | Three months ended June 30, | | | Six months ended June 30, | |
| | 2022 | | | 2021 | | | 2022 | | | 2021 | |
Net (loss) income | | $ | (1,525,442 | ) | | $ | 43,157 | | | $ | (3,603,749 | ) | | $ | 313,972 | |
Basic weighted average shares outstanding | | | 17,376,697 | | | | 11,980,397 | | | | 17,335,979 | | | | 11,633,464 | |
Dilutive effect of warrants and/or options | | | - | | | | 684,870 | | | | - | | | | 671,718 | |
Diluted weighted average shares outstanding | | | 17,376,697 | | | | 12,665,267 | | | | 17,335,979 | | | | 12,305,182 | |
Basic (loss)/earnings per share | | $ | (0.09 | ) | | $ | 0.00 | | | $ | (0.21 | ) | | $ | 0.03 | |
Diluted (loss)/earnings per share | | $ | (0.09 | ) | | $ | 0.00 | | | $ | (0.21 | ) | | $ | 0.03 | |
Note 12. | Subsequent Events |
Common Stock Purchase Agreement
On July 8, 2022, we entered into a Common Stock Purchase Agreement (the “Purchase Agreement”) and a Registration Rights Agreement (the “Registration Rights Agreement”) with B. Riley Principal Capital II, LLC (the “B. Riley”). Pursuant to the Purchase Agreement, subject to certain limitations and conditions, the Company has the right, but not the obligation, to sell to B. Riley up to $15,000,000 of shares of the Company’s common stock, par value $0.001 per share (“Common Stock”), from time to time. Sales of Common Stock to B. Riley under the Purchase Agreement, and the timing of any such sales, are solely at the Company’s option, and the Company is under no obligation to sell any securities to B. Riley under the Purchase Agreement. Pursuant to the Registration Rights Agreement, the Company agreed to file a registration statement with the Securities Exchange Commission (the “SEC”) to register under the Securities Act of 1933, as amended (the “Securities Act”) the resale by B. Riley of up to 4,500,000 shares of Common Stock that the Company may issue or elect, in the Company’s sole discretion, to issue and sell to B. Riley, from time to time under the Purchase Agreement.
Private Offering of Common Stock
During August, 2022 the Company sold 1,562,506 unregistered shares of its common stock in a private offering at a price of $1.20 per share from which it raised aggregate gross proceeds of $1,875,000.
WaveDancer, Inc. |
Form 10-Q June 30, 2022 |