Intellinetics(INLX) - 2020 Q1 - Quarterly Report

FORM 10-Q Filing Information This report is a Quarterly Report (Form 10-Q) for INTELLINETICS, INC. for the period ended March 31, 2020, identifying it as a Nevada corporation and a 'Smaller reporting company' - The filing is a Quarterly Report (Form 10-Q) for the period ended March 31, 2020, filed by INTELLINETICS, INC. (Commission file number: 000-31671)[1][2] - The registrant is a Nevada corporation, with its principal executive offices in Columbus, Ohio, and its trading symbol is INLX[2][4] - The company is classified as a 'Smaller reporting company' and is not a shell company[4][5][6] - As of May 13, 2020, there were 2,810,865 shares of the issuer's common stock outstanding[6] Cautionary Note Regarding Forward-Looking Statements This section warns that the report contains forward-looking statements based on current plans and expectations, which are subject to substantial risks and uncertainties that could cause actual results to differ materially - This report contains forward-looking statements, which are not historical facts and refer to future events or performance, identified by words like 'may,' 'will,' 'expect,' 'plan,' and 'anticipate'[9] - These statements are based on current plans and expectations but are subject to substantial risks, uncertainties, and other factors that could cause actual results to differ materially[10] - The company cautions against undue reliance on forward-looking statements and undertakes no duty to update or revise them for any reason[10][11] Part I: Financial Information Item 1. Financial Statements This section presents the unaudited condensed consolidated financial statements of Intellinetics, Inc. and its subsidiaries for the three months ended March 31, 2020 and 2019, including balance sheets, statements of operations, stockholders' equity (deficit), and cash flows, along with detailed notes explaining the company's business, accounting policies, acquisitions, debt, and other financial details Condensed Consolidated Balance Sheets This section presents the company's financial position, including assets, liabilities, and stockholders' equity, as of March 31, 2020, and December 31, 2019 Condensed Consolidated Balance Sheets (Selected Data) | Metric | March 31, 2020 | December 31, 2019 | | :-------------------------------- | :------------- | :---------------- | | Cash | $1,047,197 | $404,165 | | Total current assets | $2,794,756 | $872,132 | | Property and equipment, net | $734,798 | $6,919 | | Right of use assets | $2,937,660 | $97,239 | | Intangible assets, net | $1,214,144 | $- | | Goodwill | $1,800,176 | $- | | Total assets | $9,496,318 | $986,574 | | Total current liabilities | $2,234,087 | $7,309,514 | | Total long-term liabilities | $3,915,206 | $53,318 | | Total liabilities | $6,149,293 | $7,362,832 | | Total stockholders' equity/(deficit) | $2,660,825 | $(6,376,258) | - Total assets increased significantly by 862.5% from $986,574 at December 31, 2019, to $9,496,318 at March 31, 2020, primarily due to the Graphic Sciences acquisition, which introduced intangible assets and goodwill[15][98] - The company transitioned from a stockholders' deficit of $(6,376,258) at December 31, 2019, to a positive equity of $2,660,825 at March 31, 2020, driven by equity issuances and debt conversions[15][19] Condensed Consolidated Statements of Operations This section details the company's revenues, expenses, and net loss for the three months ended March 31, 2020, and 2019 Condensed Consolidated Statements of Operations (Selected Data) | Metric | 3 Months Ended Mar 31, 2020 | 3 Months Ended Mar 31, 2019 | | :-------------------------------- | :-------------------------- | :-------------------------- | | Total revenues | $1,213,664 | $515,385 | | Cost of revenues | $447,539 | $142,465 | | Gross profit | $766,125 | $372,920 | | Total operating expenses | $1,597,632 | $809,626 | | Loss from operations | $(831,507) | $(436,706) | | Gain on extinguishment of debt | $287,426 | $- | | Income tax benefit | $188,300 | $- | | Interest expense, net | $(290,430) | $(233,147) | | Net loss | $(646,211) | $(669,853) | | Basic and diluted net loss per share | $(0.54) | $(1.81) | | Weighted average common shares outstanding | 1,185,846 | 369,603 | - Total revenues increased by 135.5% year-over-year to $1,213,664, largely driven by the Graphic Sciences acquisition[17][189] - Net loss decreased by 3.5% to $(646,211) for the three months ended March 31, 2020, compared to $(669,853) in the prior year, despite higher operating expenses, due to a gain on debt extinguishment and income tax benefit[17][212][213] Condensed Consolidated Statement of Stockholders' Equity (Deficit) This section outlines changes in the company's equity, including common stock, additional paid-in capital, and accumulated deficit, for the three months ended March 31, 2020, and 2019 Condensed Consolidated Statement of Stockholders' Equity (Deficit) (Selected Data) | Metric | March 31, 2020 | December 31, 2019 | March 31, 2019 | | :-------------------------------- | :------------- | :---------------- | :------------- | | Common Stock (Shares) | 2,810,865 | 370,497 | 370,497 | | Common Stock (Amount) | $2,811 | $371 | $371 | | Additional Paid-in Capital | $24,100,291 | $14,419,437 | $14,305,824 | | Accumulated Deficit | $(21,442,277) | $(20,796,066) | $(19,332,638) | | Total Stockholders' Equity/(Deficit) | $2,660,825 | $(6,376,258) | $(5,056,821) | - Total stockholders' equity shifted from a deficit of $(6,376,258) at December 31, 2019, to a positive balance of $2,660,825 at March 31, 2020[19] - This change was primarily driven by significant increases in additional paid-in capital from stock issued ($3,820,000) and stock issued for convertible notes ($5,730,035), partially offset by equity issuance costs and the net loss[19] Condensed Consolidated Statements of Cash Flows This section reports the cash inflows and outflows from operating, investing, and financing activities for the three months ended March 31, 2020, and 2019 Condensed Consolidated Statements of Cash Flows (Selected Data) | Cash Flow Activity | 3 Months Ended Mar 31, 2020 | 3 Months Ended Mar 31, 2019 | | :-------------------------------- | :-------------------------- | :-------------------------- | | Net cash used in operating activities | $(143,951) | $(288,423) | | Net cash used in investing activities | $(3,896,726) | $- | | Net cash provided by/(used in) financing activities | $4,683,709 | $(11,255) | | Net increase (decrease) in cash | $643,032 | $(299,678) | | Cash - beginning of period | $404,165 | $1,088,630 | | Cash - end of period | $1,047,197 | $788,952 | - Net cash used in operating activities decreased by 50% to $(143,951) for the three months ended March 31, 2020, compared to $(288,423) in the prior year[21][229] - Net cash used in investing activities was $(3,896,726) in Q1 2020, primarily due to the Graphic Sciences acquisition, compared to no investing activities in Q1 2019[21][231] - Net cash provided by financing activities was $4,683,709 in Q1 2020, driven by proceeds from common stock issuance ($3,167,500) and notes payable ($2,000,000), offsetting offering costs and deferred financing costs[21][233] Notes to Condensed Consolidated Financial Statements (Unaudited) This section provides detailed explanations and disclosures regarding the company's significant accounting policies, acquisitions, debt, equity transactions, and other financial information - Intellinetics, Inc. acquired Graphic Sciences, Inc. on March 2, 2020, to expand its market share in the document management industry, resulting in $1,800,176 of goodwill and a $686,200 contingent consideration liability[23][97][99][134] - The company has an accumulated deficit of $21,442,277 as of March 31, 2020, and its ability to continue as a going concern is contingent upon enhancing operating cash flow and managing recent acquisitions, especially given the impact of COVID-19[28][31][32] - A one-for-fifty reverse stock split was effected on March 20, 2020, and the authorized common stock was increased to 160,000,000 shares to facilitate acquisitions and private placements[35][144][151] - The company's notes payable structure changed significantly, with $2,000,000 in new 2020 Notes issued and previous 2016-2018 unrelated and related convertible notes converted into equity on March 2, 2020, reducing debt but increasing equity[114][117][122][124] - Significant customer concentrations exist, with the State of Michigan accounting for 38% of revenues in Q1 2020, and government contracts representing 60% of net revenues[60][165][166] - Subsequent events include securing an $838,700 Paycheck Protection Program (PPP) loan in April 2020 and acquiring CEO Imaging Systems, Inc. on April 21, 2020, for approximately $300,000 cash plus potential earnouts[168][169] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's perspective on the company's financial condition and operating results for the three months ended March 31, 2020 and 2019, highlighting the impact of the Graphic Sciences acquisition, COVID-19, and strategic initiatives, along with a discussion of key financial metrics and critical accounting policies Company Overview This section describes Intellinetics as a document services and solutions software company focused on cloud-based delivery for small-to-medium businesses and governmental sectors - Intellinetics is a document services and solutions software company serving small-to-medium businesses and governmental sectors, offering a platform for document capture, management, storage, and retrieval[175] - The company's strategic focus is shifting towards cloud-based (SaaS) delivery of its software, which is anticipated to become the principal software business and primary source of revenue growth[177][179] - Cloud-based delivery revenues constituted 19% of total revenue for Q1 2020, a decrease from 39% in Q1 2019[177] How We Evaluate our Business Performance and Opportunities This section explains how management assesses performance through cloud-based revenue growth, acquisition integration, sales channels, project margins, and strategic acquisitions - Management evaluates performance by assessing the growth of cloud-based software revenues, the integration and revenue increase from Graphic Sciences, and the effectiveness of sales through resellers versus direct sales[179] - Key considerations for customer engagements include project profit margins and the potential for developing new product/service features[179] - The company monitors costs, capital needs, and continually seeks strategic acquisitions that complement its core business and are expected to be accretive to financial performance[179] Financial Impact of COVID-19 This section details the operational and financial challenges posed by the COVID-19 pandemic, including reduced demand, expense cuts, and the receipt of a PPP loan - The COVID-19 pandemic has significantly impacted operations, particularly Graphic Sciences in Michigan, which is limited to processing only 'essential' work orders[181] - The company implemented aggressive expense reduction efforts, including furloughing non-essential Michigan employees, reducing executive officer compensation by 20%, and other manager compensation by 15%[183] - A Paycheck Protection Program (PPP) loan of $838,700 was received to fund payroll and other permitted expenses, though forgiveness is not assured[183] - The company anticipates weakened demand due to reduced governmental and small-business spending and general economic uncertainty, with potential negative effects on future revenues[182] Uncertainties, Trends, and Risks that can cause Fluctuations in our Operating Results This section identifies various factors, such as economic conditions, product development, customer reliance, and regulatory compliance, that can lead to volatility in the company's financial performance - Operating results are subject to fluctuations due to factors such as capital needs, general economic conditions, new product development, and the length of the sales cycle[187] - Risks include exposure to early termination, audits, and penalties from governmental customers, reliance on channel partners, and the timing of expense recognition versus revenue[187] - Other uncertainties involve potential security breaches, data privacy regulations, customer renewal rates, ability to license third-party software, intellectual property protection, and litigation[187] Recent Developments This section highlights key events occurring after the reporting period, including the securing of a PPP loan and the acquisition of CEO Imaging Systems, Inc - On April 15, 2020, the company secured an unsecured promissory note for $838,700 under the Paycheck Protection Program (PPP), with a 1.0% interest rate and a two-year term, with potential for loan forgiveness[186] - On April 21, 2020, the company acquired substantially all assets of CEO Imaging Systems, Inc. for approximately $300,000 in cash, plus potential earnout payments of up to $370,000 over two years[188] - CEO Imaging Systems, Inc. specializes in the K-12 education market, as well as financial services[188] Executive Overview of Results This section provides a high-level summary of the company's financial performance for Q1 2020, including revenue growth, net loss, and operating cash flow Key Financial Results (Q1 2020) | Metric | Value | | :-------------------------------- | :------------ | | Revenues | $1,213,664 | | Revenue Growth (YoY) | 135% | | Cost of revenues | $447,539 | | Operating expenses (excluding cost of revenues) | $1,597,632 | | Loss from operations | $(831,507) | | Net loss | $(646,211) | | Basic and diluted net loss per share | $(0.54) | | Operating cash flow | $(143,952) | | Capital expenditures (excluding acquisition) | $7,742 | | Full-force employees (as of Mar 31, 2020) | 81 (including 4 part-time, 21 temporarily furloughed) | - Revenues grew by 135% year-over-year to $1,213,664, primarily driven by the Graphic Sciences acquisition[189][191] - Net loss was $(646,211), resulting in a basic and diluted net loss per share of $(0.54)[191] Results of Operations This section analyzes the company's revenue breakdown, cost of revenues, gross margins, and operating expenses for the three months ended March 31, 2020, and 2019 Revenue Breakdown (3 Months Ended March 31) | Revenue Category | 2020 | 2019 | Change ($) | Change (%) | | :------------------------ | :--------- | :--------- | :----------- | :--------- | | Sale of software | $94,100 | $1,750 | $92,350 | +5277% | | Software as a service | $225,994 | $199,183 | $26,811 | +13% | | Software maintenance services | $261,243 | $252,636 | $8,607 | +3% | | Professional services | $631,946 | $51,667 | $580,279 | +1123% | | Third party services | $381 | $10,149 | $(9,768) | -96% | | Total revenues | $1,213,664 | $515,385 | $698,279 | +135% | - The Graphic Sciences acquisition contributed $556,254 to total sales and $556,254 to professional services revenue, accounting for 108% and 1,077% of their respective increases[189][194] Cost of Revenues and Gross Margins (3 Months Ended March 31) | Category | 2020 Cost | 2019 Cost | Change ($) | Change (%) | 2020 Gross Margin | 2019 Gross Margin | | :------------------------ | :---------- | :---------- | :----------- | :----------- | :------------------ | :------------------ | | Total cost of revenues | $447,539 | $142,465 | $305,074 | +214% | | | | Sale of software | $38,302 | $1,846 | $36,456 | +1975% | 59% | (5%) | | Software as a service | $72,515 | $67,689 | $4,826 | +7% | 68% | 66% | | Software maintenance services | $46,516 | $29,378 | $17,138 | +58% | 82% | 88% | | Professional services | $289,467 | $33,506 | $255,961 | +764% | 54% | 35% | | Third party services | $739 | $10,046 | $(9,307) | -93% | (94%) | 1% | | Overall Gross Margin | | | | | 63% | 72% | - Total operating expenses increased by 97.3% to $1,597,632, primarily due to $460,767 in significant transaction costs related to the acquisition and $177,800 in Graphic Sciences expenses[17][208][209] - The company recognized a $287,426 gain on extinguishment of debt and an income tax benefit of $188,300[212][213] Liquidity and Capital Resources This section discusses the company's cash position, working capital, recent equity and debt financing activities, and cash flow from operating, investing, and financing activities - As of March 31, 2020, the company had $1,047,197 in cash and $560,669 in net working capital[215] - A $5.5 million private placement of equity and debt was completed on March 2, 2020, providing approximately $530,000 for working capital after acquisition and transaction fees[219] - Approximately $6 million of outstanding convertible debt was converted into common stock at $4.00 per share on March 2, 2020[224] - The company secured an $838,700 PPP loan in April 2020, with a 1.0% interest rate and a two-year term, for which forgiveness is uncertain[222] - Net cash used in operating activities decreased to $143,951 in Q1 2020 from $288,423 in Q1 2019, while net cash used in investing activities was $3,896,726, primarily for the Graphic Sciences acquisition[229][231] Critical Accounting Policies and Estimates This section outlines the key accounting policies and significant management judgments, such as revenue recognition, business acquisitions, and stock-based compensation, that materially impact the financial statements - Critical accounting policies include liquidity and going concern, revenue recognition (following ASC 606's five-step model), business acquisition accounting (preliminary allocation of purchase price to assets and liabilities, fair value of contingent consideration), and stock-based compensation (using the Black-Scholes-Merton option pricing model)[237][238][243][253][254] - Management makes significant estimates and assumptions that affect reported asset and liability amounts, and actual results may differ materially from these estimates[236][237] - The company maintains allowances for doubtful accounts and provisions for obsolete inventory, and expenses software development costs before technological feasibility is reached[242][245][248][251] Item 3. Quantitative and Qualitative Disclosures About Market Risk As a smaller reporting company, Intellinetics is not required to provide quantitative and qualitative disclosures about market risk - This item is not applicable to smaller reporting companies[255] Item 4. Controls and Procedures The principal executive and financial officers concluded that the company's disclosure controls and procedures were effective as of March 31, 2020. No material changes in internal control over financial reporting occurred during the quarter, other than previously described remediation - The principal executive officer and principal financial officer evaluated the effectiveness of disclosure controls and procedures and concluded they were effective as of March 31, 2020[256][257] - No material changes in internal control over financial reporting occurred during the three months ended March 31, 2020, other than described remediation[258] Part II: Other Information Item 1. Legal Proceedings The company reported no legal proceedings during the period - No legal proceedings were reported for the period[259] Item 1A. Risk Factors The company's business faces significant risks, particularly from the ongoing COVID-19 pandemic, which has led to operational scale-backs and demand uncertainty. Customer concentration, especially with government contracts, also poses a substantial risk, as the loss of major customers or failure to collect receivables could materially affect financial results - The COVID-19 pandemic has negatively impacted the business, requiring Graphic Sciences operations in Michigan to scale back to 'essential' projects, and could materially adversely affect business, results of operations, financial condition, and cash flows[261] - Significant customer concentration exists, with Graphic Sciences deriving over 75% of its revenues from the State of Michigan, and government contracts representing approximately 60% of the company's net revenues in Q1 2020[262][166] - Government contracts carry short terms (typically less than 18 months), and the loss of a meaningful percentage could materially affect operating results[262] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds No unregistered sales of equity securities occurred during the quarter that have not been previously disclosed - There have been no unregistered sales of equity securities during the quarterly period that have not been previously disclosed on a Current Report on Form 8-K[263] Item 3. Defaults Upon Senior Securities The company reported no defaults upon senior securities - No defaults upon senior securities were reported[264] Item 4. Mine Safety Disclosures This item is not applicable to the company - This item is not applicable to the company[265] Item 5. Other Information No other information was reported under this item - No other information was reported under this item[266] Item 6. Exhibits This section lists the exhibits filed as part of the Quarterly Report on Form 10-Q, including certifications and XBRL taxonomy documents - Exhibits include certifications of Principal Executive Officer and Principal Financial Officer pursuant to Sections 302 and 906 of The Sarbanes-Oxley Act of 2002[268] - XBRL Instance Document and Taxonomy Schema are also filed as exhibits[268] Signatures This section confirms the official signing of the report by the President, CEO, and CFO on May 15, 2020 - The report was signed on May 15, 2020, by James F. DeSocio, President and Chief Executive Officer, and Joseph D. Spain, Chief Financial Officer[270][272]