Intellinetics(INLX) - 2023 Q2 - Quarterly Report

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS Forward-looking statements are subject to risks and uncertainties, potentially causing actual results to differ - This report contains forward-looking statements based on current plans and expectations, which are subject to substantial risks, uncertainties, and other factors that could cause actual results to differ materially Investors are cautioned not to place undue reliance on these statements[8][9][11] - Examples of forward-looking statements include those concerning economic conditions, future financial performance (revenues, net income, EPS, cash flow), integration of acquisitions, product development, market position, business strategies, capital resources, and competition[10] Definitions This section defines key terms including 'Intellinetics,' 'Company,' and its wholly-owned subsidiaries - The terms 'Intellinetics,' 'Company,' 'us,' 'we,' 'our,' and similar terms refer to Intellinetics, Inc., a Nevada corporation, and its subsidiaries 'Intellinetics Ohio' refers to Intellinetics, Inc., an Ohio corporation and a wholly-owned subsidiary 'Graphic Sciences' refers to Graphic Sciences, Inc., a Michigan corporation and a wholly-owned subsidiary[13] 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 periods ended June 30, 2023, and December 31, 2022, including balance sheets, statements of operations, stockholders' equity, and cash flows, along with detailed notes explaining significant accounting policies, business combinations, intangible assets, debt, leases, and other financial disclosures Condensed Consolidated Balance Sheets This section provides a snapshot of the company's assets, liabilities, and equity at specific dates Condensed Consolidated Balance Sheets (Selected Items) | Item | June 30, 2023 | December 31, 2022 | Change (Absolute) | Change (%) | | :-------------------------------- | :-------------- | :---------------- | :---------------- | :--------- | | Total current assets | $4,001,898 | $4,893,039 | $(891,141) | -18.21% | | Total assets | $18,587,086 | $19,943,142 | $(1,356,056) | -6.80% | | Total current liabilities | $4,391,182 | $6,002,482 | $(1,611,300) | -26.84% | | Total liabilities | $9,536,370 | $11,374,340 | $(1,837,970) | -16.16% | | Total stockholders' equity | $9,050,716 | $8,568,802 | $481,914 | 5.62% | - Cash decreased significantly from $2,696,481 at December 31, 2022, to $1,130,487 at June 30, 2023[16] - Deferred revenues decreased from $2,754,064 at December 31, 2022, to $2,067,744 at June 30, 2023[16] Condensed Consolidated Statements of Operations This section details the company's revenues, costs, and net income or loss over specific periods Condensed Consolidated Statements of Operations (Selected Items) | Item | 3 Months Ended June 30, 2023 | 3 Months Ended June 30, 2022 | Change (Absolute) | Change (%) | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | Change (Absolute) | Change (%) | | :------------------------------ | :----------------------------- | :----------------------------- | :---------------- | :--------- | :----------------------------- | :----------------------------- | :---------------- | :--------- | | Total revenues | $4,258,430 | $3,415,643 | $842,787 | 24.68% | $8,445,263 | $6,119,155 | $2,326,108 | 38.02% | | Total cost of revenues | $1,667,997 | $1,226,625 | $441,372 | 35.98% | $3,208,991 | $2,298,300 | $910,691 | 39.62% | | Gross profit | $2,590,433 | $2,189,018 | $401,415 | 18.34% | $5,236,272 | $3,820,855 | $1,415,417 | 37.04% | | Income (loss) from operations | $296,388 | $(133,699) | $430,087 | 321.67% | $580,387 | $(41,224) | $621,611 | 1507.89% | | Net income (loss) | $135,734 | $(374,167) | $509,901 | 136.28% | $248,297 | $(394,293) | $642,590 | 162.97% | | Basic net income (loss) per share | $0.03 | $(0.09) | $0.12 | 133.33% | $0.06 | $(0.11) | $0.17 | 154.55% | | Diluted net income (loss) per share | $0.03 | $(0.09) | $0.12 | 133.33% | $0.06 | $(0.11) | $0.17 | 154.55% | - Software as a service revenue increased by 10% for the three months ended June 30, 2023, and by 58% for the six months ended June 30, 2023, compared to the respective prior periods[18] - Professional services revenue increased by 41% for the three months ended June 30, 2023, and by 43% for the six months ended June 30, 2023, compared to the respective prior periods[18] Condensed Consolidated Statement of Stockholders' Equity This section outlines changes in the company's equity, including net income and stock-based compensation Condensed Consolidated Statement of Stockholders' Equity (Selected Items) | Item | June 30, 2023 | June 30, 2022 | Change (Absolute) | Change (%) | | :-------------------------- | :-------------- | :-------------- | :---------------- | :--------- | | Total Stockholders' Equity | $9,050,716 | $7,912,484 | $1,138,232 | 14.38% | | Accumulated Deficit | $(21,365,992) | $(22,032,609) | $666,617 | -3.03% | - The company reported net income of $135,734 for the three months ended June 30, 2023, and $248,297 for the six months ended June 30, 2023, contributing to a reduction in the accumulated deficit[20] - Stock option compensation recognized was $115,455 for the three months and $233,617 for the six months ended June 30, 2023[20] Condensed Consolidated Statements of Cash Flows This section reports on cash generated and used by operating, investing, and financing activities Condensed Consolidated Statements of Cash Flows (Selected Items) | Item | 6 Months Ended June 30, 2023 | 6 Months Ended June 30, 2022 | Change (Absolute) | Change (%) | | :-------------------------------------- | :----------------------------- | :----------------------------- | :---------------- | :--------- | | Net cash (used in) provided by operating activities | $(299,631) | $72,649 | $(372,280) | -512.45% | | Net cash used in investing activities | $(291,101) | $(6,652,673) | $6,361,572 | -95.62% | | Net cash (used in) provided by financing activities | $(975,262) | $6,940,583 | $(7,915,845) | -114.05% | | Net (decrease) increase in cash | $(1,565,994) | $360,559 | $(1,926,553) | -534.37% | | Cash - end of period | $1,130,487 | $2,113,189 | $(982,702) | -46.51% | - Net cash used in operating activities was $(299,631) for the six months ended June 30, 2023, a significant decrease from $72,649 provided in the prior year, primarily due to changes in operating assets and liabilities[23][143] - Investing activities used significantly less cash in 2023 ($291,101) compared to 2022 ($6,652,673), as the prior year included a large cash payment for the Yellow Folder acquisition[23][144] - Financing activities shifted from providing $6,940,583 in 2022 (due to stock issuance and new borrowings) to using $975,262 in 2023, primarily for earnout liability payments and note repayments[23][146] Notes to Condensed Consolidated Financial Statements This section provides detailed explanations and disclosures supporting the condensed financial statements 1. Business Organization and Nature of Operations This note describes the company's structure, subsidiaries, and core business segments - Intellinetics, Inc (Nevada) operates through two wholly-owned subsidiaries: Intellinetics, Inc (Ohio) and Graphic Sciences, Inc (Michigan)[27] - The company provides digital transformation products and services through two segments: Document Management (software platform, including Yellow Folder acquisition) and Document Conversion (paper-to-digital conversion, storage, and retrieval, primarily Graphic Sciences acquisition)[28] - Solutions are sold directly to end-users and through resellers, creating value by making business-critical documents easy to find, access, secure, and compliant[28] 2. Basis of Presentation This note explains the accounting principles and assumptions used in preparing the financial statements - The unaudited condensed consolidated financial statements are prepared in accordance with United States generally accepted accounting principles (GAAP), including all necessary normal recurring adjustments for interim periods[29][30] - Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the full fiscal year or any other future period[31] 3. Summary of Significant Accounting Policies This note outlines key accounting policies, including consolidation, revenue recognition, and asset valuation - The company consolidates accounts of all subsidiaries where it holds a controlling interest, eliminating all significant intercompany balances and transactions[32] - An allowance for credit losses is maintained for customer receivables, which was $114,219 at June 30, 2023, up from $88,331 at December 31, 2022[34] - Deferred revenue represents amounts billed for which revenue has not yet been recognized, typically related to maintenance and software-as-a-service agreements, with approximately 97% expected to be recognized over the next 12 months[36][37] - Software development costs are expensed before technological feasibility is reached; internal-use software purchase and implementation costs are capitalized once in the development stage Capitalized internal-use software costs were $208,417 for the six months ended June 30, 2023[40][41] - The company adopted ASU No 2016-13 'Credit Losses' in the first quarter of 2023, resulting in an initial reduction in the allowance for doubtful accounts of $11,662[44] - A 100% valuation allowance has been established on deferred tax assets at June 30, 2023, and December 31, 2022, due to the uncertainty of realizing future taxable income[49] - Performance is assessed and resources are allocated based on two operating segments: Document Management and Document Conversion, with performance evaluated based on gross profits[51] 4. Business Combinations This note details the Yellow Folder acquisition, including its financial impact and purchase price allocation - On April 1, 2022, Intellinetics acquired substantially all of the assets of Yellow Folder, LLC, to expand market share in the digital transformation industry and due to synergies of product lines and services[57] Yellow Folder Acquisition - Purchase Price Allocation | Item | Amount | | :------------------------------------------ | :------------- | | Purchase price | $6,383,269 | | Goodwill recognized | $3,466,934 | Yellow Folder Revenue and Net Income Contribution | Period | Total Revenues | Net Income | | :----------------------- | :------------- | :----------- | | 3 Months Ended June 30, 2023 | $864,331 | $85,408 | | 6 Months Ended June 30, 2023 | $1,738,893 | $271,111 | | 3 Months Ended June 30, 2022 | $790,368 | $196,559 | | 6 Months Ended June 30, 2022 | $790,368 | $196,559 | 5. Intangible Assets, Net This note details the company's intangible assets, their carrying values, and amortization expense Intangible Assets, Net | Item | June 30, 2023 | December 31, 2022 | | :---------------------- | :-------------- | :---------------- | | Trade names | $235,083 | $249,933 | | Proprietary technology | $753,375 | $796,425 | | Customer relationships | $3,176,034 | $3,373,288 | | Total Intangible Assets, Net | $4,164,492 | $4,419,646 | - Amortization expense for intangible assets amounted to $127,577 for the three months and $255,154 for the six months ended June 30, 2023[64] Future Amortization Expense for Intangible Assets | Period | Amount | | :---------------------------- | :------------- | | For the Twelve Months Ending June 30, 2024 | $510,308 | | Thereafter | $2,071,378 | | Total | $4,164,492 | 6. Fair Value Measurements This note discusses the fair value of financial instruments, particularly earnout liabilities - The company paid its final earnout liability in January 2023, resulting in no remaining earnout liabilities as of June 30, 2023[66] Changes in Fair Value of Earnout Liabilities | Item | June 30, 2023 | June 30, 2022 | | :-------------------------- | :-------------- | :-------------- | | Fair value at December 31, 2022/2021 | $700,000 | $1,630,681 | | Payments | $(700,000) | $(1,018,333) | | Change in fair value | $0 | $116,505 | | Fair value at June 30, 2023/2022 | $0 | $728,853 | 7. Property and Equipment This note details the company's property and equipment, including depreciation expense Property and Equipment, Net | Item | June 30, 2023 | December 31, 2022 | | :-------------------------- | :-------------- | :---------------- | | Computer hardware and purchased software | $1,661,438 | $1,595,652 | | Leasehold improvements | $395,919 | $395,918 | | Furniture and fixtures | $71,325 | $71,325 | | Less: accumulated depreciation | $(1,103,906) | $(994,189) | | Property and equipment, net | $1,024,776 | $1,068,706 | - Total depreciation expense on property and equipment was $64,675 for the three months and $126,614 for the six months ended June 30, 2023[68] 8. Notes Payable – Unrelated Parties This note outlines the company's debt obligations to unrelated parties and associated interest expenses Notes Payable to Unrelated Parties | Item | June 30, 2023 | December 31, 2022 | | :-------------------------------- | :-------------- | :---------------- | | 2022 Unrelated Notes | $2,364,500 | $2,364,500 | | 2020 Notes | $717,500 | $980,450 | | Total notes payable | $3,082,000 | $3,344,950 | | Long-term portion of notes payable | $2,147,139 | $2,085,035 | - Future minimum principal payments of the Notes Payable to Unrelated Parties include $717,500 due in 2024 and $2,364,500 due in 2025[70] - Interest expense for these notes, including amortization of debt issuance costs and debt discount, was $136,136 for the three months and $287,741 for the six months ended June 30, 2023[72] 9. Notes Payable - Related Parties This note details the company's debt obligations to related parties and their terms Notes Payable to Related Parties | Item | June 30, 2023 | December 31, 2022 | | :-------------------------------- | :-------------- | :---------------- | | Notes payable – '2022 Related Note' | $600,000 | $600,000 | | Long-term portion of notes payable | $544,843 | $529,084 | - The 2022 Related Note has a 12% interest rate, with principal due on March 30, 2025[74][77] - Interest expense for notes payable – related parties was $25,880 for the three months and $51,759 for the six months ended June 30, 2023[75] 10. Deferred Compensation This note describes the status of accrued incentive cash compensation for company founders - Accrued incentive cash compensation for one of the company's founders was fully paid as of December 31, 2022, with $50,414 paid during the six months ended June 30, 2022[76] 11. Commitments and Contingencies This note outlines the company's operating lease commitments and other potential liabilities - The company has various operating leases for office spaces and vehicles, with lease expiry dates ranging from month-to-month to September 30, 2028[80] Future Minimum Lease Payments | Period | Finance Lease | Operating Leases | | :---------------------------- | :-------------- | :--------------- | | For the twelve months ending June 30, 2024 | $41,259 | $930,559 | | Total (net of imputed interest/short-term) | $174,183 | $3,018,555 | - Operating lease expense was $238,864 for the three months and $476,312 for the six months ended June 30, 2023[81] 12. Stockholders' Equity This note provides details on common stock, outstanding warrants, and equity incentive plans - As of June 30, 2023, there were 4,073,757 shares of common stock issued and outstanding, with 255,958 shares reserved for outstanding warrants and 497,330 shares reserved under the 2015 Equity Incentive Plan[82] Outstanding Warrants as of June 30, 2023 | Warrants Outstanding | Exercise Price | Warranty Expiry | | :------------------- | :------------- | :-------------- | | 124,258 | $4.62 | March 30, 2027 | | 95,500 | $4.00 | March 30, 2027 | | 16,000 | $9.00 | March 30, 2027 | | 17,200 | $12.50 | March 30, 2027 | | 3,000 | $15.00 | March 30, 2027 | 13. Stock-Based Compensation This note details the company's stock-based compensation plans and associated expenses - Stock compensation of $57,500 was recorded for 8,097 restricted common shares issued to directors on January 6, 2022[86] - No stock option grants were made during the six months ended June 30, 2023 On April 14, 2022, 220,587 stock options were granted to employees with a total fair value of $1,152,470[87] - Stock-based compensation for options was $115,456 for the three months and $233,618 for the six months ended June 30, 2023[88] - As of June 30, 2023, total unrecognized compensation costs related to stock options were $778,893, expected to be recognized over a weighted-average period of two years[89] 14. Concentrations This note identifies significant customer and revenue concentrations for the company - The State of Michigan was the largest customer, accounting for 36% of total revenues in Q2 2023 and 35% in 6M 2023 Rocket Mortgage was the second largest, accounting for 5% in Q2 2023 and 5% in 6M 2023[90] - Government contracts, including K-12 education, represented approximately 79% of net revenues in Q2 2023 and 76% in 6M 2023[91] - Accounts receivable concentrations from the two largest customers were 37% and 10% of gross accounts receivable as of June 30, 2023[92] 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 results of operations, highlighting key performance drivers, the impact of the Yellow Folder acquisition, current economic conditions, and segment-specific revenue and cost trends It also discusses liquidity, capital resources, and critical accounting policies Company Overview This section describes Intellinetics' business model, target markets, and core service offerings - Intellinetics is a document services and software solutions company serving small-to-medium businesses and governmental sectors with digital transformation and process automation initiatives[94] - The company's digital transformation products and services are provided through two reporting segments: Document Management (software platform, including Yellow Folder acquisition) and Document Conversion (paper-to-digital conversion, storage, and retrieval)[95] - The Software as a Service (SaaS) model has become increasingly popular and is a key ingredient in the company's revenue growth strategy, with products hosted on Amazon Web Services, Expedient, and Evocative[96] Executive Overview of Results This section summarizes key financial performance and the impact of the Yellow Folder acquisition - The acquisition of Yellow Folder on April 1, 2022, was the biggest factor in the changes in results for the six-month period 2023, as 2023 results include the full periods of Yellow Folder operations, while 2022 only included the second quarter results[101] - Strong professional services performance, growing over 40% for the six-month period 2023, was partially offset by lingering softer demand for the transactional portion of storage and retrieval services from a significant customer in the home mortgage lending industry[101] Key Financial Results (Consolidated) | Item | Q2 2023 | Q2 2022 | YoY Change (%) | 6M 2023 | 6M 2022 | YoY Change (%) | | :------------------------------ | :-------- | :-------- | :------------- | :-------- | :-------- | :------------- | | Revenues | $4,258,430 | $3,415,643 | 25% | $8,445,263 | $6,119,155 | 38% | | Cost of revenues | $1,667,997 | $1,226,625 | 36% | $3,208,991 | $2,298,300 | 40% | | Operating expenses (excl. CoR) | $2,294,045 | $2,322,717 | -1% | $4,655,885 | $3,862,079 | 21% | | Income (loss) from operations | $296,388 | $(133,699) | 322% | $580,387 | $(41,224) | 1508% | | Net income (loss) | $135,734 | $(374,167) | 136% | $248,297 | $(394,293) | 163% | | Basic/Diluted EPS | $0.03 | $(0.09) | 133% | $0.06 | $(0.11) | 155% | | Operating cash (used in)/provided by | $(125,274) | $(403,522) | 69% | $(299,631) | $72,649 | -512% | | Capital expenditures | $156,532 | $213,361 | -27% | $291,101 | $269,404 | 8% | | Employees (as of June 30) | 170 | 139 | 22% | | | | - Operating expenses for Q2 2023 decreased by 1% year over year due to reduced transaction costs and no fair value adjustments for earnout liabilities, while 6M 2023 operating expenses increased by 21% year over year[102][108] Financial Impact of Current Economic Conditions This section discusses how economic factors like inflation and supply chain issues affect company operations - Employee wages, the largest expense, have increased due to wage inflation, slightly decreasing profit margins, but the company mitigates this by appropriately increasing customer renewal rates[104] - General wage inflation resulted in a slower hiring process, particularly for the Document Conversion segment, which initially slowed project completion and reduced revenue in early 2022, but staffing levels increased by the end of 6M 2023[104][108] - Global supply chain disruptions have had and are expected to continue to have a minimal impact, and customer demand has not diminished due to adverse economic conditions as of the report date[105] Uncertainties, Trends, and Risks This section highlights factors that may cause future operating results to fluctuate - Operating results have fluctuated significantly in the past and are expected to continue to fluctuate in the future due to a variety of factors, including economic conditions and other risks discussed in the Annual Report on Form 10-K[106] - Past results of operations should not be relied upon as an indication of future performance[106] Reportable Segments This section identifies the company's two primary operating segments: Document Management and Document Conversion - The company has two reportable segments: Document Management (cloud-based and premise-based content services software) and Document Conversion (scanning, indexing, conversion, and physical document storage and retrieval)[52][53][107] Results of Operations This section provides a detailed analysis of the company's financial performance across revenue and cost categories Revenues This section analyzes total revenues by segment and source, highlighting growth drivers Revenues by Segment | Segment | Q2 2023 | Q2 2022 | YoY Change (%) | 6M 2023 | 6M 2022 | YoY Change (%) | | :------------------ | :-------- | :-------- | :------------- | :-------- | :-------- | :------------- | | Document Management | $1,879,369 | $1,572,854 | 19.49% | $3,705,103 | $2,487,804 | 49.33% | | Document Conversion | $2,379,061 | $1,842,789 | 29.10% | $4,740,160 | $3,631,351 | 30.55% | | Total revenues | $4,258,430 | $3,415,643 | 24.68% | $8,445,263 | $6,119,155 | 38.02% | Revenues by Source | Revenue Source | Q2 2023 | Q2 2022 | YoY Change (%) | 6M 2023 | 6M 2022 | YoY Change (%) | | :-------------------------- | :-------- | :-------- | :------------- | :-------- | :-------- | :------------- | | Sale of software | $63,646 | $11,105 | 473.14% | $78,939 | $75,596 | 4.45% | | Software as a service | $1,277,918 | $1,158,456 | 10.31% | $2,516,350 | $1,589,677 | 58.29% | | Software maintenance services | $349,139 | $343,881 | 1.53% | $698,681 | $680,483 | 2.67% | | Professional services | $2,298,316 | $1,625,765 | 41.37% | $4,597,605 | $3,213,713 | 43.05% | | Storage and retrieval services | $269,411 | $276,436 | -2.54% | $553,688 | $559,686 | -1.07% | | Total revenues | $4,258,430 | $3,415,643 | 24.68% | $8,445,263 | $6,119,155 | 38.02% | - Total revenues increased by 25% in Q2 2023 and 38% in 6M 2023, primarily driven by strong professional services in the Document Conversion segment and the full six-month impact of the Yellow Folder acquisition in 2023[109] Sale of Software Revenues This section discusses the trends and volatility in revenues derived from direct software sales - Revenues from the sale of software, reported as part of the Document Management segment, increased by 473% in Q2 2023 compared to Q2 2022 due to timing of direct sales projects, but only increased by 4% for 6M 2023[110][111] - The volatility of this revenue line item is expected to continue as project timing is unpredictable and the frequency of on-premise software solution sales decreases over time[111] Software as a Service Revenues This section analyzes SaaS revenue growth, including the impact of acquisitions and organic expansion - Software as a service (SaaS) revenues, reported as part of the Document Management segment, increased by 10% in Q2 2023 and 58% in 6M 2023[113] - The six-month period increase was primarily the result of the Yellow Folder acquisition, which contributed $785,481 (85% of the increase), plus organic growth in cloud-based solutions, expanded data storage, user seats, and hosting fees for existing customers[113] Software Maintenance Services Revenues This section examines modest growth in software maintenance revenues due to service expansion and price adjustments - Software maintenance services revenues, reported as part of the Document Management segment, increased by 2% in Q2 2023 and 3% in 6M 2023[114] - This small increase was driven by expansion of services with existing customers and price increases, partially offset by normal attrition and certain customers migrating their premise solution to the cloud[114] Professional Services Revenues This section details the significant increase in professional services revenues, driven by Document Conversion recovery - Overall professional services revenues increased by 41% in Q2 2023 and 43% in 6M 2023[115] - This increase is primarily the result of a strong recovery in the Document Conversion segment in 6M 2023 from softer demand in early 2022, and includes a $110,316 contribution from the Yellow Folder acquisition in Q1 2023[115] - Of professional services revenues, $2,143,613 (Q2 2023) and $4,254,336 (6M 2023) were derived from Document Conversion operations[115] Storage and Retrieval Services Revenues This section analyzes the decline in storage and retrieval revenues due to reduced customer volume - Revenues from storage and retrieval services, reported as part of the Document Conversion segment, decreased by 3% in Q2 2023 and 1% in 6M 2023[116] - This decrease was the result of a continued reduction in volume of work from the largest storage and retrieval customer, Rocket Mortgage, due to the significant slowdown in the home mortgage and refinancing industry, partially offset by Yellow Folder's revenue contribution in Q1 2023[116] Costs of Revenues and Gross Profits This section examines the trends in cost of revenues and gross profit margins by segment Cost of Revenues by Segment | Segment | Q2 2023 | Q2 2022 | YoY Change (%) | 6M 2023 | 6M 2022 | YoY Change (%) | | :------------------ | :-------- | :-------- | :------------- | :-------- | :-------- | :------------- | | Document Management | $342,984 | $246,509 | 39.14% | $651,357 | $474,981 | 37.13% | | Document Conversion | $1,325,013 | $980,116 | 35.19% | $2,557,634 | $1,823,319 | 40.28% | | Total cost of revenues | $1,667,997 | $1,226,625 | 35.98% | $3,208,991 | $2,298,300 | 39.62% | Gross Profit by Segment | Segment | Q2 2023 | Q2 2022 | YoY Change (%) | 6M 2023 | 6M 2022 | YoY Change (%) | | :------------------ | :-------- | :-------- | :------------- | :-------- | :-------- | :------------- | | Document Management | $1,536,385 | $1,326,345 | 15.84% | $3,053,746 | $2,012,823 | 51.72% | | Document Conversion | $1,054,048 | $862,673 | 22.18% | $2,182,526 | $1,808,032 | 20.71% | | Total gross profit | $2,590,433 | $2,189,018 | 18.34% | $5,236,272 | $3,820,855 | 37.04% | - Total cost of revenues increased by 36% in Q2 2023 and 40% in 6M 2023, driven by the six-month impact of Yellow Folder in Document Management and staffing ramp-up in Document Conversion[118] - Overall gross profit percentage decreased to 60.8% in Q2 2023 (from 64.1%) and 62.0% in 6M 2023 (from 62.4%), mainly due to the increased mix of lower-margin professional services revenue and slight erosion in software as a service margins[120] Cost of Software Revenues This section analyzes the cost and gross margin trends for software sales - Cost of software revenues decreased by 1% in Q2 2023 and 54% in 6M 2023, leading to a significant increase in gross margin for software revenues to 88.5% (Q2 2023) and 80.3% (6M 2023) due to favorable changes in the software solution mix[121] Cost of Software as a Service This section details the cost and gross margin changes for software as a service offerings - Cost of software as a service (SaaS) increased by 35% in Q2 2023 and 70% in 6M 2023 due to increased staffing allocations[122] - Gross margin for SaaS decreased to 79.8% in Q2 2023 (from 83.5%) and 81.0% in 6M 2023 (from 82.2%)[122] Cost of Software Maintenance Services This section reviews the cost and gross margin performance of software maintenance services - Cost of software maintenance services decreased by 21% in Q2 2023 and 15% in 6M 2023, primarily due to reduced support activity[123] - Gross margin for software maintenance services increased to 95.7% in Q2 2023 and 95.4% in 6M 2023[123] Cost of Professional Services This section analyzes the cost and gross margin trends for professional services, including staffing impacts - Cost of professional services increased by 42% in Q2 2023 and 41% in 6M 2023, primarily due to growing the Document Conversion staff to meet the increasing backlog of orders[124] - Gross margins in professional services slightly decreased to 43.1% in Q2 2023 (from 43.5%) but increased to 45.7% in 6M 2023 (from 45.0%), with improvements in Document Management consulting efficiencies largely offsetting deterioration in Document Conversion due to staffing up and training new hires[124] Cost of Storage and Retrieval Services This section examines the cost and gross margin fluctuations for storage and retrieval services - Cost of storage and retrieval services decreased by 12% in Q2 2023 due to a reduction in transaction events but increased by 6% in 6M 2023 due to general wage inflation and fuel cost increases[125] - Gross margins for storage and retrieval services increased to 70.4% in Q2 2023 (from 67.3%) but decreased to 66% in 6M 2023 (from 68.2%)[125] Operating Expenses This section provides an overview of the company's operating expenses, including general, administrative, sales, and marketing General and Administrative Expenses This section analyzes changes in general and administrative expenses, primarily due to acquisitions - General and administrative expenses increased by 24% in Q2 2023 and 42% in 6M 2023, principally related to the addition of Yellow Folder expenses for the full Q1 2023 period[127] - Document Management segment's G&A expenses increased to $794,718 (Q2 2023) and $1,597,846 (6M 2023) Document Conversion segment's G&A expenses increased to $767,221 (Q2 2023) and $1,518,704 (6M 2023)[127] Change in Fair Value of Earnout Liabilities This section discusses the absence of earnout liability adjustments in the current period - No changes in fair value of earnout liabilities were recorded in 2023, as the final earnout liabilities were paid in January 2023[128] - Fair value adjustments amounted to $52,301 in Q2 2022 and $116,505 for 6M 2022, driven by updated assumptions reflecting improved performance of affected acquisitions[128] Transaction Costs This section notes the absence of transaction costs in the current reporting period - There were no transaction costs during Q2 2023 and 6M 2023[130] - Transaction costs during Q2 2022 and 6M 2022 were comprised of investment banker success fees, legal, and consulting fees in connection with the Yellow Folder acquisition[130] Sales and Marketing Expenses This section analyzes the trends in sales and marketing expenses, influenced by acquisitions - Sales and marketing expenses decreased by 7% in Q2 2023 but increased by 22% in 6M 2023, primarily driven by the inclusion of Yellow Folder's sales and marketing expenses for the full six-month period in 2023[131] Depreciation and Amortization This section details the increase in depreciation and amortization due to new intangible assets and capitalized software - Depreciation and amortization increased by 19% in Q2 2023 and 47% in 6M 2023, resulting from the amortization of new intangible assets related to the Yellow Folder acquisition and increased amortization of capitalized software costs[132] Other Items of Income and Expense This section covers non-operating income and expense items, such as interest expense Interest Expense, Net This section analyzes the changes in interest expense, primarily due to debt repayments - Interest expense decreased by 33% in Q2 2023 and 6% in 6M 2023, primarily due to partial principal repayment of the 2020 Notes on December 1, 2022, and February 28, 2023[133] Liquidity and Capital Resources This section assesses the company's ability to meet financial obligations and fund operations Indebtedness This section details the company's outstanding long-term debt and its plans for refinancing - As of June 30, 2023, outstanding long-term indebtedness included $717,500 from 2020 Notes (due August 31, 2023) and $2,964,500 from 2022 Notes (due March 30, 2025)[137][145] - The company believes its balance sheet and financial statements would support a full or partial refinancing or other appropriate modification of the current promissory notes[137] Capital Expenditures This section reports on the company's commitments for capital expenditures - There were no material commitments for capital expenditures at June 30, 2023[142] Cash Used in and Provided by Operating Activities This section analyzes cash flows from operating activities, highlighting changes from prior periods - Net cash used in operating activities during 6M 2023 was $299,631, primarily attributable to net income adjusted for non-cash expenses, an increase in operating assets, and a decrease in operating liabilities[143] - In contrast, net cash provided by operating activities during 6M 2022 was $72,649[143] Cash Used by Investing Activities This section details cash flows from investing activities, including acquisition-related payments - Net cash used in investing activities in 6M 2023 was $291,101, including $208,417 in capitalized software[144] - This is significantly lower than $6,652,673 used in 6M 2022, which primarily included $6,383,269 related to cash paid to acquire Yellow Folder[144] Cash Used in and Provided by Financing Activities This section analyzes cash flows from financing activities, including debt and equity transactions - Net cash used by financing activities during 6M 2023 amounted to $975,262, primarily for $700,000 in earnout liability payments and $262,950 in repayment of notes payable[146] - In contrast, net cash provided by financing activities during 6M 2022 amounted to $6,940,583, resulting from cash generated from the sale of common stock ($5.7M) and new borrowings ($3.0M), partially offset by issuance costs and earnout payments[146] Critical Accounting Policies and Estimates This section discusses significant accounting policies and estimates that require management judgment - The preparation of condensed consolidated financial statements requires estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses, which are monitored for changes in facts and circumstances[147] - There were no material changes to the company's critical accounting policies and estimates during the second quarter of 2023[148] ITEM 3. Quantitative and Qualitative Disclosures About Market Risk As a smaller reporting company, Intellinetics, Inc. is not required to provide quantitative and qualitative disclosures about market risk - Not applicable to smaller reporting companies[149] ITEM 4. Controls and Procedures This section addresses the effectiveness of the company's disclosure controls and procedures and reports on any changes in internal control over financial reporting Evaluation of Disclosure Controls and Procedures This section assesses the effectiveness of the company's disclosure controls and procedures - Management concluded that as of June 30, 2023, the company's disclosure controls and procedures were effective to provide reasonable assurance that required information is recorded, processed, summarized, and reported within specified time periods[151] - The design of disclosure controls and procedures reflects resource constraints, and management applies judgment in evaluating the benefits of possible controls relative to their costs[152] Changes in Internal Control Over Financial Reporting This section reports on any material changes to the company's internal control over financial reporting - There were no changes in internal control over financial reporting that occurred during the period covered by this Quarterly Report that materially affected, or are reasonably likely to materially affect, the company's internal control over financial reporting[153] - The company regularly reviews and makes appropriate changes to its internal control over financial reporting to maintain and enhance effectiveness[154] PART II – OTHER INFORMATION ITEM 1. Legal Proceedings The company is not currently involved in any legal proceedings, claims, or litigation that are expected to have a material adverse impact on its financial position or operations - The company has no reason to believe the disposition of any current legal matter could reasonably be expected to have a material adverse impact on its financial position, results of operations, or business activities[78][156] ITEM 1A. Risk Factors There have been no material changes to the risk factors previously disclosed in the company's Annual Report on Form 10-K for the fiscal year ended December 31, 2022 - There have been no material changes to the risk factors set forth in Part I, Item 1A, 'Risk Factors,' of the Annual Report on Form 10-K for the fiscal year ended December 31, 2022[157] ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds The company did not engage in any unregistered sales of equity securities or use of proceeds during the reporting period - None[158] ITEM 3. Defaults Upon Senior Securities The company has not defaulted on any senior securities during the reporting period - None[159] ITEM 4. Mine Safety Disclosures This item is not applicable to the company's operations - Not Applicable[160] ITEM 5. Other Information The company entered into a renewal extension with its largest customer, the State of Michigan, effective October 1, 2023, through May 30, 2025, which includes an estimated net rate increase of approximately 21% - On August 3, 2023, the company entered into a renewal extension with its largest customer, the State of Michigan, effective October 1, 2023, through May 30, 2025[161] - The renewal contract contains an estimated net rate increase of approximately 21% compared to the current rates in effect for the contract period commencing June 1, 2018[161] ITEM 6. Exhibits This section lists the exhibits filed as part of the Quarterly Report on Form 10-Q, including the contract change notice with the State of Michigan and various certifications - Exhibit 10.1 is the Contract Change Notice No 2 and 3, by and between Graphic Sciences, Inc and the State of Michigan Central Procurement Services, Department of Technology, Management, dated August 3, 2023[163] - Includes certifications of Principal Executive Officer and Principal Financial Officer pursuant to Sections 302 and 906 of The Sarbanes-Oxley Act of 2002[163] - Includes Inline XBRL Instance Document and Taxonomy Schema[165] SIGNATURES This section confirms the official signing of the report by the company's executive and financial officers - The report is duly signed on behalf of Intellinetics, Inc by its President and Chief Executive Officer, James F DeSocio, and Chief Financial Officer, Joseph D Spain, on August 14, 2023[168]