Notes
to Condensed Consolidated Financial Statements
1.
|
Business
Organization and Nature of Operations
|
Intellinetics,
Inc., formerly known as GlobalWise Investments, Inc., (“Intellinetics”), is a Nevada corporation incorporated in 1997,
with a single operating subsidiary, Intellinetics, Inc., an Ohio corporation (“Intellinetics Ohio”), together with
Intellinetics, the (“Company,” “we,” “us,” and “our”). Intellinetics Ohio was
incorporated in 1996, and on February 10, 2012, Intellinetics Ohio became the sole operating subsidiary of Intellinetics as a
result of a reverse merger and recapitalization.
The
Company is a document solutions software development, sales and marketing company serving both the public and private sectors.
The Company’ s software platform allows customers to capture and manage all documents across operations such as scanned
hard-copy documents and all digital documents including those from Microsoft Office 365, digital images, audio, video and emails.
The Company’s solutions create value for customers by making it easy to connect business-critical documents to the processes
they drive by making them easy to find, secure and compliant.
The
accompanying audited consolidated financial statements have been prepared in accordance with United States generally accepted
accounting principles (“U.S. GAAP”) for interim financial information and the instructions to Form 10-Q and Article
8.03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP. In the opinion
of management, all adjustments (consisting of normal accruals) considered for a fair presentation of the consolidated financial
position of the Company as of March 31, 2017 and the consolidated results of its operations and cash flows for the three months
ended March 31, 2017 and 2016, have been included. The Company has evaluated subsequent events through the issuance of this Form
10-Q. Operating results for the three months ended March 31, 2017 are not necessarily indicative of the results that may be expected
for the year ending December 31, 2017 or any other interim or future period. For further information, refer to the consolidated
financial statements and footnotes thereto for the year ended December 31, 2016 included in the Company’s Form 10-K
filed with the Securities and Exchange Commission on March 30, 2017.
3.
|
Liquidity
and Management’s Plans
|
Through
March 31, 2017, the Company had incurred an accumulated deficit since its inception of $15,403,459. At March 31, 2017, the Company
had a cash balance of $494,935.
From
the Company’s inception, it has generated revenues from the sales and implementation of its internally generated software
applications.
The
Company’s business plan is to increase its sales and market share by developing an expanded network of resellers through
which the Company will sell its expanded software product portfolio. The Company expects that this marketing initiative will require
that it continue its efforts towards reseller training and on-boarding, and develop additional software integration and customization
capabilities, all of which will require additional capital.
The
Company expects that through the next 12 months, the capital requirements to fund the Company’s growth, service existing
debt obligations, and to cover the operating costs as a public company will consume substantially all of the cash flows that it
intends to generate from its operations. The Company further believes that during this period, while the Company is focusing on
the growth and expansion of its business, the gross profit that it expects to generate from operations will not generate sufficient
funds to cover these anticipated operating costs. Our cash requirements are insufficient by approximately $91,000 per month. During
2016 and the three months ending March 31, 2017, the Company has used the proceeds from the convertible note issuances and the
sale of equity securities to sustain operations and to follow through on the execution of its business plan. There is no assurance
that the Company’s has or will be able to obtain sufficient funds to fund the Company’s operations. Given these conditions,
the Company’s ability to continue as a going concern is contingent upon increasing its revenues and successfully managing
its cash requirements. In addition, the Company’s ability to continue as a going concern must be considered in light of
the problems, expenses and complications frequently encountered by entrants into established markets, the competitive environment
in which the Company operates and its cash requirements. These factors, among others, raise substantial doubt about the Company’s
ability to continue as a going concern.
Since
inception, the Company’s operations have primarily been funded through a combination of gross margins, state business development
loans, bank loans, convertible loans and loans from friends and family, and the sale of securities. Although management believes
that the Company may have access to additional capital resources, there are currently no commitments or arrangements in effect
that would provide for new financing and there is no assurance that the Company will be able to obtain additional funds on commercially
acceptable terms, if at all.
During
the three months ended March 31, 2017, the Company raised a net $459,745 through the issuance of convertible notes. The proceeds
from the issuance were used to fund the Company’s working capital needs and debt repayment obligations.
The
current level of cash and operating margins may not be enough to cover the existing fixed and variable obligations of the Company,
so increased revenue performance and the addition of capital are critical to the Company’s success.
The
Company’s financial statements do not include any adjustments relating to the recoverability and classification of recorded
asset amounts or the amounts and classification of liabilities that might be necessary should it be unable to continue as a going
concern.
On
February 10, 2012, Intellinetics Ohio was acquired by Intellinetics, when it was known as GlobalWise Investments, Inc., pursuant
to a reverse merger, with Intellinetics Ohio surviving as a wholly-owned subsidiary of Intellinetics.
On
September 1, 2014, the Company changed its name from GlobalWise Investments, Inc., to Intellinetics, Inc. and effected a one-for-seven
(1-for-7) reverse stock split of the Company’s common stock. All share and per share amounts herein have been adjusted to
reflect the reverse stock split.
5.
|
Summary
of Significant Accounting Policies
|
Use
of Estimates
The
preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions. Such estimates
and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and expenses. Actual results could differ from estimated
amounts.
Significant
estimates and assumptions include valuation allowances related to receivables, the recoverability of long-term assets, depreciable
lives of property and equipment, deferred taxes and related valuation allowances. The Company’s management monitors these
risks and assesses its business and financial risks on a quarterly basis.
Concentrations
of Credit Risk
The
Company maintains its cash with high credit quality financial institutions. At times, the Company’s cash and cash equivalents
may be uninsured or in deposit accounts that exceed the Federal Deposit Insurance Corporation insurance limit.
The
number of customers that comprise the Company’s customer base, along with the different industries, governmental entities
and geographic regions, in which the Company’s customers operate, limits concentrations of credit risk with respect to accounts
receivable. The Company does not generally require collateral or other security to support customer receivables; however, the
Company may require its customers to provide retainers, up-front deposits or irrevocable letters-of-credit when considered necessary
to mitigate credit risks. The Company has established an allowance for doubtful accounts based upon facts surrounding the credit
risk of specific customers and past collections history. Credit losses have been within management’s expectations. At March
31, 2017 and December 31, 2016, the Company’s allowance for doubtful accounts was $20,732 and $19,034, respectively.
Property
and Equipment
Property,
equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization. Depreciation and amortization
is computed over the estimated useful lives of the related assets on a straight-line basis. Furniture and fixtures, computer hardware
and purchased software are depreciated over three to seven years. Leasehold improvements are amortized over the life of the lease
or the asset, whichever is shorter, generally seven to ten years. Upon retirement or other disposition of these assets, the cost
and related accumulated depreciation and amortization of these assets are removed from the accounts and the resulting gains and
losses are reflected in the results of operations.
Impairment
of Long-Lived Assets
The
Company accounts for the impairment and disposition of long-lived assets in accordance with Accounting Standards Codification
(“ASC”) Topic 360, “Property, Plant, and Equipment.” The Company tests long-lived assets or asset groups,
such as property and equipment, for recoverability when events or changes in circumstances indicate that their carrying amount
may not be recoverable.
Circumstances
which could trigger a review include, but are not limited to: significant adverse changes in the business climate or legal factors;
current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with
the use of the asset; and a current expectation that the asset will more likely than not be sold or disposed of before the end
of its estimated useful life.
Recoverability
is assessed based on comparing the carrying amount of the asset to the aggregate pre-tax undiscounted cash flows expected to result
from the use and eventual disposal of the asset or asset group. Impairment is recognized when the carrying amount is not recoverable
and exceeds the fair value of the asset or asset group. The impairment loss, if any, is measured as the amount by which the carrying
amount exceeds fair value, which for this purpose is based upon the discounted projected future cash flows of the asset or asset
group.
Share-Based
Compensation
The
Company accounts for stock-based payments to employees in accordance with ASC 718, “Stock Compensation.” Stock-based
payments to employees include grants of stock that are recognized in the consolidated statement of operations based on their fair
values at the date of grant.
The
Company accounts for stock-based payments to non-employees in accordance with ASC 718 and ASC 505-50, “Equity-Based Payments
to Non-Employees,” which requires that such equity instruments are recorded at their fair value on the measurement date,
with the measurement of such compensation being subject to periodic adjustment as the underlying equity instruments vest.
The
grant date fair value of stock option awards is recognized in earnings as share-based compensation cost over the requisite service
period of the award using the straight-line attribution method. The Company estimates the fair value of the stock option awards
using the Black-Scholes-Merton option pricing model. The exercise price of options is specified in the stock option agreements.
The expected volatility is based on the historical volatility of the Company’s stock for the previous period equal to the
expected term of the options. The expected term of options granted is based on the midpoint between the vesting date and the end
of the contractual term. The risk-free interest rate is based upon a U.S. Treasury instrument with a life that is similar to the
expected term of the options. The expected dividend yield is based upon the yield expected on date of grant to occur over the
term of the option.
On
January 3 and March 17, 2017, the Company issued 61,110 and 2,941 new Shares, respectively, of restricted common stock to directors
of the Company in accordance with the 2015 Intellinetics Equity Incentive Plan (the “2015 Plan”). Stock
compensation of $57,500 was recorded on the issuance of the Shares.
On
March 15, 2017, the Company granted an employee stock options to purchase 100,000 Shares at an exercise price of $0.85 per Share,
in accordance with the 2015 Plan, with vesting continuing until 2020. The total fair value of $70,872 for these stock options
will be recognized by the Company over the applicable vesting period. The total stock option compensation for the three months
ended March 31, 2017 was $4,357.
For
the three months ended March 31, 2017, the Company recorded Share-based compensation to employees of $28,883 and to non-employees
of $57,500.
For the three
months ended March 31, 2016, the Company recorded Share-based compensation to employees of $74,693 and to non-employees of $55,000.
Software
Development Costs
Software
development costs for software to be sold or otherwise marketed incurred prior to the establishment of technological feasibility
are expensed as incurred. The Company defines establishment of technological feasibility as the completion of a working model.
Software development costs incurred subsequent to the establishment of technological feasibility through the period of general
market availability of the product are capitalized, if material. To date, all software development costs for software to be sold
or otherwise marketed have been expensed as incurred. In accordance with ASC 350-40, “Internal-Use Software,” the
Company capitalizes purchase and implementation costs of internal use software. No such costs were capitalized during the periods
presented.
Research
and Development
We
design, develop, test, market, license, and support new software products and enhancements of current products. We continuously
monitor our software products and enhancements to remain compatible with standard platforms and file formats. We expense our software
development costs as incurred. For the three months ending March 31, 2017 and 2016, our research and development costs were $50,957
and $89,889, respectively.
Recent
Accounting Pronouncements
Stock
Compensation
In
March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based
Payment Accounting (“ASU 2016-09”), which simplified certain aspects of the accounting for share-based payment transactions,
including income taxes, classification of awards and classification on the statement of cash flows. ASU 2016-09 will be effective
for the Company beginning in its first quarter of 2018. The Company is currently evaluating the impact of adopting ASU 2016-09
on its consolidated financial statements.
Leases
In
February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which modified lease accounting
for both lessees and lessors to increase transparency and comparability by recognizing lease assets and lease liabilities by lessees
for those leases classified as operating leases under previous accounting standards and disclosing key information about leasing
arrangements. ASU 2016-02 will be effective for the Company beginning in its first quarter of 2020, and early adoption is permitted.
The Company is currently evaluating the timing of its adoption and the impact of adopting ASU 2016-02 on its consolidated financial
statements.
Revenue
Recognition
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
No. 2014-09, Revenue from Contracts with Customers. The core principle of ASU 2014-09 is built on the contract between a vendor
and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the
parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective,
ASU 2014-09 requires five basic steps: (i) identify the contract with the customer, (ii) identify the performance obligations
in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in
the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. Entities will generally be
required to make more estimates and use more judgment than under current guidance, which will be highlighted for users through
increased disclosure requirements. Subsequently, the FASB has issued the following standards related to ASU 2014-09: ASU No. 2016-08,
Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (“ASU 2016-08”); ASU No.
2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing (“ASU 2016-10”);
and ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients (“ASU
2016-12”). The Company must adopt ASU 2016-08, ASU 2016-10 and ASU 2016-12 with ASU 2014-09 (collectively, the “new
revenue standards”). In July 2015, the FASB deferred the effective date of the new revenue standards for one year beyond
the originally specified effective date. The update is now effective for public entities for annual periods beginning after December
15, 2017, including interim periods therein. Earlier application is permitted only as of annual reporting periods beginning after
December 15, 2016, including interim reporting periods within that reporting period. Three basic transition methods are available
– full retrospective, retrospective with certain practical expedients, and a cumulative effect approach.
The
Company is currently in the process of assessing the adoption methodology, which allows the amendment to be applied retrospectively
to each prior period presented, or with the cumulative effect recognized as of the date of initial application. As required, the
Company will adopt the new standard on January 1, 2018. The Company believes that there will be no significant changes required
to our processes and systems to adopt the new standard. The Company anticipates this new standard will not have a material impact
on the way the Company recognizes revenues. The Company is also evaluating the impact of the guidance in Accounting Standards
Codification (ASC) 340-40, Other Assets and Deferred Costs; Contracts with Customers, under ASU 2014-09. Under ASC 340-40, the
Company would be required to capitalize and amortize incremental costs of obtaining a contract. Under our current accounting policy,
the Company does not capitalize incremental costs of obtaining a contract but rather recognize those costs when they are incurred.
Revenue
Recognition
a)
Sale of Software
The
Company recognizes revenues in accordance with ASC Topic 985-605, “Software Revenue Recognition.”
The
Company records revenues from the sale of software licenses when persuasive evidence of an arrangement exists, the software product
has been installed, there are no significant uncertainties surrounding product acceptance by the customer, the fees are fixed
and determinable, and collection is considered probable. Revenues included in this classification typically include sales of additional
software licenses to existing customers and sales of software to the Company’s Resellers (See section h) - Reseller Agreements,
below.
The
Company assesses whether payment terms are customary or extended in accordance with normal practice relative to the market in
which the sale is occurring. The Company’s sales arrangements generally include standard payment terms. These terms effectively
relate to all customers, products, and arrangements regardless of customer type, product mix or arrangement size.
If
an undelivered element for the arrangement exists under the license arrangement, revenues related to the undelivered element are
deferred based on Vendor Specific Objective Evidence (“VSOE”) of the fair value of the undelivered element. Often,
multiple-element sales arrangements include arrangements where software licenses and the associated post-contract customer support
(“PCS”) are sold together. The Company has established VSOE of the fair value of the undelivered PCS element based
on the contracted price for renewal PCS included in the original multiple element sales arrangement, as substantiated by contractual
terms and the Company’s significant PCS renewal experience, from the Company’s existing customer base.
The
Company records the revenues for the sales of software with professional services as prescribed by ASC 985-605, in accordance
with the contract accounting guidelines in ASC 605-35, “Revenue Recognition: Construction-Type and Production-Type Contracts”
(“ASC 605-35”), after evaluating for separation of any non-ASC 605-35 elements in accordance with the provisions of
ASC 605-25, “Revenue Recognition: Multiple-Element Arrangements,” as updated. The Company accounts for these contracts
on a percentage of completion basis, measured by the percentage of labor hours incurred to date to estimated total labor hours
for each contract, or on a completed contract basis when dependable estimates are not available.
The
fair value of any undelivered elements in multiple-element arrangements in connection with the sales of software licenses with
professional services are deferred based upon VSOE.
b)
Sale of Software as a Service
Sale
of software as a service (“SaaS”) consists of revenues from arrangements that provide customers the use of the Company’s
software applications, as a service, typically billed on a monthly or annual basis. Advance billings of these services are not
recorded to the extent that the term of the arrangement has not commenced and payment has not been received. Revenue on these
services is recognized ratably over the term of the underlying arrangement.
c)
Sale of Software Maintenance Services
Software
maintenance services revenues consist of revenues derived from arrangements that provide PCS to the Company’s software license
holders. These revenues are recognized ratably over the term of the contract. Advance billings of PCS are not recorded to the
extent that the term of the PCS has not commenced and payment has not been received.
d)
Sale of Professional Services
Professional
services consist principally of revenues from consulting, advisory services, training and customer assistance with management
and uploading of data into the Company’s applications. When these services are provided on a time and material basis, the
Company records the revenue as the services are rendered, since the revenues from services rendered through any point in time
during the performance period are not contingent upon the completion of any further services. Where the services are provided
under a fixed priced arrangement, the Company records the revenue on a proportional performance method, since the revenues from
services rendered through any point in time during the performance period are not contingent upon the completion of any further
services.
e)
Sale of Third Party Services
Sale
of third party services consist principally of third party software and/or equipment as a pass through of software and equipment
purchased from third parties at the request of customers.
f)
Deferred revenues
The
Company records deferred revenue primarily related to software maintenance support agreements, when the customer pays for the
contract prior to the time the services are performed. Substantially all maintenance agreements have a one-year term that commences
immediately following the delivery of the maintained products or on the date of the applicable renewal period.
g)
Rights of return and other incentives
The
Company does not generally offer rights of return or any other incentives such as concessions, product rotation, or price protection
and, therefore, does not provide for or make estimates of rights of return and similar incentives. The Company, from time to time,
may discount bundled software sales with PCS services. Such discounts are recorded as a component of the software sale and any
revenue related to PCS is deferred over the PCS period based upon appropriate VSOE of fair value.
h)
Reseller agreements
The
Company executes certain sales contracts through resellers and distributors (collectively, “Resellers”). The Company
recognizes revenues relating to sales through Resellers on the sell-through method (when reseller executes sale to end customer)
when all the recognition criteria have been met—in other words, persuasive evidence of an arrangement exists, delivery has
occurred, the fee is fixed and determinable, and collectability is probable. In addition, the Company assesses the credit-worthiness
of each Reseller, and if the Reseller is undercapitalized or in financial difficulty, any revenues expected to emanate from such
Resellers are deferred and recognized only when cash is received and all other revenue recognition criteria are met.
Advertising
The
Company expenses the cost of advertising as incurred. Advertising expense for the three months ended March 31, 2017 and 2016 amounted
to approximately $12,000 and $0, respectively.
Earnings
(Loss) Per Share
Basic
earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during
the period. The Company has outstanding stock options which have not been included in the calculation of diluted net loss per
share because to do so would be anti-dilutive. As such, the numerator and the denominator used in computing both basic and diluted
net loss per share for each period are the same.
Income
Taxes
The
Company and its subsidiary file a consolidated federal income tax return. The provision for income taxes is computed by applying
statutory rates to income before taxes.
Deferred
income taxes are recognized for the tax consequences in future years of temporary differences between the financial reporting
and tax bases of assets and liabilities as of each period-end based on enacted tax laws and statutory rates. Valuation allowances
are established when necessary to reduce deferred tax assets to the amount expected to be realized. A 100% valuation allowance
has been established on deferred tax assets at March 31, 2017 and 2016, due to the uncertainty of our ability to realize future
taxable income.
The
Company accounts for uncertainty in income taxes in its financial statements as required under ASC 740,
Accounting for Uncertainty
in Income Taxes.
The standard prescribes a recognition threshold and measurement attribute for the financial statement recognition
and measurement of a tax position taken or expected to be taken in a tax return. The standard also provides guidance on de-recognition,
classification, interest and penalties, accounting in interim periods, disclosure and transition accounting. Management determined
there were no material uncertain positions taken by the Company in its tax returns.
Statement
of Cash Flows
For
purposes of reporting cash flows, cash includes cash on hand and demand deposits held by banks.
Reclassifications
Certain
amounts in the 2016 consolidated financial statements have been reclassified to conform to current year presentation.
6.
|
Property
and Equipment
|
Property
and equipment are comprised of the following:
|
|
March
31, 2017
|
|
|
December
31, 2016
|
|
Computer hardware and purchased
software
|
|
$
|
316,095
|
|
|
$
|
309,667
|
|
Leasehold improvements
|
|
|
221,666
|
|
|
|
221,666
|
|
Furniture and
fixtures
|
|
|
88,322
|
|
|
|
88,322
|
|
|
|
|
619,655
|
|
|
|
619,655
|
|
Less: accumulated
depreciation and amortization
|
|
|
(603,877
|
)
|
|
|
(600,872
|
)
|
Property and
equipment, net
|
|
$
|
22,206
|
|
|
$
|
18,783
|
|
Total
depreciation expense on the Company’s property and equipment for the three months ended March 31, 2017 and 2016 amounted
to $3,006 and $2,956, respectively.
On
July 17, 2009, Intellinetics Ohio, now the sole operating subsidiary of the Company, issued a note payable to the Ohio State Development
Authority in the amount of $1,012,500, bearing interest at a rate of 6.00% per annum (“Authority Loan No. 1”). Pursuant
to the terms of the Authority Loan No. 1, Intellinetics Ohio was required to pay only interest through September 30, 2010 and
thereafter monthly principal and interest payments of $23,779 each through September 1, 2015. The Authority Loan No. 1 is secured
by a senior secured interest on all business assets financed with loan proceeds, as well as a second secured interest in all business
assets. Upon maturity, by acceleration or otherwise, Intellinetics Ohio is required to pay a loan participation fee of $101,250,
which is accounted for as a loan premium, accreted monthly, utilizing the interest method, over the term of the Authority Loan
No. 1. In June 2014, Intellinetics Ohio and the Ohio State Development Authority entered into a Notice and Acknowledgement of
Modification to Payment Schedule relating to Authority Loan No.1, deferring a portion of the principal and interest payment until
June 1, 2015. On September 25, 2015, Intellinetics Ohio and the Ohio State Development Authority entered into a Third Amendment
to the Loan Agreement related to Authority Loan No. 1, deferring a portion of the principal payment until October 1, 2016 and
extending the maturity date until August 1, 2018.
On
June 3, 2011, Intellinetics Ohio issued a note payable to the Ohio State Development Authority in the amount of $750,000, bearing
interest at a rate of 1% per annum for the first 12 months, then interest at a rate of 7% per annum for the second 12 months (“Authority
Loan No. 2,” and together with Authority Loan No. 1, the “Authority Loans”). Intellinetics Ohio was not obligated
to remit payments of principal until September 1, 2013. The monthly principal and interest payments, beginning on the third anniversary
of the loan origination, are $14,850 and are payable on a monthly basis through August 1, 2018. The Authority Loan No. 2 is secured
by a senior secured interest on all business assets financed with loan proceeds, as well as a second secured interest in all business
assets. Upon maturity, by acceleration or otherwise, Intellinetics Ohio is required to pay a loan participation fee of $75,000,
which is accounted for as a loan premium, accreted monthly utilizing the interest method, over the term of the Authority Loan
No. 2. The interest rate of 1% during the first 12 months of this loan was considered to be below market for that period. Intellinetics
Ohio further determined that over the life of the Authority Loan No. 2, the effective interest rate was 5.6% per annum. Accordingly,
during the first 12 months of the Authority Loan No. 2, Intellinetics Ohio recorded interest expense at the 5.6% rate per annum.
The difference between the interest expense accrual at 5.6% and the stated rate of 1% over the first 12 months is credited to
deferred interest. The deferred interest amount that is accumulated over the first 12 months of the loan term will be amortized
as a reduction to interest expense over the remaining term of the Authority Loan No. 2. On March 31, 2017 and December
31, 2016, deferred interest of $156,901 and $158,062, respectively, was reflected within long term liabilities on the accompanying
consolidated balance sheets. In June 2014, Intellinetics Ohio and the Ohio State Development Authority entered into a Notice and
Acknowledgement of Modification to Payment Schedule, deferring a portion of the principal and interest payment until June 1, 2015.
On September 25, 2015 Intellinetics Ohio and the Ohio State Development Authority entered into a Third Amendment to the Loan Agreement
related to Authority Loan No. 2, deferring a portion of the principal payment until October 1, 2016.
The
Authority Loans were granted to Intellinetics Ohio in connection with the State of Ohio’s economic development programs.
The proceeds from these loans were used by Intellinetics Ohio to support its efforts in developing software solutions for its
customers.
The
Authority Loans are subject to certain covenants and reporting requirements. Intellinetics Ohio is required to, within three years
of the respective loan origination dates of each of the Authority Loans, have created and/or retained an aggregate of 25 full
time jobs in the State of Ohio. If Intellinetics has not attained these employment levels by the respective dates, then the interest
rates on the Authority Loans shall increase to 10% per annum. In July 2014, Intellinetics Ohio informed the State of Ohio that
it would not meet the required employment level. As a result of this non-compliance with a covenant of Authority Loan No. 1, the
Ohio State Development Authority exercised its right to increase the interest rate from 6.0% to 7.0%, effective October 1, 2014.
The approximate impact of this increase is to raise Intellinetics Ohio’s balloon payment by $6,000 on Authority Loan No.
1, which is due, as amended on August 1, 2018. Intellinetics Ohio has had past instances of non-compliance with certain of the
loan covenants. Intellinetics Ohio is currently in compliance with all the other loan covenants. There can be no assurance that
Intellinetics Ohio will not become non-compliant with one or more of these covenants in the future.
The
Company evaluated the terms of its convertible notes payable in accordance with ASC 815 – 40, Derivatives and Hedging -
Contracts in Entity’s Own Stock and determined that the underlying common stock is indexed to the Company’s common
stock. The Company determined that the conversion feature did not meet the definition of a liability and therefore did not bifurcate
the conversion feature and account for it as a separate derivative liability. The Company evaluated the conversion feature for
a beneficial conversion feature. The effective conversion price was compared to the market price on the date of each note. If
the conversion price was deemed to be less than the market value of the underlying common stock at the inception of the note,
then the Company would recognize a beneficial conversion feature resulting in a discount on the note payable, upon satisfaction
of the contingency. The beneficial conversion features are amortized to interest expense over the life of the respective notes,
starting from the date of recognition.
Between
June 24, 2014 and July 7, 2014, the Company issued convertible promissory notes in an aggregate amount of $135,000 to two accredited
investors (“Unrelated Notes due December 31, 2015”). The notes matured on December 31, 2015 and bore interest at an
annual rate of interest of 10% until maturity, with interest payable quarterly. The note investors had a right, in their sole
discretion, to convert the notes into Shares under certain circumstances at a conversion rate of $0.56 per Share. Because the
notes had not been fully repaid by the Company or converted into Shares prior to maturity, the notes began accruing interest at
the annual rate of 12% commencing on the maturity date. The Company used the proceeds for working capital, general corporate purposes,
and debt repayment. On January 6, 2016, the note investors converted $135,000 of the notes and accrued interest thereon of $35,038
into 303,912 Shares and 141,698 warrants to purchase Shares, as part of a private placement and note exchange commenced in December
2015. The warrants have an exercise price equal to $0.65 per Share and contain a cashless exercise provision. All warrants are
immediately exercisable and are exercisable for five years from issuance. Interest expense of $113,762 was recorded on the issuance
of these warrants.
Between
December 30, 2016, and January 31, 2017, the Company issued convertible promissory notes in an aggregate amount of $875,000
(“Unrelated Notes due December 31, 2018”) to unrelated accredited investors. The notes mature on December 31,
2018, and bear interest at an annual rate of interest of 12% until maturity, with partial interest of 6% payable quarterly. The
note investors have a right, in their sole discretion, to convert the notes into Shares under certain circumstances at a conversion
rate of $0.65 per Share. If the notes have not been fully repaid by the Company by the maturity date or converted into Shares
at the election of the note investors prior to maturity, then such notes will accrue interest at the annual rate of 14% from the
maturity date until the date the notes are repaid in full. Any interest not paid quarterly will also accrue interest at the annual
rate of 8% instead of 6%. The Company used the proceeds of the notes for working capital, general corporate purposes, and debt
repayment. The Company recognized a beneficial conversion feature in the amount of $369,677. Interest expense recognized on the
amortization of the beneficial conversion feature was $41,880 for the three months ended March 31, 2017.
The
table below reflects all notes payable at March 31, 2017 and December 31, 2016, respectively, with the exception of related party
notes disclosed in Note 8 - Notes Payable - Related Parties.
|
|
March
31, 2017
|
|
|
December
31, 2016
|
|
Authority Loan No. 1, due August 1, 2018
|
|
$
|
302,565
|
|
|
$
|
353,346
|
|
Authority Loan No. 2, due August 1, 2018
|
|
|
395,925
|
|
|
|
433,115
|
|
Unrelated Notes due December 31, 2018
|
|
|
547,203
|
|
|
|
193,846
|
|
Total notes payable
|
|
$
|
1,245,693
|
|
|
$
|
980,307
|
|
Less unamortized debt issuance costs
|
|
|
(120,211
|
)
|
|
|
(34,029
|
)
|
Less current portion
|
|
|
(366,316
|
)
|
|
|
(360,496
|
)
|
Long-term portion of notes payable
|
|
$
|
759,166
|
|
|
$
|
585,782
|
|
Future
minimum principal payments of these notes payable with the exception of the related party notes in Note 8 - Notes Payable - Related
Parties, as described in this Note 7 are as follows:
For the Twelve Months
|
|
|
|
Ending
March 31,
|
|
Amount
|
|
2018
|
|
$
|
366,316
|
|
2019
|
|
|
879,377
|
|
Total
|
|
$
|
1,245,693
|
|
As
of March 31, 2017 and December 31, 2016, accrued interest for these notes payable with the exception of the related party notes
in Note 8 - Notes Payable - Related Parties, was $293,656 and $282,147, respectively, and was reflected within accounts payable
and accrued expenses on the consolidated balance sheets. As of March 31, 2017 and December 31, 2016, accrued loan participation
fees were $173,786 and $172,659, respectively, and reflected within accounts payable and accrued expenses on the consolidated
balance sheets. As of March 31, 2017 and December 31, 2016, deferred financing costs were $120,211 and $34,029, respectively,
and were reflected within long term liabilities on the consolidated balance sheets.
With
respect to all notes outstanding (other than the notes to related parties), for the three months ended March 31, 2017, and 2016,
interest expense, including the amortization of deferred financing costs, accrued loan participation fees, original issue discounts,
deferred interest and related fees, interest expense related to warrants issued for the conversion of convertible notes, and the
embedded conversion feature was $80,858 and $134,708, respectively.
8.
|
Notes
Payable - Related Parties
|
On
March 29, 2012, the Company issued an unsecured promissory note payable to Ramon Shealy, a then-director of the Company, who subsequently
resigned from the Company’s board of directors on December 17, 2012, for personal reasons, in the amount of $238,000, bearing
interest at a rate of 10% for the term of the note. All principal and interest was due and payable on September 27, 2012, but
was later extended to November 24, 2012. On April 16, 2012, the Company issued another promissory note payable to Mr. Shealy,
in the amount of $12,000, bearing interest at a rate of 10% per quarter. All principal and interest was due on July 15, 2012,
but was later extended to November 24, 2012. On November 24, 2012, the two notes were cancelled and replaced with a $250,000 promissory
note, under the same terms, with a maturity date of January 1, 2014. On December 24, 2013, the maturity date of the $250,000 promissory
note was extended to January 1, 2015. On March 13, 2013, the Company paid $100,000 of the principal amount of the $250,000 promissory
note to Mr. Shealy. On December 31, 2014, the Company and Ramon Shealy agreed to extended payment terms for the remaining total
principal and interest in the amount of $193,453, payable in sixty (60) monthly installments beginning January 31, 2015, with
a maturity date of January 1, 2020. As of March 31, 2017 and December 31, 2016, this Note had a principal balance of $118,186
and $127,408, respectively.
On
November 30, 2016, the Company issued convertible promissory notes in a maximum aggregate principal amount of $225,000 to Robert
and Michael Taglich (each holding more than 5% beneficial interest in the Company’s Shares) and Robert Schroeder (Director)
(“Bridge Notes”). The notes had a maturity date of December 1, 2017, bearing interest at an annual rate of interest
of 8% until maturity. Each note holder had a right, in their sole discretion, to convert the notes into securities to be issued
by the Company in a private placement of equity, equity equivalent, convertible debt or debt financing. Interest expense recognized
for the twelve months ended December 31, 2016 was $1,125. On December 30, 2016, the Bridge Notes were converted by the note holders
into the Related Notes due December 31, 2018, described below.
On
December 30, 2016, the Company issued convertible promissory notes in an aggregate amount of $375,000 (the “Related Notes
due December 31, 2018”) to accredited investors, including Robert and Michael Taglich (each holding more than 5% beneficial
interest in the Company’s Shares) and Robert Schroeder (Director), in exchange for the conversion of $225,000 principal
from the Bridge Notes and $150,000 cash. The notes bear interest at an annual rate of interest of 12 percent until maturity, with
partial interest of 6% payable quarterly, and mature on December 31, 2018. The note investors have a right, in their sole discretion,
to convert the notes into Shares at a conversion rate of $0.65 per Share. If the notes have not been fully repaid by the Company
by the maturity date or converted into Shares at the election of the note investors prior to the maturity date, then such notes
will accrue interest at the annual rate of 14% from the maturity date until the date the notes are repaid in full. Any interest
not paid quarterly will also accrue interest at the annual rate of 8% instead of 6%. The Company used the proceeds of the notes
for working capital, general corporate purposes, and debt repayment. The Company recognized a beneficial conversion feature in
the amount of $144,231. Interest expense recognized on the amortization of the beneficial conversion feature was $18,029 for the
three months ended March 31, 2017.
The
table below reflects Notes payable due to related parties at March 31, 2017 and December 31, 2016, respectively:
|
|
March
31, 2017
|
|
|
December
31, 2016
|
|
The $250,000 Shealy Note
|
|
|
118,185
|
|
|
|
127,408
|
|
Related Notes due December 31,
2018
|
|
|
248,799
|
|
|
|
230,769
|
|
Total notes payable - related party
|
|
$
|
366,984
|
|
|
$
|
358,177
|
|
Unamortized debt issuance costs
|
|
|
(17,870
|
)
|
|
|
(20,423
|
)
|
Less current
portion
|
|
|
(39,273
|
)
|
|
|
(38,307
|
)
|
Long-term portion
of notes payable-related party
|
|
$
|
309,841
|
|
|
$
|
299,447
|
|
Future
minimum principal payments of these notes payable as described in this Note 8 are as follows:
For the Twelve
Months Ending
|
|
|
|
March
31,
|
|
Amount
|
|
2018
|
|
$
|
39,273
|
|
2019
|
|
|
292,183
|
|
2020
|
|
|
35,528
|
|
TOTAL
|
|
$
|
366,984
|
|
As
of March 31, 2017 and December 31, 2016, accrued interest for these notes payable – related parties amounted to $6,609 and
$1,125, respectively.
For
the three months ended March 31, 2017, and 2016, interest expense in connection with notes payable – related parties was
$32,246 and $3,960, respectively.
Pursuant
to the Company’s employment agreements with the founders, the founders have earned incentive compensation totaling $215,012
in cash, which payment obligation has been deferred by the Company until it reasonably believes it has sufficient cash to make
the payment.
10.
|
Commitments
and Contingencies
|
Employment
Agreements
The
Company has entered into employment agreements with three of its key executives. Under their respective agreements, the executives
serve at will and are bound by typical confidentiality, non-solicitation and non-competition provisions. Deferred compensation
for the founders of the Company, as disclosed in Note 9 above, is still outstanding as of March 31, 2017.
Operating
Leases
On
January 1, 2010, the Company entered into an agreement to lease 6,000 rentable square feet of office space in Columbus, Ohio.
The lease commenced on January 1, 2010 and, pursuant to a lease extension dated August 9, 2016, the lease expires on December
31, 2021.
Future
minimum lease payments under this operating lease are as follows:
For
the Twelve Months Ending March 31,
|
|
Amount
|
|
2018
|
|
$
|
50,724
|
|
2019
|
|
|
52,020
|
|
2020
|
|
|
53,316
|
|
2021
|
|
|
54,630
|
|
2022
|
|
|
41,742
|
|
|
|
$
|
252,432
|
|
Rent
expense, recorded on a straight-line basis, charged to operations for the three months ended March 31, 2017 and 2016 amounted
to $13,252, and $10,125, respectively.