WAVEDANCER, INC. - Quarter Report: 2020 June (Form 10-Q)

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

INFORMATION ANALYSIS INCORPORATED

BALANCE SHEETS

The accompanying notes are an integral part of the financial statements

INFORMATION ANALYSIS INCORPORATED

STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited)

The accompanying notes are an integral part of the financial statements

INFORMATION ANALYSIS INCORPORATED

STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited)

The accompanying notes are an integral part of the financial statements

 INFORMATION ANALYSIS INCORPORATED

STATEMENTS OF CASH FLOWS

(Unaudited)

The accompanying notes are an integral part of the financial statements

INFORMATION ANALYSIS INCORPORATED

STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

The accompanying notes are an integral part of the financial statements

INFORMATION ANALYSIS INCORPORATED

NOTES TO FINANCIAL STATEMENTS

Item 2.      Management's Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Statement Regarding Forward-Looking Statements

This Form 10-Q contains forward-looking statements regarding our business, customer prospects, or other factors that may affect future earnings or financial results that are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. Such statements involve risks and uncertainties which could cause actual results to vary materially from those expressed in the forward-looking statements. Investors should read and understand the risk factors detailed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 (“2019 10-K”) and in other filings with the Securities and Exchange Commission.

We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control. This list highlights some of the risks which may affect future operating results. These are the risks and uncertainties we believe are most important for you to consider. Additional risks and uncertainties, not presently known to us, which we currently deem immaterial or which are similar to those faced by other companies in our industry or business in general, may also impair our business operations. If any of the following risks or uncertainties actually occurs, our business, financial condition and operating results would likely suffer. These risks include, among others, the following:

In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “intends,” “potential” and similar expressions intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We discuss many of these risks in greater detail under the heading “Risk Factors” in Item 1A of our 2019 10-K. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this report. Except as required by law, we assume no obligation to update any forward-looking statements after the date of this report.

Our Business

Founded in 1979, Information Analysis Incorporated is in the business of modernizing client information systems, performing professional information technology (IT) services, and developing and maintaining IT systems for government and commercial organizations. IAI’s core competencies lie in legacy system (COBOL) migration and modernization, including developing user-friendly interfaces for complex legacy environments, database conversion and migration, development of electronic fillable forms (e-Forms), including smart forms, Section 508 compliant forms, and web-based and mobile device forms solutions, full life cycle Oracle development, and custom software development. We also engage in sales of third-party software for electronic forms development and management, legacy systems modernization, and robotics process automation. IAI’s customers include federal and state government agencies as well as private sector organizations throughout the United States, with a concentration in the Washington, D.C. metropolitan area.

We have performed software modernization and electronic forms conversion projects for over 100 commercial and government customers, including, but not limited to, Department of Agriculture, Department of Defense, Department of Education, Department of Energy, Department of Homeland Security, Department of the Treasury, U.S. Small Business Administration, U.S. Army, U.S. Air Force, Department of Veterans Affairs, and several private sector companies. We have recently worked as a subcontractor in partnership with General Dynamics Information Technology (formerly Computer Sciences Corporation, CSRA, and Anteon), Guidehouse (formerly PriceWaterhouse Coopers), Lockheed Martin, and several other large and small prime contractors. IAI also provides services through its GSA MAS Schedule contract (47QTCA18D0080) and maintains reseller and solution partner relationships with firms such as Adobe Systems, Carahsoft, Heirloom Computing, immixTechnology, Micro Focus, Microsoft, Oracle and UiPath. Additional information on IAI may be viewed at its website located at www.infoa.com.

Business Strategy and Trends

IAI has been experiencing prolonged delays in the commencement of new professional fees contracts and subcontracts due to protests and now coronavirus. The largest of these contracts, originally delayed due to protest and subsequently delayed due to indirect effects related to coronavirus, commenced on June 1, 2020.

The effects of the coronavirus pandemic, including changes to qualifications and regulations involving lending and unemployment, as well as large scale insurance claims, health care bottlenecks, and procurement and distribution issues for personal protective equipment, have highlighted the areas where modernization of large legacy systems is essential. Federal government agencies, state agencies, and the banking, insurance, and health care industries are recognizing the need to modernize and migrate from their legacy systems quickly, rather than waiting until the next large stressor to their systems materializes.

IAI is refocusing its strategy to grow its business by aggressively pursuing these targeted markets directly and through key teaming arrangements, while controlling its administrative and overhead expenses. As our liquidity improves now that some of our delayed contracts have commenced, we will also explore growth through strategic acquisition or merger.

In direct response to the coronavirus pandemic, IAI has taken specific actions to ensure the safety of its employees. We have taken all necessary measures, most of which were already in place, to ensure that our employees can safely work from their homes. Employees and management that must access our corporate offices do so briefly, and only after coordinating with others to avoid overlap. IAI maintains continuous contact with its suppliers and its customers to stay cognizant of how any issues they are experiencing may affect our own business. As we near the time that we welcome certain employees back to working in community with others at our offices, we are carefully instituting “return-to-work” safety guidelines that are easily adaptable to changes in local, state, and federal recommendations and regulations.

Concentration of Risk

In the three months ended June 30, 2020, our prime contracts with U.S. government agencies generated 79.3% of our revenue, subcontracts under federal procurements generated 19.9% of our revenue, and commercial contracts generated 0.8% of our revenue. The terms of these contracts and subcontracts vary from single transactions to seven years. Among prime contracts with U.S. government agencies, two software sales contracts generated 40.1% and 18.4% of our revenue, respectively. Three professional services subcontracts under one prime contractor for projects at one federal agency collectively generated 12.1% of our revenue.

In the three months ended June 30, 2019, our prime contracts with U.S. government agencies generated 85.2% of our revenue, subcontracts under federal procurements generated 14.7% of our revenue, and commercial contracts generated 0.1% of our revenue. The terms of these contracts and subcontracts vary from single transactions to five years. Among prime contracts with U.S. government agencies, two software sales contracts generated 52.1% and 18.4% of our revenue, respectively. One professional services subcontract under a federal procurement generated 11.7% of our revenue.

In the six months ended June 30, 2020, our prime contracts with U.S. government agencies generated 77.5% of our revenue, subcontracts under federal procurements generated 22.0% of our revenue, and commercial and local government contracts combined generated 0.5% of revenue. The terms of these contracts and subcontracts vary from single transactions to seven years. Among prime contracts with U.S. government agencies, three software sales contracts generated 28.1%, 12.9%, 10.7% of our revenue, respectively. One subcontract under a federal procurement generated 11.8% of our revenue, and three professional services subcontracts under one prime contractor (including the one that generated 11.8% above) for projects at one federal agency collectively generated 15.1% of our revenue.

In the six months ended June 30, 2019, our prime contracts with U.S. government agencies generated 77.8% of our revenue, subcontracts under federal procurements generated 22.1% of our revenue, and commercial contracts generated 0.1% of our revenue. The terms of these contracts and subcontracts vary from single transactions to five years. Among prime contracts with U.S. government agencies, two software sales contracts generated 39.6% and 14.0% of our revenue, respectively. One professional services subcontract under a federal procurement generated 17.3% of our revenue.

At June 30, 2020, accounts receivable balances related to one prime contract with a U.S. government agency represented 10.1% of our outstanding accounts receivable, balances related to one subcontract under a federal procurement represented 19.1% of our outstanding accounts receivable, and balances related to three professional services subcontracts under one prime contractor for projects at one federal agency collectively represented 41.3% of our outstanding accounts receivable, two of which individually represented 21.5% and 14.2%, respectively.

We sold third-party software and maintenance contracts under agreements with one major supplier. These sales accounted for 79.9% of total revenue in the second quarter of 2020, and 79.3% of revenue in the second quarter of 2019, and accounted for 72.5% of total revenue in the six months ended June 30, 2020, and 68.6% of revenue in the six months ended June 30, 2019.

Three Months Ended June 30, 2020 versus Three Months Ended June 30, 2019

Revenue

Our revenues in the second quarter of 2020 were $4,819,395 compared to $3,704,417 in the second quarter of 2019, an increase of $1,114,978, or 30.1%. Professional fee revenue was $928,421 in the second quarter of 2020 versus $761,629 in the corresponding quarter in 2019, an increase of $166,792, or 21.9%, and software revenue was $3,890,974 in the second quarter of 2020 versus $2,942,788 in the second quarter of 2019, an increase of $948,186, or 32.2%. Revenue from professional fees increased due primarily to contracts that were added since the second quarter of 2019, as well as variations in the levels of activity on several other continuing contracts. The increase in our software revenue in 2020 versus the same period in 2019 is due to the non-recurring nature of many of our software sales transactions, as well as the timing of recurring orders. Software sales are subject to considerable fluctuation from period to period, based on the product mix sold and referral fees earned.

Gross Profit

Gross profit was $389,016, or 8.1% of revenue in the second quarter of 2020 versus $356,761, or 9.6% of revenue in the second quarter of 2019. For the quarter ended June 30, 2020, $326,749 of the gross profit was attributable to professional fees at a gross profit percentage of 35.2%, and $62,267 of the gross profit was attributable to software sales at a gross profit percentage of 1.6%. In the same quarter in 2019, we reported gross profit for professional fees of $326,771, or 42.9%, of professional fee revenue, and gross profit of $29,990, or 1.0% of software sales. Gross profit from professional fees remained constant, while it decreased as a percentage of sales. The percentage decrease is due to two contracts in the second quarter of 2019 for which the timing of revenue recognized was not tied to the timing of the costs incurred based on customer acceptance of units of services provided for one and a fixed-fee services arrangement for the other. Gross profit on software sales increased due to an increase in referral fees earned, for which there are few to no costs charged against them, and due to an increase in overall revenue, partially based on sales of one of our newer software offerings, for which we have found better margins. Software product sales and associated margins are subject to considerable fluctuation from period to period, based on the product mix sold and incentive payments earned, although the fluctuation does not have a material effect on our gross profit, as the gross profit percentage on software sales averages less than 2.0%.

Selling, General and Administrative Expenses

Selling, general and administrative expenses, exclusive of sales commissions, were $366,170, or 7.6% of revenues, in the second quarter of 2020 versus $528,575, or 14.3% of revenues, in the second quarter of 2019. These expenses decreased $162,405, or 30.7%, from the second quarter of 2019. These decreases are primarily related to decreases in the costs of overhead and administrative labor, and the fringe benefits associated with that labor, as well as decreases in legal and accounting expenses.

Commissions expense was $57,296, or 1.2% of revenues, in the second quarter of 2020 versus $39,815, or 1.1% of revenues, in the second quarter of 2019. Commissions are driven by varying factors and are earned at varying rates for each salesperson. Decreases in overhead labor and increases in referral fees earned led to a higher commission base for one of our commissioned business development representatives.

Net loss

Net loss for the three months ended June 30, 2020, was ($34,620), or (0.7%) of revenue, versus ($208,602), or (5.6%) of revenue, for the same period in 2019. The reduction in net loss is due to the June 1, 2020, commencement of a contract that had been delayed in protest since second quarter 2019, and winning additional contracts, including one related to the effect of coronavirus on the operations of a U.S. federal agency. We continue to incur the costs necessary to gain additional business.

We reported at December 31, 2019, that there was a delay in our ability to commence services on a material subcontract. The delay was due to the incumbent prime contractor filing an additional protest with the Government Accountability Office after losing its initial protest to the contracting officer. In April 2020, we were made aware that the incumbent withdrew its subsequent protest, thereby confirming the initial contract award to our prime contractor. The coronavirus pandemic indirectly impacted the commencement of services under this contract for a few months, but we finally commenced providing services under this seven-year subcontract award on June 1, 2020.  We anticipate net income in the third quarter due to the increase of our professional fee revenuewe are experiencing under the commencement of new contracts.

Six months Ended June 30, 2020 versus Six months Ended June 30, 2019

Revenue

Our revenues in the first six months of 2020 were $6,881,151 compared to $4,883,240 in the first six months of 2019, an increase of $1,997,911, or 40.9%. Professional fee revenue was $1,772,824 in the first six months of 2020 versus $1,523,747 in the corresponding quarter in 2019, an increase of $249,077, or 16.3%, and software revenue was $5,108,327 in the first six months of 2020 versus $3,359,493 in the first six months of 2019, an increase of $1,748,834, or 52.1%. Revenue from professional fees increased due primarily to contracts that were added since the first six months of 2019, as well as variations in the levels of activity on several other continuing contracts. The increase in our software revenue in 2020 versus the same period in 2019 is due to the non-recurring nature of many of our software sales transactions, as well as the timing of recurring orders. Software sales are subject to considerable fluctuation from period to period, based on the product mix sold and referral fees earned.

Gross Profit

Gross profit was $667,843, or 9.7% of revenue in the first six months of 2020 versus $679,600, or 13.9% of revenue in the first six months of 2019. For the quarter ended June 30, 2020, $591,521 of the gross profit was attributable to professional fees at a gross profit percentage of 33.4%, and $76,322 of the gross profit was attributable to software sales at a gross profit percentage of 1.5%. In the same quarter in 2019, we reported gross profit for professional fees of $642,021, or 42.1%, of professional fee revenue, and gross profit of $37,579, or 1.1% of software sales. Gross profit from professional fees decreased primarily due to personnel that were working full time in 2020, but for the first five months of 2020 were not fully billable (by agreement) on a contract where working together with the prime contractor, we needed to keep the team together and ready to begin another contract that had been delayed due to protest, and which finally commenced June 1, 2020. Gross profit on software sales increased due to an increase in referral fees earned, for which there are few to no costs charged against them, and due to an increase in overall revenue, partially based on sales of one of our newer software offerings, for which we have found better margins. Software product sales and associated margins are subject to considerable fluctuation from period to period, based on the product mix sold and incentive payments earned, although the fluctuation does not have a material effect on our gross profit, as the gross profit percentage on software sales averages less than 2.0%.

Selling, General and Administrative Expenses

Selling, general and administrative expenses, exclusive of sales commissions, were $706,983, or 10.3% of revenues, in the first six months of 2020 versus $1,014,027, or 20.8% of revenues, in the first six months of 2019. These expenses decreased $307,044, or 30.3%, from the first six months of 2019. These decreases are primarily related to decreases in the costs of overhead and administrative labor, and the fringe benefits associated with that labor, as well as decreases in legal and accounting expenses.

Commissions expense was $122,917, or 1.8% of revenues, in the first six months of 2020 versus $70,761, or 1.4% of revenues, in the first six months of 2019. Commissions are driven by varying factors and are earned at varying rates for each salesperson. Decreases in overhead labor and increases in referral fees led to a higher commission base for one of our commissioned business development representatives.

Net loss

Net loss for the six months ended June 30, 2020, was ($160,959), or (2.3%) of revenue, versus ($399,455), or (8.2%) of revenue, for the same period in 2019. The reduction in net loss is due to reductions in overhead and administrative labor and other administrative expenses, the June 1, 2020, commencement of a contract that had been delayed in protest since second quarter 2019, and winning additional contracts, including one related to the effect of coronavirus on the operations of a U.S. federal agency.

Liquidity and Capital Resources

Our beginning cash and cash equivalents balance, when combined with our cash flow from operations and the proceeds received from our Paycheck Protection Program loan, were sufficient to provide financing for our operations. For the first six months of 2020, net cash used in operating activities was $519,000 primarily due to our net loss of $161,000, our reduction of contract liabilities by $400,000, and our increase in accounts receivable of $299,000. Our cash flows from financing activities provided $450,000 as proceeds of our PPP loan guaranteed by the SBA. Our overall decrease in cash and cash equivalents of $78,000, when subtracted from a beginning balance of $1.04 million, yielded cash and cash equivalents of $961,000 at June 30, 2020.

We have a revolving line of credit with a bank providing for demand or short-term borrowings of up to $1,000,000. The line became effective December 20, 2005, and at June 30,2020, was due to expire on July 31, 2020. We agreed to terms with the lender to renew the line of credit until July 31, 2021. The material terms of the line of credit were modified such that the interest rate is now ICE LIBOR + 3.5%, with a floor of 4.0%, which is the current rate, we are subject to a commitment fee for amounts not borrowed, there is more frequent reporting required, a covenant has been added to have no more than two quarters per year with a loss and net income overall each year, we must maintain minimum cash and cash equivalents of $500,000, and we must report and maintain quarterly a minimum tangible net worth that is adjustable upward as a percentage of net income. As of June 30, 2020, no amounts were outstanding under this line of credit. We did not borrow against this line of credit during the first six months of 2020.

Due to the coronavirus uncertainty, and pending staffing and payroll cuts due to liquidity constraints, we applied for a Paycheck Protection Program loan (“PPP”), guaranteed by the U.S. Small Business Administration (“SBA”). We were funded by our lender on April 20, 2020, in the amount of $450,000. The loan accrues interest at a fixed rate of 1% and has a term of two years. The first payment is deferred for six months, though interest accrues during the deferral period. The loan has been used exclusively to support maintaining employee payroll and benefits. Though the PPP program was amended by the U.S. Congress to allow the proceeds of the loan that qualify for forgiveness to be extended to twenty-four weeks, we have opted to apply for forgiveness under the original PPP based on the use of proceeds over the original eight weeks. We will apply to the SBA through our lender for forgiveness for an amount of $395,000 as soon as our lender’s PPP forgiveness portal is available, which is currently expected to be in late August 2020. The amount of forgiveness for which we may be approved is uncertain.

Based on our current cash position and operating plan, including the measures we have taken and will take with regard to reducing cash outflows, and the commencement of services under a seven-year subcontract under a federal procurement, we anticipate that we will be able to meet our cash requirements for at least one year from the filing date of this Quarterly Report on Form 10-Q.

We presently lease our corporate offices on a contractual basis with certain timeframe commitments and obligations. We believe that our existing offices will be sufficient to meet our foreseeable facility requirement. With the infrastructure now in place such that our employees can work almost entirely from their own homes, we believe we have more than adequate space to operate for the foreseeable future. Should we need additional space to accommodate increased activities, management believes we can secure such additional space on reasonable terms.

We have no material commitments for capital expenditures.

Item 4.     Controls and Procedures

Disclosure Controls and Procedures

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, and people performing similar functions, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of June 30, 2020 (the “Evaluation Date”). Based upon this evaluation, our Chief Executive Officer and Acting Principal Financial Officer have concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (ii) is accumulated and communicated to management, including our Chief Executive Officer and Acting Principal Financial Officer, to allow timely decisions regarding required disclosure.

Changes in Internal Controls over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the quarter ended June 30, 2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

Because of the inherent limitations in all control systems, no control system can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of a person, by collusion of two or more people or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected. Notwithstanding these limitations, we believe that our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives.

PART II - OTHER INFORMATION

Item 1.     Legal Proceedings

None.

Item 1A.     Risk Factors

“Item 1A. Risk Factors” of our annual report on Form 10-K for the year ended December 31, 2019, as amended, includes a discussion of our risk factors. There have been no material changes from the risk factors described in our annual report on Form 10-K for the year ended December 31, 2019.

Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.     Defaults Upon Senior Securities

None.

Item 4.     Mine Safety Disclosures

Not applicable.

Item 5.     Other Information

None.

Item 6.     Exhibits

SIGNATURES

In accordance with the requirements of the Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.