WaveDancer, Inc. (“WaveDancer”), formerly known as Information Analysis Incorporated (the “Company”(“IAI”), to which we sometimes refer as IAI, is engaged in the business of developing and maintaining information technology (IT) systems, modernizing client information systems, and performingproviding professional services to U.S. government and commercial organizations. We presently concentrate ouragencies to modernize information technology services, in selling and experiencesupporting third-party software, primarily Adobe products, to developing web-basedU.S. government agencies, and, mobile device solutions (including electronic forms conversions)with our December, 2021 acquisition of Gray Matters, Inc. (“GMI” or “Gray Matters”), data analytics, cyber security applications,in providing a blockchain enabled supply chain management software solution. With the acquisition of GMI, we began implementing a strategy to expand our offerings well beyond systems modernization services and legacy software migrationsales of third-party software. We manage our business as a single operating unit and modernization for various agencies of the federal government. We provide software and services to government and commercial customers throughout the United States, with a concentration in the Washington, D.C. metropolitan area.

The accompanying unaudited condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates continuity of operations, realization of assets, and satisfaction of liabilities in the ordinary course of business. The propriety of using the going-concern basis is dependent upon, among other things, the achievement of future profitable operations, the ability to generate sufficient cash from operations and potential other funding sources, in addition to cash on-hand, to meet its obligations as they become due. On June 30, 2022, the Company had working capital of approximately $1.0 million, including cash and cash equivalents of $0.6 million, generated operating losses in 2022 and at June 30, 2022 had an accumulated deficit of $17.0 million. The Company intends to continue to pursue organic growth in revenue and profitability, and, at least in the near term, growth via acquisition. To implement this strategy, we have hired staff and implemented processes that are needed to identify, execute, and integrate acquisitions, and manage the Company post-acquisition. In addition, Gray Matters is an early-stage company that has required investments in sales, marketing, and engineering. While we intend to prioritize acquisition targets that are immediately accretive to operating cash flow, the Company will require additional capital to support its strategy. As discussed in Note 12 below, in August, 2022 the Company sold 1,562,506 unregistered shares of its common stock in a private offering at a price of $1.20 per share from which it raised aggregate gross proceeds of $1,875,000 and on July 8, 2022, the Company entered into a Common Stock Purchase Agreement with B. Riley Principal Capital II, LLC, by which it intends to raise additional capital thhrough an equity line of credit. Management believes that these actions will enable the Company to continue as a going concern through at least 12 months from the date these unaudited condensed consolidated financial statements are available to be issued.

Unaudited Interim Condensed Consolidated Financial Statements

The accompanying unaudited condensed consolidated financial statements (“financial statements”) have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions for Form 10-Q10-Q and Article 8-038-03 of Regulation S-X.S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, the unaudited financial statements include all adjustments necessary (which are of a normal and recurring nature) for the fair and not misleading presentation of the results of the interim periods presented. These unaudited interim condensed consolidated financial statements should be read in conjunction with ourthe Company’s audited financial statements for the year ended December 31, 2016 2021 included in the Annual Report on Form 10-K10-K filed by the Company with the SEC on March 31, 2017 (theApril 12, 2022 (the “Annual Report”)., as amended. The accompanying December 31, 2016 2021, balance sheet and financial information was derived from ourthe audited financial statements included in the Annual Report. The results of operations for any interim periods are not necessarily indicative of the results of operations for any other interim period or for a full fiscal year.

The condensed consolidated financial statements as of June 30, 2022, and for the six-month period ended June 30, 2022 include the accounts of WaveDancer and its consolidated subsidiaries (collectively, the “Company”, “we” or “our”). All significant intercompany transactions and balances have been eliminated in consolidation.

There have been no changes in the Company’s significant accounting policies as of SeptemberJune 30, 2017 2022, as compared to the significant accounting policies disclosed in Note 1, "Summary of Significant Accounting Policies" in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2016 that was filed with the SEC on March 31, 2017.

Preparation of condensed consolidated financial statements in accordanceconformity with GAAP requires managementus to make estimates and assumptions that affect certainthe amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates due to uncertainties, including the effects of COVID-19. On an ongoing basis, we evaluate our estimates, including those related to the allowance for credit losses; fair values of financial instruments, intangible assets, and goodwill; useful lives of intangible assets and property and equipment; the valuation of stock-based compensation, the valuation of deferred tax assets and liabilities; and contingent liabilities, among others. We base our estimates on assumptions, both historical and forward looking, that are believed to be reasonable, and the results of which form the basis for making judgments about the carrying values of assets and liabilities.

Reclassification

Beginning with the three months ended March 31, 2022, our condensed consolidated statement of cash flows presents separately the amortization of the right-of-use operating lease asset as a non-cash adjustment from net income and the change in the operating lease liability due to cash payments as a change in operating assets and liabilities. Previously, the net of these amounts was reported as a change in operating assets and liabilities. Amounts on the condensed consolidated statement of cash flows for the six months ended June 30, 2021, have been reclassified to conform to the current year presentation.

Income Taxes

Deferred tax assets and liabilities are computed based on the difference between the financial statement and tax basis of assets and liabilities and disclosureare measured by applying enacted tax rates and laws for the taxable years in which those differences are expected to reverse. In addition, a valuation allowance is required to be recognized if it is believed more likely than not that a deferred tax asset will not be fully realized. Authoritative guidance prescribes a recognition threshold of contingent assetsmore likely than not, and liabilities at the date ofa measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those positions to be recognized in the financial statementsstatements. The Company has analyzed its income tax positions using the criteria required by GAAP and concluded that as of June 30, 2022, and December 31, 2021, it has no material uncertain tax positions and no interest or penalties have been accrued.

Concentration of Credit Risk

During the reported amountsthree months ended June 30, 2022, the Company’s prime contracts with U.S. government agencies represented 43.3% of revenue, subcontracts under federal procurements represented 52.7% of revenue and expenses81.3% of gross profit, and 4.0% of revenue came from commercial and local government contracts. The terms of these contracts and subcontracts vary from single transactions to five years. Two prime contracts with U.S. government agencies represented 24.8% and 13.1% of revenue, respectively, and two subcontracts under federal procurements represented 22.3%, and 12.2% of revenue, respectively. Revenue from one prime contractor under which the Company has multiple subcontracts represented 29.8% of the Company’s revenue and 50.5% of the Company’s gross profit in aggregate.

During the three months ended June 30, 2021, the Company’s prime contracts with U.S. government agencies represented 27.0% of revenue, subcontracts under federal procurements represented 69.0% of revenue and 95.0% of gross profit, and 4.0% of revenue came from commercial and local government contracts. The terms of these contracts and subcontracts vary from single transactions to five years. Within this group of prime contracts with U.S. government agencies, one software sales contract generated 19.1% of the Company’s revenue. Two subcontracts under federal procurements generated 28.8% and 10.5% of the Company’s revenue, respectively, and all subcontracts under one of those prime contractors collectively generated 37.0% of the Company’s revenue and 70.0% of its gross profit.

During the six months ended June 30, 2022, the Company’s prime contracts with U.S. government agencies represented 39.6% of revenue, subcontracts under federal procurements represented 57.8% of revenue, and 2.6% of revenue came from commercial and local government contracts. Two prime contracts with U.S. government agencies represented 14.6% and 11.4% of revenue, respectively, and two subcontracts under federal procurements represented 24.2%, and 13.8% of revenue, respectively. Revenue from one prime contractor under which the Company has multiple subcontracts represented 33.1% of the Company’s revenue and 65.8% of the Company’s gross profit in aggregate.

During the six months ended June 30, 2021, the Company’s prime contracts with U.S. government agencies represented 32.9% of revenue, subcontracts under federal procurements represented 64.2% of revenue, and 2.9% of revenue came from commercial and local government contracts. One prime contract with a U.S. government agency represented 11.1% of revenue and one subcontract under a federal procurement represented 33.4% of revenue. Revenue from one prime contractor under which the Company has multiple subcontracts represented 42.2% of the Company’s revenue and 66.5% of the Company’s gross profit in aggregate.

The Company sold third-party software and maintenance contracts under agreements with one major supplier, accounting for 34.1% and 79.9% of total revenue during the reporting period. Actual results can, three months ended June 30, 2022 and in many cases will, differ from those estimates. 

As of SeptemberJune 30, 2017, there2022, the Company’s accounts receivable included receivables from two prime contracts with U.S. government agencies that represented 29.8% and 14.0% of the Company’s outstanding accounts receivable, respectively, and one subcontract under a federal procurement that represented 26.9% of the Company’s outstanding accounts receivable. Receivables from one prime contractor under which the Company has multiple subcontracts represented 32.8% of the Company’s outstanding accounts receivable in aggregate.

As of June 30, 2021, the Company’s accounts receivable balances related to two subcontracts under federal procurements represented 17.2% and 13.0% of the Company’s outstanding accounts receivable, respectively, and additional receivables from one prime contractor under which the Company has multiple subcontracts represented 52.7% of the Company’s outstanding accounts receivable in aggregate.

COVID-19 Update

While we have been no material changesnot experienced a significant adverse impact on our business from the pandemic as of June 30, 2022, the extent to which it will impact our business and operations will depend on future developments that are uncertain. We continue to monitor the impact of the COVID-19 pandemic on our customers, partners, employees and service providers.

Nature of Products and Services

We generate revenue from the sales of information technology professional services, sales of third-party software licenses and implementation and training services, sales of third-party support and maintenance contracts based on those software products, and incentive payments received from third-party software suppliers for facilitating sales directly between that supplier and a customer introduced by the Company. In addition, with the GMI acquisition, we expanded our offerings to include licensing and implementation services for proprietary blockchain-based SCM software. We sell through our direct relationships with end customers and under subcontractor arrangements.

Professional services are offered through several arrangements – through time and materials arrangements, fixed-price-per-unit arrangements, fixed-price arrangements, or combinations of these arrangements within individual contracts. Revenue under time and materials arrangements is recognized over time in the period the hours are worked or the expenses are incurred, as control of the benefits of the work is deemed to have passed to the Company’s uncertain tax position disclosurescustomer as providedthe work is performed. Revenue under fixed-price-per-unit arrangements is recognized at a point in Note 7time when delivery of units has occurred and units are accepted by the Annual Report. The Company does not anticipate that total unrecognized tax benefits will significantly change priorcustomer or are reasonably expected to September 30, 2018.

Third-party software licenses are classified as enterprise server-based software licenses or desktop software licenses, and desktop licenses are further classified by the service period.type of customer and whether the licenses are bulk licenses or individual licenses. The Company applies this methodCompany’s obligations as the seller for each class differ based on its reseller agreements and whether its customers are government or non-government customers. Revenue from enterprise server-based sales to either government or non-government customers is usually recognized in full at a point in time based on when the customer gains use of revenue recognitionthe full benefit of the licenses, after the licenses are implemented. If the transaction prices of the performance obligations related to renewalsimplementation and customer support for the individual contract is material, these obligations are recognized separately over time, as performed. Revenue for desktop software licenses for government customers is usually recognized on a gross basis at a point in time, based on when the customer’s administrative contact gains training in and beneficial use of maintenance contractsthe administrative portal. Revenue for bulk desktop software licenses for non-government customers is usually recognized on third-partya gross basis at a point in time, based on when the customer’s administrative contact gains training in and beneficial use of the administrative portal. For desktop software sales andlicenses sold on an individual license basis to separable maintenance elements of sales of third-party software that include fixed terms of maintenance, such as Adobe and Micro Focus software, for whichnon-government customers, where the Company is responsible for “first line support”has no obligation to the customer after the third-party makes delivery of the licenses, the Company has determined it is acting as an agent, and the Company recognizes revenue upon delivery of the licenses only for servingthe net of the selling price and its contract costs.

Third-party support and maintenance contracts for enterprise server-based software include a performance obligation under the Company’s reseller agreements for it to be the first line of support (direct support) and second line of support (intermediary between customer and manufacturer) to the customer. Because of the support performance obligations, and because the amount of support is not estimable, the Company recognizes revenue ratably over time as it makes itself available to provide the support.

Incentive payments are received under reseller agreements with software manufacturers and suppliers where the Company introduces and courts a liaisoncustomer, but the sale occurs directly between the customer and the third-party maintenance provider for issuessupplier or between the customer and the manufacturer. Since the transfer of control of the licenses cannot be measured from outside of these transactions, revenue is recognized when payment from the manufacturer or supplier is received.

Disaggregation of Revenue from Contracts with Customers

Contract Balances

Accounts Receivable

Trade accounts receivable are recorded at the billable amount where the Company is unablehas the unconditional right to resolve.

Accounts receivable as of June 30, 2022 and December 31, 2021, consist of the following: 1)

Billed receivables from the federal government include amounts due from both prime contracts and subcontracts where the federal government is the end customer.

Contract Assets

Contract assets consist of assets resulting when revenue recognized exceeds the amount billed or billable to the customer due to allocation of transaction price, and of amounts withheld from payment of invoices as a financing component of a contract. There were 0 amounts recorded to contract assets as of June 30, 2022 or December 31, 2021. Changes in contract assets balances in the six months ended June 30, 2021, were as follows:

Contract Liabilities

Contract liabilities consist of amounts that have been invoiced and for which the Company has inventory riskthe right to bill, but that have not been recognized as suppliersrevenue because the related goods or services have not been transferred. Changes in contracts liabilities balances in the three months and six months ended June 30, 2022 and 2021, are not obligatedas follows:

Revenues recognized during the three months ended June 30, 2022 and 2021, from the balances as of December 31, 2021 and 2020, were $55,168 and $352,969, respectively. Revenues recognized during the six months ended June 30, 2022 and 2021, from the balances as of December 31, 2021 and 2020, were $111,591 and $845,463, respectively.

Costs to accept returns, 2)Obtain or Fulfill a Contract

When applicable, the Company recognizes an asset related to the costs incurred to obtain a contract only if it expects to recover those costs and it would not have incurred those costs if the contract had not been obtained. The Company recognizes an asset from the costs incurred to fulfill a contract if the costs (i) are specifically identifiable to a contract, (ii) enhance resources that will be used in satisfying performance obligations in future and (iii) are expected to be recovered. There were 0 such assets as of June 30, 2022 and December 31, 2021. When incurred, these costs are amortized ratably over the periods of the contracts to which those costs apply.

Deferred Costs of Revenue

Deferred costs of revenue consist of the costs of third-party support and maintenance contracts for enterprise server-based software. These costs are reported under the prepaid expenses and other current assets caption on the Company’s condensed consolidated balance sheets. The Company recognizes these direct costs ratably over time as it makes itself available to provide its performance obligation for software support, commensurate with its recognition of revenue. Changes in deferred costs of revenue balances in the three and six months ended June 30, 2022 and 2021, are as follows:

The Company has reasonable latitude, within economic constraints,two significant operating leases, one for its headquarters offices in establishing price, 3) Fairfax, Virginia and one for additional office space in Annapolis, Maryland. The leases both commenced in 2021 and have original lease terms ranging from 37 to 67 months and rental rates escalate by approximately 2.5% annually under both leases. The Company determines if an arrangement is a lease at inception. Operating leases are included in right-of-use operating lease assets and operating lease liabilities in the Company’s condensed consolidated balance sheets as of June 30, 2022 and December 31, 2021.

As of June 30, 2022 and December 31, 2021, the Company indoes not have any sales-type or direct financing leases.

The Company’s operating lease asset represents its marketing efforts, frequently aidsright to use an underlying asset for the customerlease term and lease liabilities represent its obligation to make lease payments arising from the lease. Operating lease assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. Since the lease does not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining product specifications, 4) the Company has physical losspresent value of lease payments. The operating lease asset also includes any lease payments made and inventory risk as title transfers at the shipping point, 5) the Company bears full credit risk, and 6) the amount the Company earns in the transaction is neither a fixed dollar amount nor a fixed percentage. Generally, revenue derivedexcludes lease incentives. Lease expense for facilitating a sales transaction of Adobe products in which a customer introduced by the Company makes a purchase directly from the Company’s supplier or another designated resellerlease payments is recognized on a netstraight-line basis whenover the commission payment is received since the Company is merely acting as an agent in these arrangements. Since the Company is notlease term. The Company’s lease agreement includes rental payments escalating annually for inflation at a direct partyfixed rate. These payments are included in the sales transaction, payment by the supplier is the Company’s confirmation that the sale occurred.

The Company’s lease agreements do not contain any material residual value guarantees or material restrictions or covenants.

The Company does not sublease any real estate to third parties.

As of June 30, 2022, our two operating leases had a weighted average remaining lease term of 40 months and a weighted average discount rate of 5.0%. Future lease payments under operating leases as of June 30, 2022, were as follows:

The total expense incurred related to its operating leases was $54,460 and $26,122 for the three months ended June 30, 2022 and 2021, respectively, and $110,720 and $52,244 for the six months ended June 30, 2022 and 2021, respectively, and is included in selling, general and administrative expenses on the condensed consolidated statements of operations.

The Company defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the firsttwo are considered observable and the last unobservable, that may be used to measure fair value which are the following:

The following table represents the fair value hierarchy for the Company’s financial instruments measured at fair value on a recurring basis as of each undelivered element using vendor-specific objective evidence ("VSOE"), June 30, 2022 and (4) allocateDecember 31, 2021:

The following table is a roll-forward of the total price amongLevel 3 fair value measurements.

There were 0 unrealized gains or losses included in income for the various elements. Changes in assumptionsthree or judgments or changes to the elements in a software arrangement could cause a material increase or decrease in the amount of revenue that six months ended June 30, 2022.

Tellenger, Inc.

On April 7, 2021, the Company reports in a particular period.

Gray Matters, Inc.

On December 10, 2021, the Company purchased all existing revenue guidance affecting us under current GAAP, itthe issued and outstanding shares of Gray Matters. Gray Matters provides supply chain management software designed to aggregate customer data into a single, interconnected, blockchain secured framework. The purchase price of $11,005,100 comprises the following:

Common stock consideration consisted of 436,481 shares of WaveDancer common stock valued at $1,500,000 as of the transaction closing date. The deferred consideration of $1,335,000 is the estimated present value as of the closing date of the $1,500,000 cash payment due to the selling shareholder of GMI (the “Seller”) on the second anniversary of the acquisition. We applied a discount rate of 6% reflecting our recent secured borrowing rate adjusted to include a premium for the unsecured status of the deferred consideration liability. Accretion of the liability will impactbe recorded as interest expense. For the six months ended June 30, 2022, we recorded $19,319 of interest expense.

Contingent consideration was estimated as of the acquisition date using a probability weighted average of possible outcomes, discounted to its net present value as of the acquisition date. We identified the set of possible outcomes and assigned probabilities to each by applying management judgment to the assumptions underlying the projections of 2022 revenue and cost recognition acrossgross profit. Under the whole of our business, as well as our business processes and our information technology systems.