Note 1.  Summary of Significant Accounting Policies

Organization and Business

WaveDancer, Inc. (“WaveDancer”), formerly known as Information Analysis Incorporated (“IAI”), is engaged in providing professional services to U.S. government agencies to modernize information technology services, in selling and supporting third-party software, primarily Adobe products, to U.S. government agencies, and, with our December, 2021 acquisition of Gray Matters, Inc. (“GMI” or “Gray Matters”), in providing blockchain enabled supply chain management software solutions (“SCM”). With the acquisition of GMI, we began implementing a strategy to expand our offerings well beyond systems modernization services and sales of third-party software. Our Chief Executive Officer, as the chief operating decision maker (“CODM”), organizes our company, manages resource allocations, and measures performance among two operating and reportable segments: Tellenger and GMI.

Liquidity and Going Concern

During the nine months ended September 30, 2022, the Company generated a loss from operations of $9,247,607. As of September 30, 2022, the Company had working capital of $1,280,663, including cash and cash equivalents of $1,521,651, and had an accumulated deficit of $21,741,231 . The Company intends to continue to invest in its SCM platform and to execute its strategy to become a leading zero trust, blockchain-enabled cybersecurity company and believes strongly in the long-term viability of our strategy. However, executing our strategy requires additional sources of capital which we are pursuing, including acquisitions or mergers. There is no assurance that such activities will result in any transactions or provide additional capital, which creates substantial doubt about the Company’s ability to continue as a going concern for at least one year from the date that the accompanying financial statements are issued.

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. The Company’s unaudited consolidated financial statements do not include any adjustment that might result from the outcome of this uncertainty.

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-Q and Article 8-03 of Regulation 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 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 the Company’s audited financial statements for the year ended December 31, 2021 included in the Annual Report on Form 10-K filed by the Company with the SEC on April 12, 2022 (the “Annual Report”), as amended. The accompanying December 31, 2021 balance sheet was derived from the 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 September 30, 2022, and for the three- and nine-month periods ended September 30, 2022 include the accounts of WaveDancer and its condensed consolidated subsidiaries (collectively, the “Company”, “we” or “our”). All significant intercompany transactions and balances have been eliminated in consolidation.

Other than disclosing our policy for software development costs since these costs are now, and will likely continue to be, material, and a clarification of our policy for goodwill and intangibles, both as discussed below, there have been no changes in the Company’s significant accounting policies as of September 30, 2022, as compared to the significant accounting policies disclosed in Note 1, "Summary of Significant Accounting Policies" in the Company's Annual Report.

Use of Estimates

Preparation of condensed consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the 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 impact of rising interest rates on valuation methods as discussed in Note 5 Fair Value Measurements. 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, including the underlying estimates of cash flows of our products and reporting units; 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 consideration 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 nine months ended September 30, 2021, have been reclassified to conform to the current year presentation.

Software Development Costs

The Company capitalizes costs related to software developed or obtained for internal use in accordance with the ASC 350-40, Internal-Use Software (“ASC 350-40”). The following illustrates the various stages and related processes of computer software development in accordance with ASC 350-40:

The Company is continuing to develop its blockchain SCM software which it markets under a Software as a Service ("SaaS") model, whereby, a customer does not take possession of the Company’s software; rather, the software is accessed on an as-needed basis over the Internet.

Therefore, when the software is used to produce a product or in a process to provide a service to a customer, and the customer is not given the right to obtain or use the software, the related costs are accounted for in accordance with ASC 350-40. When a hosting arrangement includes multiple modules or components, capitalized costs are amortized on a module-by-module basis. When a module or component is substantially ready for its intended use, amortization begins, regardless of whether the overall hosting arrangement is being placed in service in planned stages. If the module’s functionality is entirely dependent on the completion of one or more other modules, then amortization does not begin until that group of interdependent modules is substantially ready for use.

As of September 30, 2022 we had $214,251 of capitalized internal use software development costs and zero accumulated amortization. Capitalized software development costs are included in plant and equipment on the condensed consolidated balance sheets.

Intangibles and Goodwill

The Company accounts for goodwill and other intangible assets in accordance with ASC Topic 350, Goodwill – Intangibles and Other (“ASC 350”) and has concluded that it has two operating segments, which are also its two reporting units for purposes of goodwill impairment testing. Goodwill is not amortized but instead tested for impairment (i) on at least an annual basis and (ii) when changes in circumstances indicate that it is more likely than not that the fair value of a reporting unit may be below its carrying value. These circumstances include, but are not limited to, significant changes in performance relative to expected operating results; significant changes in the use of the assets; significant negative industry or economic trends; a significant decline in the Company’s stock price for a sustained period of time; and changes in the Company’s planned revenue or earnings. Management evaluates the recoverability of the Company’s goodwill annually on October 31 or more often as events or circumstances indicate the fair value of a reporting unit is below its carrying value, including goodwill. If the fair value of a reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the reporting unit carrying amount exceeds the estimated fair value of the reporting unit.

Management evaluates the recoverability of the Company’s indefinite-lived intangible assets (tradenames) annually on October 31, or more often when events or circumstances indicate a potential impairment exists.

Management evaluates the recoverability of the Company’s finite-lived intangible assets and other long-lived assets when events or circumstances indicate a potential impairment exists. In determining if impairment exists, the Company estimates the undiscounted cash flows to be generated from the use and ultimate disposition of these assets or asset groups that contain those assets. If impairment is indicated based on a comparison of an asset group’s carrying values and the undiscounted cash flows, the impairment loss is measured as the amount by which the carrying amount of the asset group exceeds the fair value of the asset group.

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 are 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 more likely than not, and a 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 statements. The Company has analyzed its income tax positions using the criteria required by GAAP and concluded that as of September 30, 2022, and December 31, 2021, it has no material uncertain tax positions and no interest or penalties have been accrued. The Company expects that recent tax law changes contained in the Inflation Reduction Act and CHIPS Act will not have a material impact on its provision for income taxes.

Concentration of Credit Risk

During the three months ended September 30, 2022, the Company’s prime contracts with U.S. government agencies represented 11.4% of revenue, subcontracts under federal procurements represented 82.8% of revenue, and 5.8% of revenue came from commercial and local government contracts. The terms of these contracts and subcontracts vary from single transactions to five years. Three subcontracts under federal procurements represented 30.9%, 21.3%, and 13.0% of revenue, respectively. Revenue from one prime contractor under which the Company has multiple subcontracts represented 49.9% of the Company’s revenue in aggregate.

During the three months ended September 30, 2021, the Company’s prime contracts with U.S. government agencies represented 37.0% of revenue and subcontracts under federal procurements represented 62.9% of revenue, and 0.2% of revenue came from commercial and local government contracts. The terms of these contracts and subcontracts vary from single transactions to five years. Three subcontracts under federal procurements represented 32.5%, 11.4%, and 10.6% of revenue, respectively. Revenue from one prime contractor under which the Company has multiple subcontracts represented 45.8% of the Company’s revenue in aggregate.

During the nine months ended September 30, 2022, the Company’s prime contracts with U.S. government agencies represented 32.8% of revenue, subcontracts under federal procurements represented 63.8% of revenue, and 3.3% of revenue came from commercial and local government contracts. One prime contract with a U.S. government agency represented 11.1% of revenue, and two subcontracts under federal procurements represented 25.8%, and 15.6% of revenue, respectively. Revenue from one prime contractor under which the Company has multiple subcontracts represented 38.9% of the Company’s revenue in aggregate.

During the nine months ended September 30, 2021 the Company’s prime contracts with U.S. government agencies represented 35.1% of revenue and subcontracts under federal procurements represented 63.5% of revenue, and 1.4% of revenue came from commercial and local government contracts. The terms of these contracts and subcontracts vary from single transactions to five years. One subcontract under federal procurements represented 33.1% of revenue. Revenue from one prime contractor under which the Company has multiple subcontracts represented 44.3% of the Company’s revenue in aggregate.

The Company sold third-party software and maintenance contracts under agreements with one major supplier, accounting for 8.3% and 34.8% of total revenue during the three months ended September 30, 2022 and 2021, respectively, and 27.0% and 30.8% of total revenue during the nine months ended September 30, 2022 and 2021, respectively.

As of September 30, 2022, receivables from one prime contractor under which the Company has multiple subcontracts represented 66.8% of the Company’s outstanding accounts receivable in aggregate.

As of September 30, 2021, receivables from one prime contractor under which the Company has multiple subcontracts represented 63.7% of the Company’s outstanding accounts receivable in aggregate.