NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1: Organization
SharpSpring,
Inc. (the “Company”) provides a cloud-based marketing
automation solution. SharpSpring is designed to increase the rates
at which businesses generate leads and convert leads to sales
opportunities by improving the way businesses communicate with
customers and prospects. Our products are marketed directly by us
and through a small group of reseller partners to customers around
the world.
Note 2: Summary of Significant Accounting Policies
Basis of Presentation and Consolidation
The
accompanying financial statements have been prepared in conformity
with accounting principles generally accepted in the United States
of America (U.S. GAAP).
Our
Consolidated Financial Statements include the accounts of
SharpSpring, Inc. and our subsidiaries (“the Company”).
Our Consolidated Financial Statements reflect the elimination of
all significant inter-company accounts and transactions. The
results of operations for the interim periods presented are not
necessarily indicative of the results to be expected for any
subsequent quarter or for the entire year ending December 31,
2018.
Use of Estimates
The preparation of the consolidated financial statements in
conformity with U.S. GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported
amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Operating Segments
The Company operates as one operating segment. Operating segments
are defined as components of an enterprise for which separate
financial information is regularly evaluated by the chief operating
decision maker (“CODM”), which is the Company’s
chief executive officer, in deciding how to allocate resources and
assess performance. The Company’s CODM evaluates the
Company’s financial information and resources and assess the
performance of these resources on a consolidated basis. The Company
does not present geographical information about revenues because it
is impractical to do so.
Foreign Currencies
The Company’s subsidiaries utilize the U.S. Dollar, Swiss
Franc and South African Rand as their functional currencies. The
assets and liabilities of these subsidiaries are translated at
ending exchange rates for the respective periods, while revenues
and expenses are translated at the average rates in effect for the
period. The related translation gains and losses are included in
other comprehensive income or loss within the Consolidated
Statements of Comprehensive Loss.
Cash and Cash Equivalents
Cash equivalents are short-term, liquid investments with remaining
maturities of three months or less when acquired. Cash and cash
equivalents are deposited or managed by major financial
institutions and at most times are in excess of Federal Deposit
Insurance Corporation (FDIC) insurance limits.
Fair Value of Financial Instruments
U.S.
GAAP establishes a fair value hierarchy which has three levels
based on the reliability of the inputs to determine the fair value.
These levels include: Level 1, defined as inputs such as unadjusted
quoted prices in active markets for identical assets or
liabilities; Level 2, defined as inputs other than quoted prices in
active markets that are either directly or indirectly observable;
and Level 3, defined as unobservable inputs for use when little or
no market data exists, therefore requiring an entity to develop its
own assumptions.
The
Company’s financial instruments consist of cash and cash
equivalents, accounts receivable, deposits, embedded derivatives
(associated with our convertible notes) and accounts payable. The
carrying amount of cash and cash equivalents, accounts receivable
and accounts payable approximates fair value because of the
short-term nature of these items. The fair value of the embedded
derivatives associated with our convertible notes is calculated
using Level 3 unobservable inputs, utilizing a probability-weighted
expected value model to determine the liability. The fair value of
the embedded derivatives at September 30, 2018 and December 31,
2017 was a liability balance of $240,284 and zero,
respectively.
The
change in fair value for the three and nine months ending September
30, 2018 was a loss of $27,295 and gain of $426,154,
respectively.
Accounts Receivable
In cases where our customers pay for services in arrears, we accrue
for revenue in advance of billings as long as the criteria for
revenue recognition is met, thus creating a contract asset. A
portion of our accounts receivable balance is therefore unbilled at
each balance sheet date. Accounts receivable are carried at the
original invoiced amount less an allowance for doubtful accounts
based on the probability of future collection. Management
reviews accounts receivable on a periodic basis to determine if any
receivables will potentially be uncollectible. The Company reserves
for receivables that are determined to be uncollectible, if any, in
its allowance for doubtful accounts. After the Company has
exhausted all collection efforts, the outstanding receivable is
written off against the allowance.
The following table presents the balances of accounts receivable as
of September 30, 2018 and December 31, 2017:
|
|
|
|
|
|
Accounts
receivable
|
$
219,620
|
$
611,293
|
Unbilled
receivables
|
697,101
|
554,793
|
Gross
receivables
|
$
916,721
|
$
1,166,086
|
Allowance
for doubtful accounts
|
(175,561
)
|
(526,127
)
|
Accounts
receivable and unbilled receivables, net
|
$
741,160
|
$
639,959
|
During the nine months ended September 30, 2018, the Company wrote
off approximately $351,000 of accounts receivable against the
allowance for doubtful accounts, with zero net loss recognized in
the period as the accounts were already fully
reserved.
Intangibles
Finite-lived intangible assets include trade names, developed
technologies and customer relationships and are amortized based on
the estimated economic benefit over their estimated useful lives,
with original periods ranging from 5 to 11 years. We continually
evaluate the reasonableness of the useful lives of these assets.
Finite-lived intangibles are tested for recoverability whenever
events or changes in circumstances indicate the carrying amounts
may not be recoverable.
Impairment losses are measured as
the amount by which the carrying value of an asset group exceeds
its fair value and are recognized in operating results. Judgment is
used when applying these impairment rules to determine the timing
of the impairment test, the undiscounted cash flows used to assess
impairments and the fair value of an asset group. The dynamic
economic environment in which the Company operates, and the
resulting assumptions used to estimate future cash flows impact the
outcome of these impairment tests.
Goodwill and Impairment
As of September 30, 2018, and December 31, 2017, we had recorded
goodwill of $8,867,319 and $8,872,898, respectively. Goodwill
consists of the excess of the purchase price over the fair value of
tangible and identifiable intangible net assets acquired in the
SharpSpring and GraphicMail acquisitions. Under
Financial
Accounting Standards Board (FASB) Accounting Standards Codification
(ASC)
350,
“Intangibles - Goodwill
and Other”
deemed to have
indefinite lives are no longer amortized but are subject to annual
impairment tests, and tests between annual tests in certain
circumstances, based on estimated fair value in accordance with
FASB ASC 350-10, and written down when
impaired.
Debt Issuance Costs
We incurred certain third-party costs in connection with the
issuance of the 5% Convertible Notes maturing March 27, 2023 (the
“Notes”), as more fully described in Note 5:
Convertible Notes, principally related to legal and financial
advisory fees. These costs are included as a direct reduction to
the carrying value of the debt as part of the Notes on our
consolidated balance sheets and are being amortized to interest
expense ratably over the five-year term of the Notes.
Estimated amortization expense of debt issuance costs for the
remainder of 2018 and subsequent years is as follows:
Remainder
of 2018
|
$
6,359
|
2019
|
26,455
|
2020
|
27,855
|
2021
|
29,322
|
2022
|
30,862
|
2023
|
7,813
|
Total
|
$
128,666
|
Income Taxes
Provision
for income taxes are based on taxes payable or refundable for the
current year and deferred taxes on temporary differences between
the amount of taxable income and pretax financial income and
between the tax bases of assets and liabilities and their reported
amounts in the financial statements. Deferred tax assets and
liabilities are included in the financial statements at currently
enacted income tax rates applicable to the period in which the
deferred tax assets and liabilities are expected to be realized or
settled as prescribed in FASB ASC 740,
Accounting for Income
Taxes. As changes
in tax laws or rates are enacted, deferred tax assets and
liabilities are adjusted through the provision for income taxes. A
valuation allowance is established to reduce deferred tax assets if
it is more likely than not that a deferred tax asset will not be
realized.
The
Company applies the authoritative guidance in accounting for
uncertainty in income taxes recognized in the consolidated
financial statements. This guidance prescribes a two-step process
to determine the amount of tax benefit to be recognized. First, the
tax position must be evaluated to determine the likelihood that it
will be sustained upon external examination. If the tax position is
deemed “more-likely-than-not” to be sustained, the tax
position is then assessed to determine the amount of benefit to
recognize in the financial statements. The amount of the benefit
that may be recognized is the largest amount that has a greater
than 50% likelihood of being realized upon ultimate settlement.
There are no material uncertain tax positions taken by the Company
on its tax returns. Tax years subsequent to 2013 remain open to
examination by U.S. federal and state tax
jurisdictions.
In
determining the provision for income taxes, the Company uses
statutory tax rates and tax planning opportunities available to the
Company in the jurisdictions in which it operates. This includes
recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been included in the
consolidated financial statements or tax returns to the extent
pervasive evidence exists that they will be realized in future
periods. The deferred tax balances are adjusted to reflect tax
rates by tax jurisdiction, based on currently enacted tax laws,
which are expected to be in effect in the years in which the
temporary differences are expected to reverse. In accordance with
the Company’s income tax policy, significant or unusual items
are separately recognized in the period in which they occur. The
Company is subject to routine examination by domestic and foreign
tax authorities and frequently faces challenges regarding the
amount of taxes due. These challenges include positions
taken by the Company related to the timing, nature and amount of
deductions and the allocation of income among various tax
jurisdictions. As of September 30, 2018, the Company is being
examined by the U.S. tax authorities related to the 2016 and 2017
tax years. The Company does not expect any material adjustments as
a result of the audit.
Property and Equipment
Property
and equipment are recorded at cost and depreciated using the
straight-line method over the estimated useful life of the assets.
Upon retirement or sale, the cost of assets disposed of and the
related accumulated depreciation are eliminated from the accounts
and any resulting gain or loss is credited or charged to
operations. Repairs and maintenance costs are expensed as incurred.
Depreciation expense related to property and equipment was
$125,416 and
$71,899
for
the three months ended September 30, 2018 and 2017, respectively.
Depreciation expense related to property and equipment was $287,132
and
$207,090
for the nine
months ended September 30, 2018 and 2017, respectively. Repairs and
maintenance costs are expensed as incurred.
Property
and equipment as of September 30, 2018 and December 31, 2017 is as
follows:
|
|
|
|
|
|
Property
and equipment, net:
|
|
|
Leasehold
improvements
|
$
128,122
|
$
128,122
|
Furniture
and fixtures
|
524,698
|
355,033
|
Computer
equipment and software
|
976,467
|
776,201
|
Total
|
1,629,287
|
1,259,356
|
Less:
Accumulated depreciation and amortization
|
(721,122
)
|
(460,211
)
|
|
$
908,165
|
$
799,145
|
Useful
lives are as follows:
Leasehold
improvements
|
3-5
years
|
Furniture
and fixtures
|
3-5
years
|
Computing
equipment
|
3
years
|
Software
|
3-5
years
|
Revenue Recognition
The Company recognizes revenue from its services when it is
probable that the economic benefits associated with the
transactions will flow to the Company and the amount of revenue can
be measured reliably. All significant sources of revenue are the
result of a contract with a customer, and as such meet all of the
requirements of recognizing revenue in accordance with FASB ASC
606. For the three months ended September 30, 2018 and September
30, 2017 revenue from contracts with customers was $4.9 million and
$3.4 million, respectively. For the nine months ended September 30,
2018 and September 30, 2017 revenue from contracts with customers
was $13.5 million and $9.7 million, respectively.
For the Company’s internet-based SharpSpring marketing
automation solution, the services are typically offered on a
month-to-month basis with a fixed fee charged in arrears depending
on the size of the engagement with the customer. Monthly fees are
recorded as revenue during the month they are earned. Some
customers are charged annually in advance, for which revenues are
deferred and recorded ratably over the subscription period. The
Company also charges transactional-based fees if monthly volume
limitations are reached or other chargeable activity occurs.
Additionally, customers are typically charged an upfront
implementation and training fee. The upfront implementation and
training fees represent short-term “use it or lose it”
services offered for a flat fee. Such flat fees are recognized over
the service period, which is typically 60 days.
For the SharpSpring Mail+ product, the services are typically
offered on a month-to-month basis. Customers are either charged in
arrears based on the number of contacts in the system during the
billing period or in advance if the customer selects a plan based
on e-mail volume. The Company also charges transactional-based fees
if monthly volume limitations are reached or other chargeable
activity occurs.
Our products are billed in arrears or upfront, depending on the
product, which creates contract assets (accrued revenue) and
contract liabilities (deferred revenue). Contract assets occur due
to unbilled charges that the Company has satisfied performance
obligations for. Contract liabilities occur due to billing up front
for charges that the Company has not yet fully satisfied
performance obligations on. Both contract assets and liabilities
are recognized and deferred ratably over their service
periods
.
The Company makes judgements when determining revenue recognition.
Because many of our contracts are billed in arrears, estimates are
made for the transaction price and amounts allocated to each
accounting period related to the performance obligations of each
contract. There have been no changes to the methodology used in
these judgements and estimates for determining revenues. Some of
the estimates used when determining revenue recognition relate to
variable customer consideration that changes from month to month.
The Company uses the most likely amount method to determine the
estimated variable consideration, relying on historical
consideration received, customer status and projected usage to
determine the most likely consideration amount. The amount of
variable consideration recognized is constrained and is only
included in the transaction price to the extent that it is probable
that a significant reversal of cumulative revenue recognized will
not occur.
The performance obligations are measured using the output method to
recognize revenue based on direct measurements of the value to the
customer of the services transferred to date. Most of the
Company’s contracts are satisfied over time, and as each
contract has a predefined service period. This allows for a
reliable way to measure performance obligations remaining and
completed. The Company does have some contracts that are satisfied
at a point in time upon delivery of services. The criteria for the
completion of these contracts is defined in each contract with a
customer so that there is no judgment required in evaluating when
the service is delivered to the customer. Any discount given is
allocated to the performance obligation and is treated as reduction
to the transaction price. Due to the month to month nature of the
Company’s contracts with customers, no financing or time
value of money component exists related to the contracts with
customers. Due to the month to month nature of the Company’s
contracts with customers, we have elected to utilize the optional
practical expedient from ASC 606-10-50-14 through 50-14A for
disclosing the remaining performance obligations. The remaining
performance obligations as of the balance sheet date consist of
trainings and availability and use of the SharpSpring platform over
the remainder of the contract, which is typically less than 30
days.
From time to time, the Company offers refunds to customers and
experiences credit card chargebacks relating to cardholder disputes
that are commonly experienced by businesses that accept credit
cards. The Company makes estimates for refunds and credit card
chargebacks based on historical experience.
Deferred Revenue
Deferred revenue consists of payments received in advance of the
Company’s providing the services. Deferred revenue is earned
over the service period identified in each contract. The majority
of our deferred revenue balances (contract liabilities) arise from
upfront implementation and training fees for its SharpSpring
marketing automation solution that are paid in advance. These
services are typically performed over a 60-day period, and the
revenue is recognized over that period. Additionally, some of the
Company’s customers pay for services in advance on a periodic
basis (such as monthly, quarterly, annually or bi-annually). In
situations where a customer pays in advance for a one-year service
period, the deferred revenue is recognized over that service
period. Deferred revenue balances were $279,818 and $280,159 as of
December 31, 2017 and 2016, respectively. Deferred revenue during
the three months ended September 30, 2018 and 2017 increased by
$471,247 and $318,540, respectively. These increases were offset by
revenue recognized of $452,150 and $293,577 during the same
period
s. Deferred revenue
during the nine months ended September 30, 2018 and 2017 increased
by $1,190,856 and $795,148, respectively. These increases were
offset by revenue recognized of $1,131,162 and $800,491 during the
same periods. The Company had deferred revenue contract liability
balances of $338,419 and $279,818 as of September 30, 2018 and
December 31, 2017, respectively. The Company expects to recognize
100% of the revenue on of these remaining performance obligations
within 12 months.
Accrued Revenue
In cases where our customers pay for services in arrears, we accrue
for revenue in advance of billings as long as the criteria for
revenue recognition is met, thus creating a contract asset. A
portion of our accounts receivable balance is therefore unbilled at
each balance sheet date. The accrued revenue contract asset
balances were $554,603 and $439,559 as of December 31, 2017 and
2016, respectively.
Revenue
billed that was included in accrued revenue at the beginning of the
period for the three months ending September 30, 2018 and 2017 was
$646,452 and $502,402, respectively. Revenue billed that was
included in accrued revenue at the beginning of the period for the
nine months ending September 30, 2018 and 2017 was $554,603 and
$439,559, respectively. Accrued revenue not billed in the three and
nine months ending September 30, 2018 and 2017 was $697,101 and
$521,666, respectively. The Company had accrued revenue contract
asset balances of $697,101 and $554,603 as of September 30, 2018
and December 31, 2017, respectively.
Concentration of Credit Risk and Significant Customers
Financial
instruments that potentially expose the Company to concentrations
of credit risk consist primarily of cash and cash equivalents. At
September 30, 2018 and December 31, 2017, the Company had cash
balances at financial institutions that exceed federally insured
limits. The Company maintains its cash balances with accredited
financial institutions. The Company does not believe that it is
subject to unusual credit risk beyond the normal credit risk
associated with commercial banking relationships.
There
were no customers that accounted for more than 10% of total revenue
or 10% of total accounts receivable for any financial period
presented.
Cost of Services
Cost of
services consists primarily of direct labor costs associated with
support and customer onboarding, and technology hosting and license
costs associated with the cloud-based platform.
Credit Card Processing Fees
Credit
card processing fees are included as a component of general and
administrative expenses and are expensed as incurred.
Advertising Costs
The
Company expenses advertising costs as incurred. Advertising and
marketing expenses, excluding marketing team costs, were
$1,443,534
and
$831,642
for the three months ended
September 30, 2018 and 2017, respectively. Advertising and
marketing expenses were
$4,187,234
and
$2,174,590
for the nine months ended
September 30, 2018 and 2017, respectively.
Capitalized Cost of Obtaining a Contract
The
Company capitalizes sales commission costs which are incremental to
obtaining a contract. We expense costs that are related to
obtaining a contract, but are not incremental such as other sales
and marketing costs and other costs that would be incurred
regardless of if the contract was obtained. Capitalized costs are
amortized using the straight-line amortization over the estimated
weighted average life of the customer, which we have estimated to
be 3 years. At September 30, 2018 the net carrying value of the
capitalized cost of obtaining a contract was
$1,281,715
, of which
$683,341
is included in other current
assets and
$598,374
is included
in other long-term assets. At December 31, 2017, the net carrying
value of the capitalized cost of obtaining a contract was
$1,218,833
, of which
$631,203
is included in other
current assets and
$587,630
is
included in other long-term assets. The Company amortized expenses
for the costs of obtaining contracts of
$194,479
and
$147,523
for the three months ended
September 30, 2018 and 2017, respectively. Such capitalized cost
adjustments have been retroactively applied to prior periods. The
Company amortized expenses for the costs of obtaining contracts of
$557,718
and
$389,674
for the nine months ended
September 30, 2018 and 2017, respectively. Such capitalized cost
adjustments have been retroactively applied to prior
periods.
Stock Compensation
We
account for stock-based compensation in accordance with FASB ASC
718 “Compensation — Stock Compensation” which
requires companies to measure the cost of employee services
received in exchange for an award of an equity instrument based on
the grant-date fair value of the award. Stock-based compensation
expense is recognized on a straight-line basis over the requisite
service period.
Net Loss Per Share
Basic net loss per share is computed by dividing net loss by the
weighted average number of common shares outstanding for the
period. Diluted net loss per share is computed by giving effect to
all potential dilutive common stock equivalents for the period. For
purposes of this calculation, options to purchase common stock,
warrants and the conversion option of the convertible Notes (Note
5) are considered to be potential common shares outstanding. Since
the Company incurred net losses for each of the periods presented,
diluted net loss per share is the same as basic net loss per share.
The Company’s potential common shares outstanding were not
included in the calculation of diluted net loss per share as the
effect would be anti-dilutive.
Comprehensive Income (Loss)
Comprehensive
income or loss includes all changes in equity during a period from
non-owner sources, such as net income or loss and foreign currency
translation adjustments.
Recently Issued Accounting Standards
Recent
accounting standards not included below are not expected to have a
material impact on our consolidated financial position and results
of operations.
In
February 2016, the FASB issued guidance that requires lessees to
recognize most leases on their balance sheets but record expenses
on their income statements in a manner similar to current
accounting. For lessors, the guidance modifies the classification
criteria and the accounting for sales-type and direct financing
leases. The guidance is effective in 2019 with early adoption
permitted. The Company is currently evaluating the impact of this
guidance on the consolidated financial statements.
In
January 2017, the FASB issued guidance simplifying the accounting
for goodwill impairment by removing Step 2 of the goodwill
impairment test. Under current guidance, Step 2 of the goodwill
impairment test requires entities to calculate the implied fair
value of goodwill in the same manner as the amount of goodwill
recognized in a business combination by assigning the fair value of
a reporting unit to all of the assets and liabilities of the
reporting unit. The carrying value in excess of the implied fair
value is recognized as goodwill impairment. Under the new standard,
goodwill impairment is recognized based on Step 1 of the current
guidance, which calculates the carrying value in excess of the
reporting unit’s fair value. The new standard is effective
beginning in January 2020, with early adoption permitted. We do not
believe the adoption of this guidance will have a material impact
on our consolidated financial statements.
In May
2014, the FASB issued updated guidance and disclosure requirements
for recognizing revenue from contracts with customers. This new
revenue recognition standard became effective for the Company on
January 1, 2018. In addition to providing guidance on when and how
revenue is recognized, the new standard also provides guidance on
accounting for costs of obtaining contracts primarily related to
aligning the expense with the period in which the value is
recognized. As a result of this new standard, the Company was
required to capitalize certain costs related to obtaining contracts
associated with commissions expense paid to salespeople. The
Company is using the retrospective transition method to adjust each
prior reporting period presented for this new method of accounting
for costs associated with obtaining contracts. The application of
the retrospective transition was applied to all contracts at the
date of initial application. The following tables present our
results under our historical method and as adjusted to reflect
these accounting changes.
|
Historical Accounting Method
|
Effect of Adoption of New ASU
|
|
Three Months Ended September 30, 2018
|
|
|
|
Sales
and Marketing Expense
|
2,673,869
|
(33,172
)
|
2,640,697
|
Total
operating expense
|
5,922,531
|
(33,172
)
|
5,889,359
|
Operating
loss
|
(2,521,612
)
|
33,172
|
(2,488,440
)
|
Loss
before income taxes
|
(2,738,273
)
|
33,172
|
(2,705,101
)
|
Benefit
for income tax
|
5,130
|
-
|
5,130
|
Net
loss
|
(2,743,403
)
|
33,172
|
(2,710,231
)
|
Basic
net loss per share
|
(0.32
)
|
-
|
(0.32
)
|
Diluted
net loss per share
|
(0.32
)
|
-
|
(0.32
)
|
|
|
|
|
Nine Months Ended September 30, 2018
|
|
|
|
Sales
and Marketing Expense
|
7,431,010
|
(62,882
)
|
7,368,128
|
Total
operating expense
|
15,719,004
|
(62,882
)
|
15,656,122
|
Operating
loss
|
(6,598,792
)
|
62,882
|
(6,535,910
)
|
Loss
before income taxes
|
(7,538,705
)
|
62,882
|
(7,475,823
)
|
Benefit
for income tax
|
(247,415
)
|
-
|
(247,415
)
|
Net
loss
|
(7,291,290
)
|
62,882
|
(7,228,408
)
|
Basic
net loss per share
|
(0.86
)
|
0.01
|
(0.85
)
|
Diluted
net loss per share
|
(0.86
)
|
0.01
|
(0.85
)
|
|
|
|
|
Balance as of September 30, 2018
|
|
|
|
Other
current assets
|
398,157
|
683,341
|
1,081,498
|
Other
long-term assets
|
45,947
|
598,374
|
644,321
|
Total
assets
|
24,127,641
|
1,281,715
|
25,409,356
|
Accumulated
deficit
|
(16,384,006
)
|
1,281,715
|
(15,102,291
)
|
|
Historical Accounting Method
|
Effect of Adoption of New ASU
|
|
Three Months Ended September 30, 2017
|
|
|
|
Sales
and Marketing Expense
|
1,801,701
|
(99,480
)
|
1,702,221
|
Total
operating expense
|
3,991,363
|
(99,480
)
|
3,891,883
|
Operating
loss
|
(1,789,871
)
|
99,480
|
(1,690,391
)
|
Loss
before income taxes
|
(1,792,579
)
|
99,480
|
(1,693,099
)
|
Benefit
for income tax
|
(111,059
)
|
-
|
(111,059
)
|
Net
loss
|
(1,681,520
)
|
99,480
|
(1,582,040
)
|
Basic
net loss per share
|
(0.20
)
|
0.01
|
(0.19
)
|
Diluted
net loss per share
|
(0.20
)
|
0.01
|
(0.19
)
|
|
|
|
|
Nine Months Ended September 30, 2017
|
|
|
|
Sales
and Marketing Expense
|
5,025,539
|
(237,507
)
|
4,788,032
|
Total
operating expense
|
11,457,417
|
(237,507
)
|
11,219,910
|
Operating
loss
|
(5,552,337
)
|
237,507
|
(5,314,830
)
|
Loss
before income taxes
|
(5,476,440
)
|
237,507
|
(5,238,933
)
|
Benefit
for income tax
|
(1,004,899
)
|
-
|
(1,004,899
)
|
Net
loss
|
(4,471,541
)
|
237,507
|
(4,234,034
)
|
Basic
net loss per share
|
(0.53
)
|
0.03
|
(0.51
)
|
Diluted
net loss per share
|
(0.53
)
|
0.03
|
(0.51
)
|
|
|
|
|
Balance as of December 31, 2017
|
|
|
|
Other
current assets
|
267,924
|
631,203
|
899,127
|
Other
long-term assets
|
25,000
|
587,631
|
612,631
|
Total
assets
|
20,463,289
|
1,218,834
|
21,682,123
|
Accumulated
deficit
|
(9,092,717
)
|
1,218,834
|
(7,873,883
)
|
Note 3: Goodwill and Other Intangible Assets
Intangible assets are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized
intangible assets:
|
|
|
|
Trade
names
|
$
120,000
|
$
(110,746
)
|
$
9,254
|
Technology
|
2,130,000
|
(890,500
)
|
1,239,500
|
Customer
relationships
|
4,108,010
|
(3,375,764
)
|
732,246
|
Unamortized
intangible assets:
|
6,358,010
|
(4,377,010
)
|
1,981,000
|
Goodwill
|
|
|
8,867,319
|
Total
goodwill and intangible assets
|
|
|
$
10,848,319
|
Estimated amortization expense for the remainder of 2018 and
subsequent years is as follows:
Remainder
of 2018
|
$
115,000
|
2019
|
381,000
|
2020
|
332,000
|
2021
|
280,000
|
2022
|
228,000
|
2023
|
180,000
|
Thereafter
|
465,000
|
Total
|
$
1,981,000
|
Amortization expense for the three months ended September 30, 2018
and 2017 was $115,000 and $132,298, respectively. Amortization
expense for the nine months ended September 30, 2018 and 2017 was
$345,000 and $395,690, respectively.
Note 4: Credit Facility
In
March 2016, the Company entered into a $2.5 million revolving loan
agreement (the “Credit Facility”) with Western Alliance
Bank. The facility originally matured on March 21, 2018 and was
amended to mature on March 31, 2020. There are no mandatory
amortization provisions and the Credit Facility is payable in full
at maturity. Loan proceeds accrue interest at the higher of Western
Alliance Bank’s Prime interest rate (5.25% as of September
30, 2018) or 5.00%, plus 2.00%. The Credit Facility is
collateralized by a lien on substantially all of the existing and
future assets of the Company and secured by a pledge of 100% of the
capital stock of SharpSpring Technologies, Inc. and a 65% pledge of
the Company’s foreign subsidiaries’ stock. The Credit
Facility subjects the Company to a number of restrictive covenants,
including financial and non-financial covenants customarily found
in loan agreements for similar transactions. The Credit Facility
also restricts our ability to pay cash dividends on our common
stock. There are no amounts outstanding under the Credit Facility
and no events of default occurred.
Note 5: Convertible Notes
On
March 28, 2018, we issued $8.0 million in aggregate principal
amount of convertible notes (the “Notes”). Interest
accrues at a rate of 5.0% per year and is “payable in
kind” annually in the form of the issuance of additional
notes (“PIK Notes”). The principal amount of the Note
and the PIK Notes are due and payable in full on the fifth
anniversary of the date of the Notes. The Company shall have the
right to extend the maturity date for up to nine months on up to
three separate occasions, with interest accruing at a rate of 10%
during any such extension periods. The Notes are convertible into
shares of the Company’s common stock at any time by the
holder at a fixed conversion price of $7.50 per share, subject to
customary adjustments for specified corporate events. Additionally,
if the Notes and PIK Notes are not converted into common stock by
the holder, at the maturity date, the Company may elect to convert
all outstanding Notes and PIK Notes into shares of the
Company’s common stock at a conversion price equal to 80% of
the volume weighted average closing price of the Company’s
common stock for the 30 trading days prior to an including the
maturity date. We received net proceeds from the offering of
approximately $7.9 million after adjusting for debt issue costs,
including financial advisory and legal fees.
The
Notes are unsecured obligations and are subordinate in right of
payment to the Credit Facility (Note 4). So long as any Notes are
outstanding, except as the investor may otherwise agree in writing,
the Company shall at no time (i) have outstanding senior
indebtedness in an aggregate amount exceeding 18.6% of the
Company’s trailing twelve-month revenue, (ii) incur any
indebtedness that is both junior in right of payment to the
obligations of the Company to its senior secured lender and senior
to the Company’s obligations under the Notes or (iii) enter
into any agreement with any lender or other third party that would
(A) prohibit the Company from issuing PIK Notes at any time or
under any circumstances or (B) prohibit the conversion of the Notes
in accordance with their terms at any time or under any
circumstances. Prior to the issuance of the Notes, the Company had
no outstanding indebtedness for borrowed money. The holder of the
Notes must notify the Company at least 120 days prior to the
maturity of the Notes of its election to convert the
Notes.
The
convertible note agreement contains customary events of default
with respect to the Notes and provides that upon certain events of
default occurring and continuing, the investor, by written notice
to the Company may declare the entire outstanding principal amount
of this Note and all accrued but unpaid interest to be immediately
due and payable. During the continuance of an event of default, the
investor shall have recourse to any and all remedies available to
under applicable law. The Notes were recorded upon issuance at
amortized cost in accordance with applicable accounting guidance.
As there is no difference in the amount recorded at inception and
the face value of the Notes, interest expense will be accreted at
the stated interest rate under the terms of the Notes. Total
interest expense related to the Notes will be impacted by the
amortization of the debt issuance cost using the effective interest
method.
The
Company would be required to accelerate and issue the PIK Notes
through the maturity of the Notes if the Company elects to convert
the Notes prior to maturity (which it can do upon certain
conditions) or if there is a change in control. Pursuant to
accounting guidance, for each of these situations, the Company
determined that the economic characteristics of these “make
whole” features were not considered clearly and closely
related to the Company’s stock. Accordingly, these features
were determined to be “embedded derivatives” and were
bifurcated from the Notes and separately accounted for on a
combined basis at fair value as a single derivative. The fair value
of the derivatives as of September 30, 2018 was a liability of
$240,284 which is included within the non-current liabilities on
the balance sheet. The derivative is being accounted for at fair
value, with subsequent changes in the fair value to be reported as
part of Other income (expense), net in the Consolidated Statement
of Operations.
Additionally,
the investor’s conversion option was analyzed for embedded
derivative treatment, but the conversion option qualifies for a
scope exception as it is considered to be clearly and closely
related to the Company’s stock.
The net
carrying amount of the Notes at September 30, 2018 was as
follows:
|
|
Principal
amount
|
$
8,000,000
|
Accrued
interest paid-in-kind
|
204,301
|
Unamortized
debt issuance costs
|
(128,666
)
|
Original
embedded derivative conversion feature
|
185,870
|
Net
carrying value
|
$
8,261,505
|
We
incurred certain third-party costs in connection with our issuance
of the Notes, principally related to financial advisory and legal
fees, which are being amortized to interest expense ratably over
the five-year term of the Notes.
The
following table sets forth total interest expense related to the
Notes for the period ended September 30, 2018:
|
|
|
|
|
|
|
|
|
Contractual
interest paid-in-kind expense (non-cash)
|
$
100,000
|
$
204,301
|
Amortization
of debt issuance costs (non-cash)
|
6,359
|
12,991
|
Total
interest expense
|
$
106,359
|
$
217,292
|
Effective
interest rate
|
5.3
%
|
5.3
%
|
Note 6:
Changes
in Accumulated Other Comprehensive Income
(Loss)
|
|
|
|
|
|
Balance
as of December 31, 2017
|
$
(480,762
)
|
Other
comprehensive income (loss) prior to reclassifications
|
-
|
Amounts
reclassified from accumulated other comprehensive
income
|
-
|
Tax
effect
|
-
|
Net
current period other comprehensive loss
|
243,468
|
Balance
as of September 30, 2018
|
$
(237,294
)
|
Note 7:
Net
Loss Per Share
Basic
net loss per share is computed by dividing net loss by the weighted
average number of common shares outstanding for the period. Diluted
net loss per share is computed by giving effect to all potential
dilutive common stock equivalents for the period. For purposes of
this calculation, options to purchase common stock, warrants and
the conversion option of the convertible Notes (Note 5) are
considered to be potential common shares outstanding.
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
$
(2,710,231
)
|
$
(1,582,040
)
|
$
(7,228,408
)
|
$
(4,234,034
)
|
|
|
|
|
|
Basic
weighted average common shares outstanding
|
8,530,858
|
8,399,920
|
8,482,976
|
8,383,639
|
Add
incremental shares for:
|
|
|
|
|
Warrants
|
-
|
-
|
-
|
-
|
Stock
options
|
-
|
-
|
-
|
-
|
Convertible
notes
|
-
|
-
|
-
|
-
|
Diluted
weighted average common shares outstanding
|
8,530,858
|
8,399,920
|
8,482,976
|
8,383,639
|
|
|
|
|
|
Net
loss per share:
|
|
|
|
|
Basic
|
$
(0.32
)
|
$
(0.19
)
|
$
(0.85
)
|
$
(0.51
)
|
Diluted
|
$
(0.32
)
|
$
(0.19
)
|
$
(0.85
)
|
$
(0.51
)
|
Additionally, since
the Company incurred net losses for each of the periods presented,
diluted net loss per share is the same as basic net loss per share.
The Company’s outstanding warrants, stock options, and
convertible notes were not included in the calculation of diluted
net loss per share as the effect would be anti-dilutive. The
following table contains all potentially dilutive common stock
equivalents:
|
Three and Six Months Ended
|
|
|
|
|
|
Warrants
|
30,000
|
170,973
|
Stock
options
|
1,475,689
|
1,323,726
|
Convertible
notes
|
1,093,907
|
-
|
Note 8:
Income
Taxes
The
income tax expense we record in any interim period is based on our
estimated effective tax rate for the year for each jurisdiction
that we operate in. The calculation of our estimated effective tax
rate requires an estimate of pre-tax income by tax jurisdiction, as
well as total tax expense for the fiscal year. Accordingly, this
tax rate is subject to adjustment if, in subsequent interim
periods, there are changes to our initial estimates of total tax
expense, pre-tax income, or pre-tax income by
jurisdiction.
During
the three months ended September 30, 2018 and 2017, the Company
recorded income tax expense of $5,130 and income tax benefit of
$111,059, respectively. During the nine months ended September 30,
2018 and 2017, the Company recorded income tax benefit of $247,415
and income tax benefit of $1,004,899, respectively. The blended
effective tax rate for the nine months ending September 30, 2018
and 2017 was 3% and 18%, respectively. The blended effective tax
rate varies from our statutory U.S. tax rate due to income
generated in certain other jurisdictions at various tax rates, the
effect of changes in estimates related to the 2017 federal NOL
carryback, and changes in the valuation allowance related to
indefinite-lived deferred tax liabilities.
In
response to the enactment of the Tax Act in late 2017, the U.S.
Securities and Exchange Commission issued Staff Accounting Bulletin
No. 118 (“SAB 118”) to address situations where the
accounting is incomplete for certain income tax effects of the Tax
Act upon issuance of an entity’s financial statements for the
reporting period in which the Tax Act was enacted. Under SAB 118, a
company may record provisional amounts during a measurement period
for specific income tax effects of the Tax Act for which the
accounting is incomplete, but a reasonable estimate can be
determined, and when unable to determine a reasonable estimate for
any income tax effects, report provisional amounts in the first
reporting period in which a reasonable estimate can be determined.
In December 2017, the Company reasonably estimated that it will not
have a transition tax related to the repatriation of foreign
earnings for the impact of the U.S. Tax Cuts and Jobs Act
(“Tax Act”). The Company has not yet finalized these
calculations and no adjustments to the provisional amount have been
made in the current period. We will finalize the provisional
amounts within one year from the date of enactment.
Valuation Allowance
We
record a deferred tax asset if we believe that it is more likely
than not that we will realize a future tax benefit. Ultimate
realization of any deferred tax asset is dependent on our ability
to generate sufficient future taxable income in the appropriate tax
jurisdiction before the expiration of carryforward periods, if any.
Our assessment of deferred tax asset recoverability considers many
different factors including historical and projected operating
results, the reversal of existing deferred tax liabilities that
provide a source of future taxable income, the impact of current
tax planning strategies and the availability of future tax planning
strategies. We establish a valuation allowance against any deferred
tax asset for which we are unable to conclude that recoverability
is more likely than not. This is inherently judgmental, since we
are required to assess many different factors and evaluate as much
objective evidence as we can in reaching an overall conclusion. The
particularly sensitive component of our evaluation is our
projection of future operating results since this relies heavily on
our estimates of future revenue and expense levels by tax
jurisdiction.
In
making our assessment of deferred tax asset recoverability, we
considered our historical financial results, our projected future
financial results, the planned reversal of existing deferred tax
liabilities and the impact of any tax planning actions. Based on
our analysis we noted both positive and negative factors relative
to our ability to support realization of certain deferred tax
assets. However, based on the weighting of all the evidence,
including the near-term effect on our income projections of
investments we are making in our team, product and systems
infrastructure, we concluded that it was more likely than not that
the majority of our deferred tax assets related to temporary
differences and net operating losses may not be recovered. The
establishment of a valuation allowance has no effect on our ability
to use the underlying deferred tax assets prior to expiration to
reduce cash tax payments in the future to the extent that we
generate taxable income.
At
September 30, 2018 and December 31, 2017, we have established a
valuation allowance of $3.7 million and $1.9 million, respectively,
against certain deferred tax assets given the uncertainty of
recoverability of these amounts.
Note 9: Defined Contribution Retirement Plan
Starting
in 2016, we offered our U.S. employees the ability to participate
in a 401(k) plan. Eligible U.S. employees may contribute up to 100%
of their eligible compensation, subject to limitations established
by the Internal Revenue Code. The Company contributes a matching
contribution equal to 100% of each such participant’s
contribution up to the first 3% of their annual eligible
compensation. We charged $
64,679
and
$53,886
to expense in the three months
ended September 30, 2018 and 2017, respectively, associated with
our matching contribution in those periods. We charged
$
186,614
and
$144,960
to expense in the nine months
ended September 30, 2018 and 2017, respectively, associated with
our matching contribution in those periods.
Note 10: Stock-Based Compensation
The
Company grants stock option awards to officers and employees and
grants stock awards to directors as compensation for their service
to the Company.
In
November 2010, the Company adopted the 2010 Stock Incentive Plan
(“the Plan”) which was amended in April 2011, August
2013, April 2014, February 2016, March 2017, and June 2018. The
plan was restated in its entirety in August 2018. As amended, up to
2,600,000
shares of common
stock are available for issuance under the Plan. The Plan provides
for the issuance of stock options and other stock-based
awards.
Stock Options
Stock
option awards under the Plan have a 10-year maximum contractual
term and must be issued at an exercise price of not less than 100%
of the fair market value of the common stock at the date of grant.
The Plan is administered by the Board of Directors, which has the
authority to determine to whom options may be granted, the period
of exercise and what other restrictions, if any, should apply.
Vesting for awards granted to date under the Plan is principally
over four years from the date of the grant, with 25% of the award
vesting after one year and monthly vesting thereafter.
Option
awards are valued based on the grant date fair value of the
instruments, net of estimated forfeitures, using a Black-Scholes
option pricing model with the following assumptions:
|
Nine months
Ended
September
30
,
|
|
2018
|
|
2017
|
|
|
|
|
Volatility
|
48 – 49%
|
|
48-49%
|
Risk-free interest rate
|
2.34% - 2.99%
|
|
1.85% - 2.26%
|
Expected term
|
6.25 years
|
|
6.25 years
|
The
weighted average grant date fair value of stock options granted
during the nine months ended
September
30, 2018 and 2017
was
$2.88
and
$2.05
, respectively.
For
grants prior to January 1, 2015, the volatility assumption was
based on historical volatility of similar sized companies due to
lack of historical data of the Company’s stock price. For all
grants subsequent to January 1, 2015, the volatility assumption
reflects the Company’s historic stock volatility for the
period of February 1, 2014 forward, which is the date the
Company’s stock started actively trading. The risk-free
interest rate was determined based on treasury securities with
maturities equal to the expected term of the underlying award. The
expected term was determined based on the simplified method
outlined in Staff Accounting Bulletin No. 110.
Stock
option awards are expensed on a straight-line basis over the
requisite service period. During the three months ended
September 30, 2018 and 2017
,
the Company recognized expense of $192,202
and $137,673
, respectively, associated with
stock option awards. During the nine months ended
September 30, 2018 and 2017
, the Company
recognized expense of $
575,081 and
$384,787
, respectively, associated with stock option awards.
At
September 30, 2018
, future
stock compensation expense associated with stock options (net of
estimated forfeitures) not yet recognized was $1,673,464 and will
be recognized over a weighted average remaining vesting period of
2.9 years. The following summarizes stock option activity for the
nine months ended September 30, 2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2017
|
1,069,330
|
$
5.11
|
7.0
|
$
36,693
|
|
|
|
|
|
Granted
|
575,850
|
5.43
|
|
|
Exercised
|
(85,673
)
|
5.33
|
|
|
Expired
|
(35,481
)
|
7.60
|
|
|
Forfeited
|
(48,337
)
|
4.78
|
|
|
Outstanding
at September 30, 2018
|
1,475,689
|
$
5.17
|
8.1
|
$
13,057,617
|
|
|
5.13
|
|
|
Exercisable
at September 30, 2018
|
575,312
|
$
5.30
|
7.2
|
$
5,114,851
|
The
total intrinsic value of stock options exercised during the three
months ended September 30, 2018 was $246,672 while the total
intrinsic value of stock options exercised during the nine months
ended September 30, 2018 was $404,273. The total intrinsic value of
stock options exercised during the three and nine months ended
September 30, 2017 was $32,960.
Stock Awards
During
the three months ended
September 30,
2018 and 2017
, the Company issued
5,184
and
14,489
shares, respectively, to
non-employee directors as compensation for their service on the
board. Such stock awards are immediately vested. During the nine
months ended
September 30, 2018 and
2017
, the Company issued
21,054
and
38,159
shares, respectively, to
non-employee directors as compensation for their service on the
board. Such stock awards are immediately vested.
Stock
awards are valued based on the closing price of our common stock on
the date of grant, and compensation cost is recorded on a
straight-line basis over the share vesting period. The total fair
value of stock awards granted, vested and expensed during the three
months ended
September 30, 2018 and
2017
was $57,457 and
$62,013
, respectively. The total fair value
of stock awards granted, vested and expensed during the nine months
ended
September 30, 2018 and
2017
was $143,268 and
$174,650
, respectively. As of
September 30, 2018
, there was no
unrecognized compensation cost related to stock awards. As of
September 30, 2018
, there was
no unrecognized compensation cost related to stock
awards.
Additionally,
during the three months ended September 30, 2018, the Company
issued 36,274 shares to a service provider to satisfy a
performance-based contractual arrangement. The Company recorded an
expense of approximately $509,000 associated with this issuance in
the third quarter of 2018. These shares were not issued from the
2010 Stock Incentive Plan.
Note 11:
Warrants
During
2014, the Company issued warrants to certain service providers. The
following table summarizes information about the Company’s
warrants at
September 30,
2018
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2017
|
80,000
|
7.81
|
2.1
|
33,660
|
|
|
|
|
|
Granted
|
-
|
-
|
|
|
Exercised
|
(50,000
)
|
7.81
|
|
|
Cancelled
|
-
|
$
-
|
|
|
Outstanding
at September 30, 2018
|
30,000
|
7.81
|
1.3
|
186,225
|
|
|
|
|
|
Exercisable
at September 30, 2018
|
30,000
|
7.81
|
1.3
|
186,225
|
Note 12: Commitments and Contingencies
Litigation
The
Company may from time to time be involved in legal proceedings
arising from the normal course of business. T
he Company is not currently a party to any
litigation of a material nature.
Operating Leases and Service Contracts
The Company currently rents its primary office facility under a
five-year lease which started in September 2016 (the “2016
Lease”). On April 18, 2018, the Company entered into a lease
for the Company’s new principal office (the “2018
Lease”) to lease approximately 25,000 square feet of office
space. The term of the 2018 Lease is ten years, beginning on,
November 1, 2018, the date in which the Company took possession of
and occupied the premises for normal business activities. The term
may be extended for an additional 5 years in incremental one-year
periods, subject to certain conditions described in the 2018 Lease.
Base rent for the first year of the 2018 Lease is approximately
$619,000, with increases in base rent occurring every two years. In
conjunction with the signing of the 2018 Lease, the Company has
agreed to assign the 2016 Lease to the landlord from the 2018 Lease
(the “Assignment”). If the landlord shall fail to pay
the 2016 Lease obligations under the Assignment, the Company will
be obligated to pay the obligations, but has a contractual right to
reduce its payments to the landlord related to the 2018 Lease by
equal amounts. In the below table of future contractual payments,
the Company has reflected the 2016 Lease through October 31, 2018
and the 2018 Lease thereafter, reflecting the approximate
commencement date of the 2018 Lease and Assignment of the 2016
Lease.
Most of the Company’s service contracts are on a
month-to-month basis, however, some contracts and agreements extend
out to longer periods. Future minimum lease payments and payments
due under non-cancelable service contracts are as follows as of
September 30, 2018:
Remainder
of 2018
|
$
248,244
|
2019
|
646,682
|
2020
|
623,009
|
2021
|
645,265
|
2022
|
649,717
|
2023
|
671,973
|
Thereafter
|
3,408,119
|
Total
|
$
6,893,009
|
Employment Agreements
The Company has employment agreements with several members of its
leadership team and executive officers.
Note 13: Disaggregation of Revenue
The Company operates as one reporting segment. Operating segments
are defined as components of an enterprise for which separate
financial information in regularly evaluated by the chief operating
decision makers (“CODM”), which is the Company’s
chief executive office, in deciding how to allocate resources and
assess performance. The Company does not present geographical
information about revenues because it is impractical to do so.
Disaggregated revenue for the three and nine months ended September
30, 2018 and 2017 are as follows:
|
|
|
|
|
|
|
|
|
|
|
Revenue
by Product:
|
|
|
|
|
Mail
+ Product Revenue
|
$
79,862
|
$
172,873
|
$
324,157
|
$
504,085
|
Marketing
Automation Revenue
|
4,793,467
|
3,238,707
|
13,176,124
|
9,177,348
|
Total
Revenue
|
$
4,873,329
|
$
3,411,580
|
$
13,500,281
|
$
9,681,433
|
|
|
|
|
|
Revenue
by Type:
|
|
|
|
|
Upfront
Fees
|
$
452,457
|
$
280,228
|
$
1,168,282
|
$
774,356
|
Recurring
Revenue
|
4,420,872
|
3,131,352
|
12,331,999
|
8,907,077
|
Total
Revenue
|
$
4,873,329
|
$
3,411,580
|
$
13,500,281
|
$
9,681,433
|
Note 14: Cash Flows
The
Statement of Cash Flows consists of cash flows from continuing
operations except for $1.0 million from investing activities for
the period ending September 30, 2017 noted on the face of the
Statement of Cash Flows. This cash flow is the receipt of an
escrowed accounts receivable related to the sale of a business in
2016 treated as a discontinued operation.