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,
2019.
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 functional currency of the Company’s foreign subsidiaries
is the local currency. Assets and liabilities denominated in a
foreign currency are translated into U.S. dollars at the exchange
rates in effect at the balance sheet dates; with the resulting
translation adjustments directly recorded to a separate component
of accumulated other comprehensive loss. Income and expense
accounts are translated at the average exchange rates during the
period. Foreign currency transaction gains and losses are recorded
in other comprehensive income (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 June 30, 2019 and December 31, 2018 was
a liability balance of zero and $214,350, respectively. The change
in fair value for the three months ended June 30, 2019 and 2018 was
a gain of $189,776 and a loss of $453,449, respectively. The change
in fair value for the six months ended June 30, 2019 and 2018 was a
gain of $214,350 and a loss of $453,449, respectively.
Accounts Receivable
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. 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 and is reflected as
such on the consolidated balance sheet.
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 June 30, 2019, and December 31, 2018, we had recorded
goodwill of $8,869,548 and $8,866,413, 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
Third-party costs associated with the issuance of debt are included
as a direct reduction to the carrying value of the debt, and are
amortized to interest expense ratably over the life of the
debt.
Income Taxes
Provisions
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 2015 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 June 30, 2019, 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 audits.
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 $149,015
and
$85,733
for the three
months ended June 30, 2019 and 2018, respectively. Depreciation
expense related to property and equipment was $281,018 and
$161,716
for the six months
ended June 30, 2019 and 2018, respectively. Repairs and maintenance
costs are expensed as incurred.
Property
and equipment as of June 30, 2019 and December 31, 2018 is as
follows:
|
|
|
|
|
|
|
|
|
Property
and equipment, gross:
|
|
|
|
Leasehold
improvements
|
$
263,518
|
$
197,268
|
|
Furniture
and fixtures
|
671,324
|
611,171
|
|
Computer
equipment and software
|
1,632,723
|
1,135,012
|
|
Total
|
2,567,565
|
1,943,451
|
|
Less:
Accumulated depreciation and amortization
|
(975,682
)
|
(682,653
)
|
|
|
$
1,591,883
|
$
1,260,798
|
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 reliably measured. 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 June 30, 2019 and 2018 revenue from
contracts with customers was $5.5 million and $4.4 million,
respectively. For the six months ended June 30, 2019 and 2018
revenue from contracts with customers was $10.8 million and $8.6
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 fee charged each month 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 onboarding and training
fee. The upfront onboarding 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 (unbilled receivables) and
contract liabilities (deferred revenue). Contract assets occur due
to unbilled charges for which the Company has satisfied performance
obligations. Contract liabilities occur due to billing up front for
charges that the Company has not yet fully satisfied all
performance obligations. 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 have a predefined service period and are
therefore satisfied over that 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 to evaluate 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
initial implementation and availability and use of the SharpSpring
platform. Remaining implementation obligations typically are
provided over a period of 30 days or less as of the balance sheet
date. Remaining obligations of availability of the platform are
provided over a period ranging from less than 30 days to 12 months
as of the balance sheet date.
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 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, the deferred revenue
is recognized over that service period. Deferred revenue balances
were $250,656 and $279,818 as of December 31, 2018 and 2017,
respectively. Deferred revenue during the three months ended June
30, 2019 and 2018 increased by $27,791 and $15,582, respectively.
Deferred revenue during the six months ended June 30, 2019 and 2018
increased by $66,420 and $38,768, respectively. The Company had
deferred revenue contract liability balances of $317,077 and
$250,656 as of June 30, 2019 and December 31, 2018, respectively.
The Company expects to recognize a majority of the revenue on of
these remaining performance obligations within 12 months.
Approximately 12% of the deferred revenue balance is related to
prepaid credits. These credits are recognized as they are used. The
Company expects to recognize approximately half of the remaining
credits 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 an unbilled receivable. A
portion of our revenue is therefore unbilled at each period. The
accrued revenue balances were $740,425 and $554,603 as of December
31, 2018 and 2017, respectively.
Revenue billed that was included in accrued
revenue at the beginning of the period for the three months ending
June 30, 2019 and 2018 was $832,593 and $628,497, respectively.
Revenue billed that was included in accrued revenue at the
beginning of the period for the six months ending June 30, 2019 and
2018 was $740,425 and $554,603, respectively. Accrued revenue not
billed in the three and six months ending June 30, 2019 and 2018
was $880,333 and $646,452, respectively. The Company had accrued
revenue balances of $880,333 and $740,425 as of June 30, 2019 and
December 31, 2018, 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
June 30, 2019 and December 31, 2018, 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, customer onboarding, account management, 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
$1,487,642
and
$1,294,274
for the three months ended June
30, 2019 and 2018, respectively. Advertising and marketing
expenses, excluding marketing team costs, were
$3,031,218
and
$2,743,701
for the six months ended June
30, 2019 and 2018, 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 that are not incremental, such as other
sales and marketing costs and costs that would be incurred
regardless of a contract being 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 June 30, 2019, the net carrying value of the
capitalized cost of obtaining a contract was
$1,241,372
, of which
$691,996
is included in other current
assets and
$549,376
is included
in other long-term assets. At December 31, 2018, the net carrying
value of the capitalized cost of obtaining a contract was
$1,309,329
, of which
$699,159
is included in other
current assets and
$610,170
is
included in other long-term assets. The Company amortized expenses
for the costs of obtaining contracts of
$228,812
and
$185,701
for the three months ended June
30, 2019 and 2018, respectively. The Company amortized expenses for
the costs of obtaining contracts of
$431,757
and
$363,239
for the six months ended June 30,
2019 and 2018, respectively.
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. The company also provides
stock-based compensation to non-employee directors which are
treated as employees for the purposes stock-based compensation in
accordance with ASC 718.
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
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
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. The guidance became effective for the Company on
January 1, 2019. The Company is using the modified retrospective
transition method which allows the Company to recognize and measure
leases as of the adoption date, January 1, 2019, with the
cumulative impact being reflected in the opening balance of
retained earnings. The application of the modified retrospective
transition was applied to all active leases at the date of initial
application. There was no impact to the Company’s retained
earnings for the implementation of this accounting standard. The
following tables presents the cumulative impact to our financial
statements upon adoption.
|
|
Impact upon adoption of new ASU
|
|
As
of January 1, 2019
|
|
|
Right-of-use
assets
|
5,715,510
|
|
Total
Assets
|
$
5,715,510
|
|
|
|
|
Accrued expenses
and other current liabilities
|
$
(8,821
)
|
|
Lease liability
(current)
|
344,883
|
|
Lease liability
(non-current)
|
5,379,448
|
|
Total
Liabilities
|
$
5,715,510
|
Note 3: Goodwill and Other Intangible Assets
Intangible assets are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized
intangible assets:
|
|
|
|
|
Trade
names
|
$
120,000
|
(120,000
)
|
$
-
|
|
Technology
|
2,130,000
|
(1,073,000
)
|
1,057,000
|
|
Customer
relationships
|
4,113,939
|
(3,495,439
)
|
618,500
|
|
Unamortized
intangible assets:
|
6,363,939
|
(4,688,439
)
|
1,675,500
|
|
Goodwill
|
|
|
8,869,548
|
|
Total
goodwill and intangible assets
|
|
|
$
10,545,048
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized
intangible assets:
|
|
|
|
|
Trade
names
|
$
120,000
|
(120,000
)
|
$
-
|
|
Technology
|
2,130,000
|
(954,000
)
|
1,176,000
|
|
Customer
relationships
|
4,100,014
|
(3,410,014
)
|
690,000
|
|
Unamortized
intangible assets:
|
6,350,014
|
(4,484,014
)
|
1,866,000
|
|
Goodwill
|
|
|
8,866,413
|
|
Total
goodwill and intangible assets
|
|
|
$
10,732,413
|
Estimated amortization expense for the remainder of 2019 and
subsequent years is as follows:
|
Remainder
of 2019
|
190,500
|
|
2020
|
332,000
|
|
2021
|
280,000
|
|
2022
|
228,000
|
|
2023
|
180,000
|
|
2024
|
141,000
|
|
Thereafter
|
324,000
|
|
Total
|
$
1,675,500
|
Amortization expense for the three months ended June 30, 2019 and
2018 was $95,250 and $115,000, respectively.
Amortization expense for the six months ended June 30, 2019 and
2018 was $190,500 and $230,000, 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. As of June 30, 2019, the credit facility carried an
interest rate of 7.25%. 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 have occurred.
Note 5: Convertible Notes
On
March 28, 2018, we issued $8.0 million in aggregate principal
amount of convertible notes (the “Note”). 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”, and together with Note, the
“Notes”). The principal amount of the Notes 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 Notes 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 Notes 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 was zero of June 30, 2019. The derivative is
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.
On May
9, 2019, the Company entered into and made effective a Note
Conversion Agreement (the “Conversion Agreement”) with
SHSP Holdings, LLC (“SHSP Holdings”) and Evercel
Holdings, LLC (“Evercel,” and together with SHSP
Holdings, the “Investor”), pursuant to which the
parties agreed to the conversion (the “Conversion”) of
the Notes. The Company’s entry into the Conversion Agreement
was unanimously approved by the disinterested members of the
Company’s Board of Directors.
Under
the Conversion Agreement, the Notes were deemed to have been
converted into the Conversion Shares, and any interest in any
amount ceased to accrue or be payable with respect to the Notes,
and SHSP Holdings ceases to be a holder of any Notes, and the Notes
cease to be outstanding, for purposes of the Investors’
Rights Agreement dated as of March 28, 2018. Effective as of the
issuance and delivery of the Conversion Shares to SHSP Holdings,
the Notes were canceled and terminated in their entirety and of no
further force and effect, and any and all indebtedness and other
obligations of the Company under the Notes was fully performed and
discharged, and any and all claims or rights of SHSP Holdings or
its affiliates thereunder were fully and finally extinguished and
released. Additionally, under the terms of the Conversion Agreement
the Company agreed to pay in shares 49% of the remaining future
interest totaling 115,037 shares. As a result of accelerating the
49% of future interest along with the extinguishment of the
convertible notes, the Company incurred a loss on conversion of
debt of $2.2 million. The loss was measured as the excess fair
value of the shares issued under the modified conversion, compared
to fair value of the shares that would have been issued under an
unmodified conversion as of the measurement date. Level 1 inputs
were used to determine the fair value of the shares paid to the
Investor. The loss on conversion was partially offset by a gain of
$189,776 from the write-off of the embedded derivative
liability.
The net
carrying amount of the Notes at June 30, 2019 was as
follows:
|
|
|
|
|
|
|
|
|
Principal
amount
|
$
-
|
$
8,000,000
|
|
Accrued
interest paid-in-kind
|
-
|
304,301
|
|
Unamortized
debt issuance costs
|
-
|
(122,153
)
|
|
Unamortized
embedded derivative
|
-
|
160,278
|
|
Net
carrying value
|
$
-
|
$
8,342,426
|
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 three and six month ended June 30, 2019 and
2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractual
interest paid-in-kind expense (non-cash)
|
$
43,373
|
$
100,000
|
$
139,372
|
$
104,301
|
|
Amortization
of debt issuance costs (non-cash)
|
4,698
|
6,359
|
15,108
|
6,632
|
|
Amortization
of embedded derivative (non-cash)
|
(3,795
)
|
-
|
(12,205
)
|
-
|
|
Total
interest expense
|
$
44,276
|
$
106,359
|
$
142,275
|
$
110,933
|
|
Effective
interest rate
|
4.9
%
|
5.3
%
|
4.9
%
|
5.3
%
|
Note 6:
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
|
$
(4,238,190
)
|
$
(2,466,233
)
|
$
(7,132,035
)
|
$
(4,518,176
)
|
|
|
|
|
|
|
|
Basic
weighted average common shares outstanding
|
10,296,041
|
8,474,616
|
9,568,161
|
8,459,036
|
|
Add
incremental shares for:
|
|
|
|
|
|
Warrants
|
-
|
-
|
-
|
-
|
|
Stock
options
|
-
|
-
|
-
|
-
|
|
Convertible
notes
|
-
|
-
|
-
|
-
|
|
Diluted
weighted average common shares outstanding
|
10,296,041
|
8,474,616
|
9,568,161
|
8,459,036
|
|
|
|
|
|
|
|
Net
loss per share:
|
|
|
|
|
|
Basic
|
$
(0.41
)
|
$
(0.29
)
|
$
(0.75
)
|
$
(0.53
)
|
|
Diluted
|
$
(0.41
)
|
$
(0.29
)
|
$
(0.75
)
|
$
(0.53
)
|
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
|
-
|
44,000
|
|
Stock
options
|
1,337,486
|
1,483,566
|
|
Convertible
notes
|
-
|
1,080,573
|
Note 7:
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 June 30, 2019 and 2018, the Company recorded
income tax expense of $787 and income tax benefit of $294,543,
respectively, from continuing operations. During the six months
ended June 30, 2019 and 2018, the Company recorded income tax
expense of $3,126 and income tax benefit of $252,546, respectively,
from continuing operations. The blended effective tax rate for the
six months ending June 30, 2019 and 2018 was -0.1% and 5.3%,
respectively. The effective blended tax rate varies from our
statutory U.S. tax rate due to valuation allowances on losses and
income generated in certain other jurisdictions at various tax
rates.
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 June
30, 2019 and December 31, 2018, we have established a valuation
allowance of $5.9 million and $4.3 million, respectively, against
certain deferred tax assets given the uncertainty of recoverability
of these amounts.
Note 8: 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 99%
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 $
82,047
and
$61,586
to expense in the three months
ended June 30, 2019 and 2018, respectively, associated with our
matching contribution in those periods. We charged $
151,209
and
$121,924
to expense in the three months
ended June 30, 2019 and 2018, respectively, associated with our
matching contribution in those periods.
Note 9: 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 “2010 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.
In
April 2019, the Company adopted the 2019 Equity Incentive Plan (the
“2019 Plan”). No more than 697,039 shares of common
stock, plus the number of shares common stock underlying any award
granted under the 2010 Plan that expires, terminates, is canceled,
or is forfeited shall be available for grant under the 2019 Plan.
The Plan provides for the issuance of stock options and other
stock-based awards. During the terms of the Awards, the Company
shall keep available at all times the number of shares of Common
Stock required to satisfy such Awards.
Stock Options
Stock
option awards under the 2010 Plan and 2019 Plan (the
“Plans”) 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
Plans are 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 Plans 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:
|
|
Six Months Ended
June 30,
|
|
|
2019
|
|
2018
|
|
|
|
|
|
|
Volatility
|
49% - 50%
|
|
48% - 49%
|
|
Risk-free interest rate
|
2.27% - 2.59%
|
|
2.34% - 2.84%
|
|
Expected term
|
6.25 years
|
|
6.25 years
|
The
weighted average grant date fair value of stock options granted
during the six months ended
June 30,
2019 and 2018
was
$7.26
and
$2.34
,
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
June 30, 2019 and 2018
, the
Company recognized expense of $224,654
and $189,344
, respectively, associated with
stock option awards. During the six months ended
June 30, 2019 and 2018
, the Company
recognized expense of $493,699
and
$382,879
, respectively, associated with stock option awards.
At
June 30, 2019
, future stock
compensation expense associated with stock options (net of
estimated forfeitures) not yet recognized was $2,665,958 and will
be recognized over a weighted average remaining vesting period of
3.1 years. The following summarizes stock option activity for the
six months ended June 30, 2019:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2018
|
1,654,522
|
$
6.07
|
8.2
|
$
10,866,658
|
|
|
|
|
|
|
|
Granted
|
65,794
|
14.36
|
|
|
|
Exercised
|
(180,392
)
|
5.03
|
|
|
|
Expired
|
(1,198
)
|
5.18
|
|
|
|
Forfeited
|
(201,240
)
|
4.97
|
|
|
|
Outstanding
at June 30, 2019
|
1,337,486
|
$
6.79
|
7.7
|
$
8,392,981
|
|
|
|
|
|
|
|
Exercisable
at June 30, 2019
|
647,803
|
$
5.02
|
6.8
|
$
5,162,212
|
The
total intrinsic value of stock options exercised during the three
months ended June 30, 2019 and 2018 were $698,813 and $157,036,
respectively. The total intrinsic value of stock options exercised
during the six months ended June 30, 2019 and 2018 were $1,888,805
and $157,601, respectively.
Stock Awards
During
the three months ended
June 30, 2019
and 2018
, the Company issued 1,952 and 6,915 shares,
respectively, to non-employee directors as compensation for their
service on the board. During the six months ended
June 30, 2019 and 2018
, the Company issued
4,356 and 15,870 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
June 30, 2019 and
2018
was $37,420 and
$49,462
, respectively. The total fair value
of stock awards granted, vested and expensed during the six months
ended
June 30, 2019 and 2018
was $71,893 and
$93,341
,
respectively. As of
June 30,
2019
, there was no unrecognized compensation cost related to
stock awards.
Note 10:
Warrants
During
2014, the Company issued warrants to certain service providers. The
following table summarizes information about the Company’s
warrants at
June 30,
2019
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2018
|
30,000
|
$
7.81
|
1.1
|
$
144,525
|
|
|
|
|
|
|
|
Granted
|
-
|
-
|
|
|
|
Exercised
|
(30,000
)
|
7.81
|
|
|
|
Cancelled
|
-
|
-
|
|
|
|
Outstanding
at June 30, 2019
|
-
|
$
-
|
-
|
$
-
|
|
|
|
|
|
|
|
Exercisable
at June 30, 2019
|
-
|
$
-
|
-
|
$
-
|
Note 11: Commitments and Contingencies
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. The Company has employment
agreements with several members of its leadership team and
executive officers. The Company is not party to any non-cancellable
contracts that create a material future commitment other than its
lease as described in Note 12.
Note 12: Leases
The Company currently rents its primary office facility under a
ten-year lease which started in November 2018 (the “2018
Lease”). The term of the lease may be extended for an
additional 5 years in incremental one-year periods, subject to
certain conditions described in the 2018 Lease. In June 2019, the
Company entered into an addendum agreement to the 2018 Lease (the
“2019 Addendum”) to lease an additional approximately
18,000 square feet of office space located on the same premises as
the 2018 Lease. The term of the addendum extends through the same
period as the 2018 Lease. The base rent for the first full year of
the 2019 addendum is approximately $395,000. We do not assume
renewals in our determination of lease term unless the renewals are
deemed to be reasonably assured at lease commencement. At the
commencement of the 2018 lease, renewal was not reasonably assured.
Determination of whether a contract contains a lease is determined
at execution of the contract based on the facts of each contract.
The Company elected the package of practical expedients permitted
under ASC 842 which allows us to carryforward historical lease
classification, assessment on whether a contract was or contains a
lease, and initial direct costs for any leases that existed prior
to adoption of the standard. We have also elected to utilize
practical expedients to combine lease and non-lease components and
to not include on the balance sheet leases with an initial term of
12 months or less (“short-term leases”). Short-term
lease payments are recognized in the consolidated statements of
income on a straight-line basis over the lease term. These
practical expedients apply to all of SharpSpring’s operating
leases. The Company is not party to any financing
lease.
The weighted average remaining lease term as of June 30, 2019 is
9.3 years. The weighted average discount rate for our operating
leases as of June 30, 2019 is 6.5%. The discount rate of each lease
is determined by the company’s incremental borrowing rate at
the time of a lease contract. The lease cost associated with
short-term leases for the three months ended June 30, 2019 and 2018
were zero and $19,290 respectively. The lease cost associated with
short-term leases for the six months ended June 30, 2019 and 2018
were zero and $37,941 respectively.
Future minimum lease payments are as follows as of June 30,
2019:
|
|
|
|
Remainder
of 2019
|
$
369,119
|
|
2020
|
742,956
|
|
2021
|
766,546
|
|
2022
|
771,278
|
|
2023
|
794,937
|
|
Thereafter
|
4,020,754
|
|
Total
undiscounted cash flows
|
$
7,465,591
|
|
Less
imputed interest
|
(1,926,835
)
|
|
Present
value of lease liability
|
$
5,538,756
|
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 six months ended June 30,
2019 and 2018 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
by Product:
|
|
|
|
|
|
Marketing
Automation Revenue
|
5,450,837
|
4,319,158
|
10,712,920
|
8,382,657
|
|
Mail
+ Product Revenue
|
$
66,596
|
$
123,131
|
$
130,798
|
$
244,295
|
|
Total
Revenue
|
$
5,517,433
|
$
4,442,289
|
$
10,843,718
|
$
8,626,952
|
|
|
|
|
|
|
|
Revenue
by Type:
|
|
|
|
|
|
Recurring
Revenue
|
5,124,370
|
4,072,001
|
9,992,519
|
7,925,832
|
|
Upfront
Fees
|
$
393,063
|
$
370,288
|
$
851,199
|
$
701,120
|
|
Total
Revenue
|
$
5,517,433
|
$
4,442,289
|
$
10,843,718
|
$
8,626,952
|