SharpSpring (SHSP) 10-Q 2017 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2017
Or
[  ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-36280

SharpSpring, Inc.

(Exact name of registrant as specified in its charter)

Delaware	05-0502529
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

550 Southwest 2nd Avenue Gainesville, FL	32601
(Address of principal executive offices)	(Zip Code)

888-428-9605

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:

Large accelerated filer [  ]	Accelerated filer [  ]
Non-accelerated filer [  ]	Smaller reporting company [X]
(Do not check if a smaller reporting company)	Emerging growth company [  ]

If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes [  ] No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 8,433,581 shares of common stock as of November 9, 2017.

SharpSpring, Inc.

Table of Contents

	Page
PART I – FINANCIAL INFORMATION	1
Item 1. Financial Statements:	2
Consolidated Balance Sheets— September 30, 2017 (unaudited) and December 31, 2016	2
Consolidated Statements of Comprehensive Income (Loss) (unaudited)	3
Consolidated Statements of Cash Flows (unaudited)	4
Notes to the Consolidated Financial Statements (unaudited)	5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3. Quantitative and Qualitative Disclosures About Market Risk	24
Item 4. Controls and Procedures	24
PART II – OTHER INFORMATION	25
Item 1. Legal Proceedings.	25
Item 1A. Risk Factors.	25
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	25
Item 3. Defaults Upon Senior Securities	25
Item 4. Mine Safety Disclosures	25
Item 5. Other Information.	25
Item 6. Exhibits	26
SIGNATURES	27

i

PART I – FINANCIAL INFORMATION

Forward-Looking Information

This report on Form 10-Q contains forward-looking statements. Forward-looking statements involve risks and uncertainties, such as statements about our plans, objectives, expectations, assumptions or future events. In some cases, you can identify forward-looking statements by terminology such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “we believe,” “we intend,” “may,” “should,” “will,” “could” and similar expressions denoting uncertainty or an action that may, will or is expected to occur in the future. These statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from any future results, performances or achievements expressed or implied by the forward-looking statements.

Examples of forward-looking statements include:

● the timing of the development of future products;

● projections of costs, revenue, earnings, capital structure and other financial items;

● statements of our plans and objectives;

● statements regarding the capabilities of our business operations;

● statements of expected future economic performance;

● statements regarding competition in our market; and

● assumptions underlying statements regarding us or our business.

Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:

● strategic actions, including acquisitions and dispositions and our success in integrating acquired businesses;

● changes in customer demand;

● the extent to which we are successful in gaining new long-term relationships with customers or retaining existing ones and the level of service failures that could lead customers to use competitors’ services;

● the occurrence of hostilities, political instability or catastrophic events;

● developments and changes in laws and regulations, including increased regulation of our industry through legislative action and revised rules and standards; and

● disruptions to our technology network including computer systems and software, as well as natural events such as severe weather, fires, floods and earthquakes or man-made or other disruptions of our operating systems, structures or equipment.

The ultimate correctness of these forward-looking statements depends upon a number of known and unknown risks and events. We discuss our known material risks under Item 1.A “Risk Factors” contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. Many factors could cause our actual results to differ materially from the forward-looking statements. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

The forward-looking statements speak only as of the date on which they are made, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.

1

Item 1. Financial Statements.

SharpSpring, Inc.

CONSOLIDATED BALANCE SHEETS

	September 30, 2017			December 31, 2016
	(unaudited)			(audited)
Assets
Cash and cash equivalents	$	6,316,883		$	8,651,374
Accounts receivable, net of allowance for doubtful accounts of $459,923 and $508,288 at September 30, 2017 and December 31, 2016, respectively		687,491			1,261,923
Income taxes receivable		2,043,479			1,355,180
Other current assets		298,801			1,396,642
Total current assets		9,346,654			12,665,119
Property and equipment, net		843,606			905,345
Goodwill		8,870,649			8,845,394
Other intangible assets, net		2,458,128			2,850,635
Deferred income taxes		34,732			32,996
Deposits and other		26,022			30,464
Total assets	$	21,579,791		$	25,329,953
Liabilities and Shareholders’ Equity
Accounts payable	$	887,474		$	498,534
Accrued expenses and other current liabilities		575,406			953,171
Deferred revenue		276,673			280,159
Income taxes payable		448,694			484,349
Total current liabilities		2,188,247			2,216,213
Deferred income taxes		287,434			195,495
Total liabilities		2,475,681			2,411,708
Commitments and contingencies (Note 15)
Shareholders’ equity:
Preferred stock, $0.001 par value, 5,000,000 shares authorized, no shares issued or outstanding at September 30, 2017 and December 31, 2016		-			-
Common stock, $0.001 par value,  Authorized shares-50,000,000; issued shares-8,433,229 at September 30, 2017 and 8,380,663 at December 31, 2016; outstanding shares-8,413,229 at September 30, 2017 and 8,360,663 at December 31, 2016		8,433			8,381
Additional paid in capital		28,134,643			27,556,398
Accumulated other comprehensive income loss		(365,945	)		(445,055	)
Accumulated deficit		(8,589,021	)		(4,117,479	)
Treasury stock		(84,000	)		(84,000	)
Total shareholders’ equity		19,104,110			22,918,245
Total liabilities and shareholders’ equity	$	21,579,791		$	25,329,953

See accompanying notes to the consolidated financial statements.

2

SharpSpring, Inc.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2017			2016			2017			2016
Revenue	$	3,411,580		$	3,010,307		$	9,681,433		$	8,688,723
Cost of services		1,210,088			1,269,473			3,776,353			3,350,996
Gross profit		2,201,492			1,740,834			5,905,080			5,337,727
Operating expenses:
Sales and marketing		1,801,701			1,445,152			5,025,539			4,084,446
Research and development		703,392			612,117			2,094,309			1,651,809
General and administrative		1,353,972			1,232,996			3,941,877			3,171,052
Change in earn out liability		-			-			-			219,473
Intangible asset amortization		132,298			298,823			395,690			1,068,839
Total operating expenses		3,991,363			3,589,088			11,457,415			10,195,619
Operating loss		(1,789,871	)		(1,848,254	)		(5,552,335	)		(4,857,892	)
Other income (expense), net		(2,708	)		105,104			75,895			474,983
Loss before income taxes		(1,792,579	)		(1,743,150	)		(5,476,440	)		(4,382,909	)
Benefit for income tax		(111,059	)		(519,293	)		(1,004,899	)		(1,334,800	)
Net loss from continuing operations		(1,681,520	)		(1,223,857	)		(4,471,541	)		(3,048,109	)
Net income from discontinued operations, net of tax		-			-			-			10,187,451
Net (loss) income	$	(1,681,520	)	$	(1,223,857	)	$	(4,471,541	)	$	7,139,342
Net loss per share from continuing operations
Basic net loss per share	$	(0.20	)	$	(0.15	)	$	(0.53	)	$	(0.39	)
Diluted net loss per share	$	(0.20	)	$	(0.15	)	$	(0.53	)	$	(0.39	)
Net income per share from discontinued operations
Basic net income per share	$	-		$	-		$	-		$	1.32
Diluted net income per share	$	-		$	-		$	-		$	1.32
Net (loss) income per share
Basic net (loss) income per share	$	(0.20	)	$	(0.15	)	$	(0.53	)	$	0.92
Diluted net (loss) income per share	$	(0.20	)	$	(0.15	)	$	(0.53	)	$	0.92
Shares used in computing basic net (loss) income per share		8,399,920			8,345,750			8,383,639			7,741,351
Shares used in computing diluted net (loss) income per share		8,399,920			8,345,750			8,383,639			7,741,351
Other comprehensive income (loss):
Foreign currency translation adjustment		59,633			(64,470	)		79,110			(154,735	)
Comprehensive (loss) income	$	(1,621,887	)	$	(1,288,327	)	$	(4,392,431	)	$	6,984,607

See accompanying notes to the consolidated financial statements.

3

SharpSpring, Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine Months Ended
	September 30,
	2017			2016
Cash flows from operating activities:
Net (loss) income	$	(4,471,541	)	$	7,139,342
Deduct: Income from discontinued operations, net of income taxes		-			10,187,451
Net loss from continuing operations		(4,471,541	)		(3,048,109	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		602,780			1,169,043
Non-cash stock compensation		559,437			499,763
Deferred income taxes		24,775			(82,974	)
Loss on disposal of property and equipment		3,481			128,978
Non-cash change in value of earn out liability		-			219,473
Non-cash gain from escrow claim		-			(84,000	)
Unearned foreign currency gain/loss		52,346			(159,089	)
Changes in operating assets and liabilities:
Accounts receivable		618,140			(301,602	)
Other assets		103,345			(334,641	)
Income taxes, net		(680,297	)		(3,369,621	)
Accounts payable		366,469			120,660
Accrued expenses and other current liabilities		(323,378	)		379,324
Deferred revenue		(13,093	)		(228,472	)
Net cash used in operating activities - Continuing operations		(3,157,536	)		(5,091,267	)
Net cash provided by operating activities - Discontinued operations		-			785,830
Net cash used in operating activities		(3,157,536	)		(4,305,437	)
Cash flows from investing activities:
Purchases of property and equipment		(148,555	)		(442,231	)
Acquisitions of customer assets from resellers		(64,268	)		(548,278	)
Net cash used in investing activities - Continuing operations		(212,823	)		(990,509	)
Net cash provided by investing activities - Discontinued operations		1,000,000			13,945,548
Net cash provided by investing activities		787,177			12,955,039
Cash flows from financing activities:
Payment to reduce earn out		-			(1,207,929	)
Proceeds from exercise of stock options		18,859			1,125
Net cash provided by (used in) financing activities - Continuing operations		18,859			(1,206,804	)
Net cash provided by financing activities - Discontinued operations		-			-
Net cash provided by (used in) financing activities		18,859			(1,206,804	)
Effect of exchange rate on cash		17,009			14,730
Change in cash and cash equivalents		(2,334,491	)		7,457,528
Cash and cash equivalents, beginning of period		8,651,374			4,158,646
Cash and cash equivalents, end of period	$	6,316,883		$	11,616,174
Supplemental information on consolidated statements of cash flows:
Cash paid for income taxes	$	98,637		$	2,575,577
Supplemental information on non-cash investing and financing activities:
Receipt of common stock for escrow claim	$	-		$	84,000
Settlement of earn out liabilities with common stock	$	-		$	(4,207,929	)
Other receivable created for sale of SMTP email relay business	$	-		$	(1,000,000	)

See accompanying notes to the consolidated financial statements.

4

SharpSpring, Inc.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1: Organization

We were incorporated in Massachusetts in October 1998 as EMUmail, Inc. During 2010, we changed our name to SMTP.com, then later reincorporated in the State of Delaware and changed our name to SMTP, Inc. In December 2015, we changed our name to SharpSpring, Inc. and changed the name of our SharpSpring product U.S. operating subsidiary from SharpSpring, Inc. to SharpSpring Technologies, Inc.

In June 2016, we sold the assets related to our SMTP email relay product to the Electric Mail Company, a Nova Scotia company. See Note 5 for details of this disposition.

Our Company focuses on providing the SharpSpring 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. Prior to June 27, 2016, our Company also provided cloud-based email relay delivery services to its customers.

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, 2017.

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, South African Rand and British Pound 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.

5

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 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.

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. The Company had an allowance for doubtful accounts of $459,923 and $508,288 as of September 30, 2017 and December 31, 2016, respectively. After the Company has exhausted all collection efforts, the outstanding receivable is written off against the allowance.

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, 2017 and December 31, 2016, we had recorded goodwill of $8,870,649 and $8,845,394, 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 (See Note 3). Under FASB 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.

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 IncomeTaxes. 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.

6

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 2012 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, 2017, the Company is not being examined by domestic or foreign tax authorities.

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 from continuing operations related to property and equipment was $71,899 and $56,004 for the three months ended September 30, 2017 and 2016, respectively. Depreciation expense from continuing operations related to property and equipment was $207,090 and $97,549 for the nine months ended September 30, 2017 and 2016, respectively.

Property and equipment as of September 30, 2017 and December 31, 2016 is as follows:

	September 30, 2017			December 31, 2016
Property and equipment, net:
Leasehold improvements	$	128,122		$	128,122
Furniture and fixtures		355,050			316,819
Computer equipment and software		717,429			641,722
Construction in progress		30,236			-
Total		1,230,837			1,086,663
Less: Accumulated depreciation and amortization		(387,231	)		(181,318	)
	$	843,606		$	905,345

Useful lives are as follows:

Leasehold improvements	3-5 years
Furniture and fixtures	3-5 years
Computing equipment	3 years
Software	3-5 years

7

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. This is normally demonstrated when: (i) persuasive evidence of an arrangement exists; (ii) the fee is fixed or determinable; (iii) performance of service has been delivered; and (iv) collection is reasonably assured.

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 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, 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 60 days.

For the Company’s SMTP email delivery product (prior to its sale in June 2016), the Company’s GraphicMail email product (which was discontinued in 2016) and the SharpSpring Mail+ product, services are provided over various contractual periods for a fixed fee that varies based on a maximum volume of transactions. Revenue is recognized on a straight-line basis over the contractual period. If the customer’s transactions exceed contractual volume limitations, overages are charged and recorded as revenue in the periods in which the transaction overages occur.

Prior to June 2016, certain of the Company’s GraphicMail customers were sold through third party resellers. In some cases, we allowed the third party resellers to collect the funds directly from the customer, withhold their own reseller fee, and remit the net amount owed back to the Company. In those situations, because the Company was the primary obligor in the arrangement, the Company recorded the gross revenue and expenses such that 100% of the end customer revenue was reported by the Company and a corresponding expense was recorded for the reseller fee. The Company discontinued selling through third party resellers for the GraphicMail and SharpSpring Mail+ products during 2016.

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

Some of the Company’s customers pay for services in advance on a periodic basis (such as monthly, quarterly, annually or bi-annually). Also, the Company charges an upfront implementation and training fee for its SharpSpring marketing automation solution that is paid in advance, for which services are performed over a 60-day period. Deferred revenue consists of payments received in advance of the Company’s providing the services. Deferred revenues are amortized on a straight-line basis in connection with the contractual period or recorded as revenue when the services are used.

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. A portion of our accounts receivable balance is therefore unbilled at each balance sheet date.

Concentration of Credit Risk and Significant Customers

Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash, cash equivalents. At September 30, 2017 and December 31, 2016, 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.

For the three and nine months ended September 30, 2017 and 2016, there were no customers that accounted for more than 10% of total revenue or 10% of total accounts receivable.

8

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 from continuing operations was $831,642 and $500,735 for the three months ended September 30, 2017 and 2016, respectively. Advertising and marketing expenses from continuing operations was $2,174,590 and $1,178,308 for the nine months ended September 30, 2017 and 2016, respectively.

Research and Development Costs and Capitalized Software Costs

We capitalize certain costs associated with internal use software during the application development stage, mostly related to software that we use in providing our hosted solutions. We expense costs associated with preliminary project phase activities, training, maintenance and any post-implementation period costs as incurred. For the three months ended September 30, 2017 and 2016, we capitalized $10,537 and zero, respectively, in software development costs. For the nine months ended September 30, 2017 and 2016, we capitalized $44,475 and $6,642, respectively, in software development costs. We amortize capitalized software costs over the estimated useful life of the software, which is typically estimated to be 3 years, once the related project has been completed and deployed for customer use. At September 30, 2017 and December 31, 2016, the net carrying value of capitalized software was $82,487 and $78,005, respectively.

All other software development costs are charged to expenses when incurred, and generally consist of salaries, software development tools and personnel-related costs for those engaged in research and development activities.

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 Income (Loss) Per Share

Basic net income (loss) per share is computed using the weighted average number of common shares outstanding during the period. Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period.

Comprehensive Income or 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.

9

In March 2016, the Financial Accounting Standards Board (“FASB”) issued guidance that changes the accounting for certain aspects of share-based payments to employees. The guidance requires the recognition of the income tax effects of awards in the income statement when the awards vest or are settled, thus eliminating additional paid-in capital pools. The guidance also allows for the employer to repurchase or sell more shares than required under local statutory regulation without triggering liability accounting. In addition, the guidance allows for a policy election to account for forfeitures as they occur rather than on an estimated basis. The guidance was effective January 2017. The impact of adopting ASU 2016-09 was not material to the 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. 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 May 2014, the FASB issued updated guidance and disclosure requirements for recognizing revenue. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In July 2015, the FASB approved the deferral of the new standard’s effective date by one year. The new standard now is effective for annual reporting periods beginning January 1, 2018. The FASB will permit companies to adopt the new standard early, but not before the original effective date of January 1, 2017. The Company is currently completing its evaluation of this guidance, but does not expect any material changes in revenue or cost recognized as a result of this pronouncement due to the month-to-month nature of its revenue arrangements.

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.

Note 3: Acquisitions

During 2014, the Company pursued strategic acquisitions to further extend its product offerings. Such acquisitions have been accounted for as business combinations pursuant to ASC 805 “Business Combinations.” Under this ASC, acquisition and integration costs are not included as components of consideration transferred, but are accounted for as expenses in the period in which the costs are incurred.

SharpSpring

On August 15, 2014, the Company acquired substantially all the assets and assumed the liabilities of SharpSpring LLC, a Delaware limited liability company for a cash payment of $5,000,000 plus potential earn out consideration of $10,000,000 that was contingent on the SharpSpring product achieving certain levels of revenue in 2015. SharpSpring is a cloud-based marketing automation platform that enables users to improve the effectiveness of their marketing communications and drive increased revenues through the use of automation.

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The SharpSpring earn out was initially $10,000,000, payable 60% in cash and 40% in stock, depending on SharpSpring achieving certain revenue levels in 2015. At the time of the acquisition, the Company utilized the income approach to estimate the fair value of the earn out. The Company analyzed scenarios and determined a probability weighting for each scenario. The Company calculated the earn out payments based on the respective revenues for each scenario and then weighted the resulting payment by the probabilities of achieving each scenario. In order to calculate an appropriate risk-adjusted discount rate for the earn out, the Company calculated the weighted average cash-flows of the business based on the three scenarios and their respective weightings. The Company then calculated an implied internal rate of return (“IRR”) of 18.9%, which is the discount rate necessary in order to reconcile the weighed cash-flows of the three scenarios to the total purchase price including the earn out payment. The earn out payment was then discounted by the 18.9% IRR. Based on these methods and the Company’s original assessment of meeting those revenue levels in 2015, an earn out liability of $6,963,000 was originally recorded as a liability during purchase accounting. This was re-measured in each subsequent quarter since the transaction, resulting in additional charges of $222,000 during the nine months ended September 30, 2016 having been recorded on the Consolidated Statement of Comprehensive Income (Loss). The final payments against the earn out of $1.0 million in cash and $4.0 million in common stock occurred in the quarter ended June 30, 2016.

GraphicMail

On October 17, 2014, we acquired 100% of the equity interest owned, directly or indirectly, in GraphicMail group companies (“GraphicMail”) consisting of InterInbox SA, a Swiss corporation, InterCloud Limited, a Gibraltar limited company, ERNEPH 2012A (Pty) Ltd. dba ISMS, a South African limited company, ERNEPH 2012B (Pty) Ltd. dba GraphicMail South Africa, a South African limited company, and Quattro Hosting LLC, a Delaware limited liability company. The acquisition consideration consisted of $5.3 million, $2.6 million of which was paid in cash and $2.7 million of which was paid in stock, plus potential earn out consideration of up to $0.8 million based on achieving certain revenue levels in 2015 (paid 50% in cash and 50% in stock). GraphicMail operated as a campaign management solution, enabling customers to create content and manage emails being sent to customers and distribution lists.

Pursuant to the equity interest purchase agreement, the Company was liable for an earn out of up to $0.8 million, related to GraphicMail achieving certain revenue levels in 2015. The Company utilized the income approach to estimate the fair value of the earn out. The Company analyzed scenarios and determined a probability weighting for each scenario. The Company calculated the earn out payments based on the respective revenues for each scenario and then weighted the resulting payment by the probabilities of achieving each scenario. In order to calculate an appropriate risk-adjusted discount rate for the earn out, the Company calculated the weighted average cash-flows of the business based on the three scenarios and their respective weightings. The Company then calculated an implied internal rate of return (“IRR”) of 29.8%, which is the discount rate necessary in order to reconcile the weighed cash-flows of the three scenarios to the total purchase price including the earn out payment. The earn out payment was then discounted by the 29.8% IRR. Based on these methods and the Company’s initial assessment of meeting those revenue levels in 2015, an earn out liability of $36,000 was recorded as a liability during purchase accounting. This was re-measured in the subsequent quarters, resulting in a benefit of $2,527 during the nine months ended September 30, 2016. During March 2016, the Company paid $415,858 in the form of $207,929 in cash and 53,924 shares of common stock in full settlement of the earn out liability to the former GraphicMail shareholders.

Additionally, in March 2016, the Company received $175,970 in cash and 20,000 shares of Company stock (valued at $84,000) from the GraphicMail escrow fund related to an indemnified claim for unrecorded liabilities at the time of the acquisition. The total value of the claim of $259,970 was recorded as a gain in other income (expense), net during the nine months ended September 30, 2016. The Company accounted for the receipt of 20,000 shares as treasury stock with a carrying value of $84,000.

Note 4: Asset Purchase Agreements

During 2015 and 2016, the Company entered into separation agreements with several third-party GraphicMail resellers to terminate the reseller arrangements and for the Company to purchase the customer relationships that each had accumulated as a GraphicMail reseller. Pursuant to the terms of the separation agreements, the Company made payments to the resellers in exchange for the rights to the customer relationships. The Company accounted for these purchases as intangible asset acquisitions. The aggregate estimated purchase price for the intangible assets acquired was approximately $731,000. Due to heavy customer attrition from the GraphicMail customer base during the second half of 2016, the majority of the acquired intangible assets value was impaired during the fourth quarter of 2016.

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Note 5: Disposition

On June 27, 2016, the Company completed the sale of the assets and deferred revenue liabilities of its SMTP email relay business (“SMTP”) to the Electric Mail Company for approximately $15.0 million. Of the total proceeds from the sale of SMTP, approximately $1.0 million in cash was held in escrow until the one-year anniversary and recorded in Other current assets at December 31, 2016. The Company received the $1.0 million escrow payment in June 2017. In conjunction with the sale, the Company also entered into a transition services agreement (the “TSA”) with the buyer to assist in the transition of operations over a six-month period, which was subsequently extended for an additional three months. Pursuant to the terms of the transition services agreement, in exchange for assisting in the transfer of operations, the Company may continue utilizing the SMTP email relay platform for its email sending needs at no cost. Although no cash was exchanged for the services performed by the parties to the TSA, the Company recorded the estimated cost to utilize the SMTP sending platform as a cost of sale and recorded a benefit to Other income (expense), net for the value of services provided to the Electric Mail Company. Also, in conjunction with the sale, the Company abandoned a software asset that was not acquired, but will not be utilized by the Company in the future. The Company recorded a gain on the sale of SMTP of approximately $9.8 million, net of tax of $5.2 million in the second quarter of 2016.

Pursuant to the reporting requirements of ASC 205-20,Presentation of Financial Statements – Discontinued Operations, the Company has determined that the SMTP business qualifies for presentation as a discontinued operation because it represents a component of our entity and the sale of SMTP represents a strategic shift in our business plans. Therefore, the Company has presented the operating results of SMTP (for periods prior to the sale) as discontinued operations, net of tax, in the accompanying Consolidated Statements of Comprehensive Income (Loss) and Consolidated Statements of Cash Flows.

Financial information for the SMTP email relay business for the three and nine months ended September 30, 2017 and 2016, are presented in the following table:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2017		2016		2017		2016
Revenue	$	-	$	-	$	-	$	2,746,378
Cost of services		-		-		-		642,013
Gross profit		-		-		-		2,104,365
Operating expenses:
Sales and marketing		-		-		-		177,265
Research and development		-		-		-		152,898
General and administrative		-		-		-		474,048
							��
Total operating expenses		-		-		-		804,211
Operating income		-		-		-		1,300,154
Other income (expense), net, before gain on sale		-		-		-		-
Income before income taxes, before gain on sale		-		-		-		1,300,154
Income tax expense		-		-		-		485,998
Net income, before gain on sale	$	-	$	-	$	-	$	814,156
Gain on sale of discontinued operations		-		-		-		9,373,295
Income from discontinued operations, net of income taxes	$	-	$	-	$	-	$	10,187,451

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The financial information above includes the financial results for the SMTP email relay business through June 27, 2016, plus any residual costs incurred after June 27, 2016 related to the transition of the business to the buyer. The results are comprised of revenue and costs directly attributable to the SMTP email relay business as well as allocated costs for resources that have historically had shared roles in our consolidated operations. For resources performing shared roles, cost allocations have been created based on estimated work performed and job activities. Although our SharpSpring and GraphicMail products had utilized the SMTP email relay sending platform prior to the disposition, no intercompany revenues have been reflected in the SMTP email relay business operating results related to the use of the email sending platform by our other product lines.

Note 6: Intangible Assets

Intangible assets are as follows:

	As of September 30, 2017
	Gross					Net
	Carrying		Accumulated			Carrying
	Amount		Amortization			Value
Amortized intangible assets:
Trade names	$	344,866	$	(299,612	)	$	45,254
Technology		3,820,657		(2,326,907	)		1,493,750
Customer relationships		4,154,902		(3,235,778	)		919,124
Unamortized intangible assets:		8,320,425		(5,862,297	)		2,458,128
Goodwill							8,870,649
Total intangible assets						$	11,328,777

Estimated amortization expense for the remainder of 2017 and subsequent years is as follows:

Remainder of 2017	$	132,126
2018		460,000
2019		381,000
2020		332,000
2021		280,000
2022		228,000
Thereafter		645,002
Total	$	2,458,128

Amortization expense for the three months ended September 30, 2017 and 2016 was $132,298 and $298,823, respectively. Amortization expense for the nine months ended September 30, 2017 and 2016 was $395,690 and $1,068,839, respectively.

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Note 7: Credit Facility

In March 2016, the Company entered into a $2.5 million revolving loan agreement (the “Loan Agreement”) with Western Alliance Bank. The facility matures on March 21, 2018 and has no mandatory amortization provisions and is payable in full at maturity. Loan proceeds accrue interest at the higher of Western Alliance Bank’s Prime interest rate (4.25% as of September 30, 2017) or 3.5%, plus 1.75%. The Loan Agreement 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 Quattro Hosting, LLC and a 65% pledge of the Company’s foreign subsidiaries’ stock. The Loan Agreement subjects the Company to a number of restrictive covenants, including financial and non-financial covenants customarily found in loan agreements for similar transactions. The Loan Agreement also restricts our ability to pay cash dividends on our common stock. During June 2016, the Company amended the Loan Agreement to modify its financial covenants and allow for the sale of the SMTP business assets. During October 2017, the Loan Agreement was amended to waive the minimum adjusted EBITDA financial covenant for the third quarter of 2017 and modify the minimum adjusted EBITDA financial covenant for the fourth quarter of 2017. There are no amounts outstanding under the Loan Agreement as of September 30, 2017 and no events of default have occurred to date. As of September 30, 2017, based on the borrowing base calculations $1,817,478 was available for withdrawal under the Loan Agreement.

Note 8: Shareholders’ Equity

In March 2016, the Company issued 53,924 shares of common stock to the former owners of GraphicMail in satisfaction of the stock-based earn out. Additionally, in March 2016, the Company received 20,000 shares of stock from the GraphicMail escrow fund related to an indemnified claim.

In June 2016, the Company issued 1,039,636 shares of common stock to the RCTW, LLC shareholders to satisfy the remaining stock-based portion of the SharpSpring earn out.

Note 9: Changes in Accumulated Other Comprehensive Income (Loss)

	Foreign Currency
	Translation
	Adjustment
Balance as of December 31, 2016	$	(445,055	)
Other comprehensive income (loss) prior to reclassifications		-
Amounts reclassified from accumulated other comprehensive income		-
Tax effect		-
Net current period other comprehensive loss		79,110
Balance as of September 30, 2017	$	(365,945	)

Note 10: Net Loss Per Share

Computation of net loss per share is as follows:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2017			2016			2017			2016
Net loss from continuing operations	$	(1,681,520	)	$	(1,223,857	)	$	(4,471,541	)	$	(3,048,109	)
Basic weighted average common shares outstanding		8,399,920			8,345,750			8,383,639			7,741,351
Add incremental shares for:
Warrants		-			-			-			-
Stock options		-			-			-			-
Diluted weighted average common shares outstanding		8,399,920			8,345,750			8,383,639			7,741,351
Net loss per share:
Basic	$	(0.20	)	$	(0.15	)	$	(0.53	)	$	(0.39	)
Diluted	$	(0.20	)	$	(0.15	)	$	(0.53	)	$	(0.39	)

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For the three and nine months ended September 30, 2017, 1,086,623 stock options and 170,973 warrants were excluded from diluted net loss per share, because the effect of including these potential shares was anti-dilutive. For the three and nine months ended September 30, 2016, 1,143,529 stock options and 170,973 warrants were excluded from diluted net loss per share, because the effect of including these potential shares was anti-dilutive.

Pursuant to ASC 260,Earnings Per Share, since a loss is reported from continuing operations, diluted net loss per share has been computed with the same average common shares outstanding as basic net loss per share, even during periods when the discontinued operations provide for an overall consolidated net income.

Note 11: 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, 2017 and 2016, the Company recorded income tax benefits of $111,059 and $519,293, respectively, from continuing operations. During the nine months ended September 30, 2017 and 2016, the Company recorded income tax benefits of $1,004,899 and $1,334,800, respectively, from continuing operations. The blended effective tax rate for the nine months ending September 30, 2017 and 2016 was 18% and 30%, respectively. The effective blended tax rate varies from our statutory U.S. tax rate due to 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 carryback losses to prior periods with gains or 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 ability to utilize net operating loss carrybacks, 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 in foreign jurisdictions related to temporary differences and net operating losses may not be recovered. The establishment of a valuation allowance in these foreign jurisdictions 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, 2017 and December 31, 2016, we have established a valuation allowance of $2.6 million against certain international deferred tax assets given the uncertainty of recoverability of these amounts.

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Note 12: 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 60% 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 $53,886 and $25,892 to expense in the three months ended September 30, 2017 and 2016, respectively, associated with our matching contribution in those periods. We charged $144,960 and $79,378 to expense in the nine months ended September 30, 2017 and 2016, respectively, associated with our matching contribution in those periods.

Note 13: 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 and March 2017. As amended, up to 1,950,000 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,
	2017	2016
Volatility	48 - 49%	38% - 50%
Risk-free interest rate	1.85% - 2.26%	1.12% - 1.65%
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, 2017 and 2016 was $2.05 and $1.93, 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, 2017 and 2016, the Company recognized expense of $137,673 and $102,105, respectively, associated with stock option awards. During the nine months ended September 30, 2017 and 2016, the Company recognized expense of $384,787 and $333,650, respectively, associated with stock option awards. At September 30, 2017, future stock compensation expense associated with stock options (net of estimated forfeitures) not yet recognized was $1,221,255 and will be recognized over a weighted average remaining vesting period of 2.7 years. The following summarizes stock option activity for the three months ended September 30, 2017:

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				Weighted		Weighted		Aggregate
	Number of			Average		Average Remaining		Intrinsic
	Options			Exercise Price		Contractual Life		Value
Outstanding at December 31, 2016		1,128,368		$	5.12		7.0	$	514,439
Granted		353,500			4.78
Exercised		(14,407	)		1.31
Forfeited		(380,838	)		4.99
Outstanding at September 30, 2017		1,086,623		$	5.11		8.0	$	500
Exercisable at September 30, 2017		428,721		$	5.47		7.0	$	344

The total intrinsic value of stock options exercised during the nine months ended September 30, 2017 and September 30, 2016 was $32,960 and $1,854, respectively.

Stock Awards

During the three months ended September 30, 2017 and 2016, the Company issued 14,489 and 11,052 shares, respectively, to non-employee directors as compensation for their service on the board. During the nine months ended September 30, 2017 and 2016, such awards totaled 38,159 and 40,531 shares, respectively. 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, 2017 and 2016 was $62,013 and $61,830, respectively. The total fair value of stock awards granted, vested and expensed during the nine months ended September 30, 2017 and 2016 was $174,650 and $166,113, respectively. As of September 30, 2017, there was no unrecognized compensation cost related to stock awards.

Note 14: Warrants

Prior to 2015, the Company issued warrants to certain service providers. The following table summarizes information about the Company’s warrants at September 30, 2017:

			Weighted		Weighted
	Number of		Average		Average Remaining		Intrinsic
	Units		Exercise Price		Contractual Term		Value
Outstanding at December 31, 2016		170,973	$	6.26		4.6	$	33,660
Granted		-		-
Cancelled		-		-
Outstanding at September 30, 2017		170,973	$	6.26		3.8	$	-
Exercisable at September 30, 2017		170,973	$	6.26		3.8	$	-

Note 15: Commitments and Contingencies

Litigation

The Company may from time to time be involved in legal proceedings arising from the normal course of business. The Company is not currently a party to any litigation of a material nature.

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Operating Leases and Service Contracts

The Company rents its facilities with leases ranging from month-to-month to several years in duration. Most of its 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, 2017:

Remainder of 2017	$	171,251
2018		448,918
2019		373,015
2020		382,884
2021		292,843
2022		-
Thereafter		-
Total	$	1,668,911

Employment Agreements

The Company has employment agreements with several members of its leadership team and executive officers.

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

The following discussion and analysis should be read in conjunction with our consolidated financial statements, included herewith. This discussion should not be construed to imply that the results discussed herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of actual operating results in the future. Such discussion represents only the best present assessment of our management. This information should also be read in conjunction with our audited historical consolidated financial statements which are included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, filed with the Securities and Exchange Commission on March 31, 2017.

Overview

We provide SaaS based marketing technologies to customers around the world. Our focus is on marketing automation tools that enable customers to interact with a lead from an early stage and nurture that potential customer using advanced features until it becomes a qualified sales lead or customer. We primarily offer our premium SharpSpring marketing automation solution, but also have customers on the SharpSpring Mail+ product, which is a subset of the full suite solution.

We believe our recent growth has been driven by the strong demand for marketing automation technology solutions, particularly in the small and mid-size business market. Our products are offered at competitive prices with unlimited multi-lingual customer support. We employ a subscription-based revenue model. We also earn revenues from additional usage charges that may come into effect when a customer exceeds a transactional quota, as well as fees earned for additional products and services.

During 2016, we discontinued our GraphicMail email marketing product and migrated those customers to our SharpSpring Mail+ product. On June 27, 2016, we sold our SMTP email relay service which provided customers with the ability to increase the deliverability of email with less time, cost and complexity than handling it themselves.

Unless the context otherwise requires, in this section titled Management’s Discussion and Analysis of Financial Condition and Results of Operations all references to “SharpSpring” relate to the SharpSpring product, while all references to “our Company,” “we,” “our” or “us” and other similar terms means SharpSpring, Inc., a Delaware corporation, and all subsidiaries.

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Results of Operations

Three Months Ended September 30, 2017 Compared to the Three Months Ended September 30, 2016

Unless otherwise noted, all figures and comparisons relate to our continuing operations.

								Percent
					Change			Change
	Three Months Ended September 30,				from			from
	2017		2016		Prior Year			Prior Year
Revenues and Cost of Sales:
Revenues	$	3,411,580	$	3,010,307	$	401,273			13	%
Cost of Sales		1,210,088		1,269,473		(59,385	)		-5	%
Gross Profit	$	2,201,492	$	1,740,834	$	460,658			26	%

Revenues from continuing operations increased for the three months ended September 30, 2017 as compared to the three months ended September 30, 2016, primarily due to growth in our SharpSpring marketing automation customer base. Revenues for our flagship marketing automation platform increased to $3.2 million in the three months ended September 30, 2017 from $2.5 million in the three months ended September 30, 2016. This growth in revenues was offset by reduced revenue from our traditional email marketing products (SharpSpring Mail+ and GraphicMail) which declined from $452,863 in the three months ended September 30, 2016 to $172,873 in the three months ended September 30, 2017. We experienced high levels of attrition related to the migration of customers from the GraphicMail platform to the SharpSpring Mail+ platform during the last three quarters of 2016.

Cost of services decreased for the three months ended September 30, 2017 as compared to the three months ended September 30, 2016 primarily due to lower hosting technology costs and lower restructuring costs in 2017, offset by additional employee-related costs to support increased revenues and incremental business from new customer additions to SharpSpring. As a percentage of revenues, cost of services was 35% and 42% of revenues for the three months ended September 30, 2017 and 2016, respectively. This represents a sequential and year-over-year improvement in gross margin for our SharpSpring product, which has increased due to lower costs and increased revenue scale.

								Percent
					Change			Change
	Three Months Ended September 30,				from			from
	2017		2016		Prior Year			Prior Year
Operating expenses:
Sales and marketing	$	1,801,701	$	1,445,152	$	356,549			25	%
Research and development		703,392		612,117		91,275			15	%
General and administrative		1,353,972		1,232,996		120,976			10	%
Intangible asset amortization		132,298		298,823		(166,525	)		-56	%
	$	3,991,363	$	3,589,088	$	402,275			11	%

Sales and marketing expenses increased for the three months ended September 30, 2017 as compared to the three months ended September 30, 2016. The increase was primarily due to an increase in marketing program spending for various lead generation activities, which increased by $330,907 from last year. Additionally, we experienced an increase in marketing employee-related costs due to recent hires, offset by lower restructuring costs related to the 2016 closure of international offices.

Research and development expenses increased for the three months ended September 30, 2017 as compared to the three months ended September 30, 2016 primarily due to additional hiring of development and quality assurance staff since last year. Employee-related costs for this group increased by approximately $152,000 in the three months ended September 30, 2017 compared to the same period in 2016. These increases were somewhat offset by lower recruiting fees and lower restructuring costs in 2017 compared to 2016.

General and administrative expenses increased for the three months ended September 30, 2017 as compared to the three months ended September 30, 2016, with higher employee related costs associated with business growth, higher professional fees, and increased credit card fees, offset by lower restructuring fees.

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Amortization of intangible assets decreased for the three months ended September 30, 2017 as compared to the three months ended September 30, 2016 due primarily to the reduction of amortization related to the GraphicMail customer relationship intangibles. During the fourth quarter of 2016, the Company accelerated the amortization expense for the majority of the GraphicMail customer relationship intangible values.

										Percent
							Change			Change
	Three Months Ended September 30,						from			from
	2017			2016			Prior Year			Prior Year
Other
Other income (expense), net	$	(2,708	)	$	105,104		$	(107,812	)		-103	%
Provision (benefit) for income tax	$	(111,059	)	$	(519,293	)	$	408,234			-79	%

Other income (expense) is generally related to foreign exchange gains and losses derived from owing amounts or having amounts owed in currencies other than the entity’s functional currency.

During the three months ended September 30, 2017 and 2016, our income tax benefit from continuing operations related to losses incurred by our consolidated U.S. and international entities.

Nine Months Ended September 30, 2017 Compared to the Nine Months Ended September 30, 2016

Unless otherwise noted, all figures and comparisons relate to our continuing operations.

							Percent
					Change		Change
	Nine Months Ended September 30,				from		from
	2017		2016		Prior Year		Prior Year
Revenues and Cost of Sales:
Revenues	$	9,681,433	$	8,688,723	$	992,710		11	%
Cost of Sales		3,776,353		3,350,996		425,357		13	%
Gross Profit	$	5,905,080	$	5,337,727	$	567,353		11	%

Revenues from continuing operations increased for the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016, primarily due to growth in our SharpSpring marketing automation customer base. Revenues for our flagship marketing automation platform increased to $9.2 million in the nine months ended September 30, 2017 from $6.4 million in the nine months ended September 30, 2016. This growth in revenues was offset by reduced revenue from our traditional email marketing products (SharpSpring Mail+ and GraphicMail) which declined from $2.2 million in the nine months ended September 30, 2016 to $504,085 million in the nine months ended September 30, 2017. We experienced high attrition levels during the final nine months of 2016 following the migration of customers from the GraphicMail platform to the SharpSpring Mail+ platform.

Cost of services increased for the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016 primarily due to costs to support increased revenues and incremental business from new customer additions to SharpSpring. As a percentage of revenues, cost of services was 39% of revenues for the nine months ended September 30, 2017 and 2016. Although costs increased for support resources related to business growth, the Company achieved some operating leverage with increased revenues compared to the prior year.

								Percent
					Change			Change
	Nine Months Ended September 30,				from			from
	2017		2016		Prior Year			Prior Year
Operating expenses:
Sales and marketing	$	5,025,539	$	4,084,446	$	941,093			23	%
Research and development		2,094,309		1,651,809		442,500			27	%
General and administrative		3,941,877		3,171,052		770,825			24	%
Change in earn out liability		-		219,473		(219,473	)		-100	%
Intangible asset amortization		395,690		1,068,839		(673,149	)		-63	%
	$	11,457,415	$	10,195,619	$	1,261,796			12	%

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Sales and marketing expenses increased for the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016. The increase was primarily due to an increase in marketing program spending for various lead generation activities, which increased by $1.0 million from last year. Additionally, we experienced an increase in marketing employee-related costs due to recent hires, offset by reductions in sales team employee costs associated with the consolidation and closure of international offices.

Research and development expenses increased for the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016 primarily due to additional hiring of development and quality assurance staff since last year. Employee-related costs for this group increased by approximately $502,000 in the nine months ended September 30, 2017 compared to the same period in 2016.

General and administrative expenses increased for the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016, with employee related costs associated with business growth, higher facilities costs, and higher depreciation.

The acquisitions of SharpSpring and GraphicMail included liability-based contingent consideration which was re-measured during each reporting period until the ultimate settlement in the first half of 2016. These re-measurements resulted in additional charges that are recorded on the Consolidated Statements of Comprehensive Income (Loss). During the nine months ended September 30, 2016, we incurred a charge of $222,000 related to the adjustment to the earn out liability for SharpSpring and $2,527 benefit related to the earn out liability for GraphicMail.

Amortization of intangible assets decreased for the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016 due primarily to the reduction of amortization related to the GraphicMail customer relationship intangibles. During the fourth quarter of 2016, the Company accelerated the amortization expense for the majority of the GraphicMail customer relationship intangible values.

										Percent
							Change			Change
	Nine Months Ended September 30,						from			from
	2017			2016			Prior Year			Prior Year
Other
Other income (expense), net	$	75,895		$	474,983		$	(399,088	)		-84	%
Provision (benefit) for income tax	$	(1,004,899	)	$	(1,334,800	)	$	329,901			-25	%

Other income (expense) is generally related to foreign exchange gains and losses derived from owing amounts or having amounts owed in currencies other than the entity’s functional currency. However, during the nine months ended September 30, 2016, the Company recorded a gain related to a favorable claim from the GraphicMail escrow hold-back account of $259,760. Additionally, during the nine months ended September 30, 2017, the Company recorded other income in the amount of $57,825 related to the performance of services pursuant to the transition services agreement associated with the SMTP email relay product sale.

During the nine months ended September 30, 2017 and 2016, our income tax benefit from continuing operations related to losses incurred by our consolidated U.S. entities offset by a small amount of tax expense related to income derived in foreign jurisdictions at the applicable statutory tax rates.

								Percent
					Change			Change
	Nine Months Ended September 30,				from			from
	2017		2016		Prior Year			Prior Year
Discontinued operations
Income from discontinued operations, net of tax	$	-	$	10,187,451	$	(10,187,451	)		-100	%

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Discontinued operations, net of tax, represents revenue, offset by expenses and taxes, related to our SMTP email relay business that was sold on June 27, 2016 to an unrelated third party.

Liquidity and Capital Resources

Sources and Uses of Cash

Our primary source of operating cash inflows from continuing operations are payments from customers for use of our marketing automation technology platform. Such payments are sometimes received in advance of providing the services, yielding a deferred revenue liability on our consolidated balance sheet. On June 27, 2016, we sold our SMTP email relay business for approximately $15.0 million, approximately $14.0 million of which was received during the second quarter of 2016 and $1.0 million of which was received in the second quarter of 2017. From time to time, we also raise funds from offering our common stock for sale to new and existing investors. Additionally, in March 2016, the Company obtained a $2.5 million revolving credit facility to provide additional financing flexibility in the future. No amounts have been borrowed under the facility to date and based on the borrowing base calculations, approximately $1.8 million was available under the facility as of September 30, 2017.

Our primary sources of cash outflows from operations include payroll and payments to vendors and third party service providers. During 2016, we also acquired customer relationship assets for cash from several former GraphicMail third party resellers. Additionally, we disbursed $207,929 of cash in March 2016 for an earn out payment to the former GraphicMail shareholders and $1.0 million in June 2016 for an earn out payment to the former SharpSpring shareholders.

Analysis of Cash Flows

Net cash used in operating activities from our continuing operations improved by $1.9 million to $3.2 million used in operations for the nine months ended September 30, 2017, compared to $5.1 million used in operations for the nine months ended September 30, 2016. The improvement in cash used in operating activities was attributable primarily to lower tax payments and stronger cash collections from customers during the first nine months of 2017 compared to the same period in 2016.

Net cash used in investing activities from our continuing operations was $212,823 and $1.0 million during the nine months ended September 30, 2017, and September 30, 2016, respectively. The reduction in cash used for investing activities relates to less cash paid to several former GraphicMail third-party resells to acquire customer relationship assets in 2016. Additionally, the Company had higher purchases of fixed assets in the third quarter of 2016 associated with furniture and fixtures related to its new headquarters building.

Net cash provided by financing activities was $18,859 during the nine months ended September 30, 2017 compared to net cash used in financing activities of $1.2 million during the nine months ended September 30, 2016. During the nine months ended September 30, 2016, the Company paid $1 million to the former SharpSpring shareholders and $207,929 to the former GraphicMail shareholders related to earn out payments from those 2014 acquisitions.

We had net working capital of approximately $7.2 million and $10.4 million as of September 30, 2017 and December 31, 2016, respectively. Our cash balance was $6.3 million at September 30, 2017 compared to $8.7 million at December 31, 2016, reflecting cash used for operations and investing activities during the period, offset by $1.0 million received in June 2017 related to the escrow hold back from the SMTP business disposition in 2016.

Contractual Obligations

We rent our facilities with leases ranging from month-to-month to several years in duration. Most of our service contracts are also on a month-to-month basis. However, from time to time, we enter into non-cancelable service contracts including longer-term contracts and payments for the acquisition of customer relationships from resellers. Future minimum lease payments and payments due under non-cancelable service contracts are as follows as of September 30, 2017:

Remainder of 2017	$	171,251
2018		448,918
2019		373,015
2020		382,884
2021		292,843
2022		-
Thereafter		-
Total	$	1,668,911

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Significant Accounting Policies

Our significant accounting policies, including the assumptions and judgments underlying them, are disclosed in the Notes to the Consolidated Financial Statements. We have consistently applied these policies in all material respects. We do not believe that our operations to date have involved uncertainty of accounting treatment, subjective judgment, or estimates, to any significant degree.

Off-balance sheet arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

Item 3. Quantitative and Qualitative Disclosure About Market Risk

Not applicable.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s principal executive officer and principal financial officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of September 30, 2017. Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that, as of September 30, 2017 the Company’s disclosure controls and procedures were effective, in that they provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and is accumulated and communicated to the Company’s management, including the Company’s principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Controls Over Financial Reporting. We disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016 that management had concluded that our internal control over financial reporting was not effective as of December 31, 2016 due to gaps in controls documentation and segregation of duties. We are working to improve such documentation in order to render our internal controls effective; however, no change in our Company’s internal control over financial reporting occurred during our third fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

Not applicable.

Item 1A. Risk Factors.

Not Applicable.

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

Not Applicable.

Item 3. Defaults Upon Senior Securities.

Not Applicable.

Item 4. Mine Safety Disclosures.

Not Applicable.

Item 5. Other Information.

Not Applicable.

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Item 6. Exhibits.

INDEX TO EXHIBITS

SEC Reference Number	Title of Document	Location
10.1	Employee Agreement Amendment – Edward S. Lawton	Incorporated by reference to the Company’s Form 8-K filed on 8/1/17
10.2	Employee Agreement Amendment – Edward S. Lawton	Incorporated by reference to the Company’s Form 8-K filed on 6/24/15
10.3	Employee Agreement – Edward Lawton	Incorporated by reference to the Company’s Form 8-K filed on 8/18/14
10.4	Employee Agreement Amendment – Travis Whitton	Incorporated by reference to the Company’s Form 8-K filed on 8/1/17
	Employee Agreement Amendment – Travis Whitton	Incorporated by reference to the Company’s Form 8-K filed on 7/8/16
10.5	Employee Agreement – Travis Whitton	Incorporated by reference to the Company’s Form 8-K filed on 7/8/16
10.6	Loan Agreement dated March 21, 2016, by and among SharpSpring, Inc., Quattro Hosting LLC, SharpSpring Technologies, Inc. and Western Alliance Bank	Incorporated by reference to the Company’s Form 8-K filed on 3/22/16
10.7	Intellectual Property Security Agreementdated March 21, 2016, by and amongSharpSpring, Inc., Quattro Hosting LLC, SharpSpring Technologies, Inc. and Western Alliance Bank	Incorporated by reference to the Company’s Form 8-K filed on 3/22/16
10.8	Loan and Security Modification Agreement dated October 25, 2017, by and among SharpSpring, Inc., Quattro Hosting LLC, SharpSpring Technologies, Inc. and Western Alliance Bank	Incorporated by reference to the Company’s Form 8-K filed on10/30/17
31.1	Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed herewith
31.2	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed herewith
32.1	Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Filed herewith
32.2	Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Filed herewith
101	XBRL	Filed herewith

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

SharpSpring, Inc.
By:	/s/Richard A. Carlson
	Richard A. Carlson
	Chief Executive Officer and President (Principal Executive Officer) Date: November 13, 2017

SharpSpring, Inc.
By:	/s/ Edward Lawton
	Edward Lawton Chief Financial Officer
	(Principal Financial Officer) Date: November 13, 2017

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