| Note 2. Summary of Significant Accounting Policies | Note 2: Summary of Significant Accounting Policies Basis of Presentation and Consolidation The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP). The Company’s consolidated financial statements include the accounts of SharpSpring, Inc. and our subsidiaries (the “Company”). The Company’s consolidated financial statements reflect the elimination of all significant inter-company accounts and transactions. 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 reportable segment with two operating segments. Our operating segments consist of our SharpSpring Marketing Automation segment and Perfect Audience Ad Retargeting segment in accordance with ASC 280. 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 between our two operating segments. We do not separately allocate operating expenses, nor do we fully allocate assets to these operating segments. In accordance with ASC 280, we aggregate our two operating segments as one operating segment for financial reporting purposes. The Company does not present geographical information about revenues because it is impractical to do so. See Note 16 of the Notes to the Consolidated Financial Statements for information on our disaggregated revenues. 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 translation 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 approximate fair value because of the short-term nature of these items. The fair value of the embedded derivatives associated with our convertible notes are calculated using Level 3 unobservable inputs, utilizing a probability-weighted expected value model to determine the liability. The fair value of the embedded derivatives was a liability balance of zero at December 31, 2019. The change in fair value for the year ended December 31, 2019 was a gain of $0.21 million. There was no embedded derivative liability during 2020. 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 are 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. Business Combinations Accounting for business combinations requires us to make significant estimates and assumptions, especially at the acquisition date with respect to tangible and intangible assets acquired and liabilities assumed and pre-acquisition contingencies. We use our best estimates and assumptions to accurately assign fair value to the tangible and intangible assets acquired and liabilities assumed at the acquisition date as well as the useful lives of those acquired intangible assets. Examples of critical estimates in valuing certain of the intangible assets and goodwill we have acquired include but are not limited to: · future expected cash flows from customer contracts and acquired developed technologies and patents; · the acquired company’s trade name, vendor relationships, and customer relationships, as well as assumptions about the period of time the acquired trade name will continue to be used in our offerings; and · discount rates. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results. Intangibles Finite-lived intangible assets include trade names, developed technologies, customer relationships, and vendor 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 regularly 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, undiscounted cash flows, 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 Indefinite-Lived Intangible Assets As of December 31, 2020 and 2019, we had recorded goodwill $10.25 million and $10.92 million, 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, GraphicMail, and Perfect Audience acquisitions. Under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 350, “Intangibles - Goodwill and Other” The Company also has indefinite-lived intangible assets. As of December 31, 2020 and 2019, we had recorded indefinite-lived intangible assets of $0.38 million at each period (see Note 4). These assets are not 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 350-30, 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 Provision for income taxes is 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 consolidated 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 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 2017 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. The Company received notification January 14, 2020 that its Swiss subsidiary, InterInbox SA is under examination from the Switzerland Federal Tax Administration for the years 2015 through 2018. The Company does not expect any material adjustments as a result of the audit. Property and Equipment Property and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful life of the assets. Upon retirement or sale, the cost of assets disposed of and the related accumulated depreciation are eliminated from the accounts, and any resulting gain or loss is record in the other expense section of our Consolidated Statements of Comprehensive Loss. Repairs and maintenance costs are expensed as incurred. Depreciation expense related to property and equipment was $0.95 million and $0.63 million for the years ended December 31, 2020 and 2019, respectively. Property and equipment as of December 31 is as follows: December 31, December 31, 2020 2019 Property and equipment, gross: Leasehold improvements $ 313,119 $ 290,977 Furniture and fixtures 913,370 678,774 Computer equipment and software 3,231,366 2,350,758 Total 4,457,855 3,320,509 Less: Accumulated depreciation (2,268,907 ) (1,323,787 ) $ 2,188,948 $ 1,996,722 1) Identify the customer contract A customer contract is generally identified when the Company and a customer have an executed arrangement that calls for the Company to provide access to its software or provide professional services in exchange for consideration from the customer. 2) Identify performance obligations that are distinct A performance obligation is a promise to provide a distinct good or service or a series of distinct goods or services. A good or service that is promised to a customer is distinct if the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer, and a company’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract. The Company has determined that subscriptions for its software is distinct because, once a customer has access to the software it purchased, the software is fully functional and does not require any additional development, modification, or customization. Professional services sold are distinct because the customer benefits from the on-boarding and training to make better use of the online software products it purchased. 3) Determine the transaction price The transaction price is the amount of consideration to which the Company expects to be entitled in exchange for transferring goods or services to a customer, excluding sales taxes that are collected on behalf of government agencies. The Company estimates any variable consideration to which it will be entitled at contract inception, when determining the transaction price. The Company does not include variable consideration to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will occur when any uncertainty associated with the variable consideration is resolved. 4) Allocate the transaction price to the distinct performance obligations The transaction price is allocated to each performance obligation based on the relative standalone selling prices of the goods or services being provided to the customer. 5) Recognize revenue as the performance obligations are satisfied Revenues are recognized when or as control of the promised goods or services is transferred to customers. Revenue from the SharpSpring Marketing Automation and Mail+ software is recognized ratably over the subscription period, which typically ranges from one to twelve months. The Company recognizes revenue from on-boarding and training services as the services are provided, which is generally over 60 days. Revenue related to our other professional services is recognized as the services are provided. The Perfect Audience platform is utilized on an as needed basis, and the related revenue recognized as the service is provided. Cash payments received in advance of providing subscription or services are recorded to deferred revenue until the performance obligation is satisfied. Our products are billed in arrears or upfront, depending on the product, which creates contract assets (unbilled receivables) and contract liabilities (deferred revenue), respectively. Unbilled receivables occur due to unbilled charges for which the Company has satisfied performance obligations. Deferred revenues 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 as the performance obligations are satisfied. 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. Gross Versus Net Revenue ASC 606 provides guidance on proper recognition of principal versus agent considerations which is used to determine gross versus net revenue recognition. Under ASC 606, the core objective of the guidance on gross versus net revenue recognition is to help determine whether an entity is a principal or an agent in a transaction. In general, the primary difference between these two is the performance obligation being satisfied. The principal has a performance obligation to provide the desired goods or services to the end customer, whereas the agent arranges for the principal to provide the desired goods or services. Additionally, a fundamental characteristic of a principal in a transaction is control. A principal substantively controls the goods and services before they are transferred to the customer as well as controls the price of the good or service being provided. An agent normally receives a commission or fee for these activities. In addition to control, the level at which an entity controls the price of the good or service being transferred determines principal versus agent status. The more discretion over setting price a company has in providing the good or service, the more likely they are considered a principal rather than an agent. Under the guidance when another party is involved in providing a good or service to a customer, an entity is a principal if the entity obtains control of the asset or right to a service performed by the other party. SharpSpring never takes possession or control of the advertising space and acts an agent facilitating the customer with the desired advertisement inventory from the principal provider through our Perfect Audience retargeting platform. In addition to the lack of control of the advertising inventory, SharpSpring does not have control over the cost of the advertising inventory, but rather only receives a fee for services for providing the advertising inventory to the customer, further demonstrating SharpSpring’s role as the agent in the transaction. Therefore, as an agent in the retargeting transaction SharpSpring records revenue net of the cost of advertising inventory cost incurred for placing advertisements on websites. Deferred Revenue Deferred revenue consists of payments received in advance of the Company providing the services. Most of our deferred revenue balances (contract liabilities) arise from payments from customers in advance of service on a periodic basis (such as monthly, quarterly, annually, or bi-annually), while the portion of our deferred revenue balances associated with Perfect Audience arises from prepaid deposits for future usage of the platform. Deferred revenue from our SharpSpring Marketing Automation customers is earned over the service period identified in each contract. Deferred revenue from our Perfect Audience retargeting customers is earned as the service is used. Additionally, the Company has deferred revenue related to implementation fees for its SharpSpring Marketing Automation solution that are paid in advance, which is recognized over the service period. These implementation services are typically performed over a 60-day period. As of December 31, 2019, and 2018, the Company had deferred revenue balances of $0.86 million and $0.25 million, respectively. Deferred revenue decreased by $0.01 million and increased by $0.61 million during the years ended December 31, 2020 and 2019, respectively. Deferred revenue balances were $0.85 million and $0.86 million as of December 31, 2020 and 2019, respectively. Unbilled Receivables 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. The accrued revenue contract asset balances were $1.0 million and $0.74 million as of December 31, 2019 and 2018, respectively. Revenue billed that was included in accrued revenue at the beginning of the year ended December 31, 2020 and 2019 was $1.0 million and $0.74million, respectively. The accrued revenue not billed and ending balance in years ended December 31, 2020 and 2019 was $1.25 million and $1.0 million respectively. Notes Payable - SBA Paycheck Protection Program Loans We account for loans obtained under the Paycheck Protection Program in Section 1102 of the CARES Act (Note 7) as debt pursuant to FASB ASC 470 - Debt Interest – Imputation of Interest 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 December 31, 2020 and 2019, 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 it is subject to unusual credit risk beyond the normal credit risk associated with commercial banking relationships. For the years ended December 31, 2020, and 2019, there were no customers that accounted for more than 10% of consolidated revenue. For the year ended December 31, 2020, one customer had an open accounts receivable balance in excess of 10% of net accounts receivable. The customer balance accounted for 12.4% of net accounts receivable and did not have a balance older than 30 days as of December 31, 2020. For the year ended December 31, 2019, two customers had open accounts receivable balances which were above 10% of net accounts receivable, accounting for approximately 43% of net accounts receivable. Cost of Services Cost of services consists primarily of direct labor costs associated with support and customer onboarding and technology hosting costs 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 $3.06 million and $5.77 million for the years ended December 31, 2020 and 2019, respectively. Capitalized Cost of Obtaining a Contract The Company capitalizes sales commission costs which are incremental to obtaining a contract. We expense costs that are related to obtaining a contract but are not incremental such as other sales and marketing costs and other costs that would be incurred regardless of if the contract was obtained. Capitalized costs are amortized using straight-line amortization over the estimated weighted average life of the customer, which we have estimated to be 3 years. At December 31, 2020, the net carrying value of the capitalized cost of obtaining a contract was $1.27 million, of which $0.69 million is included in other current assets and $0.58 million is included in other long-term assets. At December 31, 2019, the net carrying value of the capitalized cost of obtaining a contract was $1.20 million, of which $0.68 million is included in other current assets and $0.52 million is included in other long-term assets. The Company amortized costs directly attributable to obtaining contracts of $0.82 million and $0.80 million during the years ended December 31, 2020 and 2019, 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 purpose of stock-based compensation in accordance with ASC 718. Stock-based compensation expense is recognized on a straight-line basis over the requisite service period for stock options. Stock-based compensation expense for restricted stock units and restricted stock awards with service based graded vesting schedules are recorded on a straight-line basis over the requisite vesting period as if the award were, in substance, a single award. 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 potentially 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 6) 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 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. In January 2017, the FASB issued ASU 2017- 04 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 2021, with early adoption permitted. The Company adopted this ASU on January 1, 2020 and has applied the provisions to quantitative goodwill impairment assessments performed in 2020. (See Note 4). In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This new accounting guidance removes: 1. the exception to the incremental approach for intraperiod tax allocations when there is a loss from continuing operations and income or gain from other items such as discontinued operation or other comprehensive income, 2. the exception to the requirement to recognize a deferred tax liability for equity method investments when a foreign subsidiary becomes an equity method investment, 3. the exception to the ability not to recognize a deferred tax liability for a foreign subsidiary when a foreign equity method investment becomes a subsidiary, and 4. the exception to the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. The new accounting guidance also simplifies the accounting for income taxes by: 1. requiring an entity to recognize franchise tax that is partially based on income as an income-based tax and account for any incremental amount incurred as a non-income-based tax, 2. requiring that an entity evaluate when a step up in the tax basis of goodwill should be considered part of the business combination in which the book goodwill was originally recognized and when it should be considered a separate transaction, 3. specifying that an entity is not required to allocate the consolidated amount of current and deferred tax expense to a legal entity that is not subject to tax in its separate financial statements, 4. requiring that an entity reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date, and 5. making minor Codification improvements for income taxes related to employee stock ownership plans and investments in qualified affordable housing projects accounted for using the equity method. This standard is effective for fiscal and interim periods beginning after December 15, 2020. The Company anticipates that the adoption of this standard will not have a material impact on its financial statements. |
