Note 4: Acquisitions

The Company pursues strategic acquisitions from time to time to leverage its existing capabilities and further build its business. Such acquisitions are 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. The earn out consideration, was scheduled to be paid 60% in cash and 40% in stock following the audit of the 2015 consolidated financial statements. However, during May 2015, the Company and RCTW, LLC (“RCTW”), the former owner of the SharpSpring assets, agreed that the earn out consideration would be paid in its entirety, with a portion of the cash-based earn out paid early in a cash and stock transaction. During this May 2015 transaction, the Company paid $2,000,000 in cash to RCTW and issued RCTW 545,455 shares in lieu of cash to settle an additional $3,000,000 of the cash-based earn out liability. As of June 30, 2015, the remaining payment due for the SharpSpring assets is $5,000,000, of which $1,000,000 will be paid in cash and $4,000,000 will be paid in stock during April 2016. The SharpSpring assets and liabilities were assigned to SMTP's wholly owned subsidiary SharpSpring, Inc. (“SharpSpring”). SharpSpring is a cloud-based marketing automation platform that enables users to connect with customers and build relationships to drive revenue through marketing automation, call tracking and customer relationship management.

The following table presents the components of the initial purchase price consideration:

Cash consideration	$	5,000,000
Earn out liability		6,963,000
Liabilities assumed		149,841
Total purchase price	$	12,112,841

The initial allocation of the purchase price is based on management estimates and assumptions, and other information compiled by management, which utilized established valuation techniques appropriate for the industry; these techniques were the income approach, cost approach or market approach, depending upon which was the most appropriate based on the nature and reliability of the data available. These amounts are provisional and subject to finalization in the next accounting period. The income approach is predicated upon the value of the future cash flows that an asset is expected to generate over its economic life. The cost approach takes into account the cost to replace (or reproduce) the asset and the effects on the assets value of physical, functional and/or economic obsolescence that has occurred with respect to the asset. The market approach is a technique used to estimate value from an analysis of actual transactions or offerings for economically comparable assets available as of the valuation date.

The following represents the initial allocation of the purchase price to the acquired net tangible and intangible assets acquired and liabilities assumed of SharpSpring:

Total purchase price	$	12,112,841
Less:
Net tangible assets acquired		(135,614)
Intangible assets acquired:
Trade Name		(120,000)
Developed Technologies		(2,130,000)
Customer Relationships		(1,320,000)
Total intangible assets		(3,570,000)
Goodwill	$	8,407,227

Acquired intangible assets include trade names which are to be amortized over the useful life of five years, and technology and customer relationships which are to be amortized over the useful life of 11 years.

Goodwill of $8,407,227 was recorded. Goodwill will not be amortized but instead tested for impairment at least annually (more frequently if certain indicators are present). Goodwill arose primarily as a result of the expected future growth of the SharpSpring product and the assembled workforce.

Pursuant to the asset purchase agreement, the Company was originally liable for an earn out of up to $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 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 $682,000 in the quarter ended December 31, 2014, $704,000 in the quarter ended March 31, 2015 and $1,030,000 in the quarter ended June 30, 2015. These earn out adjustments have been recorded on the consolidated statement of comprehensive income (loss) for the respective periods. As noted above, the Company entered into a transaction with RCTW during May 2015 to pay a portion of the cash-based earn out early, as well as to agree that the future earn out for the SharpSpring assets would be paid in its entirety. Although we are obligated to pay the full earn out for the SharpSpring assets, the earn out liability value will continue to increase over time as a result of the discount factor applied to the liability, with ultimate payment occurring in April 2016. As of June 30, 2015, the earn out liability for the $5,000,000 remaining earn out payment is recorded as $4,379,000 as a result of this discount factor. The Company will continue to increase the earn out liability over time as we get close to the ultimate payment date of April 2016 and record the expense related to those adjustments through the consolidated statements of comprehensive income (loss).

As of June 30, 2015, management had completed its evaluation of the fair value of certain intangible and other net assets acquired and does not expect future changes except for future changes to the earn out liability.

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 $0.8 million based on achieving certain revenue levels in 2015 (paid 50% in cash and 50% in stock). On October 17, 2014, the Company issued 423,426 unregistered shares of common stock which represents the $2.7 million portion of the consideration. GraphicMail operates as a campaign management solution, enabling customers to create content and manage emails being sent to customers and distribution lists.

The following table presents the components of the initial purchase price consideration:

Cash consideration	$	2,636,830
Stock consideration		2,684,138
Earn out liability		36,000
Liabilities assumed		663,704
Total purchase price	$	6,020,672

The following represents the initial allocation of the purchase price to the acquired net tangible and intangible assets acquired and liabilities assumed of GraphicMail. These amounts are provisional and subject to finalization in future accounting periods.

Total purchase price	$	6,020,672
Less:
Net tangible assets acquired		(730,276	)
Net intangible assets acquired		(4,779,000	)
Goodwill	$	511,396

Acquired intangible assets include trade names which are to be amortized over its estimated useful life of five years, and technology and customer relationships which are to be amortized over its estimated useful life of 11 years.

Goodwill will not be amortized but instead tested for impairment at least annually (more frequently if certain indicators are present). Goodwill arose primarily as a result of the expected future growth of the GraphicMail product and the assembled workforce.

Pursuant to the equity interest purchase agreement, the Company is liable for an earn out of up to $0.8 million, on 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 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 quarter ended June 30, 2015, resulting in an additional charge of $637,332. The company will continue to refine the projection of GraphicMail revenue levels in 2015 compared to the earn out revenue levels and adjust the liability accordingly through the consolidated statement of comprehensive income (loss).