Attached files

file filename
EX-32 - EX-32 - GLOBALSCAPE INCex32.htm
EX-31.2 - EX-31.2 - GLOBALSCAPE INCex31-2.htm
EX-31.1 - EX-31.1 - GLOBALSCAPE INCex31-1.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 10-Q
 

 
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2017
 
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the transition period from ____________________ to ____________________.
 
Commission file number  001-33601
 
GlobalSCAPE, Inc.
(Exact Name of Registrant as Specified in its Charter)

Delaware
 
74-2785449
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
4500 Lockhill-Selma, Suite 150
   
San Antonio, Texas
 
78249
(Address of Principal Executive Office)
 
(Zip Code)

(210) 308-8267
(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 No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data 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  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 ☐ (Do not check if a smaller reporting company)
Smaller reporting company
Emerging growth company ☐

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

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ☐ No ☐

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.  As of April 30, 2017 there were 21,571,831 shares of common stock outstanding.



GlobalSCAPE Inc.
Quarterly Report on Form 10-Q
For the Quarter ended March 31, 2017
Index
     
   
Page
     
Part I.
Financial Information
 
     
Item 1.
3
 
3
 
4
 
5
 
6
     
Item 2.
22
     
Item 3.
38
     
Item 4.
38
     
Part II.
Other Information
39
     
Item 1.
39
     
Item1A
39
     
Item 6.
39
   
40

GlobalSCAPE®, CuteFTP®, CuteFTP Pro®, CuteBackup®, DMZ Gateway®, EFT Cloud Services®, GlobalSCAPE Securely Connected®, CuteSendIt®, and Mail Express® are registered trademarks of GlobalSCAPE, Inc.  

Secure FTP Server™, Wide Area File Services™, WAFS™, CDP™, Advanced Workflow Engine™, AWE™, EFT Server™, EFT Workspaces™, Enhanced File Transfer™, Enhanced File Transfer Server™, Secure Ad Hoc Transfer™, SAT™, EFT Server Enterprise™, Enhanced File Transfer Server Enterprise™, Desktop Transfer Client™, DTC™, Mobile Transfer Client™, MTC™, Web Transfer Client™, Workspaces™, Accelerate™, WTC™, Content Integrity Control™, Advanced Authentication™ and scConnect™ are trademarks of GlobalSCAPE, Inc. 

TappIn® and design are registered trademarks of TappIn, Inc., our wholly-owned subsidiary. 

TappIn Secure Share™, Social Share™, Now Playing™, and Enhanced A La Carte Playlist™, are trademarks of TappIn, Inc., our wholly-owned subsidiary.

Other trademarks and trade names in this Quarterly Report are the property of their respective owners.
Part I. Financial Information
 
Item 1. Financial Statement

GlobalSCAPE, Inc.
Condensed Consolidated Balance Sheets
(in thousands except share amounts)

   
March 31,
   
December 31,
 
   
2017
   
2016
 
   
(Unaudited)
   
(Audited)
 
Assets
           
Current assets:
           
Cash and cash equivalents
 
$
10,400
   
$
8,895
 
Short term certificates of deposit
   
2,759
     
2,754
 
Accounts receivable, net
   
5,499
     
6,964
 
Federal income tax receivable
   
-
     
169
 
Prepaid and other expenses
   
492
     
521
 
Total current assets
   
19,150
     
19,303
 
                 
Long term certificates of deposit
   
12,837
     
456
 
Capitalized software development costs, net
   
3,731
     
12,779
 
Goodwill
   
12,712
     
3,743
 
Deferred tax asset, net
   
1,190
     
12,712
 
Property and equipment, net
   
577
     
942
 
Other assets
   
64
     
245
 
Total assets
 
$
50,261
   
$
50,180
 
                 
 Liabilities and Stockholders’ Equity
               
Current liabilities:
               
Accounts payable
 
$
657
   
$
876
 
Accrued expenses
   
1,928
     
1,836
 
Income tax payable
   
474
     
-
 
Deferred revenue
   
12,704
     
13,655
 
Total current liabilities
   
15,763
     
16,367
 
                 
Deferred revenue, non-current portion
   
3,618
     
3,790
 
Other long term liabilities
   
163
     
147
 
                 
Commitments and contingencies
               
                 
Stockholders’ equity:
               
Preferred stock, par value $0.001 per share, 10,000,000
authorized, no shares issued or outstanding
   
-
     
-
 
Common stock, par value $0.001 per share, 40,000,000
authorized, 21,970,412 and 21,920,912 shares issued
at March 31, 2017, and December 31, 2016, respectively
   
22
     
22
 
Additional paid-in capital
   
22,064
     
21,650
 
Treasury stock, 403,581 shares, at cost, at
March 31, 2017 and December 31, 2016
   
(1,452
)
   
(1,452
)
Retained earnings
   
10,083
     
9,656
 
Total stockholders’ equity
   
30,717
     
29,876
 
Total liabilities and stockholders’ equity
 
$
50,261
   
$
50,180
 

The accompanying notes are an integral part of these condensed and consolidated financial statements.
3


GlobalSCAPE, Inc.
Condensed Consolidated Statements of Operations and Comprehensive Income
(In thousands, except per share amounts)
(Unaudited)

   
Three months ended March 31,
 
   
2017
   
2016
 
             
Operating Revenues:
           
Software licenses
 
$
2,464
   
$
2,299
 
Maintenance and support
   
5,121
     
4,446
 
Professional services
   
733
     
642
 
Total Revenues
   
8,318
     
7,387
 
Cost of revenues
               
Software licenses
   
736
     
630
 
Maintenance and support
   
412
     
394
 
Professional services
   
377
     
422
 
Total cost of revenues
   
1,525
     
1,446
 
Gross profit
   
6,793
     
5,941
 
Operating expenses
               
Sales and marketing
   
3,330
     
3,048
 
General and administrative
   
1,721
     
1,733
 
Research and development
   
739
     
627
 
Total operating expenses
   
5,790
     
5,408
 
Income from operations
   
1,003
     
533
 
Other income
   
70
     
33
 
Income before income taxes
   
1,073
     
566
 
Income tax expense
   
322
     
174
 
Net income
 
$
751
   
$
392
 
Comprehensive income
 
$
751
   
$
392
 
                 
Net income per common share -
               
Basic
 
$
0.03
   
$
0.02
 
Diluted
 
$
0.03
   
$
0.02
 
                 
Weighted average shares outstanding:
               
Basic
   
21,544
     
21,033
 
Diluted
   
22,023
     
21,652
 
                 
Cash dividends declared per share
 
$
0.015
   
$
0.015
 

The accompanying notes are an integral part of these condensed and consolidated financial statements.
4


GlobalSCAPE, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)

   
For the Three Months Ended March 31,
 
   
2017
   
2016
 
Operating Activities:
           
Net income
 
$
751
   
$
392
 
Items not involving cash at the time they are recorded in the statement of operations:
         
Provision for sales returns and doubtful accounts receivable
   
11
     
43
 
Depreciation and amortization
   
541
     
501
 
Share-based compensation
   
324
     
222
 
Deferred taxes
   
(248
)
   
(19
)
Excess tax benefit from share-based
   
-
     
(3
)
Subtotal before changes in operating assets and liabilities
   
1,379
     
1,136
 
Changes in operating assets and liabilities:
               
Accounts receivable
   
1,454
     
916
 
Prepaid expenses
   
29
     
34
 
Deferred revenue
   
(1,123
)
   
(416
)
Accounts payable
   
(219
)
   
(350
)
Accrued expenses
   
92
     
(272
)
Other assets
   
181
     
22
 
Accrued interest receivable
   
(63
)
   
(16
)
Other long-term liabilities
   
16
     
3
 
Income tax receivable and payable
   
643
     
150
 
Net cash provided by operating activities
   
2,389
     
1,207
 
Investing Activities:
               
Software development costs capitalized
   
(462
)
   
(488
)
Purchase of property and equipment
   
(188
)
   
(90
)
Net cash (used in) investing activities
   
(650
)
   
(578
)
Financing Activities:
               
Proceeds from exercise of stock options
   
90
     
122
 
Excess tax benefit from share-based compensation
   
-
     
3
 
Dividends paid
   
(324
)
   
(315
)
Net cash (used in) financing activities
   
(234
)
   
(190
)
                 
Net increase in cash
   
1,505
     
439
 
Cash at beginning of period
   
8,895
     
15,885
 
Cash at end of period
 
$
10,400
   
$
16,324
 
                 
Supplemental disclosure of cash flow information:
               
Cash paid during the period for:
               
Interest
 
$
-
   
$
-
 
Income taxes
 
$
15
   
$
22
 

The accompanying notes are an integral part of these condensed and consolidated financial statements.

5


GlobalSCAPE, Inc.
Notes to Condensed Consolidated Financial Statements
As of March 31, 2017 and For the Three
Months Then Ended
(Unaudited)
 
1.
Nature of Business

We provide secure information exchange capabilities for enterprises and consumers through the development and distribution of software, delivery of managed and hosted solutions, and provisioning of associated services. Our solution portfolio facilitates transmission of critical information such as financial data, medical records, customer files, vendor files, personnel files, transaction activity, and other similar documents between diverse and geographically separated network infrastructures while supporting a range of information protection approaches to meet privacy and other security requirements. In addition to enabling secure, flexible transmission of critical information using servers, desktop and notebook computers, and a wide range of network-enabled mobile devices, our products also provide customers with the ability to monitor and audit file transfer activities.  Our primary product is Enhance File Transfer, or EFT. We have other products that complement our EFT product.

Throughout these notes unless otherwise noted, our references to the 2017 quarter and the 2016 quarter refer to the three months ended March 31, 2017 and 2016, respectively.

2.
Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Rule 10-01 of Regulation S-X, “Interim Financial Statements”, as prescribed by the Securities and Exchange Commission, or SEC. Accordingly, they do not include all information and footnotes required under generally accepted accounting principles in the United States, or GAAP, for complete financial statements. In the opinion of management, all accounting entries necessary for a fair presentation of our financial position and results of operations have been made. The results of operations for any interim period are not necessarily indicative of the results to be expected for the full year. The information included in this Form 10-Q should be read in conjunction with the financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016, which we refer to as the 2016 Form 10-K, as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations also included in our 2016 Form 10-K and in this report.

We follow accounting standards set by the Financial Accounting Standards Board. This board sets GAAP that we follow in preparing financial statements that report our financial position, results of operations, and sources and uses of cash. We also follow the reporting regulations of the United States Securities and Exchange Commission, or SEC.

The preparation of financial statements in accordance with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published, and the reported amounts of revenues and expenses during the reporting period. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of our financial statements. It is possible the actual results could differ from these estimates and assumptions and could have a material effect on the reported amounts of our financial position and results of operations.

3.
Significant Accounting Policies

Principles of Consolidation

The accompanying condensed consolidated financial statements of GlobalSCAPE, Inc. and its wholly-owned subsidiary (collectively referred to as the “Company” or “we”) are prepared in conformity with GAAP.  All intercompany accounts and transactions have been eliminated.

Changes in Accounting Methods, Reclassifications and Revisions

As part of our ongoing enhancement and refinement of our financial reporting to fairly present our results of operations and financial position, we may make changes from time-to-time in accounting methods and in the classification and presentation of our business activities in our financial statements. To ensure comparability between periods, we revise previous period financial statements presented to conform them to the method of presentation in our current period financial statements. If the changes increase or decrease previously reported amounts of revenue or expenses, we adjust retained earnings as of the beginning of the earliest period presented for the cumulative effect, if any, on that balance.  If these changes affect our financial statements for previously reported interim periods not presented herein, we present revised financial statements for those periods when they are reported in the future.

6


Method of Amortization of Deferred Revenue Related to M&S Contracts

In previously issued financial statements, we amortized deferred revenue related to maintenance and support, or M&S, contracts by recording a full month of amortization in the first month of a contract. We used that method based on our intent to match revenue from our M&S contracts to the expense we incur when delivering M&S services. We acknowledge that the more common and widespread practice is to amortize deferred revenue based upon the specific number of days the M&S contract is in place during that month. Both methods result in the recognition of the same amount of revenue over the term of the M&S contract but yield differing amounts of revenue being recognized in the first month and last month of an M&S contract.

Commencing with the issuance of our financial statements as of December 31, 2016, and for the year then ended, we changed our method of amortizing deferred revenue related to M&S contracts such that our consolidated statements of operations and balance sheets included herein are now prepared using the specific number of days method. This change decreased M&S revenue and net income for the three months ended March 31, 2016, as reported herein by immaterial amounts relative to amounts previously reported for that period. This change increased deferred revenue as of March 31, 2016, by an immaterial amount relative to the amount previously reported as of that date. This change has no effect on the total amount of revenue we will realize from our M&S contracts.

Method of Recording M&S Billings

We may invoice a customer for M&S to be provided commencing on a date in a month subsequent to the month in which we invoice the customer. We typically receive a purchase order from our customers for M&S prior to invoicing them, and it is not uncommon for a customer to pay us in advance of that M&S commencement date either on their own or when we request such payment. Accordingly, in our previously issued financial statements as of March 31, 2016, we recorded an account receivable and deferred revenue for these invoices as of the date of the invoice. Commencing with the preparation and issuance of our financial statements as of December 31, 2016, we determined that a reasonable, alternate and more conservative method would be to wait until the commencement date of the M&S contract had arrived to record the account receivable and deferred revenue for any such invoices for which we have not been paid as of the balance sheet date. Accordingly, our condensed consolidated balance sheet as of March 31, 2016, included herein is now prepared and presented using that method. This change had the effect of decreasing our reported amounts of accounts receivable and deferred revenue relative to the method we previously used but does not affect any of our reported amounts of revenue or net income.

Reclassification of Sales Engineer Expenses

We employ sales engineers who assist our sales staff in addressing technical considerations by our customers prior to their purchasing our product. Our use of sales engineers has expanded in recent quarters. Prior to 2016, we classified the expense of sales engineers as part of costs of revenue – professional services. Commencing with the preparation and issuance of our financial statements as of December 31, 2016, we began classifying these expenses as part of sales and marketing expense to more appropriately present the current nature of the activities of our sales engineers. This change has the effect of decreasing cost of revenue – professional services and increasing sales and marketing expense. It does not affect any of our reported amounts of revenue or net income.

Reclassification of Reserve for Uncertain Tax Position

As described in Note 9, we maintain a reserve for uncertain tax positions. Previously, we classified that reserve as a current liability since it was not material to our financial statements taken as a whole. Commencing with the preparation of our financial statements as of December 31, 2016, we determined it appropriate to classify it as a component of other long term liabilities. This change has the effect of decreasing current income taxes payable and increasing other long term liabilities.

Reclassification of Professional Services Revenue

In preparing our condensed consolidated statement of operations and comprehensive income for the 2017 quarter, we changed the classification of certain revenue from M&S to professional services to better reflect the nature of that revenue. We have made the same reclassification in our condensed consolidated statement of operations and comprehensive income for the 2016 quarter presented herein.

With respect to the above items, we have revised our financial statements as of March 31, 2016 and for the three months then ended. The following tables illustrate the effects of the above items on those previously issued financial statements:
7


Condensed Consolidated Statement of Operations and Comprehensive Income
(in thousands, except per share amounts)

   
For the Three Months Ended March 31, 2016
 
         
Revision Related To
       
   
As Previously
Reported
   
Change in Method of Deferred Revenue Amortization
   
Reclassification of Sales
Engineer Expenses
   
Reclassification of Professional Service Revenue
   
As
Revised
 
Operating revenues:
                             
Software licenses
 
$
2,299
                     
$
2,299
 
Maintenance and support
   
4,497
     
(23
)
         
(28
)
   
4,446
 
Professional services
   
614
                   
28
     
642
 
Total revenues
   
7,410
     
(23
)
   
-
             
7,387
 
Costs of revenues
                                       
Software licenses
   
630
                             
630
 
Maintenance and support
   
394
                             
394
 
Professional services
   
569
             
(147
)
           
422
 
Total costs of revenues
   
1,593
     
-
     
(147
)
           
1,446
 
Gross Profit
   
5,817
     
(23
)
   
147
             
5,941
 
Operating expenses
                                       
Sales and marketing
   
2,901
             
147
             
3,048
 
General and administrative
   
1,733
                             
1,733
 
Research and development
   
627
                             
627
 
Total operating expenses
   
5,261
     
-
     
147
             
5,408
 
Income from operations
   
556
     
(23
)
   
-
             
533
 
Other income (expense), net
   
33
                             
33
 
Income before income taxes
   
589
     
(23
)
   
-
             
566
 
Income tax expense
   
182
     
(8
)
   
-
             
174
 
Net income
 
$
407
   
$
(15
)
 
$
-
           
$
392
 
Comprehensive income
 
$
407
   
$
(15
)
                 
$
392
 
Comprehensive income
 
$
407
   
$
(15
)
 
$
-
           
$
392
 
                                         
Net income per common share - basic
 
$
0.02
   
$
-
   
$
-
           
$
0.02
 
                                         
Net income per common share - diluted
 
$
0.02
   
$
-
   
$
-
           
$
0.02
 

8

Condensed Consolidated Balance Sheets
(in thousands)

   
As of March 31, 2016
 
         
Revision Related To
       
   
As Previously
Reported
   
Change in Method of Deferred Revenue Amortization
   
Change in Method of Recording M&S Billings
   
Change in Classification of Reserve for Uncertain Tax Position
   
As
Revised
 
Assets
                             
Current assets:
                             
Cash and cash equivalents
 
$
16,324
                     
$
16,324
 
Short term investments
   
3,270
                       
3,270
 
Accounts receivable, net
   
5,340
         
$
(423
)
         
4,917
 
Federal income tax receivable
   
35
   
$
362
                   
397
 
Prepaid and other expenses
   
477
                           
477
 
                                       
Total current assets
   
25,446
     
362
     
(423
)
   
-
     
25,385
 
                                         
Long term investments
                                       
Property and equipment, net
   
517
                             
517
 
Capitalized software development costs, net
   
4,040
                             
4,040
 
Goodwill
   
12,712
                             
12,712
 
Deferred tax asset, net
   
959
                             
959
 
Other assets
   
38
                             
38
 
                                         
Total assets
 
$
43,712
   
$
362
   
$
(423
)
 
$
-
   
$
43,651
 
                                         
Liabilities and Stockholders’ Equity
                                       
Current liabilities:
                                       
Accounts payable
   
489
                             
489
 
Accrued expenses
   
1,621
                             
1,621
 
Deferred revenue
   
11,672
     
(29
)
   
347
             
11,990
 
Income taxes payable
   
34
     
62
             
(96
)
   
-
 
                                         
Total current liabilities
   
13,816
     
33
     
347
     
(96
)
   
14,100
 
                                         
Deferred revenue, non-current portion
   
3,718
     
68
     
76
             
3,862
 
Other long term liabilities
   
41
                     
96
     
137
 
                                         
Stockholders’ Equity:
                                       
Preferred stock
   
-
                             
-
 
Common stock
   
21
                             
21
 
Additional paid-in capital
   
19,930
                             
19,930
 
Treasury stock
   
(1,452
)
                           
(1,452
)
Retained earnings
   
7,638
     
(585
)
                   
7,053
 
Total stockholders’ equity
   
26,137
     
(585
)
                   
25,552
 
                                         
Total liabilities and stockholders’ equity
 
$
43,712
   
$
(484
)
 
$
423
   
$
-
   
$
43,651
 
9

Condensed Consolidated Statements of Cash Flows
(in thousands)

   
For the Three Months Ended March 31, 2016
 
   
As Previously
Reported
   
Change in Method of Deferred Revenue Amortization
   
Change in Method of Recording M&S Billings
   
Change in Classification of Reserve for Uncertain Tax Position
   
As
Adjusted
 
                               
Operating Activities:
                             
Net income
 
$
407
     
(15
)
             
$
392
 
Adjustments to reconcile net income to net cash provided by operating activities:
                             
Bad debt expense
   
43
                         
43
 
Depreciation and amortization
   
501
                         
501
 
Stock-based compensation
   
222
                         
222
 
Deferred taxes
   
(19
)
                       
(19
)
Excess tax deficiency from exercise of share based compensation
   
(3
)
                       
(3
)
Subtotal before changes in operating assets and liabilities
   
1,151
     
(15
)
   
-
     
-
     
1,136
 
Changes in operating assets and liabilities:
                                       
Accounts receivable
   
698
             
218
             
916
 
Prepaid expenses
   
34
                             
34
 
Federal income taxes
   
165
     
(9
)
           
(6
)
   
150
 
Accrued interest receivable
   
(16
)
                           
(16
)
Other assets
   
22
                             
22
 
Accounts payable
   
(350
)
                           
(350
)
Accrued expenses
   
(272
)
                           
(272
)
Deferred revenues
   
(222
)
   
(412
)
   
218
             
(416
)
Other long-term liabilities
   
(3
)
                   
6
     
3
 
Net cash provided by (used in) operating activities
   
1,207
     
(436
)
   
436
     
-
     
1,207
 
Investing Activities:
                                       
Software development costs
   
(488
)
                           
(488
)
Purchase of property and equipment
   
(90
)
                           
(90
)
Net cash provided by (used in) investing activities
   
(578
)
   
-
     
-
     
-
     
(578
)
Financing Activities:
                                       
Proceeds from exercise of stock options
   
122
                             
122
 
Tax deficiency (benefit) from stock-based compensation
   
3
                             
3
 
Dividends paid
   
(315
)
                           
(315
)
Net cash provided by (used in)  financing activities
   
(190
)
   
-
     
-
     
-
     
(190
)
Net increase (decrease) in cash
   
439
                             
439
 
Cash at beginning of period
   
15,885
     
-
     
-
     
-
     
15,885
 
Cash at end of period
 
$
16,324
   
$
-
   
$
-
   
$
-
   
$
16,324
 
                                         
Supplemental disclosure of cash flow information:
                                       
Cash paid during the period for:
                                       
Interest
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
Income taxes
 
$
22
   
$
-
   
$
-
   
$
-
   
$
22
 

10


Revenue Recognition

We develop, market and sell software products. We recognize revenue from a sale transaction when the following conditions are met:

· Persuasive evidence of an arrangement exists.
· Delivery has occurred or services have been rendered.
· The amount of the sale is fixed or determinable.
· Collection of the sale amount is reasonably assured.

For a sale transaction not meeting any one of these four criteria, we defer recognition of revenue related to that transaction until all the criteria are met.

We earn the majority of our software license revenue from software products sold under perpetual software license agreements. At the time our customers purchase these products, they typically also purchase an M&S contract. These transactions are multiple element software sales for which we assess the presence of vendor specific objective evidence (“VSOE”) of the fair value of the undelivered elements to determine the portion of these sales to recognize as revenue upon delivery of the software product and the portion of these sales to record as deferred revenue at the time the product is delivered. We amortize the deferred revenue component to revenue in future periods as we deliver the related future services to the customer. For transactions, if any, for which we cannot establish VSOE of the fair value of the undelivered elements, we initially record the entire transaction as deferred revenue and amortize that amount to revenue in future periods as we deliver the related future services to the customer.

We provide services under M&S contracts with terms generally ranging from one to three years. We require up-front payment of our M&S fee in an amount that covers the entire term of the agreement.  We record as deferred revenue amounts due or paid that relate to future periods during which we will provide the M&S service. Deferred revenue related to services we will deliver within one year is presented as a current liability while deferred revenue related to services that we will deliver more than one year into the future is presented as a non-current liability. We reduce deferred revenue and recognize revenue ratably in future periods as we deliver the M&S service.

For our products licensed and delivered under a software-as-a-service, or SaaS, transaction on a monthly or other periodic subscription basis, we recognize subscription revenue, including initial setup fees, on a monthly basis ratably over the contractual term of the customer contract as we deliver our products and services. Amounts paid prior to this revenue recognition are presented as deferred revenue until earned.

We provide professional services to our customers consisting primarily of software installation support, operations support and training. We recognize revenue from these services as they are completed and accepted by our customers.

We collect sales tax on many of our sales. We do not include sales tax collected in our revenue. We record it as a liability payable to taxing authorities.

Cash and cash equivalents

Cash and cash equivalents includes all cash and highly liquid investments with original maturities of three months or less.

Property and Equipment

Property and equipment is comprised of furniture and fixtures, software, computer equipment and leasehold improvements which are recorded at cost and depreciated using the straight-line method over their estimated useful lives. Furniture, fixtures and equipment have a useful life of five to seven years, computer equipment and software have a useful life of three years and leasehold improvements have a useful life that is the shorter of the term of the lease under which the improvements were made or the estimated useful life of the asset.

Expenditures for maintenance and repairs are expensed as incurred.

Goodwill

Goodwill is not amortized. On at least an annual basis, we test goodwill for impairment at the reporting unit level using December 31 as the measurement date. We operate as a single reporting unit.

11


When testing goodwill, we first assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of our reporting unit is less than its carrying amount, including goodwill. In performing this qualitative assessment, we assess events and circumstances relevant to us including, but not limited to:

·
Macroeconomic conditions.
·
Industry and market considerations.
·
Cost factors and trends for labor and other expenses of operating our business.
·
Our overall financial performance and outlook for the future.
·
Trends in the quoted market value and trading of our common stock.

In considering these and other factors, we consider the extent to which any adverse events and circumstances identified could affect the comparison of our reporting unit’s fair value with its carrying amount. We place more weight on events and circumstances that most affect our reporting unit’s fair value or the carrying amount of our net assets. We consider positive and mitigating events and circumstances that may affect our determination of whether it is more likely than not that the fair value of our reporting unit is less than its carrying amount. We evaluate, on the basis of the weight of the evidence, the significance of all identified events and circumstances in the context of determining whether it is more likely than not that the fair value of our reporting unit is less than its carrying amount.

If, after assessing the totality of these qualitative events and circumstances, we determine it is not more likely than not that the fair value of our reporting unit is less than its carrying amount, we conclude there is no impairment of goodwill and perform no further testing in accordance with GAAP. If we conclude otherwise, we proceed with performing the first step, and if necessary, the second step, of the two-step goodwill impairment test prescribed by GAAP.

As of December 31, 2016, after assessing the totality of the relevant events and circumstances, we determined it not more likely than not that the fair value of our reporting unit was less than its carrying amount. Accordingly, we concluded there was no impairment of goodwill as of that date. There have been no material events or changes in circumstances since that time indicating that the carrying amount of goodwill may exceed its fair market value and that interim testing needed to be performed.

Capitalized Software Development Costs

When we complete research and development for a software product and have in place a program plan and a detail program design or a working model of that software product, we capitalize production costs incurred for that software product from that point forward until it is ready for general release to the public. Thereafter, we amortize capitalized software production costs to expense using the straight-line method over the estimated useful life of that product, which is generally three years. We periodically assess the carrying value of capitalized software development costs and our method of amortizing them relative to our estimates of realizability through sales of products in the marketplace.

Research and Development

We expense research and development costs as incurred.

Advertising Expense

We expense advertising costs as incurred as a component of our sales and marketing expenses.  Advertising expense was $455,080 and $407,441 in the 2017 quarter and the 2016 quarter, respectively.

Share-Based Compensation

We measure the cost of share-based payment transactions at the grant date based on the calculated fair value of the award. We recognize this cost as an expense ratably over the recipient’s requisite service period during which that award vests or becomes unrestricted.

For stock option awards, we estimate their fair value at the grant date using the Black-Scholes option-pricing model considering the following factors:

·
We estimate expected volatility based on historical volatility of our common stock.
·
We use primarily the simplified method to derive an expected term which represents an estimate of the time options are expected to remain outstanding. We use this method because our options are plain-vanilla options, and we believe our historical option exercise experience is not adequately indicative of our future expectations.
·
We base the risk-free rate for periods within the contractual life of the option on the U.S. treasury yield curve in effect at the time of grant.
·
We estimate a dividend yield based on our historical and expected future dividend payments.
12


For restricted stock awards, we use the quoted price of our common stock on the grant date as the fair value of the award.

Income Taxes

We account for income taxes using the asset and liability method.  We record deferred tax assets and liabilities based on the difference between the tax bases of assets and liabilities and their carrying amount for financial reporting purposes, as measured by the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred tax assets and liabilities are carried on the balance sheet with the presumption that they will be realizable in future periods in which we generate taxable income.

We assess the likelihood that deferred tax assets will be realized from future taxable income. Based on this assessment, we provide any necessary valuation allowance on our balance sheet with a corresponding increase in the tax provision on our statement of operations.   Any valuation allowances we establish are determined based upon a number of assumptions, judgments, and estimates, including forecasted earnings, future taxable income, and the relative proportions of revenue and income before taxes in the various domestic jurisdictions in which we operate.

We account for uncertainty in income taxes using a two-step process to determine the amount of tax benefit to be recognized. First, we evaluate the tax position 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, we assess the tax position to determine the amount of benefit to recognize in the financial statements. The amount of the benefit we recognize is the largest amount that we believe has a greater than 50 percent likelihood of being realized upon ultimate settlement. Unrecognized tax benefits represent tax positions for which reserves have been established.

Earnings Per Share

We compute basic earnings per share using the weighted-average number of common shares outstanding during the periods.  We compute diluted earnings per share using the weighted-average number of common shares outstanding plus the number of common shares that would be issued assuming conversion of all potentially dilutive common shares outstanding.

Awards of non-vested restricted stock and options are considered potentially dilutive common shares for the purpose of computing earnings per common share.  We apply the treasury stock method to non-vested options under which the assumed proceeds include the amount the employee must pay to exercise the option plus the amount of unrecognized cost attributable to future periods less any expected tax benefits.

Recent accounting pronouncements

ASU 2017-04, Intangibles – Goodwill and Other (issued January 2017) - To simplify the subsequent measurement of goodwill, Step 2 was eliminated from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in this update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. Any loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. This update also eliminated the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. Therefore, the same impairment assessment applies to all reporting units. An entity is required to disclose the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount of net assets. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. A public business entity that is a U.S. Securities and Exchange Commission (SEC) filer is required to adopt the amendments in this update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. We expect that the application of the provisions of this update will not have a material effect on our financial statements.

ASU 2016-15, Statement of Cash Flows – Classification of Certain Cash Receipts and Cash Payments (issued June 2016) - This pronouncement provides guidance as to the treatment of transactions in a statement of cash flows with respect to eight specific cash flow issues. During 2017 and 2016, we had no transactions of the type cited in the statement and do not anticipate having any such transactions in the foreseeable future. Accordingly we do not expect this pronouncement to have a material effect on how we present items in our statement of cash flows.

13


ASU 2016-13, Financial Instruments – Credit Losses (issued June 2016) - Among the provisions of this ASU is a requirement that assets measured at amortized cost, which includes trade accounts receivable, be presented at the net amount expected to be collected. This pronouncement requires that an entity reflect all of its expected credit losses based on current estimates which will replace the current standard requiring that an entity need consider only past events and current conditions in measuring an incurred loss. We are subject to this guidance effective with financial statements we issue for the year ending December 31, 2020, and the quarterly periods during that year. We do not expect the amounts we report as accounts receivable in those future periods under this guidance to be materially affected relative to current guidance.

ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (issued March 2016) – This standard discontinued the recording in equity of tax benefits or tax deficiencies that arise from differences between share-based payment compensation expense recorded for financial statement purposes and that expense deductible for tax purposes. This new standard requires that the tax effect of all such differences be recorded and reported in the statement of operations. This standard also requires that tax-related cash flows resulting from share-based payments be reported as operating activities in the statement of cash flows which is a change from the current requirement to present such tax-related items as an inflow from financing activities and an outflow from operating activities. As prescribed by this standard, we adopted it beginning January 1, 2017, and followed it in the preparation of our financial statements as of March 31, 2017, and for the three months then ended.

This standard also permits an accounting policy election for the impact of forfeitures on the recognition of expense for share-based payment awards. Forfeitures may be either estimated (as has been the requirement in the past) or recognized when they occur. We elected to continue estimating forfeitures consistent with our existing practices thereby resulting in no change to our application of GAAP for this aspect of computing share-based compensation.

ASU 2016-02, Leases (issued February 2016) - The main difference between existing GAAP and this ASU 2016-02 is the presentation by lessees on their financial statements of lease assets and lease liabilities arising from operating leases. Since this new standard retains the distinction between finance and operating leases, the effect of leases in the statement of operations and the statement of cash flows will be largely unchanged from existing GAAP. Our only lease of significance is our operating lease for our corporate office space for which we will present a right-to-use asset and a lease liability on our balance sheet when we implement this standard. We are in the process of determining those amounts. In accordance with this standard, we will implement it beginning with our interim and annual financial statements for 2019. The extent of the effect of this standard on our financial statements for 2019 and later will depend upon the leases, if any, that we have in effect at that date.

ASU 2015-17, Income Tax: Balance Sheet Classification of Deferred Taxes (issued November 2015) - This pronouncement requires that all deferred tax assets and liabilities for a tax jurisdiction, along with any related valuation allowance, be classified as noncurrent on the balance sheet. We have implemented this ASU in the accompanying financial statements in the manner described in the Note 9 below.

ASU 2014-09, Revenue from Contracts with Customers (issued May 2014) - The core principle of this guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects consideration to which the entity expects to be entitled in exchange for those goods or services. We are subject to this guidance effective with financial statements we issue for the year ending December 31, 2018, and the quarterly periods during that year. Our qualitative assessments to date indicate that the application of this ASU will not have a material effect on the amounts or timing of revenue we report in those future periods relative to current guidance. We are in the process of completing our quantitative analysis to support those qualitative assessments. We are also evaluating the method we will apply for adopting this principle.

We believe the application of ASU 2014-09 will result in a change in the manner in which we record sales commission expense related to M&S contracts. Currently, we record the full amount of the sales commission paid on the full value of an M&S contract as an expense on the inception date of the M&S contract. We believe that under ASU 2014-09, we will record that commission expense ratably over the term of the M&S contract. We are in the process of quantifying the effect this change will have on our financial statements.

Use of Estimates

The preparation of condensed consolidated financial statements in accordance with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published, and the reported amounts of revenues and expenses during the reporting period. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of the Company’s financial statements. It is possible that the actual results could differ from these estimates and assumptions, which could have a material effect on the reported amounts of the Company’s financial position and results of operation.

14


4.
Certificates of Deposit

Our certificates of deposit are held at a bank and mature at various dates through December 2021. Certificates of deposit with contractual maturity dates less than one year from the balance sheet date are presented as current assets.  Certificates of deposit with contractual maturity dates beyond one year from the balance sheet date are presented as non-current assets.

We have the ability to hold these certificates of deposit until their maturity dates and as of the date of this report intend to do so. We measure these investments on a recurring basis using Level 1 of the fair value hierarchy prescribed by GAAP which results in them being presented at original cost plus accrued interest earned. There is no amortization of original cost associated with our certificates of deposit.

5.
Accounts Receivable

We bill our customers and issue them an invoice when we have delivered our goods or services to them. In addition, when our customers agree to purchase or renew M&S services, we bill and invoice our customers at that time which could be before the date we begin delivering those services. In that event, we exclude from accounts receivable (and from the related deferred revenue, see Note 3) the invoices we have issued for which the M&S services commencement date is in the future and which have not been paid by the customer as of the date of our financial statements. Accordingly, we determine our accounts receivable as follows ($ in thousands):

   
March 31,
2017
   
December 31,
2016
 
Total invoices issued and unpaid
 
$
6,259
   
$
7,680
 
Less: Unpaid invoices relating to M&S contracts with a start date subsequent to the balance sheet date
   
(410
)
   
(381
)
Gross accounts receivable
   
5,849
     
7,299
 
Allowance for sales returns and doubtful accounts
   
(350
)
   
(335
)
Accounts receivable, net
 
$
5,499
   
$
6,964
 

6. Capitalized Software Development Costs

Our capitalized software development costs balances and activities were as follows: ($ in thousands):

   
March 31,
   
December 31,
 
   
2017
   
2016
 
Gross capitalized cost
 
$
7,714
   
$
7,252
 
Accumulated amortization
   
(3,983
)
   
(3,509
)
Net balance
 
$
3,731
   
$
3,743
 

   
Three Months Ended March 31,
 
   
2017
   
2016
 
Amount capitalized
 
$
462
   
$
488
 
Amortization expense
   
(474
)
   
(430
)

   
Released
   
Unreleased
 
   
Products
   
Products
 
Gross capitalized amount at March 31, 2017
 
$
6,171
   
$
1,543
 
 
Future amortization expense:
               
Nine months ending December 31, 2017
   
1,116
         
Year ending December 31,
               
2018
   
856
         
2019
   
216
         
2020
   
-
         
Total
 
$
2,188
         

The future amortization expense of the gross capitalized software development costs related to unreleased products will be determinable at a future date when those products are ready for general release to the public.
15


7.
 Deferred Revenue

As described in Note 5 regarding accounts receivable, when our customers agree to purchase or renew M&S services, we bill and invoice our customers at that time which could be before the date we begin delivering those services. In that event, we exclude from deferred revenue (and from the related accounts receivable) the invoices we have issued for which the M&S services commencement date is in the future and which have not been paid by the customer as of the date of our financial statements. Accordingly, we determine our deferred revenue as follows ($ in thousands):

   
March 31, 2017
   
December 31, 2016
 
Total invoiced for M&S contracts for which revenue will be recognized in future periods
 
$
16,732
   
$
17,826
 
Less: Unpaid invoices relating to M&S contracts with a start date subsequent to the balance sheet date
   
(410
)
   
(381
)
Total deferred revenue
 
$
16,322
   
$
17,445
 
                 
Deferred revenue, current portion
 
$
12,704
   
$
13,655
 
Deferred revenue, non-current portion
   
3,618
     
3,790
 
Total deferred revenue
 
$
16,322
   
$
17,445
 

8.
Stock Options, Restricted Stock and Share-Based Compensation

We have stock-based compensation plans under which we have granted, and may grant in the future, incentive stock options, non-qualified stock options, and restricted stock to employees and non-employee members of the Board of Directors. Our share-based compensation expense was as follows ($ in thousands):

   
Three Months Ended March 31,
 
   
2017
   
2016
 
Share-based compensation expense
 
$
324
   
$
222
 

Stock Options

We have granted stock options to our officers and employees under long-term equity incentive plans that originated in 2000, 2010 and 2016. During the 2017 quarter, we granted stock options only under the 2016 plan.

Provisions and characteristics of the options granted to our officers and employees under our long-term equity incentive plans include the following:

·
The exercise price, term and other conditions applicable to each stock option or stock award granted are determined by the Compensation Committee of the Board of Directors.
·
The exercise price of stock options is set on the grant date and may not be less than the fair market value per share of our stock at market close on that date.
·
Stock options we issue generally become exercisable ratably over a three-year period, expire ten years from the date of grant, and are exercisable for a period of ninety days after the end of employment.
·
Upon exercise of a stock option, we issue new shares from the shares of common stock we are authorized to issue.

We currently issue stock-based awards to our officers and employees only under the 2016 plan which authorizes the issuance of up to 5,000,000 shares of common stock for stock-based incentives including stock options and restricted stock awards. As of March 31, 2017, stock-based incentives for up to 4,329,500 shares remained available for issuance in the future under this plan.

We have not previously issued any restricted stock under any of these plans.

16


Our stock option activity has been as follows:

         
Weighted
             
         
Average
   
Weighted Average
   
Aggregate
 
         
Exercise
   
Remaining
   
Intrinsic
 
   
Number of
   
Price
   
Contractual
   
Value
 
   
Shares
   
Per Share
   
Term in Years
   
(000’s)
 
                         
Outstanding at December 31, 2016
 
 
2,407,005
   
$
3.00
   
 
7.19
   
$
2,574
 
Granted
   
660,000
     
3.76
                 
Forfeited
   
(86,080
)
   
3.87
                 
Exercised
   
(49,500
)
   
1.82
                 
Outstanding at March 31, 2017
   
2,931,425
     
3.17
     
7.56
     
2,238
 
                                 
Exercisable at March 31, 2017
   
1,245,214
     
2.59
     
5.17
     
1,681
 

Additional information about our stock options is as follows:

   
Three Months Ended March 31,
 
   
2017
   
2016
 
Weighted average fair value of options granted
 
$
1.47
   
$
1.65
 
Intrinsic value of options exercised
 
$
100,386
   
$
71,745
 
Cash received from stock options exercised
 
$
90,114
   
$
121,671
 
                 
Number of options that vested
   
295,124
     
193,866
 
Fair value of options that vested
 
$
450,336
   
$
248,148
 
                 
Unrecognized compensation expense related to non-vested options at end of period
 
$
2,279,284
   
$
1,673,156
 
Weighted average years over which non-vested option expense will be recognized
   
2.34
     
2.50
 

As of March 31, 2017
 
       
Options Outstanding
 
Options Exercisable
 
       
Weighted
             
       
Average
 
Weighted
     
Weighted
 
   
Underlying
 
Remaining
 
Average
 
Number of
 
Average
 
Range of
 
Shares
 
Contractual
 
Exercise
 
Underlying
 
Exercise
 
Exercise Prices
 
Outstanding
 
Life
 
Price
 
Shares
 
Price
 
 
$
0.85 - $1.43
     
87,100
     
3.32
   
$
1.07
     
87,100
   
$
1.07
 
 
$
1.47 - $2.32
     
459,745
     
4.64
   
$
1.83
     
458,385
   
$
1.83
 
 
$
2.34 - $3.52
     
1,144,680
     
8.03
   
$
3.22
     
525,179
   
$
3.02
 
 
$
3.53 - $4.25
     
1,239,900
     
8.50
   
$
3.76
     
174,550
   
$
4.05
 
Total options
     
2,931,425
                     
1,245,214
         

We used the following assumptions to determine compensation expense for our stock options using the Black-Scholes option-pricing model:

   
Three Months Ended March 31,
 
   
2017
   
2016
 
Expected volatility
   
45
%
   
56
%
Expected annual dividend yield
   
1.50
%
   
1.50
%
Risk free rate of return
   
1.94
%
   
1.53
%
Expected option term (years)
   
6.00
     
6.00
 

17


Restricted Stock Awards

Our 2015 Non-Employee Directors Long Term Incentive Plan (“2015 Directors Plan”) provides for the issuance of either stock options or restricted stock awards for up to 500,000 shares of our common stock. Provisions and characteristics of this plan include the following:

·
The exercise price, term and other conditions applicable to each stock option or stock award granted are determined by the Compensation Committee of the Board of Directors.
·
Restricted stock awards are initially issued as restricted shares with a legend restricting transferability of the shares until the recipient satisfies the vesting provision of the award, which is generally continuing service for one year subsequent to the date of the award, after which time the restrictive legend is removed from the shares.
·
Restricted shares participate in dividend payments and may be voted.
·
As of March 31, 2017, stock based incentives for up to 340,000 shares remained available for issuance in the future under this plan.

Our restricted stock awards activity has been as follows:

             
Total
 
         
Grant Date
 
Fair Value of
 
   
Number of
   
Fair Value
 
Shares That
 
   
Shares
   
Per Share
 
Vested
 
Restricted shares outstanding at December 31, 2016
   
80,000
   
$
3.31
     
Shares granted with restrictions
   
-
   
$
-
     
Shares vested and restrictions removed
   
-
   
$
-
   
$
-
 
Restricted shares outstanding at March 31, 2017
   
80,000
   
$
3.31
         
                         
Unrecognized compensation expense for non-vested shares as of March 31, 2017
         
Expense to be recognized in future periods
 
$
25,322
                 
Weighted average number of months over which expense is expected to be recognized
   
1.2
                 

9.
Income Taxes

The components of our income tax expense (benefit) are as follows ($ in thousands):

   
Three months ended March 31,
 
   
2017
   
2016
 
   
Current
   
Deferred
   
Total
   
Current
   
Deferred
   
Total
 
Federal
 
$
519
   
$
(238
)
 
$
281
   
$
172
   
$
(7
)
 
$
165
 
State
   
51
     
(10
)
   
41
     
21
     
(12
)
   
9
 
Total
   
570
     
(248
)
   
322
     
193
     
(19
)
   
174
 

18


Deferred income taxes on our balance sheet reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.  Significant components of our deferred tax assets and liabilities are as follows ($ in thousands):

   
March 31,
   
December 31,
 
   
2017
   
2016
 
Deferred tax assets:
           
Deferred revenue
 
$
1,331
   
$
1,228
 
Capital loss carryforward
   
1,099
     
1,099
 
Share-based compensation
   
619
     
578
 
Compensation and benefits
   
270
     
176
 
Texas franchise tax R&D credit
   
156
     
153
 
Allowance for doubtful accounts
   
119
     
114
 
Net operating loss carryforward
   
76
     
91
 
Other
   
62
     
51
 
Less Valuation Allowances:
               
Capital loss carryforward
   
(1,099
)
   
(1,099
)
Texas franchise tax R&D credit
   
(156
)
   
(153
)
Total deferred tax assets
   
2,477
     
2,238
 
                 
Deferred tax liabilities:
               
Intangible assets
   
1,285
     
1,289
 
Depreciation
   
2
     
7
 
Total gross deferred tax liabilities
   
1,287
     
1,296
 
                 
Net deferred tax assets
 
$
1,190
   
$
942
 

In assessing the realizability of deferred tax assets, we consider whether it is more-likely-than-not that a deferred tax asset will not be realized.  Our assessment of the likelihood of having sufficient taxable income in the future to support deduction or utilization of the items giving rise to our deferred tax assets indicates it is more-likely-than-not that we will realize the deferred tax assets listed in the table above.

As of March 31, 2017, we had federal income tax net operating loss carryforwards of $225,000 available to offset future federal taxable income, if any. These carryforwards became available through our acquisition of TappIn, Inc. in 2011.  These carryforwards expire in 2030 and 2031.

As of March 31, 2017, we had federal income tax capital loss carryforwards of $3,231,000 which resulted from the reduction of our investments in and notes receivable from CoreTrace Corporation in 2012.  We can realize capital loss carryforwards to the extent we have capital gains in future periods against which this capital loss can be deducted.  We believe it uncertain that we will have sufficient capital gains in the future to support this deduction and accordingly have provided a valuation allowance for the full amount of this carryforward. This carryforward expires in 2017.

As of March 31, 2017, we had Texas R&D tax credit carryforwards of $156,000.  We can realize Texas R&D tax credit carryforwards to the extent we have sufficient Texas Franchise Tax in future years.  We believe it uncertain that we will have sufficient Texas Franchise Tax in the future to support utilization of these credits and, accordingly, have provided a valuation allowance for the full amount of this carryforward.  These carryforwards expire in 2034 through 2036.

We claim research and experimentation tax credits, or R&D tax credits, on certain of our tax returns and have included the effect of those credits in our provision for income taxes. A routine examination of our 2008, 2009 and 2010 federal income tax returns conducted and completed by the Internal Revenue Service resulted in the amount of the R&D tax credits allowed for those years being less than the amounts we claimed on those federal income tax returns. If the Internal Revenue Service examines our federal income tax returns for 2011 and later years, we believe they may apply their same criteria to the R&D tax credits we claimed on those tax returns. Accordingly, we believed it more-likely-than-not that the R&D tax credit allowed for those years may be less than the amounts we have claimed.  As a result, we maintain a reserve for an uncertain tax position for this matter in the amount of $136,000 as of March 31, 2017.

19


The aggregate changes in the balance of our gross unrecognized tax benefits were as follows ($ in thousands):

   
Three Months Ended March 31,
 
   
2017
   
2016
 
Balance at beginning of period
 
$
116
   
$
90
 
Increases for tax positions related to the current year
   
4
     
6
 
Increases for tax positions related to prior years
   
16
     
-
 
Decreases for tax positions related to prior years
   
-
     
-
 
Decreases due to settlements related to prior years
   
-
     
-
 
Balance at end of period
 
$
136
   
$
96
 

We believe it reasonably possible that we will not recognize any of our unrecognized tax benefits at least through March 31, 2017. If we realized and recognized any of our gross unrecognized tax benefits, such benefits would reduce our effective tax rate in the year of recognition.

We are subject to taxation in the United States and in multiple state jurisdictions. Our federal income tax returns for 2015, 2014 and 2013 are subject to examination by the Internal Revenue Service.  Our amended federal income tax returns for 2012 and 2011 are subject to examination with the amount of any claim for payment of additional taxes limited to the amount by which the tax due on those amended returns was less than the tax due on the returns for those years as originally filed.  Our state tax returns are subject to examination for varying periods of time by numerous state taxing authorities. Currently, none of our federal or state income tax returns are under examination.

To the extent they arise, we record interest and penalty expenses related to income taxes as components of other expense in our statement of operations.  We incurred no such expenses in the 2017 quarter or the 2016 quarter.

We file state tax returns in various states.  The taxes resulting from these filings are included in income tax expense.

Our income tax expense (benefit) reconciles to an income tax expense resulting from applying an assumed statutory federal income rate of 34% to income before income taxes as follows ($ in thousands):

   
Three months ended March 31,
 
   
2017
   
2016
 
Income tax expense (benefit) at federal statutory rate
 
$
365
   
$
193
 
Increase (decrease) in taxes resulting from:
               
State taxes, net of federal benefit
   
24
     
2
 
Stock based compensation
   
59
     
16
 
Other
   
(22
)
   
9
 
R&D tax credit uncertain tax position (net)
   
(110
)
   
(32
)
Research and development credit
   
20
     
6
 
Domestic production activities deduction
   
(14
)
   
(20
)
Income tax expense (benefit) per the statement of operations
 
$
322
   
$
174
 
 
20

10.
Earnings per Common Share

Earnings per share for the periods indicated were as follows ($ in thousands, except per share amounts):

 
Three Months Ended
 
 
March 31,
 
 
2017
   
2016
 
Numerators
       
Numerator for basic and diluted earnings per share:
       
Net income
 
$
751
   
$
392
 
               
Denominators
               
Denominators for basic and diluted earnings per share:
               
Weighted average shares outstanding - basic
   
21,544
     
21,033
 
               
Dilutive potential common shares
               
Stock options and awards
   
479
     
619
 
Denominator for diluted earnings per share
   
22,023
     
21,652
 
               
Net income per common share - basic
 
$
0.03
   
$
0.02
 
Net income per common share – diluted
 
$
0.03
   
$
0.02
 
 
 
As a result of our implementation of ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (issued March 2016), the estimated proceeds resulting from equity compensation deductible for federal income tax purposes being greater than the associated share-based compensation expense are no longer considered as part of the treasury stock method used in computing diluted earnings per share. This change had no material effect on our earnings per share computations.

11.
Dividends

We paid dividends as follows:

 
Three Months Ended March 31,
 
 
2017
 
2016
 
Dividend per share of common stock
 
$
0.015
   
$
0.015
 
Dividend record date
February 23, 2017
 
February 23, 2016
 
Dividend payment date
March 8, 2017
 
March 8, 2016
 

12.
Commitments and Contingencies

We have agreements with key personnel that provide for severance payments to them in the event of a change in control of the Company, as defined in those agreements, and their employment is terminated in connection with that change in control. In such event, our aggregate severance payments to those employees would be $1.9 million.

13.
Concentration of Business Volume and Credit Risk

In order to leverage the resources of third parties, we make our products available for purchase by end users through third-party, channel distributors even though those end users can also purchase those products directly from us. In both the 2017 quarter and 2016 quarter, we earned approximately 14% of our revenue from such sales through our largest, third party, channel distributor. As of March 31, 2017, approximately 16% of our accounts receivable were due from this channel distributor with payment for substantially all such amounts having been received subsequent to that date.

14.
Segment and Geographic Disclosures

In accordance with FASB ASC Topic 280, Segment Reporting, we view our operations and manage our business as principally one segment. As a result, the financial information disclosed herein represents all of the material financial information related to our principal operating segment.

Revenues derived from customers and partners located in the United States accounted for approximately 78% and 73% of our total revenues in 2017 and 2016 quarter, respectively.  The remaining revenues were from customers and partners located in foreign countries with each individual foreign country accounting for less than 10% of total revenues in all periods.  We attribute revenues to countries based on the country in which the customer or partner is located. None of our property and equipment was located in a foreign country as of March 31, 2017.

21


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

This Quarterly Report on Form 10-Q and any documents incorporated by reference herein contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended.  “Forward-looking statements” are those statements that are not of historical fact but describe management’s beliefs and expectations.  We have identified many of the forward-looking statements in this Quarterly Report by using words such as “anticipate,” “believe,” “could,” “estimate,” “may,” “expect,” “potentially” and “intend.”  Although we believe these expectations are reasonable, our operations involve a number of risks and uncertainties, including those described in the “Risk Factors” section of our 2015 Form 10-K and other documents filed with the Securities and Exchange Commission.  Therefore, GlobalSCAPE’s actual results of operations and financial condition in the future could differ materially from those discussed in this Quarterly Report.

In the following discussion, our references to the 2017 quarter and the 2016 quarter refer to the three months ended March 31, 2017 and 2016, respectively.

Overview

We develop and sell computer software that provides secure information exchange, data transfer and sharing capabilities for enterprises and consumers. We have been in business for over twenty years and have sold our products to thousands of enterprises and more than one million individual consumers throughout the world.

Our primary business is selling and supporting managed file transfer, or MFT, software for enterprises. The brand name of our MFT product platform is Enhanced File Transfer, or EFT.

We earn most of our revenue from the sale of EFT and products that are part of our EFT platform. We earn revenue from the sale of perpetual software licenses, providing products under software-as-a-service, or SaaS, subscriptions, providing maintenance and support services, or M&S, and offering professional services for product customization and integration.

We also sell other products that are synergistic to EFT including Mail Express, WAFS, and CuteFTP. Collectively, these products constitute less than 10% of our total revenue.

We focus on selling our EFT platform products in a business-to-business environment. The majority of the resources we will expend in the future for product research, development, marketing and sales will focus on our EFT platform products. We believe our products and business capabilities are well-positioned to compete effectively in the market for MFT products.  For a more comprehensive discussion of the products we sell and the services we offer, see Software Products and Services below.

As a corporation, we have won multiple awards for performance and reputation, including:

·
In 2017:
-
Recognized for three Info Security Products Guide 2017 Global Excellence Awards for distinguished achievements in product innovation in categories that included:
-
Innovation in Compliance (Gold Winner) – Enhanced File Transfer
-
Cloud/SaaS Solutions (Gold Winner) – EFT Cloud Services
-
BYOD Security (Bronze Winner) – EFT Workspaces
-
Received a 5-Star rating in The Channel Company’s CRN 2017 Partner Program Guide for the third year in a row.
-
Honored with the 2017 Total Rewards & Benefits Excellence Award by the HRO Today Services and Technology Association.
-
Selected as a finalist in the 2017 Cybersecurity Product Awards Secure File Transfer: EFT Enterprise

·
In 2016:
-
Recognized as a 2016 Top Workplace by San Antonio Express-News, marking our sixth recognition as a Top Workplace in San Antonio.
-
Named as Leader in Secure Information Exchange Services 2016 – Texas by the Corp America 2016 Small Cap Awards.
-
Earned awards from Info Security Guide in several categories, including:
-
EFT Workspaces – Gold Winner in BYOD Security.
-
Enhanced File Transfer – Silver Winner in Compliance.
-
EFT Cloud Services – Bronze Winner in Cloud Security.
-
Mail Express – Bronze Winner in Email Security and Management.
-
Received a 5-Star rating in The Channel Company’s CRN 2016 Partner Program Guide for the second year in a row.
-
Named by Texas Monthly magazine as one of the best companies to work for in Texas for the sixth year in a row with a ranking of #16 in the medium size category.
22


-
Honored as the HR Employer of the Year and Excellence in Engagement Strategy in North America by the HRO Today Services and Technology Association.
-
Recognized by the San Antonio Business Journal as a 2016 Best Place to Work, making this the fifth time GlobalSCAPE has received this honor.
-
Named by Computerworld as one of the best companies to work for in IT for the third consecutive year with a ranking of #3 in the small company category.

Key Business Metrics

We review a number of key business metrics on an ongoing basis to help us monitor our performance and to identify material trends which may affect our business. The significant metrics we review are described below.

Revenue Growth

We believe annual revenue growth is a key metric for monitoring our continued success in developing our business in future periods. Given our diverse solution portfolio, we regularly review our revenue mix and changes in revenue across all solutions to identify emerging trends. We believe our revenue growth is primarily dependent upon executing our business strategies which include:

·
Ongoing innovation of our EFT platform to address the expanding needs of our existing customers and enhancing our products’ appeal to new customers.

·
Licensing, developing and/or acquiring technologies with features and functions that are complementary to and synergistic with our EFT platform so as to expand the breadth of our products offerings.

·
Enhancing our sales and marketing programs to improve identification of potential demand for our products and to increase the rate at which we are successful in selling our products.

To support product innovation, we continue to enhance our software engineering group and our focus on optimizing the manner in which we assess the development of new technologies, our approach to managing those projects, and the timelines over which we do that work.

We remain alert for attractive opportunities to collaborate with others or perhaps combine other revenue-producing technologies with ours to expand our product offerings and reach. To that end, we continually assess products and services offered by others that might be synergistic with our existing products. We may elect to take advantage of those opportunities through cooperative marketing agreements or licensing arrangements or by acquiring an ownership position in the enterprise offering the opportunity.

In continuing to develop our demand generation activities, we have made and continue to make ongoing changes in sales and marketing including:

·
Increasing sales staff capacity as needed to address our markets.
·
Aligning our sales group to enhance its industry and geographic focus.
·
Implementing new sales and marketing campaigns.
·
Using third party digital marketing experts with search engine optimization expertise to enhance our efforts in this area.
·
Evolving our lead generation programs to increase our sales staff’s exposure to potential purchasers.
·
Enhancing our support of channel partners and engaging them to sell our products through training, orientation and marketing programs.

As part of growing revenue in total, we are focused on increasing license revenue both in terms of absolute dollars and as a percent of total revenue. When we sell our licensed products, we also typically create a recurring revenue stream from M&S since almost all purchasers of our licensed enterprise products also purchase an M&S contract. Most of our M&S contracts are for one year although we also sell multi-year contracts. The customer pays us the M&S fee for the entire term of the agreement at the time the contract begins. We recognize that amount as revenue ratably in future periods over the term of the contract.

We typically experience a high renewal rate for M&S services for our enterprise products so long as a customer continues using the licensed product they purchased from us. As a result, growing license revenue not only contributes to increasing revenue growth at the time the license is sold but also provides a foundation for future recurring revenue as the purchasers of our licensed products renew M&S contracts to support their ongoing product support needs. This pattern of activity can create a cumulative effect for M&S renewals as a result of the cumulative number of licensed software installations sold over multiple years that create M&S renewals in any single year predictably (and in line with our expectations) exceeding the number of new software licenses we sell in a single year. We expect this cumulative effect to continue to grow if we continue to increase enterprise software license revenue in future periods. For these reasons, we expect M&S revenue will remain a substantial part of our total revenue.

See Comparison of the Statement of Operations for the Three Months Ended March 31, 2017 and 2016 for a discussion of trends in our revenue growth that we monitor using this metric.
23



Bookings

Bookings is a business metric we use to measure the success of our sales and marketing programs. For this purpose, we define bookings as the sum of the sales of:

·
Software licenses.
·
M&S contracts sold with software licenses for which the M&S services will be delivered within the next year.
·
SaaS arrangements for up to one year.
·
Professional services.

Most of the resources we expend for sales and marketing are targeted toward increasing our revenue from the four sources listed above. M&S contract renewals bookings, which are an additional source of revenue for us, typically are not significantly dependent upon our sales and marketing programs to be successful. Based upon these factors, beginning in 2017, we revised the definition our bookings metric to exclude amounts related to renewals of M&S contracts so as to better measure the success of our sales and marketing programs.

Bookings is not a measure of financial performance under GAAP and should not be considered a substitute for revenue. Bookings has limitations as an analytical tool and when assessing our operating performance. Bookings should not be considered in isolation or as a substitute for revenue or other income statement data prepared in accordance with GAAP.

Our bookings trends and the reconciliation of bookings to revenue are as follows ($ in thousands):

   
Three Months Ending March 31,
 
   
2017
   
2016
 
             
Revenue
 
$
8,317
   
$
7,387
 
                 
Products and services sold for which we will recognize revenue at a future date when the goods and services are delivered to and accepted by the customer
   
2,218
     
1,773
 
                 
Products and services delivered to and accepted by the customer for which revenue recognition had been deferred in the past at the time of booking
   
(6,643
)
   
(5,534
)
                 
Bookings
 
$
3,892
   
$
3,626
 

Our bookings increased 7.3%. This increase was a result of our continuing development and implementation of sales and marketing programs designed to increase the level of our sales of software licenses.

Amounts we previously reported as bookings reconcile to the bookings in the table above as follows:

 
Three Months Ended
 
 
March 31, 2016
 
     
Bookings as previously reported
 
$
7,779
 
         
M&S renewals and M&S to be delivered beyond one year in the future not part of bookings
   
(4,153
)
         
Bookings as now reported
 
$
3,626
 

While M&S renewals and M&S to be delivered beyond one year in the future are not part of bookings, we record and include these items in deferred revenue on our balance sheet at the time we record them as an account receivable.

In connection with the bookings metric we previously reported, we also reported potential future revenue as a key business metric. With the refinement of our bookings key business metric, we no longer rely on potential future revenue as a key business metric since we have determined that our revenue growth metric discussed above is the primary metric upon which we rely to measure our outlook for revenue in the future.
24


Adjusted EBITDA (Non-GAAP Measurement)

We utilize Adjusted EBITDA (Earnings Before Interest, Taxes, Total Other Income/Expense, Depreciation, Amortization, other than amortization of capitalized software development costs, and Share-Based Compensation Expense) to provide us a view of income and expenses and cash flow from our operations that is supplemental and secondary to our primary assessment of net income as presented in our condensed consolidated statement of operations and comprehensive income and of cash flow from operating activities as presented on our condensed consolidated statement of cash flows. We use Adjusted EBITDA to provide another perspective for measuring profitability and cash flow from our core operating activities that does not include the effects of expenses that typically do not require us to pay them in the current period (such as depreciation, amortization and share-based compensation), the cost of financing our business, and the effects of income taxes, as well as the effects on our cash of changes in certain balance sheet items such as accounts receivable and accounts payable. We monitor the components of Adjusted EBITDA to assess our actual performance relative to our plans, budgets and expectations and use the results of that assessment to adjust our future activities to the extent we deem necessary.  Our Adjusted EBITDA results indicate that we have been able to sustain consistently positive cash flow to help fund our future operations.

Adjusted EBITDA is not a measure of financial performance under GAAP. It should not be considered as a substitute for net income presented on our condensed consolidated statement of operations and comprehensive income or for net cash provided by operating activities presented on our condensed consolidated statement of cash flows. Adjusted EBITDA has limitations as an analytical tool and when assessing our operating performance. Adjusted EBITDA should not be considered in isolation or without a simultaneous reading and consideration of our financial statements prepared in accordance with GAAP.

We compute Adjusted EBITDA as follows ($ in thousands):

   
Three Months Ended
 
   
March 31,
 
   
2017
   
2016
 
Net Income
 
$
751
   
$
392
 
Add (subtract) items to determine adjusted EBITDA:
               
Income tax expense
   
322
     
174
 
Interest (income) expense, net
   
(70
)
   
(33
)
Depreciation and amortization:
               
Total depreciation and amortization
   
541
     
501
 
Amortization of capitalized software development costs
   
(474
)
   
(430
)
Stock-based compensation expense
   
324
     
222
 
Adjusted EBITDA
 
$
1,394
   
$
826
 

See Comparison of the Statement of Operations for the Three Months Ended March 31, 2017 and 2016 for discussion of the variances between periods in the components comprising Adjusted EBITDA. 

Software Products and Services

We develop and sell computer software that provides secure information exchange, file transfer and file sharing capabilities for enterprises and consumers. We have been in business for over twenty years and have sold our products to thousands of enterprises and more than one million individual consumers throughout the world.

Our primary business is selling and supporting MFT software for enterprises. MFT software facilitates the transfer of data from one location to another across a computer network within a single enterprise or between multiple computer networks in multiple enterprises. These transfers may be ongoing, repetitive activities executed by automated software routines that occur without human intervention, or they may be transfers that people create and complete in the absence of automated routines or as a result of ad-hoc, special situations that arise from time-to-time. Examples of enterprise-level activities that rely on MFT software include:

·
Transfer of transactional information within an enterprise on a repetitive basis from one geographic location to another, such as a transfer of deposit and withdrawal information throughout the day from a branch of a bank to a central data processing center at another location.
·
Movement of accumulated information within an enterprise from one data processing application to another on a periodic basis, such as a transfer of bi-weekly payroll information from a payroll system that is used to pay employees to a job cost system that is used to manage the cost of a project.
·
Exchange of information between enterprises to facilitate the completion of one or more business transactions, such as a retailer transmitting inventory purchasing requirements produced by its material requirements planning system to an order entry system at a supplying vendor.
25



We have multiple revenue streams from our MFT products that include:

·
Perpetual software licenses under which customers install our products in their information systems environment on computers they manage and either own or otherwise procure from a cloud services provider, including deploying our products at a cloud services provider in a BYOL environment.
·
Cloud-based, hosted SaaS solutions that we sell on an ongoing subscription basis resulting in our earning a recurring, monthly subscription fee to access the service.
·
M&S.
·
Professional services for product customization and integration.

We also sell products that can be synergistic to our MFT products. These products have capabilities that:

·
Support information sharing and exchange capabilities using traditional email systems.
·
Enable enterprise file synchronization and sharing.
·
Enhance the ability to replicate, share and backup files within a wide area network or local area network, thereby allowing users to access their data at higher speeds than possible with most alternate approaches.
·
Support file transfers by individuals and small businesses.

We earn most of our revenue from the sale of our MFT products that support business-to-business activities and are strategically focused on selling products in that environment. The majority of our resources that we will expend in the future for product research and development, marketing, and sales will concentrate on the MFT business-to-business market. We believe our products and business capabilities are well-positioned to compete effectively in that market.

Some of our products support consumer-oriented file transfers and file sharing. Even though these products are profitable on an overall basis, we anticipate the future resources we will expend related to products sold to consumers and the associated revenue we earn from those products will continue to be a minor part of our business.

The discussion following presents a summary description of our specific products and solutions.

Managed File Transfer – Enhanced File Transfer Platform

Enhanced File Transfer, or EFT, is the brand name of our core MFT product platform. EFT was awarded multiple industry awards in compliance categories in 2016 including the 2016 Golden Bridge awards, the Network Product Guide’s 2016 IT World Awards, and the 2016 Info Security Products Guide Global Excellence Awards.

The EFT platform provides users the ability to securely transmit data from one location to another using any number of files of any size or configuration. It facilitates management, monitoring, and reporting on file transfers and delivers advanced data transfer workflow capabilities to move data and information into, out of, and throughout an enterprise. Notable features and capabilities of the EFT platform include:

·
State-of-the-art, enterprise-level security when transferring information within or between computer networks as well as for collaboration with business partners, customers, and employees. EFT provides automation that supports effective integration of back-end systems. It has built-in regulatory compliance, governance, and visibility controls to provide a means of safely maintaining information. EFT offers a high level of performance and scalability to support operational efficiency and maintain business continuity. Administrative tools are provided at various levels of granularity to allow for complete control and monitoring of file transfer activities.
·
Transmission of critical information such as financial data, medical records, customer files, vendor files, personnel files, transaction activity, and other similar documents between diverse and geographically separated network infrastructures while supporting a range of information protection approaches to meet privacy and other security requirements. In addition to enabling the secure, flexible transmission of critical information using servers, desktop, and notebook computers and a wide range of network-enabled mobile devices, our products also provide customers with the ability to monitor and audit file transfer activities.
·
Compliance with government regulations and industry standards relating to the protection of information while allowing users to reduce information systems and technologies costs, increase efficiency, track and audit transactions, and automate processes. Our solutions also provide data replication, acceleration of file transfer, sharing/collaboration, and continuous data backup and recovery to our customers.

26


The EFT platform provides a common, scalable MFT environment that accommodates a broad family of accompanying modules to provide enterprises with increased security, automation, and performance when compared to traditional FTP-based and e-mail delivery systems. Various, optional modules allow users to select the solution configuration most applicable to their requirements for auditing and reporting, encryption, ad hoc and web-based file transfers, operability in or through a DMZ network, and integration with back-end business processes, including workflow automation capabilities.

Since 2015, we have released new versions of our EFT platform and new modules which added several enhancements and capabilities including:

·
Advanced Authentication Module (AAM) that increases the interoperability of EFT with multiple authentication methods. AAM provides a single source of authentication across a customer’s infrastructure.
·
Workspaces, which is a file-sharing module that allows employees to create their own groups and assign permissions for those groups, much like a virtual data room, to provide access to files for which they themselves have access on the EFT server.  This functionality is accomplished without compromising the security, control, and governance of those files.
·
A Workspaces Outlook plugin that provides secure ad hoc file transfers via email, providing customers with the reporting features in EFT and combining them with the simplicity and security of sending files with Mail Express. The integration of these two products takes the best features in Mail Express and incorporates them into EFT.
·
Accelerate, which is an accelerated file transfer module that boosts the speed and efficiency of secure data transfers and allows for the fast transfer of large files over disparate geographic distances.
·
Enhanced compatibility of web transfer client file transfers through HTML5 support in addition to the existing Java Runtime Environment.
·
Increased scalability and business continuity with more flexible, uninterrupted file transfer service.
·
Improved facilitation of PCI DSS version 3.0 compliance with updates to security components, such as PGP and AS2.
·
Enhanced and expanded event rule functionality which improves the ability to integrate our products with client business processes and backend systems.
·
Support for active-active high availability in Amazon Web Services.
·
Enhanced security features supporting improved compliance with HIPPA guidelines.

We expect to continue to enhance the EFT platform with capabilities that improve its speed and responsiveness of performance, provide additional administration flexibility supporting cross-platform implementation with our DMZ Gateway solution, offer business activity monitoring, and provide additional language support.

Most EFT customers choose to purchase a perpetual software license for a one-time fee paid at the time of purchase and under which they install the software on equipment they own and/or manage. In almost all cases, they also purchase ongoing M&S for which they pay us a recurring, annual amount that typically is 20% to 30% of the price of the software license.

If a customer prefers to use the capabilities of EFT in a SaaS fashion, we offer EFT Cloud Services for a monthly subscription fee. The EFT platform delivered in this manner has the same features and functionality as our EFT platform installed at a customer site. EFT Cloud Services allows users to reduce their upfront cost and achieve other recognized benefits of cloud-based managed file transfer SaaS subscription solutions, including strong service level agreements for information technologies infrastructure reliability and performance.  EFT can also be deployed for customers, on a BYOL basis, in their infrastructures running through Amazon Web Services or Microsoft Azure. We have also initiated offering EFT Enterprise direct to buyers on a pre-deployed basis in the Amazon Web Services and Microsoft Azure Marketplaces.

EFT Cloud Services provides a flexible continuum of features and functions that gives the user the ability to pick and choose the extent to which they want to own or outsource the capabilities of our EFT platform. EFT Cloud Services gives organizations the flexibility of deploying on-premises, in the cloud or in a hybrid cloud environment with all of the security, compliance, scalability, and visibility features of an on-premises managed file transfer solution. Users of EFT Cloud Services have the option to work with a variety of top hosting providers that best fit their needs. We offer flexible subscription pricing under one, two, and three-year contracts that can help our customers minimize or eliminate upfront capital expenditures and possibly reduce their ongoing operating costs. Subscription revenue from EFT Cloud Services is increasing but is not yet a material portion of the total revenue from our EFT platform.

Secure Information Sharing and Exchange Solution – Mail Express

Mail Express is a solution that provides secure information sharing and exchange capabilities leveraging traditional email workflow. It is a stand-alone product installed in a client-server environment that allows users to send and receive secure, encrypted e-mail and attachments of virtually unlimited size. Mail Express was a Bronze Winner in Email Security and Management by Network Products Guide’s 2016 IT World Awards.
27


To broaden the appeal and capabilities of Mail Express, we are developing functionality that integrates the features of Mail Express into the EFT platform. This integration will take the superior control, visibility and monitoring capabilities of the EFT platform and make them available to administrators and users in an email environment.  This integrated product will improve operational efficiency by providing a coordinated user interface through which data movement activities using both our EFT and Mail Express products can be managed.
Wide Area File Services Solution - WAFS

Our WAFS software product uses data synchronization to further enhance the ability to replicate, share and backup files within a wide area network or local area network, thereby allowing users to access their data at higher speeds than possible with most alternate approaches. The software uses byte-level differencing technology to update changes to files with minimal impact on network bandwidth while also ensuring that files are never overwritten, even if opened by other remote users. Other key features of WAFS include native file locking, replication to multiple locations simultaneously, adherence to access control list file permissions, and full UTF-8 support.

We will continue to offer WAFS as a stand-alone product and provide M&S services to customers who purchased WAFS in the past and who purchase it in the future. We do not expect to expend significant resources in the future expanding the features and capabilities of WAFS.

File Transfer Solution for Consumers - CuteFTP

CuteFTP is our original product introduced in 1996. It is a file transfer program generally used by individuals and small businesses. It remains popular today and generates incremental revenue for us at a relatively low cost.

CuteFTP continues to have significant brand recognition in the market.  Our current CuteFTP Version 9 introduced several notable new features including:

·
Support for Unicode (UTF-8) characters that allows greater international use.
·
Web Distributed Authoring and Versioning (WebDAV) support to facilitate collaboration between users in editing and managing documents and files stored on World Wide Web servers.

Version 9 simplified our CuteFTP product line by consolidating all the features of our previous multi-product CuteFTP product line for Windows operating systems into this single version. We continue to offer CuteFTP Version 3.1 software for Mac platforms. We believe current versions of CuteFTP appeal to users wanting features more robust than offered in free alternatives such that it will be a product competitive in the marketplace for the foreseeable future.

We will continue selling CuteFTP as a stand-alone product and providing M&S services to customers who purchased CuteFTP in the past and who purchase it in the future. We do not expect to expend significant resources in the future expanding the features and capabilities of CuteFTP.

Professional Services

We offer a range of professional services to complement our on-premises and SaaS solutions. These professional services include product customization and system integration, solution “quickstart” implementations, business process and workflow, policy development, education and training, and solution health checks. In addition, we may provide longer-term engineering services, including supporting multi-year contracts, if necessary, to support certain solution implementations and integrations. 

Maintenance and Support

We offer M&S contracts to licensees of all of our software products. These M&S contracts entitle the licensee to software upgrades and technical support services in accordance with the terms of our M&S contract.  Standard technical support services are provided via email and telephone during our regular business hours.  For certain of our products, we offer a Platinum M&S contract which provides access to emergency technical assistance 24 hours per day, 7 days a week.

Most of our M&S contracts are for one year although we also sell multi-year contracts. M&S is purchased by substantially all buyers of our EFT platform as well as by many customers who purchase our other products. Customers with M&S pay us a recurring, annual amount that is typically 20% to 30% of the software license price. A majority of our customers with M&S contracts renew them each year.
28


Employees

Our number of employees is as follows:
 
   
March 31,
 
Department
 
2017
   
2016
 
Sales and Marketing
   
52
     
46
 
Engineering
   
36
     
29
 
Professional Services
   
8
     
14
 
Customer Support
   
21
     
20
 
Management and Administration
   
19
     
19
 
Total
   
136
     
128
 

Solution Perspective and Trends

 The components of our revenue are as follows ($ in thousands):

   
Three Months Ended March 31
 
   
2017
   
2016
 
         
Percent of
         
Percent of
 
   
Amount
   
Total
   
Amount
   
Total
 
Revenue By Type
                       
License
 
$
2,464
     
29.6
%
 
$
2,299
     
31.1
%
M&S
   
5,121
     
61.6
%
   
4,446
     
60.2
%
Professional Services
   
733
     
8.8
%
   
642
     
8.7
%
                                 
Total Revenue
 
$
8,318
     
100.0
%
 
$
7,387
     
100.0
%
                                 
Revenue by Product Line
                               
License
                               
EFT Platform
 
$
2,283
     
92.7
%
 
$
1,995
     
86.8
%
Other
   
181
     
7.3
%
   
304
     
13.2
%
                                 
Total License Revenue
   
2,464
     
100.0
%
   
2,299
     
100.0
%
                                 
M&S
                               
EFT Platform
   
4,841
     
94.5
%
   
4,125
     
92.8
%
Other
   
280
     
5.5
%
   
321
     
7.2
%
                                 
Total M&S Revenue
   
5,121
     
100.0
%
   
4,446
     
100.0
%
                                 
Professional Services (all EFT Platform)
   
733
     
100.0
%
   
642
     
100.0
%
                                 
Total Revenue
                               
EFT Platform
   
7,857
     
94.5
%
   
6,762
     
91.5
%
Other
   
461
     
5.5
%
   
625
     
8.5
%
                                 
Total Revenue
 
$
8,318
     
100.0
%
 
$
7,387
     
100.0
%

Our total revenue increased 13% in the 2017 quarter compared to the 2016 quarter. Revenue from our EFT platform products and services increased 16% which consisted of EFT platform license revenue increasing 14%, EFT platform M&S revenue increasing 17%, and professional services revenue increasing 14%. Revenue from our other product lines decreased which is consistent with our expectations as discussed below. For a more complete discussion of these revenue trends, see Comparison of the Statement of Operations for the Three Months Ended March 31, 2017 and 2016.
29


We earn revenue primarily from the following activities:

·
License revenue from sales of our EFT platform products that we deliver as either perpetually-licensed software installed at the customer’s premises, for which we earn the full amount of the license revenue at the time the license is delivered, or as a cloud-based service under our EFT Cloud Services brand delivered using a SaaS model, for which we earn monthly subscription revenue as these services are delivered.
·
License revenue from sales of our Mail Express, WAFS and CuteFTP products that are installed at the customer’s premises under a perpetual license for which we earn the full amount of the license revenue at the time the license is delivered.
·
M&S revenue under contracts to provide ongoing product support and software updates to our customers who have purchased license software which we recognize ratably over the contractual period, which is typically one year, but can be up to three years.
·
Professional services revenue from a variety of customization, implementation, and integration services, as well as delivery of education and training associated with our solutions, which we recognize as the services are performed and accepted by the client.

We earn most of our revenue from the sale of our EFT platform products and the associated M&S and professional services related to those products. With our core competency being in products that address the MFT  market, we believe our EFT platform products provide the best opportunity for our future growth. Accordingly, expansion of the capabilities of the EFT platform will be our primary focus in the future. While we will continue to sell and support our other products for the foreseeable future, they will not be an area of emphasis for us going forward.

We believe that continuing to offer licensed products installed on-premises for which we recognize revenue up-front and that carry with them a recurring M&S revenue stream is important to our future success. At the same time, we recognize that a migration of capabilities to a SaaS platform is attractive to a growing number of customers. We have, and have had for quite some time, the capabilities in place to deliver our EFT platform in that manner through our EFT Cloud products. While our SaaS revenue is not yet a material component of our total revenue, a migration by our customers to our EFT Cloud products could create some near-term decreases in the growth rate of license revenue, and may result in similar decreases in future periods, because it typically takes approximately 24 to 36 months of SaaS revenue to yield total revenue equivalent to that realized up-front from the sale of a license for an on-premise installation.

In mid-2016, we reviewed the allocation of our product research and development resources across all of our products. As a result of that review, we decided to adjust that allocation to focus most of our engineering resources involved in product research and development on our EFT platform products in order to expand their capabilities and to remain positioned to be responsive to the evolving needs of our customers.

Over the past few years, we have developed and offered individual product lines that include EFT, Mail Express, WAFS, and CuteFTP. Each of these product lines addresses distinct needs in the marketplace. While some customers purchase products from more than one of these product lines, for the most part, customers in a particular market or vertical have needs that are addressed by only one of these products and, therefore, purchase only that product. With respect to Mail Express, while we will continue to offer them as stand-alone products for the time being, the engineering resources we allocate to these technologies will focus on migrating them to becoming an integrated component of our EFT platform. We do not expect to expend significant resources in the future on expanding the features and capabilities of WAFS and CuteFTP although we will continue to sell those products and support them.

To support product innovation, we continue to enhance our software engineering group and our focus on optimizing the manner in which we assess the development of new technologies, our approach to managing those projects, and the timelines over which we do that work. In continuing to develop our demand generation activities, we have made and continue to make ongoing changes in sales and marketing including:

·
Increasing sales staffing and capabilities as needed to address our markets.
·
Aligning our sales group to enhance its industry and geographic focus.
·
Implementing new sales and marketing campaigns.
·
Evolving our lead generation programs to increase our sales staff’s exposure to potential purchasers.
·
Enhancing our support of channel partners and engaging them to sell our products through training, orientation and marketing programs.

30


Liquidity and Capital Resources

Our total cash, cash equivalents, certificates of deposit and working capital positions were as follows ($ in thousands):

   
March 31, 2017
   
December 31, 2016
 
Cash and cash equivalents
 
$
10,400
   
$
8,895
 
Certificates of deposit, current
   
2,759
     
2,754
 
Certificates of deposit, long term
   
12,837
     
12,779
 
Total cash, cash equivalents and certificates of deposit
 
$
25,996
   
$
24,428
 
                 
Current assets
 
$
19,150
   
$
19,303
 
Current liabilities
   
(15,763
)
   
(16,367
)
Working capital
 
$
3,387
   
$
2,936
 

At March 31, 2017, our certificates of deposit in current assets mature on various dates through October 2017. Our long term certificates of deposit mature after March 31, 2018, on various dates through December 2021.

When assessing our liquidity and capital resources, we consider the following factors:

·
We may access and monetize our certificate deposits at any time without risk of loss of the original amounts invested. If we were to redeem these certificates of deposit prior to their maturity, we may incur a penalty and forfeit certain amounts of accrued interest, but we view such amounts as not material.
·
Deferred revenue, unlike the other liability components of our working capital, is an obligation we will satisfy by providing services in the future to our customers as part of our ongoing operating activities from which we have historically generated cash flow. Our deferred revenue does not involve a disbursement of cash as a direct payment of that liability although we will incur operating expenses in the future as we deliver those M&S services.

Our capital requirements principally relate to our need to fund our ongoing operating expenditures, which are primarily related to employee salaries and benefits. We make these expenditures to enhance our existing products, develop new products, sell those products in the marketplace and support our customers after the sale.

We rely on cash and cash equivalents on hand and cash flows from operations to fund our operating activities and believe those items will be our principal sources of capital for the foreseeable future. If our revenue declines and/or our expenses increase, our cash flow from operations and cash on hand could decline.  We plan to expend significant resources in the future for research and development of our products and expansion and enhancement of our sales and marketing activities. If sales decline or if our liquidity is otherwise under duress, we could substantially reduce personnel and personnel-related costs, reduce or substantially eliminate capital expenditures and/or reduce or substantially eliminate certain research and development and sales and marketing expenditures. We may also sell equity or debt securities or enter into credit arrangements in order to finance future acquisitions or licensing activities, to the extent available.

Cash provided or used by our various activities consisted of the following ($ in thousands):

   
Cash Provided (Used) During the
Three Months Ended March 31,
 
   
2017
   
2016
 
Operating activities
 
$
2,389
   
$
1,207
 
Investing activities
   
(650
)
   
(578
)
Financing activities
   
(234
)
   
(190
)

31


Our cash provided by operating activities increased during the 2017 quarter compared to the 2016 quarter primarily due to the following factors:

·
Net income after considering items not involving cash at the time they are recorded in the statement of operations, as set forth on our Condensed Consolidated Statements of Cash Flow, increased $243,000. See the section below underComparison of the Statement of Operations for the Three Months Ended March 31, 2017 and 2016 for a discussion of the changes in the components of these amounts.

·
Cash flow from payments by customers resulted in accounts receivable decreasing $1.5 million in the 2017 quarter compared to $916,000 in the 2016 quarter. This increased cash flow was primarily due to the increase in our revenue during the three months ended December 31, 2016, compared to the three months ended December 31, 2015, which in turn resulted in increased cash collections during the 2017 quarter when the accounts receivable from those sales were due.

·
Payments to our vendors and service providers resulted in accounts payable decreasing $219,000 during the 2017 quarter compared to decreasing $925,000 during the 2016 quarter. The change in the amount of the decrease was primarily due to:

o
The payment during the 2016 quarter of invoices for certain marketing expenses incurred in 2015 for initial expansion of certain sales and marketing programs which were expenses that did not have to be repeated in the 2016 quarter and paid in the 2017 quarter; and
o
Normal variations in the timing of payments to our vendors.

·
Income tax receivable and payable decreased $643,000 in the 2017 quarter compared to decreasing $151,000 in the 2016 quarter primarily due to:

o
Receiving from the Internal Revenue Service during the 2017 quarter a refund of taxes paid in previous years as a result of favorable adjustments to our research and development tax credits previously claimed; and
o
Normal variations in the timing of our tax payments.

Offset by:

·
Deferred revenue decreasing $1.1 million in the 2017 quarter compared to decreasing $416,000 in the 2016 quarter primarily as a result of our new emphasis on selling one year M&S contracts instead of multi-year agreements as discussed above.
·
Accrued expenses increased $92,000 in the 2017 quarter compared to increasing $303,000 in the 2016 quarter primarily due to normal variations in the timing of our payroll payment dates relative to the date of the balance sheet presented as a part of our financial statements.

The amount of cash we used for investing activities during the 2017 quarter increased compared to the 2016 quarter due primarily to:

·
An increase in the purchase of property and equipment as a result of remodeling of our sales and engineering office spaces to improve the efficiency of these work environments; and
·
A decrease in our software development costs capitalized due to it taking longer than expected to fill open engineering positions with the skillsets needed to support new product development as a result of competition in the marketplace for software engineers.

Our financing activities used more cash in the 2017 quarter than the 2016 quarter due to an increase in the amount of dividends paid as a result of an increase in our outstanding shares of common stock offset by a decrease in proceeds from stock option exercises as a result of fewer option holders electing to exercise their options.

Contractual Obligations and Commitments

As of March 31, 2017, our contractual obligations and commitments consisted primarily of the following items:

·
An obligation to deliver services in the future to satisfy our right to earn our deferred revenue of $16.3 million. Those future services primarily relate to our obligations under M&S contracts. We will recognize this deferred revenue as revenue over the remaining life of those contracts which generally ranges from one to three years. Deferred revenue, unlike the other liability components of our working capital, is an obligation we will satisfy by providing services in the future to our customers as part of our ongoing operating activities from which we have historically generated cash flow. Our deferred revenue does not involve a disbursement of cash as a direct payment of that liability although we will incur operating expenses in the future as we deliver those M&S services.
32



·
Trade accounts payable and accrued liabilities which include our contractual obligations to pay software royalties to third parties that vary in amount based on our sales volume of products upon which royalties are payable.
·
Operating lease for our office space.
·
Federal and state taxes.

Our non-cancellable, contractual obligations at March 31, 2017, consisted primarily of the lease for our office space with amounts due as follows ($ in thousands):

   
Amounts Due for the Period
 
   
Nine Months Ending
December 31,
   
Fiscal Years
 
   
2017
    2018 - 2019    
2019 - 2020
   
Thereafter
   
Total
 
                                   
Operating leases
 
$
270
   
$
480
   
$
-
   
$
-
   
$
750
 

As of March 31, 2017, we had no interest-bearing obligations in the form of loans, notes payable or similar debt instruments.

We plan to continue to expend significant resources in the future on product development, sales and marketing which may require that we enter into additional contractual arrangements and use our cash to acquire or license technology, intellectual property, products, services or businesses related to our current business strategy.

Comparison of the Statement of Operations for the Three Months Ended March 31, 2017 and 2016

   
Three Months Ended March 31,
       
   
2017
   
2016
   
$ Change
 
   
$ in thousands
 
                   
Total revenues
 
$
8,318
   
$
7,387
   
$
931
 
Total cost of revenues
   
1,525
     
1,446
     
79
 
Gross profit
   
6,793
     
5,941
     
852
 
Operating expenses
                       
Sales and marketing
   
3,330
     
3,048
     
282
 
General and administrative
   
1,721
     
1,733
     
(12
)
Research and development
   
739
     
627
     
112
 
Total operating expenses
   
5,790
     
5,408
     
382
 
Income from operations
   
1,003
     
533
     
470
 
Other income
   
70
     
33
     
37
 
Income before income taxes
   
1,073
     
566
     
507
 
Income tax expense
   
322
     
174
     
148
 
Net income
 
$
751
   
$
392
   
$
359
 

In the discussion below, we refer to the three months ended March 31, 2017, as the “2017 quarter” and the three months ended March 31, 2016, as the “2016 quarter”. The percentage changes cited in our discussions are based on the 2017 quarter amounts compared to the 2016 quarter amounts.

33


Revenue. The components of our revenues were as follows ($ in thousands):

   
Three Months Ended March 31
 
   
2017
   
2016
 
         
Percent of
         
Percent of
 
   
Amount
   
Total
   
Amount
   
Total
 
                         
Revenue By Type
                       
License
 
$
2,464
     
29.6
%
 
$
2,299
     
31.1
%
M&S    
5,121
     
61.6
%
   
4,446
     
60.2
%
Professional Services
   
733
     
8.8
%
   
642
     
8.7
%
                                 
Total Revenue
 
$
8,318
     
100.0
%
 
$
7,387
     
100.0
%
                                 
Revenue by Product Line
                               
License
                               
EFT Platform
 
$
2,283
     
92.7
%
 
$
1,995
     
86.8
%
Other
   
181
     
7.3
%
   
304
     
13.2
%
                                 
     
2,464
     
100.0
%
   
2,299
     
100.0
%
M&S                                
EFT Platform
   
4,841
     
94.5
%
   
4,125
     
92.8
%
Other
   
280
     
5.5
%
   
321
     
7.2
%
                                 
     
5,121
     
100.0
%
   
4,446
     
100.0
%
                                 
Professional Services (all EFT Platform)
   
733
     
100.0
%
   
642
     
100.0
%
                                 
Total Revenue
                               
EFT Platform
   
7,857
     
94.5
%
   
6,762
     
91.5
%
Other
   
461
     
5.5
%
   
625
     
8.5
%
                                 
   
$
8,318
     
100.0
%
 
$
7,387
     
100.0
%

Our total revenue increased 13%. This increase consisted of growth in total revenue from our EFT platform products and services of $1.1 million, or 16%, offset by a decrease in revenue from our other products that constitute less than 10% of our total revenue. These trends are in line with our expectations in light of our announcement in mid-2016 that our focus would be on our EFT platform products. At the same time, we announced that while we would continue selling our other products consisting of Mail Express, WAFS, CuteFTP, and TappIn, we would de-emphasize those products in the future, not expend future significant product development and engineering resources to enhance those products, and not dedicate significant future sales and marketing activities to them. We intend to maintain our focus on our EFT platform for the foreseeable future such that we expect to see a continuing decline in revenue from our products other than those that are part of the EFT platform.

EFT Platform Products

License, M&S and professional services revenue from our EFT platform products increased 14%, 17% and 14% respectively. The increases across these products and services were primarily due to continued enhancement in our product development and software engineering groups which allowed us to refine our process for identifying new product opportunities, to better focus our resources on products that would yield larger and more immediate revenue opportunities, and to optimize our project management and software engineering processes to reduce the time necessary to produce new or improved products.

To improve our ability to successfully sell existing EFT platform products as well as new products produced by our software engineering team, we continued to make ongoing changes in sales and marketing personnel and activities including:

·
Increasing sales staffing and capabilities as needed to address our markets.
·
Aligning our sales group to enhance its industry and geographic focus.
·
Implementing new sales and marketing campaigns.
·
Evolving our lead generation programs to increase our sales staff’s exposure to potential purchasers.
·
Enhancing our support of channel partners and engaging them to sell our products through training, orientation and marketing programs.

34


The 14% increase in license revenue from our EFT platform products was primarily due to:

·
The introduction of new products or new versions of products as described above underBusiness-Software Products and Services.
·
Our focus on leveraging the changes to our sales and marketing activities described above toward new customers who may not have previously used our products. While sales to existing customers often consist primarily of new modules added to existing software licenses, new customers present the potential for higher license sales since they typically need to purchase a license for our core products in addition to licenses for additional modules.

The 17% increase in M&S revenue from our EFT platform products was also due to:

·
Ongoing and increased license sales since a majority of license sales are accompanied by an M&S contract. The change in M&S revenue typically lags behind the related change in license revenue because license sales are recognized as revenue in full in the period the license is delivered while the related M&S revenue is recognized in future periods as those services are delivered.
·
Sustaining high renewal rates of M&S contracts by customers who initially purchased these services in earlier periods. We believe these renewals result from our programs designed to provide high-quality and responsive M&S services to our customers.

The 14% increase in professional services revenue was primarily related to the increased license revenue from our EFT platform since the demand for our professional services is closely related to purchases of licenses for our EFT platform products. The remaining increase was due to an enhanced focus on managing our queue of professional services projects to be delivered which resulted in a reduction in our backlog of professional services related to earlier EFT platform license sales.

When we sell our licensed products, we also typically create a recurring revenue stream from M&S since almost all purchasers of our licensed products also purchase an M&S contract. In general, and depending upon the level of M&S a customer purchases, this recurring revenue stream is 20% to 30% per year of the price of the underlying software license to which the M&S relates.

Our M&S contracts are typically for one year, with some customers buying two or three year contracts. The customer pays us the M&S fee for the entire term of the agreement at the time the contract begins. We recognize that amount as revenue ratably in future periods over the term of the contract.

We typically experience a high renewal rate for M&S services for our enterprise products so long as a customer continues using the licensed product they purchased from us. As a result, growing license revenue not only contributes to increasing revenue growth at the time the license is sold but also provides a foundation for future recurring revenue as the purchasers of our licensed products continually renew M&S contracts to support their ongoing product support needs. This pattern of activity can create a cumulative effect for M&S renewals as a result of the cumulative number of licensed software installations sold over multiple years that create M&S renewals in any single year predictably (and in line with our expectations) exceeding the number of new software licenses we sell in a single year. We expect this cumulative effect to continue to grow if we continue to increase enterprise software license revenue in future periods.

Even though we experienced growth in EFT platform license revenue, that revenue as a percent of our total EFT platform revenue was 29% in the 2017 quarter compared to 30% in the 2016 quarter. This decrease was due to the continuing accumulation of our recurring M&S revenue stream from prior license sales and the revenue produced by the reduction of our backlog of professional services.

Other Products

In mid-2016, we announced that our focus would be on our EFT platform products. At the same time, we announced that while we would continue selling our Mail Express, WAFS, CuteFTP, and TappIn products that collectively constitute less than 10% of our total revenue, in the future we would de-emphasize these stand-alone products that are not part of our EFT platform. Accordingly, during the second half of 2016, we curtailed our product development and engineering resources for these products and significantly reduced our sales and marketing activities supporting them. As a result, our license and M&S revenue from those products collectively declined 26%. Our future focus will be on our EFT platform such that we expect to see a continuing decline in revenue from these other products although we do expect them to continue to produce a modest contribution margin that contributes to our future profitability.

Cost of Revenues.  These expenses are associated with the production, delivery and support of our products and services. We believe it is most meaningful to view cost of revenues as a percent of the revenues to which those costs relate since many of those costs are variable relative to revenue.
35


Cost of license revenue consists primarily of:

·
Amortization of capitalized software development costs we incur when producing our software products. This amortization begins when a product is ready for general release to the public and generally is an expense that is not directly variable relative to revenue.
·
Royalties we pay to use software developed by others for certain features of our products that is generally an expense that is variable relative to revenue.
·
Fees we pay to third parties who provide services supporting our SaaS and cloud-based subscription solutions that generally have components that are both variable and not variable relative to revenue.

Cost of M&S revenue and cost of professional services revenue consist primarily of salaries and related costs of our employees and third parties we use to deliver these services.

Cost of software license revenue increased 17% and as a percent of software license revenue was 30% in the 2017 quarter compared to 27% in the 2016 quarter. These increases were primarily due to:

·
An increase in expense from the amortization of capitalized software development costs as a result of our release of new software products and new versions of existing products in periods subsequent to the 2016 quarter.
·
An increase in our royalties expense as a result of an increase in sales volume of products that contain components on which we pay royalties.

Cost of M&S revenue as a percent of M&S revenue was substantially unchanged. Cost of revenue for M&S in absolute dollars increased by 5% due to an increase in M&S revenue. The cost of delivering M&S can vary slightly up or down from period-to-period, but we believe such changes are typically not indicative of long term trends or permanent changes in our cost of delivering M&S. Our gross margin on these services generally remains greater than 90% as a result of a consistent application of our customer support delivery protocols and practices.

Cost of professional services revenue as a percent of that revenue was 51% in the 2017 quarter as compared to 66% in the 2016 quarter. This variation resulted from the varying scope and mix of the professional services we deliver that can change from period-to-period in response to the circumstances of the customer environments in which we are working. In addition, during the second half of 2016, we undertook a refinement of our professional services organization and the manner in which we manage and deliver these services which resulted in more efficient processes from which we began to realize the cost benefit in 2017. Cost of revenue for professional services in absolute dollars decreased 11% for the reasons discussed above.

Sales and Marketing.  We believe it most meaningful to view cost of sales and marketing as a percent of revenues since many of those costs, particularly sales commissions, are variable relative to revenue. These expenses were 40% of total revenue for the 2017 quarter compared to 41% of total revenue for the 2016 quarter. In absolute dollars these expenses increased 9%. These variations were primarily due to:

·
Increasing the size of our sales, marketing and product strategy teams and increased compensation rates due to competitive demands in the marketplace.
·
Increasing marketing activities related to competitive intelligence and channel development.
·
An increase in revenue which resulted in a higher absolute dollar amount of sales commissions paid to employees although the commission rate as a percent of sales did not change materially.

General and Administrative.  These expenses were substantially unchanged between periods. This consistent outcome was a result of our ongoing programs to manage these expenses.

Research and Development.  The overall profile of our research and development activities was as follows ($ in thousands):

   
Three Months Ended March 31,
 
   
2017
   
2016
 
R&D expenditures expensed
 
$
738
   
$
627
 
R&D expenditures capitalized
   
462
     
488
 
Total R&D expenditures (non-GAAP measurement)
 
$
1,200
   
$
1,115
 

36


Total R&D expenditures increased 8% primarily due to a planned increase in our software engineering headcount offset by a decrease in the cost of third-party software developers as a result of our efforts during 2016 to reduce our reliance on those outsourced services. Our R&D expense increased 18% as we continued our enhanced focus on our EFT platform and its installed customer base to ensure the products those customers are using remain optimized to meet their needs. Our R&D capitalized decreased 5% primarily due to those amounts in the 2016 quarter including higher cost, outsourced engineering work on products other than those that are part of our EFT platform which is work that did not occur in the 2017 quarter as a result of our focus on the development of our EFT platform primarily using our in-house personnel.

Total resources expended for R&D set forth above as total R&D expenditures serves to illustrate our total corporate efforts to improve our existing products and to develop new products regardless of whether or not our expenditures for those efforts were expensed or capitalized. Total resources expended for R&D is not a measure of financial performance under GAAP and should not be considered a substitute for R&D expense and capitalized software development costs individually. While we believe the non-GAAP, total resources expended for R&D amount provides useful supplemental information regarding our overall corporate product improvement and new product creation activities, there are limitations associated with the use of this non-GAAP measurement. Total resources expended for R&D is a non-GAAP measure not prepared in accordance with GAAP and may not be comparable to similarly titled measures of other companies since there is no standard for preparing this non-GAAP measure. As a result, this non-GAAP measure of total resources expended for R&D has limitations and should not be considered in isolation from, or as a substitute for, R&D expense and capitalized software development cost individually.

Other Income.  Other income consists primarily of interest income earned on certificates of deposit. The increase in this amount was due primarily to enhanced investment of our cash to earn a higher rate of interest.

Income Taxes.  Our effective tax rate was 30% for the 2017 quarter and 31% for the 2016 quarter. These rates differed from a federal statutory tax rate of 34% primarily due to:

·
The domestic production activities deduction and the research and development credit that are tax credit incentives that serve to reduce the rate at which we pay federal income taxes in exchange for us conducting certain aspects of our business in a manner promoted by the Internal Revenue Code.

Offset by:

·
Certain expenses in our financial statements, such as a portion of meals and entertainment expenses, that are not deductible on our federal income tax return.
·
State income taxes included in income tax expense in our financial statements.

37



Item 3. Quantitative and Qualitative Disclosures About Market Risk

We have not utilized derivative financial instruments or derivative commodity instruments. We do not expect to employ these or other strategies to hedge market risk in the foreseeable future. We may invest our cash in money market funds which are subject to minimal credit and market risk. We believe that the interest rate risk and other relevant market risks associated with these financial instruments are immaterial.

During the 2017 quarter and 2016 quarter, we earned approximately 14% of our revenue from a single third party channel distributor who purchases products from us and resells them to their customers. Approximately 16% of our accounts receivable as of March 31, 2017, were due from this distributor. We have since received payment for substantially all of these accounts receivable.

We earned approximately 22% and 27% of our revenue from customers outside the United States during the 2017 quarter and the 2016 quarter, respectively. We receive all revenue in U.S. dollars, so we have no material exchange rate risk with regard to our sales. We charge Value Added Taxes to our non-business customers in the European Union. We remit these taxes periodically in pound sterling. The impact of this currency translation has not been material to our business.

Item 4. Controls and Procedures

As of the end of the period covered by this report, our President and Chief Executive Officer and our Chief Financial Officer carried out an evaluation of the effectiveness of GlobalSCAPE’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) and concluded that the disclosure controls and procedures were effective.

There were no changes in our internal controls over financial reporting during the three months ended March 31, 2017, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
38




Part II. Other Information
Item 1. Legal Proceedings

GlobalSCAPE had been named as one of a number of defendants in a patent infringement suit filed by Digital Reg of Texas, LLC in the United States District Court for the Eastern District of Texas, Tyler Division. The complaint alleged that we infringed on a patent that regulates access to digital content. In February 2017, we settled this matter for an amount that was immaterial to our financial position and results of operations.

Item 1A. Risk Factors.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our 2016 Form 10-K filed with the Securities and Exchange Commission on March 27, 2017. These risk factors could materially affect our business, financial condition or future results, but they are not the only risks facing GlobalSCAPE. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, and/or operating results.

Item 6. Exhibits

(a)
Exhibits


 
31.1
     
 
31.2
     
 
32
     
 
101
Interactive Data File.
39



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.

       
       
     
GLOBALSCAPE, INC.
       
May 12, 2017
 
By:  
/s/ James W. Albrecht, Jr.
Date
   
James W. Albrecht, Jr.
     
Chief Financial Officer






40