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 September 30, 2019.

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 Offices	Zip Code

Registrant’s Telephone Number, Including Area Code

210-308-8267

Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, par value $0.001 per share	GSB	NYSE American, LLC
(Title of Class)	(Trading Symbol)	(Name of exchange on which registered)

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 every Interactive Data File required to be submitted 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 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 ☐	Smaller reporting company ☒
Emerging growth company ☐

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

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

As of October 31, 2019 there were 17,371,375 shares of common stock outstanding.

GlobalSCAPE, Inc.

Quarterly Report on Form 10-Q

For the Quarter ended September 30, 2019

Index

		Page
Part I.	Financial Information
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets	2
	Condensed Consolidated Statements of Operations and Comprehensive Income	3
	Condensed Consolidated Statements of Cash Flows	4
	Condensed Consolidated Statement of Stockholders’ Equity	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	37
Item 4.	Controls and Procedures	37
Part II.	Other Information	38
Item 1.	Legal Proceedings	38
Item 1A.	Risk Factors	38
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	38
Item 6.	Exhibits	38
Signatures		39

Preliminary Notes

GlobalSCAPE®, CuteFTP®, CuteFTP Pro®, DMZ Gateway®, EFT Cloud Services®, GlobalSCAPE Securely Connected®, 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™, EFT Insight™, 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™, AAM™ 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 on Form 10-Q (this “Report”) are the property of their respective owners.

In this Report, we use the following terms:

“BYOL” means bring your own license.

“Cloud” or “cloud computing” refers to pooled computing resources, delivered on-demand, over the Internet. In the same manner that electricity is delivered on-demand from large scale power plants, cloud computing is delivered from centralized data centers to users all over the world.

“DMZ” or Demilitarized Zone refers to a computer host or perimeter network inserted between a trusted internal network and an untrusted public network such as the Internet.

“FTP” or File Transfer Protocol is a protocol used to exchange or manipulate files over a computer network such as the Internet.

“MFT” or Managed File Transfer refers to software solutions that facilitate the secure transfer of data from one computer to another through a network.

“SaaS” or Software-as-a-Service uses hosted, cloud computing approaches in which the customer does not need to install the underlying software on its own computer systems to access the application.

1

Part I. Financial Information

Item 1. Financial Statements

GlobalSCAPE, Inc.

Condensed Consolidated Balance Sheets

(in thousands except share amounts)

	September 30,			December 31,
	2019			2018
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	13,396		$	9,173
Accounts receivable, net		5,491			6,657
Federal income tax receivable		323			-
Prepaid and other current assets		1,269			1,521
Total current assets		20,479			17,351
Capitalized software development costs, net		2,689			3,133
Goodwill		12,712			12,712
Deferred tax asset, net		651			395
Property and equipment, net		296			399
Right-of-use asset		2,970			-
Other assets		463			502
Total assets	$	40,260		$	34,492
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	501		$	820
Accrued expenses		1,783			1,214
Income tax payable		-			148
Deferred revenue		14,592			13,301
Total current liabilities		16,876			15,483
Deferred revenue, non-current portion		1,954			2,936
Lease liability		2,967			-
Other long term liabilities		70			117
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, 22,750,875 and 22,441,860 shares issued: 17,371,375 and 17,130,918 outstanding at September 30, 2019 and December 31, 2018, respectively		22			22
Additional paid-in capital		27,998			25,584
Treasury stock, 5,379,500 and 5,310,942 shares, at cost, at September 30, 2019 and December 31, 2018, respectively		(23,087	)		(22,712	)
Retained earnings		13,460			13,062
Total stockholders’ equity		18,393			15,956
Total liabilities and stockholders’ equity	$	40,260		$	34,492

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

2

GlobalSCAPE, Inc.

Condensed Consolidated Statements of Operations and Comprehensive Income

(In thousands, except per share amounts)

(Unaudited)

	Three months ended September 30,					Nine months ended September 30,
	2019		2018			2019		2018
Operating Revenues:
Software licenses	$	2,762	$	2,843		$	8,231	$	7,726
Maintenance and support		6,754		5,488			19,432		15,872
Professional services		614		649			2,149		1,549
Total Revenues		10,130		8,980			29,812		25,147
Cost of revenues:
Software licenses		666		721			2,006		2,225
Maintenance and support		551		514			1,649		1,574
Professional services		270		264			853		880
Total cost of revenues		1,487		1,499			4,508		4,679
Gross profit		8,643		7,481			25,304		20,468
Operating expenses:
Sales and marketing		1,940		2,261			5,755		8,229
General and administrative		1,618		1,589			5,390		4,883
Legal and professional		457		1,510			1,255		4,235
Severance		7		381			11		488
Research and development		334		368			934		1,654
Total operating expenses		4,356		6,109			13,345		19,489
Income from operations		4,287		1,372			11,959		979
Interest income (expense), net		29		(93	)		83		63
Income before income taxes		4,316		1,279			12,042		1,042
Income tax expense		736		281			2,409		386
Net income	$	3,580	$	998		$	9,633	$	656
Comprehensive income	$	3,580	$	998		$	9,633	$	656
Net income per common share -
Basic	$	0.21	$	0.05		$	0.56	$	0.03
Diluted	$	0.19	$	0.05		$	0.52	$	0.03
Weighted average shares outstanding:
Basic		17,347		21,688			17,271		21,746
Diluted		18,769		21,940			18,398		22,044
Cash dividends declared per share	$	0.015	$	-		$	0.530	$	0.030

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

3

GlobalSCAPE, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)

	For the Nine Months Ended September 30,
	2019			2018
Operating Activities:
Net income	$	9,633		$	656
Items not involving cash at the time they are recorded in the statement of operations:
Provision (recoveries) for doubtful accounts receivable		63			(64	)
Depreciation and amortization		1,335			1,641
Share-based compensation		1,985			972
Deferred taxes		(256	)		61
Subtotal before changes in operating assets and liabilities		12,760			3,266
Changes in operating assets and liabilities:
Accounts receivable		1,103			1,136
Prepaid and other current assets		252			(1,868	)
Deferred revenue		309			(1,914	)
Accounts payable		(319	)		82
Accrued expenses		569			1,707
Operating lease right-of-use asset		105			-
Other assets		39			116
Operating lease liabilities		(108	)		-
Other long-term liabilities		(47	)		(48	)
Income tax payable (receivable)		(471	)		82
Net cash provided by operating activities		14,192			2,559
Investing Activities:
Software development costs capitalized		(741	)		(1,057	)
Purchase of property and equipment		(47	)		(143	)
Redemption of Certificates of Deposit		-			14,264
Net cash provided by (used in) investing activities		(788	)		13,064
Financing Activities:
Proceeds from exercise of stock options		874			341
Stock option cash settlement		(445	)		-
Purchase of Treasury Stock		(375	)		(17,262	)
Dividends paid		(9,235	)		(655	)
Net cash used in financing activities		(9,181	)		(17,576	)
Net increase (decrease) in cash		4,223			(1,953	)
Cash at beginning of period		9,173			11,583
Cash at end of period	$	13,396		$	9,630
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	-		$	-
Income tax payments	$	3,008		$	238
Supplemental disclosure of noncash activities:
Right-of-use assets obtained in exchange for operating lease obligations	$	3,075		$	-

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

4

GlobalSCAPE, Inc.

Condensed Consolidated Statement of Stockholders' Equity

(in thousands, except number of shares)

(unaudited)

						Additional
	Common Stock					Paid-in			Treasury			Retained
	Shares			Amount		Capital			Stock			Earnings			Total
Balance at December 31, 2017		22,196,712		$	22	$	23,793		$	(1,452	)	$	9,353		$	31,716
Retained Earnings Adjustment due to ASC 606													979			979
Stock-based compensation expense
Stock options							587									587
Restricted stock							84									84
Common stock cash dividends, $0.015 per share													(327	)		(327	)
Net Income (loss)													(935	)		(935	)
Balance at March 31, 2018		22,196,712		$	22	$	24,464		$	(1,452	)	$	9,070		$	32,104
Stock-based compensation expense
Stock options							155									155
Restricted stock		80,000					36									36
Common stock cash dividends, $0.015 per share													(328	)		(328	)
Net Income													593			593
Balance at June 30, 2018		22,276,712		$	22	$	24,655		$	(1,452	)	$	9,335		$	32,560
Purchase of Treasury Stock										(17,262	)					(17,262	)
Cancellation of Restricted Stock		(40,000	)													-
Shares issued upon exercise of stock options		146,150					341									341
Stock-based compensation expense
Stock options							110									110
Net Income													998			998
Balance at September 30, 2018		22,382,862		$	22	$	25,106		$	(18,714	)	$	10,333		$	16,747
Balance at December 31, 2018		22,441,860		$	22	$	25,584		$	(22,712	)	$	13,062		$	15,956
Purchase of Treasury Stock										(375	)					(375	)
Shares issued upon exercise of stock options		156,489					519									519
Stock option cash settlement							(445	)								(445	)
Stock-based compensation expense
Stock options							775									775
Restricted stock							100									100
Common stock cash dividends, $0.015 per share													(259	)		(259	)
Net Income													2,420			2,420
Balance at March 31, 2019		22,598,349		$	22	$	26,533		$	(23,087	)	$	15,223		$	18,691
Shares issued upon exercise of stock options		55,520					179									179
Stock-based compensation expense
Stock options							197									197
Restricted stock		40,000					377									377
Common stock cash dividends, $0.50 per share													(8,713	)		(8,713	)
Net Income													3,633			3,633
Balance at June 30, 2019		22,693,869		$	22	$	27,286		$	(23,087	)	$	10,143		$	14,364
Shares issued upon exercise of stock options		57,006					176									176
Stock-based compensation expense
Stock options							321									321
Restricted stock							215									215
Common stock cash dividends, $0.015 per share													(263	)		(263	)
Net Income													3,580			3,580
Balance at September 30, 2019		22,750,875		$	22	$	27,998		$	(23,087	)	$	13,460		$	18,393

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

5

GlobalSCAPE, Inc.

Notes to Condensed Consolidated Financial Statements

As of September 30, 2019 and For the Three and Nine

Months Then Ended

(Unaudited)

1. Nature of Business

GlobalSCAPE, Inc., together with its wholly-owned subsidiary (collectively referred to as the “Company”, “GlobalSCAPE”, “we”, “us” or “our”), provides 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 Enhanced File Transfer, or EFT. We have other products that complement our EFT product.

We sell other products that are synergistic to EFT including CuteFTP. Collectively, these products aimed at consumers and small businesses constitute less than 3% of our total revenue. We continue to offer product support for Mail Express and WAFS, which we discontinued as products for sale as of January 1, 2019.

Throughout these notes unless otherwise noted, our references to the 2019 quarter and the 2018 quarter refer to the three months ended September 30, 2019 and 2018, respectively, and references to the 2019 nine months and the 2018 nine months refer to the nine months ended September 30, 2019 and 2018, 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 United States Securities and Exchange Commission, or the SEC. Accordingly, they do not include all information and footnotes required under United States generally accepted accounting principles, 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 Report should be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed with the SEC on March 18, 2019, which we refer to as the 2018 Form 10-K, as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations also included in our 2018 Form 10-K and in this Report.

We follow accounting standards set by the Financial Accounting Standards Board, or FASB. The FASB sets GAAP, which 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 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.

6

3. Significant Accounting Policies

Principles of Consolidation

The accompanying condensed consolidated financial statements are prepared in conformity with GAAP. All intercompany accounts and transactions have been eliminated.

Revenue Recognition 

Products and Services

We earn revenue by delivering the following software products and services:

● Perpetual software licenses under which customers install our products in their information systems environment on computers they manage, own or otherwise procure from a cloud services provider. Customers also deploy our products with cloud services providers in a BYOL environment.

● Cloud-based, hosted SaaS solutions that we sell on an ongoing subscription basis resulting in our earning recurring, monthly subscription and usage fees to access the service.

● Maintenance and support services, or M&S, that generally consist of telephone support and access to unspecified future software upgrades.

● Professional services for product integration and configuration that generally do not significantly modify our software products.

We earn the majority of our revenue from the sale of perpetual software licenses and associated contracts for M&S.

We recognize revenue when we have satisfied a performance obligation by transferring control over a product or delivering a service to a customer. We measure revenue based upon the consideration set forth in an arrangement or contract with a customer. The revenue recognition criteria we apply to each of our software products and services are as follows:

● Perpetual software licenses – These licenses grant a right to use our functional intellectual property. We recognize revenue at the point in time when we electronically deliver to our customer the software license key that provides the ability to access and use our product. If our customer is a reseller who will further transfer the ability to access and use our product to a third party under a separate arrangement that the reseller has with that third party, we recognize revenue at the time we deliver the software license key to the reseller since our contract is with the reseller.

● Cloud-based, hosted SaaS solutions – These solutions grant a right to access our functional intellectual property. We recognize revenue over time on a monthly basis as we deliver the services to which our customers subscribe. Revenue can include basic monthly fees to access the software and usage fees based upon the volume of certain resources the customer consumes (such as volumes of storage or bandwidth). We are generally paid for these services on a month-to-month basis, but if a customer pays us in advance for services we will deliver in the future, we record as deferred revenue the amount of such payment related to services we have not yet delivered.

● M&S – We provide these services to purchasers of perpetual software licenses under agreements 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 paid that relate to future periods during which we will provide the M&S service. We reduce deferred revenue and recognize revenue ratably in future periods as we deliver the M&S service.

● Professional services – We recognize revenue from these services when the services are completed. If we are paid in advance for these services, we record such payment as deferred revenue until we complete the services.

The delivery of our software products and services generally does not involve any variable consideration, financing components or consideration payable to a customer such as rebates or other incentives that reduce amounts owed to us by customers.

Deferred Revenue Classification and Activity

Deferred revenue related to services we will deliver within one year is presented as a current liability. Deferred revenue related to services that we will deliver more than one year into the future is presented as a non-current liability.

7

The activity in our deferred revenue balances has been as follows ($ in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Deferred revenue, beginning of period	$	16,986		$	16,013		$	16,237		$	17,050
Deferred revenue resulting from new contracts with customers		6,938			4,764			21,880			14,321
Deferred revenue at the beginning of the period that was amortized to revenue		(6,464	)		(5,113	)		(18,259	)		(14,727	)
Deferred revenue arising during the period that was amortized to revenue		(914	)		(528	)		(3,312	)		(1,508	)
Deferred revenue, end of period	$	16,546		$	15,136		$	16,546		$	15,136

Multi-Element Transactions

At the time customers purchase perpetual software licenses, they also typically purchase M&S although it is not mandatory. We do not sell separate M&S to subscribers to our SaaS solutions as M&S is provided as part of their SaaS subscription. Customers may also purchase professional services at the time they purchase perpetual software licenses or a SaaS subscription. Each of the components of these multi-element transactions is a separately identifiable performance obligation.

For multi-element transactions, we allocate the transaction price to each performance obligation on a relative stand-alone selling price basis. We determine that stand-alone selling price for each item at the inception of the transaction involving these multiple elements.

We sell, as stand-alone transactions, renewals of pre-existing M&S contracts, professional services to customers seeking assistance with products they have previously purchased from us, or SaaS subscriptions to customers not requiring any of our other products or services. Accordingly, we are able to estimate the stand-alone selling price of these items based upon our observation of those transactions. Since most of our sales of perpetual software licenses are part of multi-element transactions that also involve M&S and/or professional services, and because the selling price of those licenses can vary significantly among customers, we use the residual approach under FASB Accounting Standards Codification Topic 606, or ASC 606, to estimate the selling price of perpetual software licenses in a multi-element transaction by reference to the total transaction price less the sum of the observable stand-alone selling prices of M&S and/or professional services.

Sales Tax

We collect sales tax on many of our transactions with customers as required under applicable law. We do not include sales tax collected in our revenue. We record it as a liability payable to taxing authorities.

Allowance for Sales Returns

We provide an allowance for sales returns. We estimate this allowance based upon our historical experience and the nature of recent transactions with customers. This amount is included in accrued liabilities in our condensed consolidated balance sheets.

Contract Assets

We generally bill customers for professional services when we have fully delivered the services specified in the contract. We may incur costs in delivering the services prior to that time. Such costs are generally not material. Accordingly, we do not record a contract asset for professional service engagements in process but not yet billed.

8

Incremental Costs of Obtaining a Contract to Deliver Goods and Services

We incur incremental costs in the form of sales commissions paid to our sales personnel and royalties on certain products paid to third parties. These are costs we would not incur if we did not obtain a contract to deliver our goods and services. We account for these costs as follows:

● If the costs are associated with products and services for which we recognize revenue at a fixed point in time (primarily sales of perpetual software licenses and professional services), we expense these costs in full at the time we recognize that revenue.

● If the costs are associated with services for which we recognize revenue over time (primarily sales of M&S and SaaS subscriptions) for which we believe it is likely that the contract for those services will be renewed for additional terms in the future, provided we deem these costs to be recoverable, we record these costs as a deferred expense asset and amortize that cost to expense as follows:

o For the portion of the cost that we determine benefits us primarily only over the term of the specific underlying contract currently in force (such as the term of an M&S contract), we recognize expense ratably each month over that term.

o For the portion of the cost that we determine benefits us over an overall customer relationship that is likely to span a period of time that is longer than an initial contract term (for example, an M&S contract renewed for multiple terms in the future), we recognize expense ratably monthly over the estimated life of the customer relationship.

Our activity in deferred costs of obtaining a contract to deliver goods and services has been as follows ($ in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Deferred expense, beginning of period	$	963		$	1,172		$	1,009		$	1,240
Deferred expense resulting from new contracts with customers		195			149			580			496
Deferred expense amortized to expense		(224	)		(216	)		(655	)		(631	)
Deferred expense, end of period	$	934		$	1,105		$	934		$	1,105

At September 30, 2019, $577,000 was recorded in prepaid and current other assets and $357,000 was recorded in other assets in our condensed consolidated balance sheet. At December 31, 2018 we had $571,000 recorded in prepaid and other current assets and $438,000 recorded in noncurrent other assets in our condensed consolidated balance sheet.

Leases

We determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (“ROU”) assets, other current liabilities, and operating lease liabilities on our consolidated balance sheets. Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. The operating lease ROU asset also includes any lease payments made and excludes lease incentives and initial direct costs incurred. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, which are generally accounted for separately. On April 18, 2019, the Company signed a new operating lease for our existing office space location. The lease is for a period of 10 years at an average annual rent of $462,000 beginning May 1, 2019. We recorded a right-of-use asset and lease liability of approximately $3 million at the commencement of the lease.

Cash and cash equivalents

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

9

Fair Value of Financial Instruments

For financial assets and liabilities recorded at fair value on a recurring or non-recurring basis, fair value is the price we would receive to sell an asset, or pay to transfer a liability, in an orderly transaction with a market participant at the measurement date. In the absence of such data, fair value is estimated using internal information consistent with what market participants would use in a hypothetical transaction. In determining fair value, observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions; preference is given to observable inputs. These two types of inputs create the following fair value hierarchy:

Level 1: Quoted prices for identical instruments in active markets.

Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3: Significant inputs to the valuation model are unobservable.

As of September 30, 2019, we did not have any assets measured at fair value on a recurring basis that would require disclosure based on the fair value hierarchy of valuation techniques. In addition, certain non-financial assets and liabilities are to be initially measured at fair value on a nonrecurring basis. This includes items such as non-financial assets and liabilities initially measured at fair value in a business combination (but not measured at fair value in subsequent periods) and non-financial, long-lived assets measured at fair value for an impairment assessment. In general, non-financial assets and liabilities including goodwill, capitalized software and property and equipment are measured at fair value using Level 3 inputs, which result in management’s best estimate of fair value from the perspective of a market participant, when there is an indication of impairment and are recorded at fair value only when impairment is recognized.

Our financial instruments consist principally of cash and cash equivalents, accounts receivable and accounts payable. The carrying amount of cash and cash equivalents, accounts receivable, and accounts payable, approximates fair value due to the short term maturity of these instruments, all of which mature within 12 months.

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. Annually, we test goodwill for impairment at the reporting unit level using December 31 as the measurement date, and will also evaluate throughout the year if any indicators of a potential impairment are identified. We operate as a single reporting unit.

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.

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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, 2018, 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, have in place a program plan and a detailed 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.

Cost of revenue

Cost of revenue consists of expenses associated with the production, delivery and support of the products and services we sell. Cost of license revenue consists primarily of amortization of the capitalized software development costs we incur when producing our software products, royalties we pay to use software developed by others for certain features of our products, and fees we pay to third parties who provide services supporting our SaaS solutions. 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.

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 approximately $45,000 and $172,000 in the 2019 quarter and the 2018 quarter, respectively, and $140,000 and $750,000 in the 2019 nine months and 2018 nine months, 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 primarily use 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.

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

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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 condensed consolidated 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 an 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 condensed consolidated financial statements.

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 the condensed consolidated financial statements we issue for the year ending December 31, 2022, 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.

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ASU 2016-02, Leases (Topic 842): In February 2016, the FASB issued a new standard related to leases to increase transparency and comparability among organizations by requiring the recognition of ROU assets and lease liabilities on the balance sheet. Most prominent among the changes in the standard is the recognition of ROU assets and lease liabilities by lessees for those leases classified as operating leases. Under the standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. We are also required to recognize and measure leases existing at, or entered into after, the beginning of the earliest comparative period presented using a modified retrospective approach, with certain practical expedients available. We adopted ASC 842 using the modified retrospective approach effective January 1, 2019. As leases in-place at the time of adoption were not material, no right-of-use assets or lease liabilities were recorded upon adoption. We elected the available practical expedients and implemented internal controls and key system functionality to enable the preparation of financial information on adoption. On April 18, 2019, the Company signed a new operating lease for our existing office space location. The lease is for a period of 10 years at an average annual rent of $462,000 beginning May 1, 2019. We recorded a right-of-use asset and lease liability of approximately $3 million at the commencement of the lease.

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 have implemented these new principles using the modified retrospective transition method and recorded an increase (tax effected) to retained earnings at January 1, 2018 of $979,000. We also recorded as an asset deferred expense of approximately $1.2 million. We are accounting for these costs we incur to obtain a contract as follows:

● If these costs are associated with products and services for which we recognize revenue at a point in time (primarily sales of perpetual software licenses and professional services), we expense these costs in full at the time we recognize that revenue.

● If these costs are associated with services for which we recognize revenue over time (primarily sales of M&S and SaaS subscriptions) for which we believe it is likely that the contract for those services will be renewed for additional terms in the future, provided we deem these costs to be recoverable, we record these costs as deferred expense asset and amortize that cost to expense as follows:

o For the portion of the cost that we determine benefits us primarily only over the term of the specific underlying contract currently in force (such as the term of an M&S contract), we will recognize expense ratably each month over that term.

o For the portion of the cost that we determine benefits us over an overall customer relationship that is likely to span a period of time that is longer than an initial contract term (for example, an M&S contract renewed for multiple terms in the future), we will recognize expense ratably monthly over the estimated life of the customer relationship.

4. Accounts Receivable, Net

We bill customers and issue invoices when we have delivered goods or services. In addition, when customers agree to purchase or renew M&S services, we bill and invoice 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 condensed consolidated financial statements. We continually assess the collectability of our accounts receivable. If we deem it less than probable that we will collect an amount due us, we write-off that balance against our allowance for doubtful accounts. Accordingly, we determine our accounts receivable, net, as follows ($ in thousands):

	September 30, 2019			December 31, 2018
Total invoices issued and unpaid	$	6,460		$	7,990
Less: Unpaid invoices relating to M&S contracts with a start date subsequent to the balance sheet date		(869	)		(1,233	)
Gross accounts receivable		5,591			6,757
Allowance for doubtful accounts		(100	)		(100	)
Accounts receivable, net	$	5,491		$	6,657

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5. Capitalized Software Development Costs, Net

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

	September 30,			December 31,
	2019			2018
Gross capitalized cost	$	11,195		$	10,454
Accumulated amortization		(8,506	)		(7,321	)
Capitalized software development costs, net	$	2,689		$	3,133

	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Amount capitalized	$	304		$	264		$	741		$	1,057
Amortization expense		(379	)		(460	)		(1,185	)		(1,459	)

	Released			Unreleased
	Products			Products
Gross capitalized amount at September 30, 2019	$	10,254		$	941
Accumulated amortization		(8,506	)		-
Net capitalized cost at September 30, 2019	$	1,748		$	941

Future amortization expense:
Three months ending December 31, 2019		372
Year ending December 31,
2020		1,064
2021		301
2022		11
Total	$	1,748

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.

6. Deferred Revenue

As described in Note 4 regarding accounts receivable, when 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):

	September 30, 2019			December 31, 2018
Total invoiced for M&S contracts for which revenue will be recognized in future periods	$	17,415		$	17,470
Less: Unpaid invoices relating to M&S contracts with a start date subsequent to the balance sheet date		(869	)		(1,233	)
Total deferred revenue	$	16,546		$	16,237
Deferred revenue, current portion	$	14,592		$	13,301
Deferred revenue, non-current portion		1,954			2,936
Total deferred revenue	$	16,546		$	16,237

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7. Stock Options, Restricted Stock and Stock-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 our Board of Directors. Our stock-based compensation expense was as follows ($ in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019		2018
Stock-based compensation expense	$	536	$	110	$	1,985	$	972

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 2019 nine months, we granted stock options only under the 2016 Employee Long-Term Equity Incentive Plan (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 our 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 September 30, 2019, stock-based incentives for up to 2,826,008 shares remained available for issuance in the future under the 2016 Plan.

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

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, 2018		2,536,320		$	3.53		6.97	$	2,464
Granted		702,500		$	7.94
Forfeited		(352,007	)	$	3.85
Exercised		(269,015	)	$	3.25
Outstanding at September 30, 2019		2,617,798		$	4.83		5.73	$	17,389
Exercisable at September 30, 2019		1,337,664		$	3.60		2.42	$	10,533

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Additional information about our stock options is as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019		2018
Weighted average fair value of options granted	$	4.35	$	1.57	$	5.73	$	1.56
Intrinsic value of options exercised	$	570,245	$	205,111	$	1,125,635	$	205,111
Cash received from stock options exercised	$	176,987	$	341,489	$	874,499	$	341,489
Number of options that vested		186,113		72,748		832,060		511,900
Fair value of options that vested	$	314,293	$	139,406	$	1,312,096	$	861,904
Unrecognized compensation expense related to non-vested options at end of period	$	2,844,578	$	1,286,260	$	2,844,578	$	1,286,260
Weighted average years over which non-vested option expense will be recognized		3.03		2.15		3.03		2.15

Plan	Shares outstanding
2000 Stock Option Plan		2,500
2010 Employee LT Equity Incentive Plan		498,472
2016 Employee LT Equity Incentive Plan		2,116,826
Total shares Outstanding at September 30, 2019		2,617,798

As of September 30, 2019
			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
$1.43 - $2.35		123,004		0.93	$	1.75		123,004	$	1.75
$2.39 - $3.59		582,296		3.94	$	3.44		429,003	$	3.41
$3.60 - $5.90		1,225,998		4.89	$	4.02		785,657	$	3.99
$6.83 - $10.40		678,500		9.59	$	7.97		-	$	-
$10.70 - $13.27		8,000		9.88	$	11.69		-	$	-
Total options		2,617,798						1,337,664

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Expected volatility		47	%		48	%		47	%		48	%
Expected annual dividend yield		1.50	%		1.50	%		1.50	%		1.50	%
Risk free rate of return		1.78	%		2.80	%		2.23	%		2.75	%
Expected option term (years)		6.00			6.00			6.23			6.00

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Restricted Stock Awards

Our 2015 Non-Employee Directors Long-Term Equity Incentive Plan (the “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 2015 Directors 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 our 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 September 30, 2019, stock based incentives for up to 80,000 shares remained available for issuance in the future under the 2015 Directors Plan.

						Total
				Grant Date		Fair Value of
	Number of			Fair Value		Shares That
	Shares			Per Share		Vested
Restricted shares outstanding at December 31, 2018		100,000		$	4.06
Shares granted with restrictions		80,000		$	8.85
Shares vested and restrictions removed		(40,000	)	$	6.46	$	354,000
Restricted shares outstanding at September 30, 2019		140,000		$	6.11
Unrecognized compensation expense for non-vested shares as of September 30, 2019
Expense to be recognized in future periods	$	330,079
Weighted average number of months over which expense is expected to be recognized		7.1

8. Income Taxes

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

	Three months ended September 30,													Nine months ended September 30,
	2019							2018						2019							2018
	Current		Deferred			Total		Current		Deferred		Total		Current		Deferred			Total		Current		Deferred		Total
Federal	$	675	$	47		$	722	$	166	$	43	$	209	$	2,226	$	(93	)	$	2,133	$	243	$	51	$	294
State		157		(143	)		14		67		5		72		439		(163	)		276		82		10	$	92
Total	$	832	$	(96	)	$	736	$	233	$	48	$	281	$	2,665	$	(256	)	$	2,409	$	325	$	61	$	386

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Deferred income taxes on our consolidated 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):

	September 30		December 31,
	2019		2018
Deferred tax assets:
Deferred revenue	$	557	$	809
Share-based compensation		469		329
Compensation and benefits		123		49
Texas franchise tax R&D credit		147		194
Allowance for doubtful accounts		37		37
Deferred state income taxes		60		45
Accrued expenses not deducted for tax		7		6
Valuation allowance		-		(194	)
Total deferred tax assets		1,400		1,275
Deferred tax liabilities:
Intangible assets		553		667
Deferred expenses		196		213
Total deferred tax liabilities		749		880
Net deferred tax assets	$	651	$	395

In assessing the realizability of deferred tax assets, we consider whether it is more-likely-than-not that some portion or all the deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We have concluded it is more-likely-than-not that our ability to generate future taxable income will allow us to realize those deferred tax assets.

As of September 30, 2019, we had Texas Research and Development tax credit carryforwards of $147,000. These carryforwards expire in years 2034 through 2039.

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

	Nine Months Ended September 30,
	2019			2018
Balance at beginning of period	$	113		$	158
Increases for tax positions related to the current year		-			10
Increases for tax positions related to prior years		-			-
Decreases for tax positions where the statue has expired		(43	)		(48	)
Balance at end of period	$	70		$	120

Our unrecognized tax benefit is related to research and development credits taken on our U.S. income tax returns in 2013, 2016, and 2017 and the uncertainty related to the realization of a portion of those credits based on prior experience. We believe it reasonably possible that we will recognize $46,000 of our unrecognized tax benefits on or before December 31, 2019. If we realized and recognized any of our unrecognized tax benefits, such benefits would reduce our effective tax rate in the year of recognition.

We record interest and penalty expense related to income taxes as interest and other expense, respectively. At September 30, 2019, no interest or penalties had been or were required to be accrued. We file income tax returns in the US and in various state jurisdictions with varying statues of limitations. We are no longer subject to income tax examination by tax authorities for years prior to 2013 with respect to our federal income tax returns and years prior to 2014 with respect to most of our state income tax returns. We do not file, and are not required to file, any foreign income tax returns.

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Our income tax expense reconciles to an income tax expense resulting from applying an assumed statutory federal income tax rate of 21% for the 2019 and 2018 quarter and the 2019 and 2018 nine months to income before income taxes as follows ($ in thousands):

	Three months ended September 30,						Nine months ended September 30,
	2019			2018			2019			2018
Income tax expense at federal statutory rate	$	906		$	269		$	2,529		$	219
Increase (decrease) in taxes resulting from:
State taxes, net of federal benefit		175			58			378			89
Stock based compensation		(35	)		14			(27	)		164
Other		(4	)		2			22			7
R&D tax credit uncertain tax position (net)		(43	)		(45	)		(43	)		(38	)
Research and development credit		17			(17	)		-			(55	)
Change in valuation allowance on state tax credits		(194	)					(194	)
Foreign derived intangible income deduction		(86	)		-			(256	)		-
Income tax expense per the statements of operations	$	736		$	281		$	2,409		$	386

On June 21, 2018, in South Dakota v Wayfair Inc., the United States Supreme Court held that states may charge sales tax on purchases made from out-of-state sellers, even if the seller does not have a physical presence in the taxing state. Currently, we file state income tax returns in those states in which we have a physical presence and/or are otherwise required by a state to register to do business. In addition, we collect and remit sales tax in states where we have met the nexus requirements. We perform quarterly assessments of nexus requirements for both income and sales tax to determine any additional requirements.

9. Earnings per Common Share

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

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2019		2018		2019		2018
Numerators
Numerator for basic and diluted earnings per share:
Net income	$	3,580	$	998	$	9,633	$	656
Denominators
Denominators for basic and diluted earnings per share:
Weighted average shares outstanding - basic		17,347		21,688		17,271		21,746
Dilutive potential common shares
Stock options and awards		1,422		252		1,127		298
Denominator for diluted earnings per share		18,769		21,940		18,398		22,044
Net income per common share - basic	$	0.21	$	0.05	$	0.56	$	0.03
Net income per common share – diluted	$	0.19	$	0.05	$	0.52	$	0.03

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10. Dividends

We paid dividends during the 2019 nine months and 2018 nine months as follows: 

	Three Months Ended
	March 31, 2019		March 31, 2018		June 30, 2019		June 30, 2018		September 30, 2019
Dividend per share of common stock	$	0.015	$	0.015	$	0.500	$	0.015	$	0.015
Dividend record date	March 11, 2019		March 9, 2018		May 13, 2019		June 8, 2018		August 6, 2019
Dividend payment date	March 25, 2019		March 23, 2018		May 28, 2019		June 22, 2018		August 20, 2019

11. Commitments and Contingencies 

Severance Payments

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 between approximately $700,000 and $1.4 million depending upon the circumstances.

Legal and Regulatory Matters

As disclosed in a Current Report on Form 8-K filed on March 16, 2018, the Fort Worth, Texas Regional Office of the SEC has opened a formal investigation of issues relating to the restatement of our condensed consolidated financial statements as of and for the years ended December 31, 2016 and 2015 and our consolidated financial statements as of and for the three months ended March 31, 2017, with which the Company is cooperating fully.  At this time, the Company is unable to predict the duration, scope, result or related costs associated with the SEC’s investigation.  The Company is also unable to predict what, if any, action may be taken by the SEC, or what penalties or remedial actions the SEC may seek.  Any determination by the SEC that the Company’s activities were not in compliance with existing laws or regulations, however, could result in the imposition of fines, penalties, disgorgement, equitable relief, or other losses, which could have a material adverse effect on the Company’s financial position, liquidity, or results of operations.

On May 31, 2018, the Company was served with a subpoena issued by a grand jury sitting in the United States District Court for the Western District of Texas (the “Grand Jury Subpoena”). The Grand Jury Subpoena requests all documents and emails relating to the Company’s investigation of the potential improper recognition of software license revenue. The Company intends to fully cooperate with the Grand Jury Subpoena and related investigation being conducted by the United States Attorney’s Office for the Western District of Texas (the “U.S. Attorney’s Investigation”). At this time, the Company is unable to predict the duration, scope, result or related costs of the U.S. Attorney’s Investigation. The Company is also unable to predict what, if any, further action may be taken in connection with the Grand Jury Subpoena and the U.S. Attorney’s Investigation, or what, if any, penalties, sanctions or remedial actions may be sought. Any determination by the U.S. Attorney’s office that the Company’s activities were not in compliance with existing laws or regulations, however, could result in the imposition of fines, penalties, disgorgement, equitable relief, or other losses, which could have a material adverse effect on the Company’s consolidated financial position, liquidity, or results of operations.

12. Leases

On April 18, 2019, the Company signed a new operating lease for our existing office space location. The lease is for a period of 10 years at an average annual rent of $462,000 beginning May 1, 2019. We recorded a right-of-use asset and lease liability of approximately $3 million at the commencement of the lease.

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Our non-cancellable, contractual obligations at September 30, 2019, consisted primarily of the following ($ in thousands):

	Operating Lease
2019 (remaining three months)	$	103
2020		420
2021		431
2022		442
2023		453
Thereafter		2,597
Total lease payments	$	4,446

Supplemental other information related to leases:

	Three Months Ended September 30,			Nine Months Ended September 30,
	2019			2019
Operating lease cost	$	101		$	284
Weighted-average remaining lease term (years)		9.5			9.5
Weighted-average discount rate (%)		5	%		5	%
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	103		$	292

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 the 2019 quarter and 2018 quarter, we earned approximately 17% and 12%, respectively, of our revenue from such sales through our largest third-party channel distributor. During the 2019 nine months and 2018 nine months, we earned approximately 17% and 13% of our revenue from such sales, respectively. As of September 30, 2019, approximately 21% 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 ASC 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 outside the United States accounted for approximately 25% and 30% of our total revenues in the 2019 quarter and 2018 quarter, respectively, and 25% and 29% for the 2019 nine months and 2018 nine months, respectively. Each individual foreign country accounts for less than 10% of total revenue 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 September 30, 2019.

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

This Quarterly Report on Form 10-Q (this “Quarterly Report”) of GlobalSCAPE, Inc. and its wholly-owned subsidiary (collectively referred to as “GlobalSCAPE”, the “Company”, “we” or “our”), 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, (the “Securities Act”) and Section 21E of the Securitas Exchange Act of 1934, as amended (the “Exchange Act”). “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 Annual Report on Form 10-K for the fiscal year ended December 31, 2018 (the “2018 Form 10-K”) and other documents filed with the Securities and Exchange Commission (the “SEC”). 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 2019 quarter and the 2018 quarter refer to the three months ended September 30, 2019 and 2018, respectively. Our references to the 2019 nine months and the 2018 nine months refer to the nine months ended September 30, 2019 and 2018, 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 more than twenty years.

Our primary business is selling and supporting managed file transfer (“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.

Our MFT products are based upon our Enhanced File Transfer (“EFT”) platform. This on-premise and cloud-based delivery platform emphasizes secure and efficient data exchange for virtually any organization. It enables business partners, customers and employees to share information safely and securely. The EFT platform provides enterprise-level security while automating the integration of back-end systems which are features often missing from traditional file transfer software. The EFT platform features built-in regulatory compliance, governance, and visibility controls to maintain data safety and security. It can replace legacy systems, homegrown servers, expensive leased lines and virtual area networks. The EFT platform promotes ease of administration while providing the detailed capabilities necessary for complete control of a file transfer system.

We continue to explore all strategic alternatives to maximize value for shareholders, including without limitation to improve the market position and profitability of our product offerings in the marketplace, generate additional liquidity, and enhance our valuation. We may pursue our goals through organic growth or strategic or other alternatives. We will also continue to monitor capital markets for opportunities to repurchase shares, as well as consider other actions designed to enhance shareholder value.

We earn most of our revenue from the sale of products and services that are part of our EFT platform. Customers can purchase the capabilities of our EFT platform in two ways:

● Under a perpetual software license for which they pay a one-time fee and under which they typically install our product on computers that they own and/or manage. Our brand name for this product is EFT. Almost all customers who purchase EFT also purchase a maintenance and support (“M&S”) contract for which they pay us an annual recurring fee. Most of the revenue we have earned from our EFT platform products has been from sales of perpetual software licenses and related M&S.

● As a software-as-a-service, or SaaS, under which they pay us ongoing fees to access the capabilities of the EFT platform in the cloud. In January 2018, we introduced EFT Arcus, our SaaS offering of the EFT platform for which users pay a base monthly subscription fee plus an additional variable amount determined based upon their metered usage of EFT Arcus resources.

We sell other products that are synergistic to our EFT platform including CuteFTP. Collectively, these products constituted less than 3% of our total revenue in the 2019 quarter and 2019 nine months. Customers pay a one-time fee to purchase these products under a perpetual software license. Some customers also purchase an M&S contract. We do not offer a SaaS version of these products and have no plans to do so. We continue to offer product support for Mail Express and WAFS, which we discontinued as products for sale as of January 1, 2019.

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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 this product line. We expect to expend minimal resources developing and selling our other products. We believe our EFT platform products and business capabilities are well-positioned to compete effectively in the market for these products. For a more comprehensive discussion of the products we sell and the services we offer, see “Software Products and Services” below.

Appointment of new Interim Chief Executive Officer

As previously disclosed, the Company’s President and Chief Executive Officer, Matthew Goulet, unexpectedly passed away on March 30, 2019. On March 31, 2019, the Board of Directors named Robert Alpert, Chairman of the Board of Directors, as Interim CEO.

Key Business Metrics

We review two key business metrics on an ongoing basis to help us monitor our performance and to identify material trends which may affect our business: revenue growth and Adjusted EBITDA (as defined and further 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.

See “Comparison of the Consolidated Statement of Operations for the Three Months Ended September 30, 2019 and 2018” and “Comparison of the Consolidated Statement of Operations for the Nine Months Ended September 30, 2019 and 2018” for a discussion of trends in our revenue growth that we monitor using this metric.

Adjusted EBITDA (Non-GAAP Measurement)

We utilize Adjusted EBITDA (Earnings Before Interest, Taxes, Total Other Income/Expense, Depreciation, Amortization, and Share-Based Compensation Expense) to provide us a view of income and expenses that is supplemental and secondary to our primary assessment of net income as presented in our consolidated statement of operations and comprehensive income. We use Adjusted EBITDA to provide another perspective for measuring profitability that does not include the effects of the following items:

● Expenses that typically do not require us to pay them in cash in the current period (such as depreciation, amortization and share-based compensation);

● The cost of financing our business; and

● The effects of income taxes.

Prior to 2018, we did not add back the amortization of capitalized software development costs in our Adjusted EBITDA computation. In 2018, after researching the methods used by other software companies, we changed our method of computing Adjusted EBITDA to include the amortization of capitalized software development cost in order to enhance the comparability of the computation to that of our peers.

We monitor Adjusted EBITDA to assess our performance relative to our intended strategies, expected patterns of action, and budgets. We use the results of that assessment to adjust our future activities to the extent we deem necessary.

Adjusted EBITDA is not a measure of financial performance under United States generally accepted accounting principles (“GAAP”). It should not be considered as a substitute for net income presented on our condensed consolidated statement of operations and comprehensive income. 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 condensed consolidated financial statements prepared in accordance with GAAP.

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

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2019			2018		2019			2018
Net Income	$	3,580		$	998	$	9,633		$	656
Add (subtract) items to determine Adjusted EBITDA:
Income tax expense		736			281		2,409			386
Interest (income) expense, net		(29	)		93		(83	)		(63	)
Depreciation and amortization:
Total depreciation and amortization		419			522		1,335			1,641
Share-based compensation expense		536			110		1,985			972
Adjusted EBITDA	$	5,242		$	2,004	$	15,279		$	3,592

Amounts we previously reported as Adjusted EBITDA reconcile to the metric in the table above as follows:

	Three Months Ended		Nine Months Ended
	September 30,		September 30,
	2018		2018
Adjusted EBITDA as previously reported	$	1,544	$	2,133
Amortization of capitalized software development costs		460		1,459
Adjusted EBITDA as now reported	$	2,004	$	3,592

See “Comparison of the Consolidated Statement of Operations for the Three Months Ended September 30, 2019 and 2018” and “Comparison of the Consolidated Statement of Operations for the Nine Months Ended September 30, 2019 and 2018” 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, data transfer, and data sharing capabilities for enterprises and consumers. We have been in business for more than twenty years having sold our products to thousands of enterprises and individual consumers globally.

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. 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.

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We earn over 95% of our revenue from the sale of MFT products and services that are part of our EFT platform. We have multiple revenue streams from the EFT platform that include:

● Perpetual software licenses under which customers pay a one-time fee for the right to 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 bring-your-own-license, or BYOL, environment. Our brand name for this product is EFT. Historically, most of the revenue we have earned from our EFT platform products has been from sales of EFT perpetual software licenses and related M&S.

● Cloud-based, SaaS solutions that we sell on an ongoing subscription basis. In January 2018, we introduced EFT Arcus, our SaaS offering of the EFT platform going forward, for which users pay a base monthly subscription fee plus an additional variable amount based upon their metered usage of EFT Arcus resources.

● M&S.

● Professional services for product installation, integration and training.

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 this product line. We expect to expend minimal resources developing and selling our other products. We believe our EFT platform products and business capabilities are well-positioned to compete effectively in the market for these products. For a more comprehensive discussion of the products we sell and the services we offer, see below.

We sell other products that are synergistic to our EFT platform including CuteFTP. Collectively, these products constituted less than 3% of our total revenue in the 2019 quarter. Customers pay a one-time fee to purchase these products under a perpetual software license. Some customers also purchase an M&S contract. We do not offer a SaaS version of these products and have no plans to do so. We continue to offer product support for Mail Express and WAFS, which we discontinued as products for sale as of January 1, 2019.

We earn most of our revenue from the sale of our EFT platform products that support business-to-business activities and are strategically focused on selling products in that environment. We intend to expend the majority of our resources in the future for product research and development, marketing, and sales in a manner that concentrates on the business-to-business market. We believe our products and business capabilities are well-positioned to compete effectively in that market.

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

Managed File Transfer – Enhanced File Transfer Platform

EFT is the brand name of our core MFT product platform. 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.

The EFT platform provides a common, scalable MFT environment that accommodates a broad family of accompanying modules to provide enterprises with increased security, automation, compliance and performance when compared to traditional FTP-based and email delivery systems. Various optional modules allow users to select the solution configuration most applicable to their requirements for auditing, 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.

General 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 also 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 provide for complete control and monitoring of file transfer activities.

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● 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, compliance and security requirements. In addition to enabling the secure, flexible transmission of critical information using servers, 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 and collaboration, and continuous data backup and recovery.

EFT Platform – Delivery Offerings

Our customers can purchase the capabilities of our EFT platform in two ways:

● Under a perpetual software license for which they pay a one-time fee and under which they typically install our product on computers that they own and or manage. The EFT platform purchased in this manner can also be used in a bring-your-own-license environment hosted by major cloud providers such as Amazon Web Services or Microsoft Azure. Almost all customers who purchase a perpetual license to use the EFT platform also purchase an M&S contract for which they pay us a recurring fee that is typically 20% to 30% of the perpetual license fee per year.

● As a SaaS under which the customer pays us monthly subscription and usage fees to access the capabilities of the EFT platform in the cloud. Our brand name for this product is EFT Arcus. We introduced this product in January 2018. We have not yet earned significant revenue from the SaaS offering of our EFT platform.

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 generates incremental revenue for us at a relatively low cost. We will continue selling CuteFTP as a stand-alone product and providing M&S services to customers, but will not invest significantly in enhancing or marketing the product.

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Professional Services

We offer a wide range of professional services to complement our on-premises and SaaS solutions. These services can include:

● System integration and implantation

● Business process and workflow planning

● Policy development

● Education and training

● Solution health checks

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 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 contracts pay us a recurring, annual fee that is typically 20% to 30% of the software license price. A majority of our customers with M&S contracts renew them each year.

Employees

Our workforce is organized as follows:

	September 30,
Department	2019		2018
Sales and Marketing		41		36
Engineering		12		9
Professional Services		6		5
Customer Support		23		24
Management and Administration		17		16
Total		99		90

On August 3, 2018, we implemented a plan to restructure our organization, which included a reduction in workforce of approximately 40 employees, representing approximately 30% of the Company’s total pre-restructuring workforce. We recorded a charge of $381,000 in the 2018 quarter relating to this reduction in force, consisting primarily of one-time severance payments and termination benefits. The Company’s goal in the restructuring was to better focus our workforce on retaining current customers, gaining incremental business from current customers, and winning new business in the market segments where we can leverage our expertise and long history as an EFT pioneer.

Through the first nine months of 2019, the realignment has resulted in a significant reduction in total operating expenses and a significant increase in operating income. No assurance can be provided that operating expenses will continue to decline or that operating income will continue to increase. Please see the Company’s discussion of “Risk Factors – Risks Related to Our Operations” in our 2018 Form 10-K filed with the SEC on March 18, 2019.

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Solution Perspective and Trends

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

Three Months Ended September 30,