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 June 30, 2020

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

210-308-8267

Registrant’s Telephone Number, Including Area Code

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 ☐

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

As of July 31, 2020 there were 18,782,318 shares of common stock outstanding.

GlobalSCAPE, Inc.

Quarterly Report on Form 10-Q

For the Quarter ended June 30, 2020

Index

		Page
Explanatory Note
Part I.	Financial Information
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets	5
	Condensed Consolidated Statements of Operations and Comprehensive Income	6
	Condensed Consolidated Statements of Stockholders’ Equity (Deficit)	7
	Condensed Consolidated Statements of Cash Flows	8
	Notes to Condensed Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	43
Item 4.	Controls and Procedures	43
Part II.	Other Information	44
Item 1.	Legal Proceedings	44
Item 1A.	Risk Factors	44
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	46
Item 5	Other Information	46
Item 6.	Exhibits	46
Signatures		47

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. 

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 client does not need to install the underlying software on its own computer systems to access the application.

EXPLANATORY NOTE

On July 19, 2020, GlobalSCAPE, Inc., a Delaware corporation (the “Company”), entered into an Agreement and Plan of Merger (the “Merger Agreement”) by and among Help/Systems, LLC, a Delaware limited liability company (“Parent”), Grail Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”), and solely with respect to certain sections therein, HS Purchaser, LLC, a Delaware limited liability company and Help/Systems Holdings, Inc., a Delaware corporation. Pursuant to the Merger Agreement and upon the terms and subject to the conditions thereof, Merger Sub commenced a tender offer (the “Offer”) to purchase any and all of the outstanding shares (the “Shares”) of common stock of the Company, par value $0.001 per share, at a price of $9.50 per Share (the “Offer Price”), subject to any required withholding of taxes, net to the seller in cash without interest, on the terms and subject to the conditions set forth in the Merger Agreement.

Upon the terms and subject to the conditions of the Merger Agreement, Merger Sub commenced the Offer on July 31, 2020. Subject to the terms and conditions set forth in the Merger Agreement, Merger Sub shall, promptly after the expiration of the Offer, accept for payment all Shares validly tendered and not withdrawn pursuant to the Offer (the time at which Shares are first accepted for payment under the Offer, the “Acceptance Time”), and after the Acceptance Time, Merger Sub shall pay the Offer Price for such Shares.

Pursuant to the Merger Agreement, following the consummation of the Offer, and subject to the conditions set forth in the Merger Agreement, Merger Sub will be merged with and into the Company (the “Merger”), whereupon the separate existence of Merger Sub shall cease, and the Company shall be the surviving corporation of the Merger and a wholly owned subsidiary of Parent. The Merger shall be governed by and effected under Section 251(h) of the Delaware General Corporation Law (the “DGCL”), without a vote of the stockholders of the Company.

At the effective time of the Merger, all remaining outstanding Shares not tendered in the Offer (other than Shares held by Parent or any of its subsidiaries, including Merger Sub, or in the treasury of the Company, or Shares held by stockholders who are entitled to exercise, and properly exercise, appraisal rights with respect to such Shares pursuant to, and who comply in all respects with, the provisions of Section 262 of the DGCL) will be cancelled and converted into the right to receive cash in an amount equal to the Offer Price, without interest, subject to any required withholding of taxes.

The Merger Agreement is more fully described in a Current Report on Form 8-K filed by the Company with the Securities and Exchange Commission on July 20, 2020. A copy of the Merger Agreement was filed by the Company as an exhibit to that Current Report. The descriptions herein of the Offer, the Merger and the Merger Agreement do not purport to be complete and are subject to, and qualified in their entirety by, the full text of the Merger Agreement filed with that Current Report.

Part I. Financial Information

Item 1. Financial Statements

GlobalSCAPE, Inc.

Condensed Consolidated Balance Sheets

(in thousands except share amounts)

	June 30,			December 31,
	2020			2019
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	12,463		$	4,702
Accounts receivable, net		6,308			7,239
Federal income tax receivable		1,371			1,759
Prepaid and other current assets		1,296			1,366
Total current assets		21,438			15,066
Capitalized software development costs, net		2,570			2,650
Goodwill		12,712			12,712
Deferred tax asset, net		295			493
Property and equipment, net		265			274
Right-of-use asset		2,864			2,905
Other assets		421			459
Total assets	$	40,565		$	34,559
Liabilities and Stockholders’ Equity (Deficit)
Current liabilities:
Accounts payable	$	639		$	746
Accrued expenses		1,500			1,598
Deferred revenue		16,500			15,683
Long term debt, current portion		5,825			4,575
Total current liabilities		24,464			22,602
Deferred revenue, non-current portion		2,718			2,572
Lease liability		2,853			2,900
Long term debt, non-current portion		39,208			42,745
Other long term liabilities		24			24
Commitments and contingencies
Stockholders’ equity (deficit):
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, 24,161,818 and 23,890,890 shares issued: 18,782,318 and 18,511,390 outstanding at June 30, 2020 and December 31, 2019, respectively		24			24
Additional paid-in capital		33,868			32,156
Treasury stock, 5,379,500 and 5,379,500 shares, at cost, at June 30, 2020 and December 31, 2019, respectively		(23,087	)		(23,087	)
Retained earnings (deficit)		(39,507	)		(45,377	)
Total stockholders’ equity (deficit)		(28,702	)		(36,284	)
Total liabilities and stockholders’ equity (deficit)	$	40,565		$	34,559

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

5

GlobalSCAPE, Inc.

Condensed Consolidated Statements of Operations and Comprehensive Income

(In thousands, except per share amounts)

(Unaudited)

	Three months ended June 30,					Six months ended June 30,
	2020			2019		2020			2019
Operating revenues:
Software licenses	$	2,228		$	2,835	$	4,223		$	5,469
Maintenance and support		7,295			6,602		14,361			12,678
Professional services		508			832		1,159			1,535
Total revenues		10,031			10,269		19,743			19,682
Cost of revenues:
Software licenses		729			731		1,407			1,340
Maintenance and support		607			566		1,220			1,098
Professional services		271			290		562			583
Total cost of revenues		1,607			1,587		3,189			3,021
Gross profit		8,424			8,682		16,554			16,661
Operating expenses:
Sales and marketing		2,062			1,899		4,137			3,815
General and administrative		1,450			1,757		2,974			3,776
Legal and professional		462			222		1,077			798
Research and development		352			275		664			600
Total operating expenses		4,326			4,153		8,852			8,989
Income from operations		4,098			4,529		7,702			7,672
Interest income (expense), net		(628	)		30		(1,402	)		54
Income before income taxes		3,470			4,559		6,300			7,726
Income tax expense		(31	)		926		430			1,673
Net income	$	3,501		$	3,633	$	5,870		$	6,053
Comprehensive income	$	3,501		$	3,633	$	5,870		$	6,053
Net income per common share -
Basic	$	0.19		$	0.21	$	0.31		$	0.35
Diluted	$	0.18		$	0.20	$	0.31		$	0.33
Weighted average shares outstanding:
Basic		18,750			17,268		18,681			17,233
Diluted		19,119			18,379		19,072			18,120
Cash dividends declared per share	$	-		$	0.500	$	-		$	0.515

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

6

GlobalSCAPE, Inc.

Condensed Consolidated Statement of Stockholders' Equity (Deficit)

(in thousands, except number of shares)

(unaudited)

					Additional
	Common Stock				Paid-in			Treasury			Retained
	Shares		Amount		Capital			Stock			Earnings			Total
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
Shares issued upon exercise of stock options		1,060,015		2		3,728									3,730
Stock-based compensation expense
Stock options						288									288
Restricted stock		80,000				142									142
Common stock cash dividends, $3.365 per share												(62,471	)		(62,471	)
Net Income												3,634			3,634
Balance at December 31, 2019		23,890,890	$	24	$	32,156		$	(23,087	)	$	(45,377	)	$	(36,284	)
Shares issued upon exercise of stock options		198,924				768									768
Stock-based compensation expense
Stock options						365									365
Restricted stock						132									132
Net Income												2,369			2,369
Balance at March 31, 2020		24,089,814	$	24	$	33,421		$	(23,087	)	$	(43,008	)	$	(32,650	)
Shares issued upon exercise of stock options		11,794				35									35
Stock-based compensation expense
Stock options						356									356
Restricted stock		60,210				56									56
Net Income												3,501			3,501
Balance at June 30, 2020		24,161,818	$	24	$	33,868		$	(23,087	)	$	(39,507	)	$	(28,702	)

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

7

GlobalSCAPE, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)

	For the Six Months Ended June 30,
	2020			2019
Operating Activities:
Net income	$	5,870		$	6,053
Items not involving cash at the time they are recorded in the statement of operations:
Provision for doubtful accounts receivable		4			63
Depreciation and amortization		917			916
Share-based compensation		909			1,449
Amortization of debt issuance costs		213			-
Deferred taxes		198			(159	)
Subtotal before changes in operating assets and liabilities		8,111			8,322
Changes in operating assets and liabilities:
Accounts receivable		927			537
Prepaid and other current assets		70			104
Deferred revenue		963			749
Accounts payable		(107	)		63
Accrued expenses		(98	)		303
Operating lease right-of-use asset		41			42
Other assets		38			9
Operating lease liabilities		(47	)		(43	)
Other long-term liabilities		-			(4	)
Income tax payable (receivable)		388			179
Net cash provided by operating activities		10,286			10,261
Investing Activities:
Software development costs capitalized		(768	)		(437	)
Purchase of property and equipment		(60	)		(32	)
Net cash used in investing activities		(828	)		(469	)
Financing Activities:
Proceeds from exercise of stock options		803			698
Stock option cash settlement		-			(445	)
Purchase of Treasury Stock		-			(375	)
Notes payable principle payments		(2,500	)		-
Dividends paid		-			(8,972	)
Net cash used in financing activities		(1,697	)		(9,094	)
Net increase in cash		7,761			698
Cash at beginning of period		4,702			9,173
Cash at end of period	$	12,463		$	9,871
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	1,436		$	-
Income tax payments (refunds)	$	(187	)	$	1,491
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.

8

GlobalSCAPE, Inc.

Notes to Condensed Consolidated Financial Statements

As of June 30, 2020 and For the Three and Six

Months Then Ended

(Unaudited)

1. Nature of Business

GlobalSCAPE, Inc., together with its wholly-owned subsidiary (TappIn, Inc., which was dissolved June 16, 2020) (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, client 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 clients 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 2% 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 2020 quarter and the 2019 quarter refer to the three months ended June 30, 2020 and 2019, respectively, and references to the 2020 six months and the 2019 six months refer to the six months ended June 30, 2020 and 2019, 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, 2019, filed with the SEC on March 16, 2020, which we refer to as the 2019 Form 10-K, as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations also included in our 2019 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.

9

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 clients install our products in their information systems environment on computers they manage, own or otherwise procure from a cloud services provider. Clients 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 client. We measure revenue based upon the consideration set forth in an arrangement or contract with a client. 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 client the software license key that provides the ability to access and use our product. If our client 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 clients subscribe. Revenue can include basic monthly fees to access the software and usage fees based upon the volume of certain resources the client consumes (such as volumes of storage or bandwidth). We are generally paid for these services on a month-to-month basis, but if a client 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 client such as rebates or other incentives that reduce amounts owed to us by clients.

10

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. 

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

	Three Months Ended June 30,						Six Months Ended June 30,
	2020			2019			2020			2019
Deferred revenue, beginning of period	$	18,208		$	16,544		$	18,255		$	16,237
Deferred revenue resulting from new contracts with customers		8,827			7,841			16,558			14,943
Deferred revenue at the beginning of the period that was amortized to revenue		(7,009	)		(6,164	)		(13,830	)		(11,796	)
Deferred revenue arising during the period that was amortized to revenue		(808	)		(1,235	)		(1,765	)		(2,398	)
Deferred revenue, end of period	$	19,218		$	16,986		$	19,218		$	16,986

Multi-Element Transactions

At the time clients 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. Clients 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 clients seeking assistance with products they have previously purchased from us, or SaaS subscriptions to clients 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 clients, 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. 

We allocate discounts proportionally to all of the components of a multi-element transaction unless the entire discount relates to only one or more, but not all, performance obligations in a contract.

Sales Tax

We collect sales tax on many of our transactions with clients 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 clients. This amount is included in accrued liabilities in our condensed consolidated balance sheets.

Contract Assets

We generally bill clients 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.

11

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 client 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 client relationship.

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

	Three Months Ended June 30,						Six Months Ended June 30,
	2020			2019			2020			2019
Deferred expense, beginning of period	$	933		$	979		$	943		$	1,009
Deferred expense resulting from new contracts with customers		226			206			444			385
Deferred expense amortized to expense		(221	)		(222	)		(449	)		(431	)
Deferred expense, end of period	$	938		$	963		$	938		$	963

At June 30, 2020, $584,000 was recorded in prepaid and current other assets and $354,000 was recorded in noncurrent other assets in our condensed consolidated balance sheet. At December 31, 2019, we had $577,000 recorded in prepaid and other current assets and $366,000 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 condensed 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.

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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 June 30, 2020, 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, accounts payable and notes 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.

The principal amount of our notes payable, including the current portion, as of June 30, 2020 was $46,875,000. This carrying value, net of unamortized debt issuance costs, approximates fair value based on interest rates that are currently available to us for issuance of debt with similar terms and maturities.

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

We account for goodwill in accordance with FASB Accounting Standards Codification 350, or ASC 350, as amended by ASU 2017-04, Simplifying the Test for Goodwill Impairment (effective January 1, 2020, as described in recent accounting pronouncements below). 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 with $12,712,000 of goodwill. As of June 30, 2020 and December 31, 2019, this single reporting unit had a negative carrying value.

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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 to perform a quantitative goodwill impairment test to identify both the existence of impairment and the amount of impairment loss. In a quantitative test, the fair value of a reporting unit is compared to its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered unimpaired. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. 

As of December 31, 2019, 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 (including the recent coronavirus COVID-19 outbreak), or changes in circumstances since that time indicating that the carrying amount of our reporting unit may exceed its fair market value and that interim testing needed to be performed. Additionally, because our single reporting unit has a negative carrying value, reasonable changes in the assumptions used would not indicate impairment. 

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. 

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Advertising Expense

We expense advertising costs as incurred as a component of our sales and marketing expenses. Advertising expense was approximately $31,000 and $44,000 in the 2020 quarter and the 2019 quarter, respectively, and $90,000 and $95,000 in the 2020 six months and the 2019 six months, respectively.

Stock-Based Compensation

We measure the cost of stock-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.

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.

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Recent accounting pronouncements

Accounting Standards Update (“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. We adopted ASU 2017-04 effective January 1, 2020, and its adoption did not have material impact on our internal 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 consolidated financial statements we issue for the year ending December 31, 2023, 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 2016-02, 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 2018-15 Internal-Use Software. In August 2018, the FASB issued new guidance that clarifies the accounting for implementation costs in a cloud computing arrangement. The new guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The standard will be effective for us in the first quarter of fiscal 2021. We have evaluated the impact of the adoption of this guidance on our Consolidated Financial Statements and disclosures and have determined that it is not material.

ASU 2019-12 Income taxes. In December 2019, the FASB issued new guidance that simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The guidance also clarifies and amends existing guidance to improve consistent application. The standard will be effective for us in our first quarter of fiscal 2023, with early adoption permitted. We are currently evaluating the adoption date and the impact of the adoption of this guidance on our Consolidated Financial Statements and disclosures.

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4. Accounts Receivable, Net

We bill clients and issue invoices when we have delivered goods or services. In addition, when clients agree to purchase or renew M&S services, we bill and invoice clients 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 6) 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 client 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):

	June 30, 2020			December 31, 2019
Total invoices issued and unpaid	$	7,537		$	8,245
Less: Unpaid invoices relating to M&S contracts with a start date subsequent to the balance sheet date		(1,129	)		(906	)
Gross accounts receivable		6,408			7,339
Allowance for doubtful accounts		(100	)		(100	)
Accounts receivable, net	$	6,308		$	7,239

5. Capitalized Software Development Costs, Net

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

	June 30, 2020			December 31, 2019
Gross capitalized cost	$	12,297		$	11,529
Accumulated amortization		(9,727	)		(8,879	)
Capitalized software development costs, net	$	2,570		$	2,650

	Three Months Ended June 30,						Six Months Ended June 30,
	2020			2019			2020			2019
Amount capitalized	$	404		$	236		$	768		$	437
Amortization expense		(442	)		(453	)		(848	)		(806	)

	Released			Unreleased
	Products			Products
Gross capitalized amount at June 30, 2020	$	11,828		$	469
Accumulated amortization		(9,727	)		-
Net capitalized cost at June 30, 2020	$	2,101		$	469

Future amortization expense:
Six months ending December 31, 2020		657
Year ending December 31,
2021		825
2022		535
2023		84
Total	$	2,101

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.

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6. Deferred Revenue

As described in Note 4 regarding accounts receivable, when clients agree to purchase or renew M&S services, we bill and invoice our clients 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 client as of the date of our financial statements. Accordingly, we determine our deferred revenue as follows ($ in thousands):

	June 30, 2020			December 31, 2019
Total invoiced for M&S contracts for which revenue will be recognized in future periods	$	20,347		$	19,161
Less: Unpaid invoices relating to M&S contracts with a start date subsequent to the balance sheet date		(1,129	)		(906	)
Total deferred revenue	$	19,218		$	18,255
Deferred revenue, current portion	$	16,500		$	15,683
Deferred revenue, non-current portion		2,718			2,572
Total deferred revenue	$	19,218		$	18,255

7. Notes Payable

In November 2019, we entered into a credit facility with J.P. Morgan Chase Bank, N.A, as Administrative Agent and East West Bank as Syndication Agent consisting of a $50.0 million term loan and a $5 million revolving agreement (the “Loan Agreement”), which is secured by substantially all of our assets. Funds from the term loan were substantially used to fund a special dividend of $3.35 to our common shareholders which was paid on December 5, 2019. The revolving loan may be accessed to fund working capital needs. The loans bear a variable interest rate of LIBOR plus a Term Loan Spread between 3.75% and 2.25%. The amount of the Term Loan Spread is a function of the Company’s Leverage Ratio. Effective January 3, 2020, the Company entered into an Amendment and Waiver No. 1 to the Credit Agreement to increase the amount of the special dividend permitted to be paid to stockholders on December 5, 2019 to accommodate last minute option exercises and to exclude the May 28, 2019 special dividend from the fixed charges calculation. Effective April 13, 2020 the Company entered into Amendment No. 2 to the Credit Agreement which provided consent for the Company to borrow $2.0 million under the U.S. Small Business Administration Payroll Protection Program authorized by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). Following receipt of the loan proceeds, we evaluated our access to credit through other sources of funding and returned the funds on May 5, 2020.

At June 30, 2020, the principal balance outstanding under the term note payable was $46.9 million and the balance of the revolving note payable was zero.

The aggregate maturities of our notes payable, as of June 30, 2020, are as follows: $2.5 million in 2020, $7.5 million in 2021, $7.5 million in 2022, $10.0 million in 2023, and $19.4 million in 2024.

Interest payments under the credit facility are due monthly. Principal payments are due quarterly. The loans may be prepaid at any time without penalty.  

The Loan Agreement contains the following financial covenants:

●           We must not exceed a Total Leverage Ratio of 3.25x. This ratio decreases to 3.0x at September 30, 2020, 2.75x at March 31, 2021 and 2.25x at March 31, 2022. This ratio is defined in the Loan Agreement as the ratio of consolidated total funded indebtedness to consolidated EBITDA minus capitalized software expenditures for the period of the four most recent consecutive fiscal quarters. As of June 30, 2020, this debt service coverage ratio was 2.57x.

●           We must maintain a Fixed Coverage Charge Ratio of 1.25x. This ratio is defined in the Loan Agreement as the ratio of consolidated EBITDA minus unfinanced capital expenditures to cash interest expense plus scheduled principal payments made plus taxes paid in cash plus restricted payments made in cash. As of June 30, 2020, this debt to tangible net worth ratio was 2.69x.

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The Loan Agreement contains customary covenants relating to maintaining legal existence and good standing, complying with applicable laws, delivery of financial statements, payment of taxes and maintaining insurance. The Loan Agreement also contains customary events of default including the failure to make payments of principal and interest, the breach of any covenants, the occurrence of a material adverse change, and certain bankruptcy and insolvency events. Additionally, we may be restricted from declaring dividends if an Event of Default exists, or if immediately prior to and after giving effect of such dividend it would cause us to exceed our maximum Total Leverage Ratio, or fall below our minimum Fixed Charge Coverage Ratio.

The following table represents the components of our long-term debt disclosed on the condensed consolidated balance sheet as of June 30, 2020.

	June 30,
	2020
Credit facility	$	46,875
Unamortized debt issuance costs		(1,842	)
Total long-term debt		45,033
Less current portion of long-term debt		5,825
Total long-term debt, non-current portion	$	39,208
Interest rate		5.4	%

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

We have granted stock-based incentive awards to our officers and employees under long-term equity incentive plans that originated in 2000, 2006, 2010, 2015 and 2016. We currently issue stock-based awards to our officers and employees under the 2015 Non-Employee Directors Long-Term Equity Incentive Plan (“2015 Directors Plan”) and 2016 Employee Long-Term Equity Incentive Plan (“2016 Employee Plan”). The 2015 Directors Plan and 2016 Employee Plan authorize the issuance of up to 500,000 and 5,000,000 shares of common stock for stock-based incentives, including stock options and restricted stock awards, respectively. As of June 30, 2020, stock-based incentives for up to 80,000 and 2,581,925 shares remained available for issuance in the future under these plans, respectively. The following shares are currently outstanding under our long-term equity incentive plans: 

Plan	Shares outstanding
2010 Employee LT Equity Incentive Plan		23,207
2015 Directors Plan		-
2016 Employee LT Equity Incentive Plan		1,565,642
Total shares Outstanding at June 30, 2020		1,588,849

Under these stock-based compensation plans 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 June 30,				Six Months Ended June 30,
	2020		2019		2020		2019
Stock-based compensation expense	$	412	$	574	$	909	$	1,449

Stock Options

During the 2020 six months, we granted stock options only under the 2016 Employee Plan.

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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 or following a four-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.

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, 2019		1,563,784		$	5.78		8.69	$	6,372
Granted		132,000		$	9.56
Forfeited		(18,668	)	$	7.33
Exercised		(210,718	)	$	3.81
Outstanding at June 30, 2020		1,466,398		$	6.38		8.45	$	4,995
Exercisable at June 30, 2020		195,428		$	4.14		7.30	$	1,096

Additional information about our stock options is as follows: 

	Three Months Ended June 30,				Six Months Ended June 30,
	2020		2019		2020		2019
Weighted average fair value of options granted	$	3.72	$	2.78	$	3.93	$	2.76
Intrinsic value of options exercised	$	79,754	$	297,289	$	1,299,868	$	555,390
Cash received from stock options exercised	$	35,307	$	178,541	$	803,238	$	697,725
Number of options that vested		14,334		19,669		57,838		645,947
Fair value of options that vested	$	33,583	$	32,982	$	105,310	$	997,803
Unrecognized compensation expense related to non-vested options at end of period	$	2,511,397	$	2,651,482	$	2,511,397	$	2,651,482
Weighted average years over which non-vested option expense will be recognized		2.61		3.20		2.61		3.20

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As of June 30, 2020
			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
$2.35 - $3.53		83,649		7.56	$	3.35		25,355	$	3.13
$3.54 - $5.31		556,916		7.83	$	4.03		164,070	$	4.14
$5.34 - $8.01		328,833		8.80	$	6.81		2,001	$	6.99
$8.30 - $12.45		491,000		9.06	$	9.20		4,002	$	9.26
$13.07 - $19.61		6,000		9.30	$	13.21		-	$	-
Total options		1,466,398						195,428

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

	Three Months Ended June 30,						Six Months Ended June 30,
	2020			2019			2020			2019
Expected volatility		48	%		47	%		48	%		47	%
Expected annual dividend yield		0.00	%		1.50	%		1.43	%		1.50	%
Risk free rate of return		0.43	%		2.19	%		1.52	%		2.20	%
Expected option term (years)		6.00			4.05			6.19			4.10

The risk free rate of return has seen a significant decrease in the 2020 three months and 2020 six months as a direct result from the decrease in the U.S. Department of Treasury daily treasury yield curve rates in response to economic conditions including COVID-19. 

Restricted Stock Awards 

Prior to the fourth quarter of 2019 we issued restricted stock only from the 2015 Directors Plan. Beginning in the fourth quarter of 2019, shares of restricted stock were granted from the 2016 Employee Plan in addition to the 2015 Directors Plan. Provisions and characteristics of these plans include the following:

● The exercise price, term and other conditions applicable to each 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, after which time the restrictive legend is removed from the shares.

● Restricted shares participate in dividend payments and may be voted.

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, 2019		184,079		$	9.32
Shares granted with restrictions		-		$	-
Shares forfeited		(1,418	)	$	9.54
Shares vested and restrictions removed		(60,210	)	$	8.85	$	576,195
Restricted shares outstanding at June 30, 2020		122,451		$	9.54
Unrecognized compensation expense for non-vested shares as of June 30, 2020
Expense to be recognized in future periods	$	1,007,577
Weighted average number of months over which expense is expected to be recognized		41.0

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9. Income Taxes

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

	Three months ended June 30,															Six months ended June 30,
	2020								2019							2020						2019
	Current			Deferred		Total			Current		Deferred			Total		Current		Deferred		Total		Current		Deferred			Total
Federal	$	(232	)	$	60	$	(172	)	$	904	$	(130	)	$	774	$	21	$	152	$	173	$	1,550	$	(139	)	$	1,411
State		119			22		141			167		(15	)		152		211		46		257		282		(20	)	$	262
Total	$	(113	)	$	82	$	(31	)	$	1,071	$	(145	)	$	926	$	232	$	198	$	430	$	1,832	$	(159	)	$	1,673

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):

	June 30,		December 31,
	2020		2019
Deferred tax assets:
Deferred revenue	$	480	$	672
Right-of-use operating lease asset		599		609
Share-based compensation		207		200
Compensation and benefits		130		123
Texas franchise tax R&D credit		120		150
Allowance for doubtful accounts		37		37
Deferred state income taxes		29		45
Tangible assets		31		24
Accrued expenses not deducted for tax		10		8
Total deferred tax assets		1,643		1,868
Deferred tax liabilities:
Right-of-use operating lease liability		601		610
Intangible assets		550		567
Deferred expenses		197		198
Total deferred tax liabilities		1,348		1,375
Net deferred tax assets	$	295	$	493

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 June 30, 2020, we had Texas Research and Development tax credit carryforwards of $120,000. 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):

	Six Months Ended June 30,
	2020		2019
Balance at beginning of period	$	24	$	113
Increases for tax positions related to the current year		-		-
Increases for tax positions related to prior years		-		-
Decreases for tax positions where the statue has expired		-		-
Balance at end of period	$	24	$	113

22

Our unrecognized tax benefit is related to research and development credits taken on our 2017 U.S. income tax return and the uncertainty related to the realization of a portion of those credits based on prior experience. 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 June 30, 2020, 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 2016 with respect to our federal income tax returns and years prior to 2015 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.

Our income tax expense reconciles to an income tax expense resulting from applying an assumed statutory federal income tax rate of 21% for the 2020 quarter and 2019 quarter to income before income taxes as follows ($ in thousands):

	Three months ended June 30,				Six months ended June 30,
	2020		2019		2020		2019
Income tax expense at federal statutory rate	$	729	$	957	$	1,323