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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2011

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 No. 001-33601

 

 

GlobalSCAPE, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   74-2785449

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

4500 Lockhill-Selma, Suite 150

San Antonio, Texas

  78249
(Address of Principal Executive Office)   (Zip Code)

(210) 308-8267

(Registrant’s Telephone Number, Including Area Code)

 

 

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

 

Title of each class   Name of each exchange on which registered
Common Stock, par value $0.001 per share   NYSE Amex

 

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

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

¨  Yes     x  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

¨  Yes     x  No

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.

x  Yes     ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

x  Yes     ¨  No

Indicate by check mark whether disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):

 

Large Accelerated filer  ¨

   Accelerated filer  ¨

Non-Accelerated filer  ¨

   Smaller Reporting Company  x

(Do not check if a smaller reporting company)

  

Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Act).

¨  Yes     x    No

The aggregate market value of the registrant’s outstanding common stock held by non-affiliates was approximately $21,955,050 as of the last business day of the registrant’s most recently completed second fiscal quarter, based upon the closing sales price of $2.20 per share on such date on the NYSE Amex.

As of March 15, 2012 there were 18,288,366 shares of common stock outstanding.

Documents Incorporated by Reference

Portions of the Registrant’s Proxy Statement for the 2012 Annual Meeting of Stockholders to be held on June 4, 2012, are incorporated by reference in Part III hereof.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page  
PART I   

Item 1.

   Business      3   

Item 1A.

   Risk Factors      23   

Item 1B.

   Unresolved Staff Comments      38   

Item 2.

   Properties      38   

Item 3.

   Legal Proceedings      38   

Item 4.

   Mine Safety Disclosures      38   
PART II   

Item 5.

  

Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity

     39   

Item 6.

   Selected Financial Data      39   

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operation      40   

Item 8.

   Financial Statements and Supplementary Data      60   

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      82   

Item 9A.

   Controls and Procedures      82   

Item 9B.

   Other Information      82   
PART III   

Item 10.

   Directors, Executive Officers and Corporate Governance      83   

Item 11.

   Executive Compensation      83   

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     83   

Item 13.

   Certain Relationships and Related Transactions, and Director Independence      83   

Item 14.

   Principal Accountant Fees and Services.      83   
PART IV   

Item 15.

   Exhibits, Financial Statement Schedules      84   


Table of Contents

Preliminary Notes

GlobalSCAPE®, CuteFTP®, CuteFTP Pro®, Cute Backup®, DMZ Gateway® and CuteSendIt®, are registered trademarks of GlobalSCAPE, Inc. Secure FTP ServerTM, Wide Area File ServicesTM, WAFSTM, CDPTM, DMZ Gateway, Advanced Workflow EngineTM, Applicability Statement 2 TM, AS2TM, AWETM, Enhanced File Transfer ServerTM, Managed Information XchangeTM, MIXTM, Hosted Enhanced File Transfer ServerTM, EFT ServerTM, CuteFTP LiteTM, CuteFTP HomeTM, Mail ExpressTM, Secure Ad Hoc TransferTM, Total Path SecurityTM, Enhanced File Transfer ServerTM, EFT Server EnterpriseTM, Enhanced File Transfer Server Enterprise TM, and appShieldTM are trademarks of GlobalSCAPE, Inc. TappInTM, Now Playing TM, TappIn Secure Share TM, Social Share TM, and Enhanced A La Carte Playlist, are trademarks of our wholly-owned subsidiary TappIn, Inc. Other trademarks and trade names in this Annual Report are the property of their respective owners.

In this report, we use the following terms:

“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.

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

“HTTP” or Hyper Text Transfer Protocol is a protocol commonly used to transfer hypertext documents between a web server and a web browser.

“HTTPS” or Hyper Text Transfer Protocol Secure is a combination of HTTP and a network security protocol such as Secure Sockets Layer or Transport Layer Security.

“LAN” or Local Area Network provides networking capability to a group of computers in close proximity to each other, such as in an office building or home.

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

“RFC” or Request for Comment is a memorandum published by the Internet Engineering Task Force describing methods, research, or innovations applicable to the working of the Internet and Internet-connected systems.

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

“S/KEY” is a security system in which a one-time challenge-response password scheme is used to authenticate access to data. The purpose of S/Key is to eliminate the need for the same password to be sent over a network each time a password is needed for access.

“SNMP” is a User Datagram Protocol-based network protocol primarily used in network management systems to monitor network-attached devices for conditions that warrant administrative attention.

“SQL” or Structured Query Language is a database computer language.

“SSH2” or Secure Shell is a protocol that provides encrypted network communications between two computers.

 

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“SSL” or Secure Sockets Layer and “TLS” or Transport Layer Security uses cryptography to encrypt data between the web server and the web browser.

“WAN” or Wide Area Network is a computer network that spans a relatively large geographical area, and typically connects multiple LANs. The largest WAN in existence is the Internet.

“XML” or Extensible Markup Language is a set of rules for encoding documents electronically usually for usability over the internet.

Forward-Looking Statements

This Annual Report on Form 10-K and the documents incorporated by reference herein contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. “Forward-looking statements” are those statements that are not of historical fact, but describe management’s beliefs and expectations. We have identified many of the forward-looking statements in this Annual 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 this Annual Report and other documents filed with the Securities and Exchange Commission. Therefore, GlobalSCAPE’s actual results could differ materially from those discussed in this Annual Report.

 

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PART I

 

Item 1. Business

Company Overview

We provide secure information exchange capabilities for consumers and enterprises through the development and distribution of software, delivery of managed and hosted solutions, and provision of associated services. Since our organization in 1996, we have evolved from a company focused primarily on personal file transfer products, sold over the Internet, to a solution provider deriving over 90 percent of revenue from sales to small and medium business, or SMB, and enterprise customers worldwide.

Today, we have thousands of enterprise customers and more than one million individual consumers in over 150 countries. In addition, our solutions are used by more than 20,000 U.S. Army users deployed worldwide. We currently operate primarily in the Managed File Transfer, or MFT, industry. Beginning in 2009, we began an evolution from an ‘MFT company’ into adjacent solution spaces applicable to what we refer to as Total Path Security. The Total Path Security framework addresses data and information security in motion (for example, with traditional MFT solutions delivered as on-premises software or as a cloud service) and at rest (for example, with endpoint security solutions such as appShield). Our solution portfolio facilitates delivery of critical information such as financial data, medical records, customer files and other similar documents while supporting a range of information protection approaches to meet privacy and other security requirements. The recently acquired TappIn technology (described below) allows us to securely, and more flexibly, deliver such critical information to a wider range of network-enabled systems, including mobile devices. In addition, our solutions ensure compliance with government regulations relating to the protection of information while allowing users to reduce IT costs, increase efficiency, track and audit transactions and automate processes. Our solutions also provide data replication, acceleration of file transfer, sharing/collaboration and continuous data backup and recovery to our customers. We believe that we are strongly positioned to provide secure transfer, sharing, and replication of files that need to be transmitted inside the user’s firewall to distributed offices, or outside the user’s firewall to business and trading partners, including to tablet computers and smartphones. Our acquisition of TappIn provides additional capabilities applicable throughout the Total Path Security framework.

Our initial product, CuteFTP, a file transfer protocol client program used mostly by individuals and small businesses, was first distributed in 1996 over the Internet and achieved significant success and popularity. Since then, we have continued to enhance our portfolio of products to meet the increasing demand for secure information exchange in the MFT industry and adjacent markets such as cloud services. Our capabilities have evolved from personal and small business MFT products to include standard and enterprise versions of our Enhanced File Transfer Server software, with an increasing number of add-on modules that provide additional capabilities such as ad hoc file transfer, advanced auditing and reporting, government-validated cryptography, and workflow automation. We have also developed Wide-Area File Services (“WAFS”), and Continuous Data Protection (“CDP”) software which further enhance the ability to replicate, share and backup files within a wide area network or local area network, at WAN and LAN speeds.

More recently, we have launched managed e-mail attachment, software-as-a-service (SaaS), and cloud-based subscription solutions for information sharing solutions. Our managed e-mail attachment solution addresses the needs of customers who are constrained by the typical limits on e-mail attachment size or who require additional security, auditing, and reporting for file attachments shared through e-mail. Our SaaS and cloud-based subscription solutions allow customers to reduce their upfront and total cost of ownership and achieve other recognized benefits of cloud-based solutions, including service elasticity and strong service level agreements for IT infrastructure reliability and performance.

The addition of managed cloud-based subscription solutions to our portfolio is a significant change in our manner of conducting business because it provides recurring revenue which builds over time, as compared to

 

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sales of on-premises software licenses which must be reconstituted every period. While we still are in the early stages of growing our subscription services, we already have added capability to deliver these services in additional geographies, such as the United Kingdom and Canada, where country-specific compliance requirements may necessitate in-country service delivery.

In the first quarter of 2011, we announced our planned entry into the antivirus segment of the endpoint security market with the development of a consumer application control (or “whitelisting”) product, appShield. The appShield product is designed to defeat malicious software applications by allowing only designated applications and executables (i.e., those on the “whitelist”), to run on protected systems. This approach changes the paradigm of traditional “blacklisting” solutions, such as antivirus software, which typically use signature-based approaches to identify, quarantine, or block execution of an exponentially growing number of malware threats.

In December 2011, we entered the secure content mobility market with the acquisition of TappIn, Inc. Secure content mobility provides users with the ability to easily and securely access and share data and information using a web-browser, tablet or other mobile device such as a smartphone. Secure content mobility integrates aspects of ad hoc file transfer, broader MFT capabilities, cloud services, and endpoint security to address growing market demand for secure, ‘anytime and anywhere’, device-independent access to distributed content. We believe that the addition of secure content mobility capability to our portfolio potentially has profound implications due to the continuing exponential growth of tablet computers and smartphone sales, and their increasing adoption by business users.

Industry Background

The Internet has become an integral part of daily operations for individual users and companies of all sizes, not only for e-commerce, but also as a means of managing information between central and remote locations and with associates, employees, partners, suppliers, and customers. Corporate information managers must protect business assets, ensure that policies and processes meet regulations governing the management of sensitive information, and ensure that the right people have access to the right information at the right time. Global operations, diverse business partners and networks further emphasize the need for common standards to ensure compatibility, scalability privacy, security and cost-effective integration. All of these needs have created the need for data and information security in motion (for example, with traditional MFT solutions delivered as on-premises software or as a cloud service) and at rest (for example, with endpoint security solutions such as appShield).

The need for MFT, endpoint security, and secure content mobility solutions is particularly strong for organizations faced with a daunting array of privacy and security challenges stemming from various regulatory and business requirements for data privacy and confidentiality. Regulatory and privacy requirements include federal legislation and regulations such as the Health Insurance Portability and Accountability Act (HIPAA), the Gramm-Leach-Bliley Act (GLBA),the Federal Trade Commission Red Flags Rules, as well as state legislation and regulations in the U.S such as California Senate Bill (SB) 1386 and the data security regulations issued by the Massachusetts Office of Consumer Affairs and Business, as well as the extraterritorial requirements such as the European Union’s Privacy Directive, some of which impose severe penalties for improper disclosure of confidential information. Additionally, industry best-practices such as the Payment Card Industry Data Security Standard (PCI DSS) and self-imposed business requirements lead to the need for consumer information, intellectual property and trade secret protection and controls. These measures offer protection against disclosure of proprietary information and also reduce corporate risks associated with the potentially devastating consequences of security breaches.

The MFT and endpoint security markets grew from mainstream adoption of the Internet, the subsequent exponential growth in data and information sharing, and the growing realization that information is a significant

 

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business currency requiring appropriate security, management, auditing, and reporting, and also subject in many cases to regulatory and privacy requirements. Similarly, the cloud services market arose from recognition that the Internet allows ubiquitous, global access to data and information services. By leveraging Internet technologies, and delivering services through appropriately secured and managed shared resources, cloud-based solutions allow businesses and other organizations to achieve economies of scale and greater operational agility. Cloud solutions also can support individual consumer needs for information access and sharing at very affordable costs. Secure content mobility solutions provide these same benefits, but extend the information delivery model to and from the broadest range of network-enabled devices, including smartphones and tablets.

Our primary industry is known as managed file transfer. The MFT industry has its technical origin in the file transfer protocol. FTP dates back to 1980 (RFC 765, later superseded by RFC 959), with even earlier RFCs guiding prior attempts to establish standards for file transfer protocols. The use of file transfer protocols increased dramatically with the explosive growth of the Internet and the World Wide Web during the 1990s. The MFT industry arose from recognition that FTP, alone, does not provide adequate security and management capabilities for file transfers. MFT solutions offer a greater degree of security and control than FTP. Features available in MFT solutions now include integrated security, auditing capabilities, performance monitoring, and reporting. The MFT industry includes low cost, or even free, solutions that offer basic capabilities. However, businesses and even individuals procure more advanced solutions that provide scalability, enhanced security options, automated workflow, dedicated maintenance and support, and other features that facilitate high-confidence, cost effective file transfers.

Cloud computing is a model for enabling convenient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications, and services) that can be rapidly provisioned, released, and scaled to meet requirements. We believe that the movement to cloud services is analogous to the telecommunications shift from dedicated point-to-point circuits to a delivery model in which the entire telecommunications infrastructure potentially can be used to establish, maintain, and manage individual connections on an as-needed basis. Cloud implementations may be public, private, community or a hybrid combination. In a private cloud, the cloud infrastructure is operated solely for an organization. Within a community cloud the cloud infrastructure is shared by several organizations and supports a specific community that has shared concerns (e.g., mission, security requirements, policy, and compliance considerations). Conversely, in a public cloud the cloud infrastructure is made available to the general public or a large industry group. A hybrid cloud is a composition of two or more clouds (private, community, or public) that remain unique entities but are bound together by standardized or proprietary technologies that enable data and application portability (for example, cloud bursting for load-balancing between clouds).

The endpoint security market includes solutions implemented to protect individual host systems (known within the IT industry as endpoints). Specific solution categories include antivirus (including anti-spyware and anti-adware), behavior-blocking, firewall, and intrusion prevention software. While even early mainframe systems included basic user access controls, the Internet and resulting extension of computing systems to exponentially growing numbers of endpoints launched the current endpoint security market. Computer viruses, and other malware, have increased significantly in number and sophistication since the 1990s. The same Internet infrastructure that facilitates legitimate personal and business operations potentially allows malware to spread with remarkable speed and damaging effect. Antivirus software has evolved from definition, detection, and blocking of specific malware ‘signatures’ to more sophisticated heuristic and reputation-based approaches that attempt to address the variability of malware and, specifically, malware authoring techniques that allow malicious software to change signatures automatically over time. These polymorphic viruses and other newly created malware programs constitute the “zero day” threat that evades detection by traditional signature-based antivirus software. In addition, advanced persistent threats have become much more common as malicious individuals, organizations, and even nation–states conduct long-term probes against cyber targets and, in some cases, launch very sophisticated, coordinated cyber attacks. In recent years, application control, or whitelisting, has emerged as a technique for countering even the most sophisticated malware and advanced persistent threats. With application whitelisting, only applications and specific executables on an administrator or user-defined list

 

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of approved programs (the whitelist) are permitted to run on the protected system. Application control solutions have been deployed on a limited scale in enterprises, and some consumer antivirus products now also have some whitelisting features.

The secure content mobility market has emerged from a confluence of the same primary market forces that drove demand for MFT, cloud services, and endpoint security solutions, with those forces magnified by the exponential, worldwide proliferation of mobile devices. According to a recent report by Cisco Systems, global mobile data traffic grew by 133% in 2011, more than doubling for the fourth year in a row. The Cisco report also states that mobile data traffic in 2011 was eight times the size of the entire global Internet in 2000 and projects that such traffic will increase 18-fold between 2011 and 2016. Secure content mobility solutions will become increasingly necessary to allow business and consumers to securely access and share data, potentially across multiple network-enabled devices to include smartphones and tablets. The content delivery model will include solutions like TappIn that provide access directly to and from on-premises or personal devices, with those solutions possibly interoperating with cloud-based data repositories.

Strategy

Our goal is to build upon our leadership position in the MFT market to provide businesses, other organizations, and individual users with the solutions necessary to meet their growing need for secure information exchange within the Total Path Security framework, which encompasses protection of data in motion and at rest. From our perspective, more fully addressing this need for secure information exchange requires consideration of capabilities beyond traditional MFT, including managed e-mail attachment, cloud-based, and endpoint security solutions such as whitelisting. In addition, we believe we must consider ongoing, fundamental changes in customer technologies and processes, such as the rapidly increasing use of mobile devices, including “Bring Your Own Device” (“BYOD”) aspirations, in the workplace.

Our strategic focus continues to center on:

 

   

Entering and establishing leadership in broader information exchange markets while maintaining leadership in the MFT industry.

 

   

Growing recurring revenue

 

   

Developing and enhancing our software solutions

 

   

Entering and extending our presence in the endpoint security market

 

   

Increasing international and channel sales

 

   

Growing our government sales; and

 

   

Developing our corporate brand and market recognition

Entering and Establishing Leadership in Broader Markets

We were in the leader’s quadrant of the Gartner Magic Quadrant for Managed File Transfer for the last two years in which Gartner published this magic quadrant. Gartner and other industry analysts have stated that the annual MFT market is approximately $550 million. While we intend to sustain our leadership in the traditional MFT market, we believe our future growth requires extending our market reach further into the cloud-services and ad hoc (on-demand) file transfer aspects of MFT, while also increasing our B2B and secure content mobility capabilities. Several opportunities and trends lead us to this conclusion.

We have achieved initial traction in the much larger, and adjacent, cloud services market with our current offerings such as Managed Information Xchange (“MIX”) and Hosted Enhanced File Transfer Server solutions.

 

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Industry analysts such as Gartner believe the cloud services market was $68 billion in 2010 and growing at more than 20 percent per year. Our partner agreements with hosting providers such as Rackspace, and the proven, modular capabilities of our Enhanced File Transfer Server solution suite made this a straightforward market entry from a technical delivery perspective. As we gain additional sales traction and experience in the cloud services market, and possibly develop additional cloud-based solutions, we believe this potentially provides an opportunity broader than the traditional MFT market.

In addition, we have recognized increasing revenue from our Secure Ad Hoc Transfer module (or “SAT module”) for EFT Server as well as from other EFT modules and Mail Express. The SAT module is designed for companies that need an out-of-the-box solution to exchange files without the problems typically associated with having to manually create temporary FTP accounts, accept the size limitations and security issues of regular email, or contend with the time delays and high costs of overnight and physical shipments. The SAT Module works in conjunction with EFT Server and allows users inside an enterprise to send and receive files of any size to and from recipients outside the organization with secure authentication, non-repudiation and auditing capabilities. We have added other adjacent-market capabilities, such as business automation, to EFT Server also through our modular solution architecture, and these capabilities are helping to underpin the consistent growth in revenue from the EFT Server solution suite. After a relatively slow start, following launch of the solution in late 2008, Mail Express revenue continued to increase during 2011, and this solution was recognized by Info Security Products Guide as a “Global Excellence Award” winner in February 2012 in the Email Management and Security category. We believe strengthening our ad hoc file transfer solutions remains a key strategy element and we intend to pursue solution enhancements in this area in future periods.

Newly acquired secure content mobility competencies provide a potentially compelling complement to traditional MFT capabilities, including ad hoc file transfer solutions. We have developed a secure mobile access module for EFT Server as an initial point of integration with the TappIn technology acquired in December 2011. We regard secure content mobility potentially as a unifying concept for our solution portfolio, including future endpoint security solutions like appShield, given the central position and importance of content (i.e., data and information) in the market drivers for our solutions. We intend to further integrate our solution capabilities to take advantage of potential synergies and strengths across our solution portfolio, while also possibly simplifying our marketing and sales processes.

Building on our MFT capabilities provides a clear opportunity to increase our average transaction size and repeat business through greater scalability, business integration, and application of professional services to support implementation planning and execution. Our enterprise solutions, such as Enhanced File Transfer Server, have increased considerably in capability over the years and these enhanced capabilities directly contribute to increased revenue derived from enterprise customers. In particular, the add-on modules available for Enhanced File Transfer Server, and increased technical performance for other offerings in our portfolio, provide a strong platform for greater business adoption and integration of our solutions. We believe continued focus on capabilities necessary for even broader B2B applicability, including appropriate treatment of evolving secure content mobility requirements, is a key strategic opportunity for our future business operations.

With MFT capabilities increasingly being integrated into B2B gateway, data integration, service oriented architecture, and other technical solutions, the need to keep evolving our solutions and entering adjacent markets also is clear. We continue to believe the market will shift toward consideration of traditional MFT as more of a “feature” than a solution. This shift may take many years, but we believe early recognition of the trend and appropriate strategic planning increase our potential for evolving our solutions in front of the ongoing market changes.

Growing Recurring Revenue

Recurring revenue includes revenue from M&S contracts and subscriptions for our cloud-based managed and hosted solutions. In the broadest sense, delivery of labor hours on long-duration contracts also fits within this strategy

 

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because such contracts provide a book of sold business that will be recognized from aggregate contract value, or ACV, into revenue in future periods, with some revenue from these labor contracts potentially visible even two or three years in the future.

We believe that execution on this strategy element potentially could provide greater predictability of revenue in future periods and a stronger hedge against future business (or broader economic) downturns. Our recurring revenue, primarily in the form of M&S contracts and subscriptions for managed solutions, grew from 37 percent in 2009 to 42 percent in 2010 and to 46 percent in 2011. We intend to focus on delivering continued growth in deferred revenue, while assessing market traction for the full range of our solutions on an ongoing basis. From this perspective, deferred revenue may continue to grow in absolute terms, and as a percentage of total revenue, for some period of time, depending on the relative future growth rates of all of our solutions.

As discussed under “Key Business Metrics” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” subscription sales may change the trajectory of our prior revenue growth. We believe that, due to compounding effects and after the current transition period, subscription revenue can grow more quickly and significantly than software license revenue, while supporting increased operating margins after the transition.

Developing and Enhancing Our Solutions

We have allocated significant resources to enhancing and developing our solutions in recent years. This strategic focus has delivered substantially more capable releases of our WAFS, Mail Express, and Enhanced File Transfer solutions, plus our cloud-based offerings and professional services. We intend to maintain our focus on developing our solution portfolio and, as appropriate, enhancing our existing solutions.

Our solution portfolio may evolve over time, for example, through development of new offerings in adjacent markets or through acquisitions. We maintain an active R&D program and work closely with partners and others within industry, to identify new solution opportunities. As an example, we began our original OEM partnership with Network Automation in 2008, embedding Network Automation’s AutoMate product as the Advanced Workflow Engine (“AWE”) module to our Enhanced File Transfer Server solution. During 2010, we expanded our partner agreement to become a worldwide reseller of Network Automation’s software solutions, AutoMate and AutoMate Business Process Automation Server. During 2010 and throughout 2011, we partnered with hosting providers (including Rackspace Hosting) to deliver the MIX and Hosted EFT Server solutions. Most recently, in December 2011, we announced the acquisition of TappIn, Inc.

As we evolve our solution portfolio, we intend to maintain an appropriate balance between legacy and new solutions, including making choices about transitioning, sustaining, or retiring solutions as necessary to best operate under prevailing business conditions. Transitioning or sustaining solutions may involve consolidating capabilities within our solution portfolio, releasing upgrades in response to market or customer needs, or making bug fixes in accordance with our communicated End of Life (“EOL”) Policy. We also will phase out solutions periodically in accordance with the EOL Policy.

Entering and Extending our Presence in the Endpoint Security Market

We continue to plan for entry into the antivirus segment of the endpoint security market with appShield. The appShield solution, along with the current TappIn service, provides an opportunity for us to increase sales of our consumer products, which have declined in recent years. The endpoint security market also is attractive because consumer sales typically are relatively low-touch and accomplished largely through our online cart, over the Internet.

From this initial market entry with appShield we intend to explore, and potentially develop or acquire, other security-oriented solutions, including those most applicable to increasing our secure content mobility capabilities. These additional solutions may be complementary to appShield or to our other solutions. Like appShield and TappIn, the other solutions also may appeal to SMB or even enterprise customers.

 

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Increasing International and Channel Sales

We have added several channel partners in recent years and also organized our sales force and associated sales processes, to more effectively support our partner network worldwide. Channel partners resell, distribute, or integrate our solutions. These channel partners also provide us with additional opportunities to penetrate deeper into existing markets and enter new sales territories.

Channel sales also can help us establish a lower-touch delivery model through which we train and provision the partners to sell and distribute our solutions. To facilitate this, we have hosted channel partner conferences in each of the last two years to provide a forum for exchanging ideas and deliver partner-specific sales education and training. Achieving additional traction in new sales territories potentially can increase our sales in future years, considering we currently derive approximately 87 percent of our sales from just the United States, United Kingdom, Canada, and Australia

Growing Government Sales

We are leveraging our prior Army contracts, and other government orders, to gain the insights, establish the past performance, and sustain the credentials necessary to pursue additional government business directly and through channel partners. We are a subcontractor on the McLane Advanced Technologies (MAT) industry team that won a $52 million contract with the U.S. Army for the Standard Army Maintenance System—Enhanced (SAMS-E) and are supporting that contract with several engineers on a full-time basis. We are also working independently as well as in conjunction with MAT, Carahsoft, and other partners to pursue additional government business.

Government sales, particularly large contracts from the U.S. Army, have had a significant positive impact on our growth and market image since 2007; however, these large contracts also cause significant swings in our financial results. We continue to focus on more deliberate growth in government sales, including software and associated services, potentially augmented by occasional large product orders. Our engineering services activities in support of the SAMS-E contract are part of this long-term focus.

We may obtain, sustain, or update government certifications as necessary to compete in this sector. For example, we have received Federal Information Processing Standards (“FIPS”) 140-2 validation of the GlobalSCAPE Cryptographic Module embedded in Enhanced File Transfer Server. In addition, Enhanced File Transfer Server Version 6 and CuteFTP Pro received the Certificate of Networthiness from the U.S. Army Network Technology Command during 2009. Our receipt of this certificate enables Army installations worldwide to install and operate these server and client-based secure information exchange solutions.

Developing our Corporate Brand

GlobalSCAPE traditionally has been better known for CuteFTP than as a corporate brand. Since the late-2008 timeframe, we have made a concerted effort to elevate our corporate profile. We have retained outside marketing communications and branding firms, as well as the Summit IR Group for investor relations support. We also have established a strong, but informal, relationship with America’s Growth Capital, an investment bank focused on emerging growth markets especially those focused on the cybersecurity space.

Through our efforts in this area, we have participated in numerous analyst briefings and non-deal investor conferences that have increased our recognition within the investor and analyst communities. We also have obtained national media coverage. In addition, we have revised our website, logos, and other areas reflecting our corporate brand. Through these activities, we have established a much more consistent, recognizable brand that may better support future growth and market visibility.

We also believe we have continued to enhance our brand through additional national and regional attention resulting from corporate awards received during 2011. We were named as one of the “Best Places to Work in IT”

 

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for the second year in a row in 2011 by Computerworld. This recognition is a ranking of the top 100 work environments for technology professionals. Organizations that are selected are those that challenge their IT staff with exciting projects, offer them access to, and training with, today’s hottest technology, and provide great benefits and compensation. We also were ranked in 2011 among the top 50 workplaces in San Antonio by the San Antonio Express-News and named one of the “Best Places to Work” for 2011 by the San Antonio Business Journal, with both awards also being received for the third year in a row. These awards honor companies with the best workplaces in the greater San Antonio area.

In addition, we were named as one of the 2011 “Best Companies to Work for in Texas”. The awards program, created in 2006, is a project of Texas Monthly, the Texas Association of Business (TAB), the Texas State Council of the Society for Human Resource Management, and Best Companies Group. The “Best Companies to Work for in Texas” is a statewide survey and awards program that identifies, recognizes, and honors the best places of employment in Texas. One hundred companies were selected, all identified as benefiting the state’s economy, its workforce, and businesses. We were also named Software Magazine’s Software 500 ranking of the world’s largest software and service providers, now in its 29th year.

The Software 500 is a revenue-based ranking of software and services suppliers targeting medium to large enterprises, their IT professionals, software developers, and business managers involved in software and services purchasing. The ranking was based on total worldwide software and services revenue for 2010, including revenue from software licenses, maintenance and support, training and software-related services and consulting.

In addition to these corporate awards, we were named to Deloitte’s Technology Fast 500 for 2010 and 2009, a ranking that recognizes the fastest growing technology, media, telecommunications, life sciences and clean technology companies in North America on the basis of five-year revenue growth. We believe our corporate, financial, and technical awards in aggregate increase our market visibility and provide a stronger basis for continued development of the GlobalSCAPE brand.

Software Products

Managed File Transfer Solutions

Our MFT solutions are best known for the CuteFTP product line. They primarily consist of products that help users securely move and copy files on the Internet. FTP, along with more secure protocols such as SFTP, FTP/S, and HTTP/S, requires two software programs: a client program to start a transfer and a server program to accept the connection. Our MFT product line includes CuteFTP Pro, CuteFTP Home, CuteFTP Lite, and the Enhanced File Transfer Server solution suite. A substantial portion of our revenues is derived from licensing our file management products, especially Enhanced File Transfer Server.

Cute FTP Programs

CuteFTP. CuteFTP is a “client-side” program, meaning that it permits a user to request a file from or send a file to an FTP server or host computer. The user base for this program ranges from corporate IT professionals who use it to transfer data between locations via the Internet to individual Web site operators who use it to upload their Web pages to their Web hosting provider. CuteFTP simplifies use of file transfer protocol by hiding the technical processes behind a user-friendly, graphical user interface, which allows users to “drag and drop” files between computers. CuteFTP has won several awards, and has been favorably reviewed over the years in leading online and print trade journals, as being the most powerful, easy-to-use file transfer protocol program available. We offer CuteFTP in German, French, Spanish, Japanese, Traditional and Simplified Chinese, Russian, Portuguese and Turkish.

CuteFTP was first distributed as a commercial product by GlobalSCAPE in April 1996. In October 2003, we released CuteFTP Mac, our easy-to use FTP client for the Macintosh operating system. CuteFTP Mac

 

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incorporates many of the popular features of CuteFTP for Windows, while adhering to Apple’s user interface and usability guidelines. In 2008, we delivered the initial release of CuteFTP Lite, adding an entry-level FTP product to our solution portfolio.

CuteFTP Pro. CuteFTP Pro is a secure FTP client program designed for advanced users and information technology professionals. CuteFTP Pro incorporates standards for encrypting data during transport and at rest, accelerating transfer of large files, and automating common file transfer tasks. It includes various features attractive to advanced users such as multi-part and concurrent file transfers to maximize transfer speed, additional secure protocols, scheduled file transfers, automated site backups and scripting ability for automating FTP tasks. CuteFTP Pro has been favorably reviewed by leading online publications including CNet’s Download.com and PC Review. CuteFTP Pro was released in March 2001.

Server-Based Managed File Transfer Software Solutions

Our server software solutions are designed to provide businesses with increased security, automation, and performance when compared to traditional FTP-based and e-mail delivery systems. Our server solutions also offer substantial ease-of-use advantages compared to competitive products.

During 2009, we introduced our Enhanced File Transfer Server, or EFT Server, Version 6 product a rebranded version of our Secure FTP Server software with many new features and enhancements. Our legacy Secure FTP Server and EFT Server solutions are now available as EFT Server and EFT Server Enterprise, respectively. With the rebranding, we adopted a common, scalable solution platform that accommodates a broad family of add-on modules to support our customers’ complex information sharing needs, while also maintaining appropriate backward compatibility with our legacy solutions. During 2010, we released a new multi-platform version of the DMZ Gateway solution that replaces the previous Windows-only version. During 2011, we delivered updated versions of EFT Server and EFT Server Enterprise with two-factor authentication, enhanced visibility and monitoring of file transfers, support for IPv6, and additional security enhancements.

Enhanced File Transfer Server. Enhanced File Transfer Server complements CuteFTP Pro and other third party FTP clients by enabling encrypted transfers using SSL, SSH2 and advanced S/KEY password encryption. When used with CuteFTP Pro, Enhanced File Transfer Server offers a complete digital certificate management system, giving system administrators the ability to manage digital certificates, as well as initiate back-end processes with other customer systems. The latter functionality can be used as a partial or total replacement for more complex enterprise-level electronic data interchange systems, or EDI. Additional features include remote management capability, the ability to operate multiple FTP sites with unique user management from a single server, and the ability to manage user accounts with advanced settings for maximum security and control.

Enhanced File Transfer Server supports add-on modules and software such as the Auditing and Reporting module, High-Security Payment Card Industry module, OpenPGP module, Web Transfer Client, Secure Ad hoc Transfer module, DMZ gateway, and FIPS 140-2 validated cryptographic libraries. Enhanced File Transfer Server Version 6 and the latest version of CuteFTP Pro also received the Certificate of Networthiness (CoN) from the U.S. Army Network Technology Command (NETCOM) during 2009. Our receipt of this certificate enables Army installations worldwide to install and operate these server and client-based secure information exchange solutions. The availability of add-on modules, and migration to a common software code base with Enhanced File Transfer Server Enterprise have dramatically increased the capabilities of EFT Server, as compared to the legacy Secure FTP Server.

Enhanced File Transfer Server was first released in January 2002, as Secure FTP Server. Secure FTP Server has been favorably reviewed by leading publications including Server Watch and File Forum.

Enhanced File Transfer Server Enterprise. Enhanced File Transfer Server Enterprise is an enterprise file server, building on the base features of Enhanced File Transfer Server. Enhanced File Transfer Server Enterprise

 

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supports large-enterprise installations and is compatible with the Advanced Workflow Engine (AWE) module released by GlobalSCAPE in 2009. The AWE module provides over 200 built-in “drag and drop” workflow actions, including sending SNMP traps, communicating with mainframe computers, redirecting or relocating files, integrating SQL and XML capabilities, and executing third-party applications, custom programs, and batch files.

Enhanced File Transfer Server Enterprise also supports the Applicability Statement 2 (AS2) protocol, encrypting file system (EFS), the multi-site (and, as of early 2010, multi-platform) version of DMZ Gateway, two-factor authentication, active directory administration, Oracle DBMS, and many more enterprise capabilities.

Enhanced File Transfer Server Enterprise was first released in November 2004 and has been favorably reviewed by leading publications including Server Watch and Network Products Guide, which named the EFT Server solution a winner of a 2010 Product Innovation Award for Managed File Transfer.

Wide-Area File Services and Continuous Data Protection Solutions

Our Wide Area File Services, or WAFS, software provides a file sharing, collaboration, and replication solution over multiple sites. WAFS technology can have our CDP product added to it to provide enterprises with a file access and data protection combination that centralizes data storage and IT administration facilities but doesn’t compromise data sharing and protection.

Wide Area File Services. Our WAFS software delivers a unified and accelerated file access system, instant file-sharing and server-to-server mirroring across any distance, with full coherency and at near-LAN access speeds. WAFS delivers a true wide area file solution for collaboration. Continuous, real-time multi-directional acceleration and mirroring technology ensures that data exists in multiple places simultaneously and in complete synchronization, no matter where a change in any file is made. The data is mirrored between servers on the LAN, virtual private network, or across firewalls in real time, with full support for file locking ensuring coherency. Our WAFS product ensures bandwidth efficient WAN utilization, and that users have access to the most recent data. The off-line mode ensures continued data access in the event of WAN or server outage. Our WAFS software is easy to deploy and manage remotely. During 2009, we announced a significantly enhanced version of WAFS, including support for the Autodesk® Revit® Architecture construction and design application, along with broader enhancements that improve data replication performance and collaboration capabilities. During 2010, we announced additional performance enhancements to the WAFS solution, focused on file upload and download time improvements. During 2011, we released WAFS 4, a major version upgrade that provided an enhanced user interface, support for additional Windows operating systems, compatibility with Unicode character sets, and a new feature (Local Sync) that allows users to rapidly synchronize data while also simplifying implementation.

CDP. Our CDP continuous backup software transparently and continuously captures data from local and remote servers, eliminating the backup window and restoring data rapidly. Our software-only solution supports the ability to backup any number of branch servers or remote laptops to one or more centrally located systems. As files change, file servers backup in real time to the customer’s backup site which can be at the same or a remote location. The backup server can keep any number of past versions of each file (and deleted files) which gives the customer immediate restore, as well as the ability to perform point-in-time snapshots. Bandwidth requirements are minimal since only file differences are transferred to the backup system.

Managed E-mail Attachment Solution

Not all customers will use FTP or even traditional MFT solutions, to transfer large files. Some customers prefer using their familiar e-mail application to send and receive large files such as images, video, data files, etc. However, e-mail traditionally has been ill-suited to delivery of certain attachments due to typical infrastructure and administrator-defined limitations on e-mail attachment size. In many cases, these limitations preclude sending or receiving e-mail attachments larger than even 10 or 20 MB.

 

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Mail Express is a software add-in (also sometimes referred to as a plug-in) compatible with Microsoft Outlook. The add-in transparently redirects e-mail attachments, up to 25 GB in size, for delivery in accordance with administrator-defined policies. Attachments specified in the policy (for example, by type or size) are replaced in the e-mail message with a hyperlink; the files are transferred securely to the Mail Express server. The e-mail recipient clicks the hyperlink and is able to download the files from the Mail Express server using standard web-based download procedures with all communications using HTTPS (SSL or TLS encryption). This approach can ease the load on the e-mail infrastructure and the long-term storage requirements associated with e-mail attachments. Mail Express also allows enhanced tracking and auditing of the file attachments through read receipts and log files. Mail Express requires little or no user training because the add-in is transparent from the perspective of the sender and the recipient is able to use a familiar web browser for downloading the attachments.

Mail Express was first released in December 2008. During 2010, we released Mail Express 3, a significant improvement over prior versions. The improvements in Mail Express 3 introduced two-way file sharing and collaboration and also improved the administrator experience through enhanced workflow in the user interface and a simplified deployment process. During 2011, we released additional upgrades to Mail Express. The latest upgrades provided improved security by supporting communication through the GlobalSCAPE DMZ Gateway. This DMZ Gateway support allows customers to implement Mail Express behind a demilitarized zone (DMZ) firewall, providing an added layer of protection for data storage and retrieval, user authentication, and firewall traversal. The latest versions also include the Mail Express Internal Web Portal. The portal provides full Mail Express functionality via a standard web browser to customer employees who may not use Microsoft Outlook as their primary mail client. Other key features of this new version of Mail Express included support for Microsoft Outlook and Exchange 2010, improved performance and optimization when interacting with anti-virus software, and improved scalability.

In February 2012, Mail Express was recognized by Info Security Products Guide as a Global Excellence Award winner in the Email Management and Security category. The Global Excellence Awards recognize excellence in all areas of information security, including the industry’s best products, people, and companies. A panel of more than 50 judges from a broad spectrum of industries around the world determined the finalists and winners.

Endpoint Security Solution

In 2011 we announced ongoing development of appShield, a consumer endpoint security solution to protect computers against the rapid growth of viruses and other malicious software. The appShield solution continues in development, with release planned for 2012. The appShield software is based on proven enterprise-level application whitelisting technology from CoreTrace Corporation. Previously, in 2010, we entered into a reseller agreement with CoreTrace, under which we resell CoreTrace’s BOUNCER enterprise whitelisting solution.

Unlike traditional “blacklisting” solutions, such as antivirus software, that attempt to detect and remove infected files and applications running on a computer, whitelisting allows users to lock servers, personal computers, and other devices into a known, trusted state and allows only approved applications to run. By ensuring that only approved applications can run, appShield automatically blocks unauthorized applications—including viruses and rogue applications that may have been inadvertently downloaded from email or social media websites, for example.

Data Backup and Recovery Solution

In 2011 we released CuteBackup, a data backup and recovery software solution, compatible with Windows operating systems, aimed at helping consumers and small business owners avoid a data loss catastrophe. The scalable, automated solution gives home and small business computer users complete backup and recovery protection, with an intuitive setup wizard that enables a simplified, effective way of securing data. CuteBackup also offers “Boot Corrector” protection that can reboot the system and subsequently correct most common issues if the computer crashes and fails to restart. Additional features include automated backup routines and selective restores. CuteBackup is powered by Paragon Software Group’s Backup and Recovery 10 Suite.

 

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Maintenance and Support

We offer maintenance and support, or M&S, contracts for 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 e-mail and telephone during our regular business hours. Optionally, for Enhanced File Transfer Server Enterprise and WAFS software we offer a Platinum M&S contract which provides access to emergency technical assistance 24 hours per day 7 days a week.

Cloud-Based Services

GlobalSCAPE Managed Solutions

During 2010, we announced that we had executed a partner agreement with Rackspace Hosting, Inc., a world leader in the hosting and cloud computing industry. Through Rackspace and other partner infrastructure, GlobalSCAPE delivers cloud-based managed file transfer solutions for the secure exchange of business-to-business data, including large files and sensitive data. Our cloud-based solutions allow customers to outsource all or part of their complex and demanding information exchange needs to reduce costs, improve operational efficiencies, track and audit transactions, and provide a greater level of security. We expanded our cloud services capability to the United Kingdom and Canada in 2011, to support solution delivery in instances where country-specific compliance requirements may necessitate in-country delivery of the services.

Managed Information Xchange. Our Managed Information Xchange, or MIX, service delivers a hosted and managed MFT solution that enables cost effective, secure exchange of business-to-business data, including large files and sensitive data. MIX is a fully GlobalSCAPE-managed solution for companies seeking complete support for the contracted services. The tiered service allows customers to outsource all or part of their complex and demanding information exchange needs to reduce costs, improve operational efficiencies, track and audit transactions, and provide a greater level of security. Available solution tiers range from trial and proof-of-concept implementations to enterprise-scale managed services.

Key benefits and features of the Managed Information Xchange offering include: “pay as you go,” flexible pricing that helps customers eliminate upfront capital expenditures; reduced ongoing maintenance expenses, including hardware, software, personnel, utility services, and backup costs; improved IT infrastructure reliability and performance enabled by the Rackspace global infrastructure and other partner capabilities; easy and rapid deployment with scalable processing and storage capabilities; the market-leading features and security capabilities of our Enhanced File Transfer Server solution adopted by thousands of customers worldwide; and operation of the cloud-based secure file transfer capability by our technical resources, in accordance with service level agreements.

We introduced our MIX solution in July 2010. In February 2011, Info Security Products Guide recognized MIX as the winner of the 2011 Global Excellence Award in the Cloud category. The Info Security Product Guide recognition, together with previous awards received for Enhanced File Transfer Server, broadened our portfolio of industry and market validations for our cloud-based solutions.

Hosted Enhanced File Transfer Server. In February 2011, we announced availability of our Hosted Enhanced File Transfer Service. This service expands our cloud-based solution portfolio by integrating a hosted version of our market-leading Enhanced File Transfer Server solution with Rackspace Hosting and other partner infrastructure. This scalable and tiered service is structured for the SMB market, and also allows customers of all sizes to outsource all or part of their complex and demanding secure information exchange needs. Through such outsourcing, customers can greatly reduce costs, increase efficiencies, track and audit transactions, and provide a greater level of security and compliance, at affordable price points. The Hosted EFT Server offering delivers these benefits while allowing direct customer management of the Enhanced File Transfer Server solution (as contrasted with the fully managed MIX service)

 

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Software as a Service Solutions

SaaS delivers a software application over the Internet, or across other networks, to users on an on-demand basis. The SaaS delivery model allows central administration and maintenance of the application with user access provided through a provider hosted website. SaaS appeals to many prospective customers because it uses cloud computing approaches in which the customer does not need to install special software on the computer systems accessing the application. Also, SaaS eliminates the need for the customer to purchase, install and maintain servers and other IT infrastructure to use and maintain the software.

Our SaaS solution, CuteSendIt, is a file transfer service for individuals, professionals, and businesses. CuteSendIt uses cloud computing approaches to deliver files through a hosted web portal. This solution approach meets the needs of users who do not have, or wish to invest in, file transfer infrastructure such as FTP servers or even client application software. The solution scales from single-user to multi-user licensing with varying file transfer capabilities based, for example, on a maximum number of files, the aggregate data volume for files transferred each month, and the amount of long-term online storage required for the files. Depending on the necessary level of service, CuteSendIt is available in plans ranging from a free plan up to a multi-user plan for $79.99 per month.

Users access the CuteSendIt web portal at www.cutesendit.com which is also accessible from the GlobalSCAPE site. From there the portal users can upload files to a CuteSendIt hosted server managed by GlobalSCAPE for delivery in accordance with the previously selected licensing. CuteSendIt delivers the files, using SSL encryption for the paid plans, by sending an e-mail message to the recipients. The body of the e-mail message contains text entered by the sender through the portal. The e-mail messages also include hyperlinks to the files. The e-mail recipient clicks the hyperlink and is able to download the files from the CuteSendIt server using standard web-based download procedures. CuteSendIt was first released in July 2008.

Secure Content Mobility Solution

In December 2011, we announced that we had acquired TappIn, Inc. The TappIn by GlobalSCAPE service solves a real problem that millions have today—how to easily and securely access and share documents, pictures, videos and music anytime, anywhere. From the office, at home, or on the road, customers can “Tapp In” to their files, stored in multiple locations, using any web browser and most Internet-enabled mobile devices (including Apple iPhone and iPad, Google, Android and Windows Phone, and most recently, Kindle Fire). TappIn removes the need for uploading, syncing, or paying for additional cloud storage. Instead, the TappIn service securely accesses the user’s existing storage devices, allows sharing files of any size, and provides encryption to safeguard content.

The innovative TappIn by GlobalSCAPE service incorporates elements of on-premises software, cloud, and SaaS delivery models. Unlike remote access products that consume mass amounts of storage, TappIn makes content available through a secure cloud pathway, thereby allowing users access to their storage location, wherever that may be. TappIn’s unique cloud access portal means users can obtain content without having to download, save, and manage it on their mobile device. This method of delivery not only saves storage space, it ensures content remains secure and private on the user’s home or work computer or other storage device. Key features include TappIn SecureShare, SocialShare, and Enhanced A La Carte Playlist.

TappIn allows users to selectively share their sensitive data with selected recipients in a secure and protected manner. With TappIn’s SecureShare feature, users can customize authentication capabilities to protect sensitive information by providing selective access and requiring specific recipients to login securely before viewing private files. Users can choose to authenticate via login or share files via public access with a link to the photo, file, or folder. Using TappIn, users can also easily import contacts from Gmail, Yahoo!, Hotmail, and other email providers directly into TappIn, providing one-click sharing.

 

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SocialShare allows users to share photos, files, or folders from their supported devices directly to Facebook. A link to the file and a thumbnail of the photo are posted to the user’s Facebook wall, along with any comment to Facebook “Friends.” Files are not uploaded to Facebook, but remain securely stored on the user’s computer, allowing for easy control and removal.

TappIn’s A La Carte Playlist capability allows Apple users to generate playlists from multiple iTunes and MP3 libraries. With one click, the TappIn service populates a list of all folders that contain music files, and allows users to select from those folders to create a single, unique playlist. TappIn’s Now Playing feature enables users to stream music while simultaneously using other applications. Streaming access also eliminates the need to download and manage the content on mobile devices, saving time and storage space, and safeguarding privacy.

Since launching its innovative service in 2010, TappIn, Inc. has won numerous awards and accolades from leading industry authorities. In December 2011, TappIn was selected as a Red Herring 2011 Top 100 Global award recipient, a prestigious recognition honoring the year’s most audacious and far reaching private technology companies and entrepreneurs from across the globe. Red Herring’s editorial staff evaluated the companies on both quantitative and qualitative criteria, such as financial performance, technology innovation, management quality, strategy, and market penetration. Red Herring’s Global 100 list has become a mark of distinction for identifying promising companies and entrepreneurs. Red Herring editors were among the first to recognize that companies such as Google, Skype, Baidu, Salesforce.com, YouTube, and eBay would facilitate transformational change in the Internet Era. Most recently, in February 2012, the TappIn solution was selected as recognized by Info Security Products Guide as a Global Excellence Award winner in the Software as a Service (SaaS)/Cloud Solutions category.

Professional Services

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

Product Customization and System Integration. Through our product customization and system integration services, we customize the branding, reporting, and administration capabilities of our solutions to meet specific customer requirements. Typical deliverables include customized implementations, documentation for installations and customizations, and the installer programs necessary to install or reinstall the applicable solutions, drivers, and other software included in the customization and systems integration project.

Custom Branding. Custom branding services allow customers to incorporate logos, different fonts, colors, hyperlinks, and additional text within the Web Transfer Client and the SAT module used with our Enhanced File Transfer Server solution, as well as within our Mail Express offering.

Custom Reporting. Custom reporting services leverage the flexibility and power of the Auditing and Reporting Module used with our Enhanced File Transfer Server solution, to deliver customer-specific formatting and content, using data tracked within the Enhanced File Transfer Server solution. Custom reporting services also can provide customers with a web browser-accessible reporting module for the Enhanced File Transfer Server solution. This module allows users to generate reports without requiring administrative access to the Enhanced File Transfer Server.

Custom Administration and System Integration. Custom administration and system integration services provide web-based administration and development capabilities for our Enhanced File Transfer Server solution.

 

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A browser-accessible administrative module facilitates sub-domain administration of Enhanced File Transfer Server through separation of duties. The web-based user provisioning does not require full administrative access to the Enhanced File Transfer Server and provides convenient access without the need to install client software. Other web services-based customizations expose much of the functionality within the Enhanced File Transfer Server component object model (COM) application programming interface (API). Exposure of the COM API allows integration with a customer’s existing IT infrastructure via open standards.

Solution Quickstart Implementation

Our Quickstart Implementation services accelerate implementation of our file transfer solutions within customer IT environments. Our engineers lead the product installation and configuration and provide training and knowledge transfer to customer administrators. Quickstart Implementation services are available for the Enhanced File Transfer Server, WAFS, and Mail Express secure information exchange solutions. Typical deliverables include requirements documentation, implementation plans, and configuration documentation.

Business Process and Workflow

Business Process and Workflow services include workflow site surveys and implementation of the AWE Module used with our Enhanced File Transfer Server solution. The workflow site surveys assist customers with documenting business processes as they pertain to information delivery and sharing associated with file transfers. Typical deliverables include business process documentation for file transfers, recommendations for process automation, workflow implementation and use documentation, and installation of the AWE module for use with the Enhanced File Transfer Server solution.

Policy Development

Policy Development services help customers establish and implement file transfer policies that address regulatory requirements and comply with corporate policies. Typical deliverables include a map or census of existing file transfer policies, standards, and procedures; recommended improvements based on our best practices; and updated policy documentation with customer-approved improvements.

Education and Training

Education and Training services provide classroom and hands-on instruction for implementing, maintaining, and optimizing our secure information exchange solutions. Intermediate and advanced classes cover the use of our Enhanced File Transfer Server solution. We also provide business process instruction tailored to the AWE module. We can deliver training at customer facilities or from our San Antonio location. Typical deliverables include the instruction hours plus training materials and solution documentation.

Health Checks

Health Check services provide customers with periodic assessments, education, and training, to help them get the most value from our solution implementations. These services also allow customers to more easily maintain currency with the latest versions of our software and with best practices for sustaining and enhancing the deployments.

Longer-Term Engineering Services

In addition to the previously described professional services, we have developed our capacity to deliver longer-term engineering services. During 2010 we announced that we are a subcontractor on the McLane Advanced Technologies (MAT) industry team that won a $52.3 million re-compete contract for the U.S. Army Standard Army Maintenance System (SAMS-E). Work on this contract began late in 2010 and the customer

 

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exercised the first of two option years in 2011. As part of the MAT industry team, we are providing professional and technical services to support the SAMS-E program, including the Enhanced File Transfer Server (known as Secure FTP Server before the release of Enhanced File Transfer Server 6 in early 2009) and CuteFTP solutions integrated into the SAMS-E environment. We have deployed several engineers onsite at the MAT facility in Temple, TX, and continue to adjust the size of this team as required to best support contract requirements. Our increased capacity to deliver longer-term professional services also may be applicable to the commercial sector as we work closely with our enterprise customers to help them best sustain their secure information exchange solutions and infrastructure.

Sales and Marketing

In recent years, we have sustained our emphasis on developing our direct sales staff and reseller channels to capture those sales that require individual attention. For example, sales of our more complex enterprise solutions, such as Enhanced File Transfer Server, WAFS and Mail Express, sales to larger enterprises, and sales of managed solutions and M&S contracts are delivered by our direct sales staff and resellers.

We provide both our sales staff and our resellers with training and professional development opportunities to ensure that they are capable of meeting the needs of our prospects and customers. These sales team development activities focus on technical and process-oriented topical areas to enhance the ability of our sales team to identify prospects, best position our solutions, and develop pipeline opportunities into sales.

Our reseller and distributor relationships allow us to increase our market reach, including pursuing international sales. We have established such relationships within specific industries, such as the government sector, and in multiple geographies outside of North America, for example in Europe, Australia, Asia, Latin America, and Africa.

We also sell our file transfer client programs, such as CuteFTP, as well as Enhanced File Transfer Server, certain of our enterprise solution add-on modules, and CuteBackup via download from our Web site, www.globalscape.com. Prospective buyers may use certain of our software products for free during an evaluation period of up to thirty days. The programs are automatically disabled if a license is not purchased by the end of the trial period. Our software is also available for download from a variety of independent Internet software sites such as CNet’s Download.com, as well as sites in Western Europe, Canada, Australia, and Asia.

Post-sale, we provide customers with both free, and under our maintenance and support plans, contracted support. To facilitate self-help for common inquiries and issues, we provide free customer support via a searchable knowledge base on our website. We also sell maintenance and support plans to customers requiring assistance from our support services team.

Our marketing activity during 2011 consisted primarily of online paid advertising (for example, Google AdWords), improvement of natural search-engine results, marketing communications initiatives such as press releases and increased media outreach, and attendance at occasional industry trade shows, such as the RSA Security Conference. We also added an online chat capability that allows us to interact in real time or near-real time with visitors to our website. Our reliance on online paid advertising has declined in recent years as we have transitioned to a more strategic business development and sales approach, as reflected in the substantial increase in our enterprise sales. We also have reduced our reliance on online paid advertising by conducting ongoing search-engine optimization to enhance our ranking for particular key words in natural search results of major search engines.

We also leverage our website for certain marketing communication activities. The CuteFTP products, in particular, are well known and easy to install and use. This historically has made them good products for attracting users to our website and for email marketing campaigns oriented toward CuteFTP users. We continued to update the design of our website in 2011 to provide a more solution-oriented perspective of our business, improve site navigation, and provide additional opportunities for visitors to contact us through the website.

 

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Customers

Our solutions have been sold to most of the Fortune 100. Our customers are international, with our products having been sold into more than 150 countries. No single customer accounts for more than 10 percent of our revenue.

We continue to derive most of our revenue from commercial customers in the U.S., U.K., Canada, and Australia. Our primary commercial vertical markets include finance, health care, energy, retail, manufacturing, and engineering. We also have a significant customer base in the local, state, and federal government spaces. We continue to pursue additional government business by leveraging our certifications and industry validations.

Seasonality

Our products are marketed to individuals as well as large organizations. As a result of this mix within our customer base, we typically have not experienced significant seasonality in our sales. However, during 2011, we experienced some seasonality effects in the first quarter, as some customers delayed purchases into the second quarter.

Network and Equipment

We have contracted with various network providers for Internet access. Our arrangements provide for redundancy in the event of a failure, and also for expansion of available bandwidth in the event that there is a dramatic increase in demand. To protect critical customer data, GlobalSCAPE’s Internet shopping cart utilizes SSL encryption. During 2009, we completed an internal project to implement other technical and physical measures and procedures compliant with the PCI DSS. As part of this project, we retained the services of a certified Approved Scanning Vendor and verified our compliance with the PCI DSS.

We have dedicated servers on and off site and expansion plans in place to allow rapid and cost effective scalability. Our offsite servers and data backup procedures provide a warm backup to our onsite servers for contingency purposes. The backups are performed in accordance with our disaster recovery plan.

Research and Development

Our internal software engineers are responsible for software design, managing the development process, testing and quality assurance. We utilize offshore developers for a portion of the coding phase of software development for certain products. Our use of external developers allows us to tap into a highly skilled labor pool, maintain a 24-hour development schedule, decrease time to market, and minimize programming costs.

All phases of development, including scope approval, functional and implementation design, object modeling and programming, are subject to extensive internal quality assurance testing. During 2011, we continued our prior focus on improving our quality assurance testing infrastructure and practices. Technical reporting, for example through WinQual, and customer support feedback during the year confirmed the continuing positive effect of our enhanced R&D and quality assurance processes.

For the years 2011, 2010 and 2009, we spent approximately $3.1 million, $3.0 million and $2.8 million, respectively, on research and development all of which was expensed. We expect to continue to increase our research and development spending in 2012 as we focus on integrating TappIn technology, improving our current products, and introducing new products such as appShield.

 

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Competition

The file management, content management and Web development software market sectors are intensely competitive, subject to rapid change and are significantly affected by new product introductions and other activities of market participants. Our primary competitors vary by product and are listed below.

We have limited information regarding our products’ market shares in their respective categories. Many of our competitors have substantially greater financial, technical, sales, marketing, personnel, and other resources, as well as greater name recognition and a larger customer base than we do. Significant competition characterizes the markets for our traditional MFT products and we anticipate that we will continue to face increasing pricing pressures from competitors in the future. Moreover, given that there are low barriers to entry into the software market, and the market is rapidly evolving and subject to rapid technological change, we believe that competition will persist and intensify in the future. With these market forces we have experienced price decreases on some products and faced price pressure from free and low cost competitors over the last several years. A reduction in the price of our products would negatively affect gross margin percentage, and would require us to increase software unit sales, in order to maintain net revenues at existing levels. For more discussion on the risks associated with our competition, you should read the information under “Risk Factors — Risks Related to Operations.”

CuteFTP Home and Lite. CuteFTP exists in a highly competitive environment with numerous FTP software utilities available on the Internet. We believe our primary competitors are WS_FTP Professional Client from Ipswitch, Inc. and FTP Voyager by Rhino Software, Inc. CuteFTP was the second Windows-based FTP client to market and is consistently among the most frequently downloaded FTP clients on popular download sites. CuteFTP Mac, our FTP client for the Macintosh platform, competes with Fetch, by Fetch Softworks, Interachry, by Nolobe, and Transmit FTP, by Panic Inc.

CuteFTP Pro. CuteFTP Pro competes in the higher end of the same market as CuteFTP, targeting the security-minded IT professional. CuteFTP Pro is positioned as one of the only secure FTP client programs that support a wide range of security standards related to the FTP protocol. Competitors in the general FTP market offer products that support a smaller subset of these security standards and address a narrower segment of the secure FTP market. Competitors include Van Dyke, Inc., Ipswitch, Inc., and Rhino Software, Inc.

Enhanced File Transfer Server. EFT Server competes against a limited number of secure Windows-based FTP servers. We believe our primary competitors are WS_FTP Server, Serv-U, and JSCAPE. EFT Server has the advantage of leveraging the success of CuteFTP Pro through product integration, offering proprietary extensions to the FTP protocol, and cross-marketing efforts to an existing customer base.

Enhanced File Transfer Server Enterprise. EFT Server Enterprise competes in the managed file transfer server market. We believe our primary competitors are Axway, IBM-Sterling Commerce, Proginet-Tibco, SSH’s Tectia and Ipswitch. EFT Server Enterprise has the advantage of being very cost effective in its market while leveraging and extending the security and file management features of our other FTP products.

WAFS. WAFS competes in the Wide Area File Services/Storage market. We believe our primary competitors are Riverbed, Blue Coat and Cisco, who are delivering proprietary based appliances. We believe that WAFS has the advantage of being a software only solution which leverages corporate infrastructure and minimizes the total cost of ownership.

CDP. CDP competes in the highly competitive continuous data protection market. We believe our primary competitors are CA XOsoft, Doubletake and Symantec/Veritas. We believe that CDP has the advantage of transparently and continuously capturing data from local and remote servers, eliminating the backup window and restoring data rapidly.

 

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Mail Express. Mail Express competes in areas of the file transfer market associated with e-mail attachment offloading. We believe our primary competitors are Accellion, Proginet-Tibco, Leapfile, and Biscom. Mail Express has the advantage of centralized policies for outbound file attachments and a transparent end-user experience, which allows for rapid customer deployments.

appShield. As a new product in an emerging market, appShield has a limited number of competitors. There are some apparent, direct competitors such as AppGuard, from Blue Ridge Networks. In addition, many antivirus solution providers are either delivering some application control features in their software or, in the case of Bit9, Lumension, and others, have enterprise application control solutions that provide a technology base from which they could enter the consumer/SMB whitelisting market should they choose to do so.

CuteBackup. CuteBackup competes in a highly competitive, and even saturated, market for on-premises backup solutions. While there are few means of differentiation in such an environment, CuteBackup allows us to make opportunistic sales, particularly to customers who visit our website for other solutions, such as CuteFTP, or who wish to contract with one vendor for multiple products (for example, for consistency of support).

CuteSendIt. CuteSendIt competes in the SaaS, segment of the file transfer market. There are a large number of competitors, but we believe our primary competition includes YouSendIt, LeapFILE, Dilbert Files, DropSend, SendThisFile, Box.net, and Pando. CuteSendIt has the advantage of supporting multiple users, allowing larger files to be sent, and providing additional file tracking. However, some of the competitors offer significant capabilities for free.

Cloud-based Managed Solutions for Secure Information Exchange. Our MIX and Hosted Enhanced File Transfer Server solutions compete with MFT SaaS solutions. We believe our primary competitors are Ipswitch, Axway, IBM-Sterling Commerce, Thru, Inc. and Accellion. MIX and Hosted Enhanced File Transfer Server have the advantage of leveraging cost effective, secure hosting and cloud infrastructures, as well as Enhanced File Transfer Server management services provided by GlobalSCAPE’s experts.

TappIn by GlobalSCAPE. The TappIn solution has direct competitors such as PogoPlug and FileTek. In addition, TappIn competes for mindshare in the market with pure-play cloud data repositories like Dropbox and Box and with computer remote control solutions like GoToMyPC and LogMeIn.

Governmental Regulation

Export Control Regulations. All of our products are subject to U.S. export control laws and applicable foreign government import, export and/or use requirements. The level of control generally depends on the nature of the goods and services in question. For example, the level of control is impacted by the nature of the software and encryption incorporated into our products. Where controls apply, the export of our products may require an export license or authorization or that the transaction qualify for a license exception or the equivalent, and may also be subject to corresponding reporting requirements. For the export of some of our products, we may be subject to various post-shipment reporting requirements. Minimal U.S. export restrictions apply to all of our products, whether or not they perform encryption functions. Additionally, because GlobalSCAPE is a Department of Defense contractor, there are certain registration requirements that may be triggered by our sales. In addition, certain GlobalSCAPE items and/or transactions may be subject to the International Traffic in Arms Regulations (ITAR) if our software or services are specifically designed or modified for defense purposes. Companies engaged in manufacturing or exporting ITAR-controlled goods and services (even if these companies do not export such items) are required to register with the U.S. State Department.

Enhancements to existing products may, and new products will, be subject to review under the Export Administration Act to determine what export classification they will receive. In light of the ongoing discussions regarding anti-terrorism legislation in the U.S. Congress, there continues to be discussions regarding the correct

 

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level of export control. Export regulations may be modified at any time. Modifications to the export regulations could reduce or eliminate our ability to export some or all of our products from the U.S. without a license in the future, which could put us at a disadvantage in competing for international sales compared to companies located outside of the U.S. that would not be subject to these restrictions. Modifications to the export regulations could prevent us from exporting our existing and future products in an unrestricted manner without a license or make it more difficult to receive the desired classification. If export regulations were to be modified in such a way, we may be put at a competitive disadvantage with respect to selling our products internationally. We are working on enhancing our systems to address the impact of these regulations on our products and services and understand the need to comply. We will complete technical reviews on any new products that we acquire or develop that may be subject to the requirements before we can export them.

Privacy Laws. As our business evolves to incorporate more cloud and SaaS solutions, we will receive, transmit, and store more and more information and as a result we may be subject to various federal and State regulations regarding the protection of personally identifying information. Applicable laws may include, without limitation, federal laws such as the GLBA and HIPAA, as well as state and regulations in the U.S., as international laws and regulations including the European Union’s Privacy Directive. In the event our systems are compromised by an unauthorized party, many of these privacy laws require that we provide notices to our customers whose personally identifiable data we reasonably believe may have been compromised. To mitigate the risk of compromised information, we use encryption and other security to protect our databases.

Intellectual Property

We regard some of the features of our internal operations, software, and documentation as proprietary and rely on copyright, patent, and trademark and service mark laws and trade secret protection, such as confidentiality procedures, contractual arrangements, non-disclosure agreements and other measures to protect our proprietary information. Our intellectual property is an important and valuable asset that enables us to gain recognition for our products, services, and technology and enhance our competitive position and market value.

As part of our confidentiality procedures, we generally enter into non-disclosure agreements with our employees and independent contractors, resellers, and corporate partners, and we enter into license or subscription services agreements with respect to our software, documentation, and other proprietary information. Our standard license agreements are transferable only in limited circumstances and have a perpetual term and our subscription services agreement for our hosted solutions restrict access and have a definite term. We also educate our employees on trade secret protection and employ measures to protect our facilities, equipment, and networks.

Our trademarks and copyrights are central to our business. We have U.S. federal trademark registrations for GlobalSCAPE and design, CuteFTP, CuteFTP Pro, Cute Backup, Cute SendIt and design, DMZ Gateway, Enhanced File Transfer Server and design, Availl and SnapEdit and pending U. S. federal trademark applications for appShield and design, Mail Express and design, CuteSendit and design, Total Path Security, Stop to Ask, Stop Tomorrow’s Viruses Today, and other products on our roadmap. We have trademarks registered in Canada and the European Union for GlobalSCAPE. We have obtained twenty-seven United States copyright registrations for all but the most recent versions of our software applications, and have applied for registration for the most recent versions. Our subsidiary, TappIn, Inc., has pending U.S. federal trademark applications for TappIn. We have two patents in the U.S. TappIn, Inc. has one pending patent application in the U.S and one pending application filed under the Patent Cooperation Treaty (PCT).

Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products, which are licensed by the thousands and sold world-wide, is difficult. While we are unable to determine the extent to which piracy of our software products exists, software piracy is a persistent problem. In selling our products, we rely primarily on click-wrap licenses which are not signed in writing by licensees, and may be

 

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unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Companies in the software industry, and other patent and trademark holders seeking to profit from royalties in connection with grants of licenses, own large numbers of patents, copyrights, trademarks, service marks, and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. We have received, and may receive in the future, communications from third parties asserting that our products infringe, or may infringe, the proprietary rights of third parties, seeking damages resulting from such infringement or indicating that we may be required to obtain a license or royalty from such third parties. For more discussion on the risks associated with our intellectual property, you should read the information under “Risk Factors,” especially “Risks Related to Legal Uncertainty.”

Employees

As of February 28, 2012, we had 94 full-time and 2 part-time employees organized within eight functional areas. The employee distribution according to function is as follows:

 

Department

   Number of
Employees
 

Management and Administration

     14   

Research and Development

     16   

Quality Assurance

     6   

Marketing

     6   

Information Services

     9   

Professional Services

     4   

Sales

     22   

Customer Support

     19   
  

 

 

 

Total

     96   
  

 

 

 

None of our employees are covered by collective bargaining agreements and we believe our employee relations are good.

Available Information

We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission. You may read and copy any document we file with the SEC at the SEC’s public reference room at 100 F Street, NE, Room 1580, Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for information on the public reference room. The SEC maintains an internet web site that contains annual, quarterly and current reports, proxy statements and other information that issuers (including GlobalSCAPE) file electronically with the SEC. The SEC’s web site is www.sec.gov. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other reports and amendments filed with the Securities and Exchange Commission are available free of charge on our web site at www.globalscape.com in the Investor Relations section as soon as practicable after such reports are filed. Information on our website is not incorporated by reference into this Form 10-K and should not be considered part of this report or any other filing that we make with the SEC.

 

Item 1A. Risk Factors

We have described below risks that we are aware of that could have a material adverse effect on your stock ownership and our business.

 

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Risks Related to Our Operations

We may not achieve the expected market traction and financial results from our recent solution additions, such as Mail Express, our cloud-based Managed Information Xchange and Hosted Enhanced File Transfer Server solutions, and TappIn, or from future solutions such as appShield.

Much of our revenue growth in recent years is attributable to sales of Enhanced File Transfer Server Enterprise software (and from maintenance and support contracts associated with Enhanced File Transfer Server Enterprise) and from delivery of our professional services. While Enhanced File Transfer Server revenues continue to grow, this solution has numerous competitors and new license sales have slowed in recent years. Similarly, we have grown our professional services capabilities, and associated revenues years in recent years. However, the cost of revenues from professional services are significantly higher than for software license sales and a significant part of our services revenue is associated with a single contract (McLane Advanced Technologies), supporting a single U.S. Army customer.

For these reasons, we believe improving, and possibly even sustaining, our financial results is dependent on achieving additional market traction with our recent and potential future solution additions. We have announced several new solutions since the beginning of 2010, including our Managed Information Exchange and Hosted Enhanced File Transfer Server cloud-based solutions, the appShield consumer security solution, and a new version of Mail Express. Most recently, in December 2011, we announced the acquisition of TappIn, Inc. Through introduction of these solutions, we have entered the cloud services and secure content mobility markets and, with the new releases of Mail Express, extended our capabilities in the MFT market. In addition, we plan to enter the antivirus segment of the endpoint security market with appShield.

We believe the cloud services, secure content mobility, and endpoint security markets potentially provide significant upside to our historical MFT business results. However, entering and gaining traction in such markets will require that we market, sell, and support these solutions effectively. Each of these success factors has inherent risks due to, for example, our limited corporate expertise in the adjacent markets and the possibility that the specific buyers of solutions in these adjacent markets may be different from the buyers with whom we interact throughout our traditional MFT sales cycle. In addition, entering, obtaining traction, and sustaining growth in these markets requires investments in engineering, marketing, sales, customer support, and internal business systems.

Because our experience suggests that it takes several quarters, or even longer, to obtain market traction with a new solution and to identify the trends necessary to develop projections of future business performance, it is difficult to determine when, or if, these prior, ongoing, and future solution investments will be offset by increased sales and revenue. Therefore, inability to gain additional sales traction with recent and new solutions in markets like cloud services, secure content mobility, and endpoint security may adversely impact our financial results in the future.

Our recent acquisition of TappIn, Inc. and possible future acquisitions give rise to risks and challenges that could adversely affect our future financial results.

The TappIn acquisition, and acquisitions generally, involve a number of risks and challenges, including:

 

   

Complexity, time, and costs associated with integration of the acquired business operations, workforce, products, and technologies into our existing business, sales force, employee base, product lines, marketing and technology. The possibility exists that the integration ultimately may not be successful;

 

   

Diversion of management time and attention from our existing business and other business opportunities throughout the integration;

 

   

Potential loss or termination of employees, including costs associated with the termination or replacement of those employees;

 

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Assumption of debt or other liabilities of the acquired business, including any future litigation related to alleged liabilities of the acquired business;

 

   

The incurrence of additional acquisition-related debt as well as increased expenses and working capital requirements;

 

   

Potential dilution of earnings per share;

 

   

Increased costs and efforts in connection with compliance with Section 404 of the Sarbanes-Oxley Act; and

 

   

Potentially substantial accounting charges for restructuring and related expenses, write-off of in-process research and development, impairment of goodwill, amortization of intangible assets, and stock-based compensation expense.

If the integration of TappIn is not successful, we may not realize the potential benefits of the acquisition or undergo other adverse effects. To integrate acquired businesses, including TappIn, we must determine and leverage the actual market synergies, sustain and even extend the business performance of the acquired entity, implement our technology systems in the acquired operations and integrate and manage the personnel of the acquired operations. We also must effectively integrate the different cultures of acquired business organizations into our own in a way that aligns various interests.

Through the TappIn acquisition, we have entered a new adjacent market in which we have limited experience. Secure content mobility market is an emerging market, with a wide range of potential solution approaches. Established cloud-based data repositories and service providers compete for market share with TappIn. Some of these competitors have much stronger market positions than TappIn. The time and expense to market, sell and support the TappIn solution and possible future versions of the solution, introduce additional risk to current operations.

Any of the foregoing, and other factors, could harm our ability to achieve anticipated levels of financial performance from TappIn or to realize other anticipated benefits of the acquisition. In addition, because acquisitions of technology companies are inherently risky, no assurance can be given that our previous, current, or future acquisitions will be successful and will not adversely affect our business, operating results, or financial condition.

Our addition of subscription services, such as our cloud-based Managed Information Xchange and Hosted Enhanced File Transfer Server solutions announced in 2010 and early 2011, may adversely impact our prior revenue trends in the near term as some opportunities that otherwise would have materialized as software license sales potentially shift to subscription-based sales.

Much of our revenue growth in recent years is attributable to sales of Enhanced File Transfer Server Enterprise software (and from maintenance and support contracts associated with Enhanced File Transfer Server Enterprise) and from delivery of our professional services. Software license sales typically are intended for implementations on customer premises and are recognized into revenue when delivery of the software has occurred and collection of fees from the customer is deemed probable. Because revenue from a subscription is recognized ratably, over the life of the subscription, changes in the proportion of sales from software licenses and from subscriptions may result in substantial changes in our revenue trends and other financial metrics.

In practice, software sales typically are recognized into revenue within 30 to 90 days of the sale. Subscription services, on the other hand, are recognized into revenue as the services are delivered (assuming collection is deemed probable), typically on a monthly basis. Therefore, only a fraction of the total value of a subscription services sale is recognizable into revenue each month with the rest being included in deferred revenue. This fraction becomes less as the contract term increases from 12 to 24, or 36 months.

 

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The impact of subscription services on prior revenue growth trends depends on several key factors, including the number of customers who may shift from software licenses to subscription services, and rate at which they may do so, the subscription term and fees, and the comparative value of the opportunity had it materialized as a software license sale instead of as a subscription service. Generally, for a fixed number of opportunities (that is, without considering the possibility that a new service offering may result in additional sales opportunities), addition of subscription services reduces revenue growth rates for several quarters for the associated solutions until cumulative subscription revenue increases and, potentially, surpasses comparable software license revenue. The revenue impacts are particularly pronounced early in the introduction of subscription services because there has been only a short time period for accumulation of the recurring revenue stream.

Because we announced our subscription services in the second half of 2010, there is little historical basis for quantifying some of these key risk factors or assessing the extent to which availability of our new subscription services may, or may not, increase the total number of sales opportunities. Therefore, it is difficult to predict the impact of our cloud-based subscription services on our prior revenue growth trends. However, revenue derived from sales of our Enhanced File Transfer Server solution, the comparable on-premises software solution in our portfolio, is most subject to ongoing transitory risk from the introduction of these subscription services.

Fluctuations in professional services revenue may be greater than experienced in previous reporting periods and have a disproportionate impact on our financial results. For example, increased professional services sales, especially to the government, may result in lower earnings as a percentage of revenue.

Our solution portfolio includes software licenses, subscription services, and professional services. Because they are relatively labor intensive, professional services typically have substantially lower margins than software solutions and subscription services. However, these services represent a strategic capability that helps customers plan, implement, and sustain our solutions and also provide us with the demonstrated past performance necessary to participate in certain procurements.

Professional services historically have been an immaterial contributor to our revenue and earnings, typically representing much less than five percent of our revenue. However, since the third quarter of 2010 we have added several engineers to the McLane Advanced Technology (MAT) industry team supporting the U.S. Army’s Standard Army Maintenance System—Enhanced (SAMS-E) program. We also may continue to adjust, up or down, our professional services support to the Army, and to other customers within the government and commercial sectors, in a given reporting period.

Depending on our mix of software licenses, subscription, and professional services revenue in a given reporting period, our earnings as a percentage of revenue may fluctuate from historical norms. For example, if we were to derive a relatively large (compared to historical norms) component of our revenue from professional services in a reporting period, earnings as percentage of revenue may decline in that period due to lower margin contribution from the labor-intensive services as compared to software license and subscription service revenue.

If we are unable to develop and deliver new and enhanced products and services that achieve widespread market acceptance, or if we are unable to continually improve the performance, features, and reliability of our existing products and services, our business and operating results could be adversely affected.

Our future success depends on our ability to respond to the rapidly changing needs of our customers by developing or introducing new products, product upgrades, and services on a timely basis. We have in the past incurred, and we believe that we will continue to incur, significant research and development expenses as we strive to remain competitive. Innovation, new product development, and go-to-market activities involve a significant commitment of time and resources and are subject to a number of risks and challenges including:

 

   

Developing, sustaining, and appropriately leveraging market intelligence to identify areas of market need that offer potentially high return on investment for solution development;

 

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Managing the length of the development cycle for new products and product enhancements, which may be longer than originally expected;

 

   

Adapting to emerging and evolving industry standards and to technological developments by our competitors and customers;

 

   

Extending the operation of our products and services to new platforms and operating systems;

 

   

Entering into new or unproven markets with which we have limited experience;

 

   

Managing new product and service strategies, including integrating our various security and file replication technologies, management solutions, customer service, and support into unified enterprise security and file replication solutions;

 

   

Incorporating acquired products and technologies;

 

   

Developing or expanding efficient sales channels; and

 

   

Obtaining sufficient licenses to technology and technical access from operating system software vendors on reasonable terms to enable the development and deployment of interoperable products, including source code licenses for certain products with deep technical integration into operating systems.

If we are not successful in managing these risks and challenges, or if our new products, product upgrades, and services are not technologically competitive or do not achieve market acceptance, we could have expended substantial resources and capital without realizing sufficient revenues in return, and our business and operating results could be adversely affected. For example, the development cycle for the appShield solution has been considerably longer than originally envisioned and market feedback may result in an extended cycle of further development. We also have experienced longer than expected development and ongoing quality assurance testing cycles for WAFS.

Our indebtedness may adversely affect our cash flow and business operations.

At December 31, 2011, we had a total of $7.0 million of indebtedness under our loan agreements. Our indebtedness could have important consequences to us, including:

 

   

our ability to obtain additional financing, if necessary, for working capital, capital expenditures, acquisitions or other purposes which may be impaired or not available on favorable terms;

 

   

covenants contained in our loan agreements require us to meet financial tests that may affect our flexibility in planning for and reacting to changes in our business, including future business opportunities;

 

   

we may need a substantial portion of our cash flow from operations to make principal and interest payments on our indebtedness, reducing the funds that would otherwise be available for operations and future business opportunities; and

 

   

our level of indebtedness will make us more vulnerable to competitive pressures if there is a downturn in our business or the economy in general, than our competitors with less debt.

Our ability to service our indebtedness will depend upon, among other things, our future financial and operating performance, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors, some of which are beyond our control. If our operating results are not sufficient to service our current or future indebtedness, we will be forced to take actions such as reducing or delaying capital expenditures, acquisitions and/or, selling assets, restructuring or refinancing our indebtedness or seeking additional debt or equity capital or bankruptcy protection. We may not be able to affect any of these remedies on satisfactory terms or at all.

 

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A breach of the terms and conditions of our loan agreements, including the inability to comply with the required financial covenants, could result in an event of default. If an event of default occurs (after any applicable notice and cure periods), the lender would be entitled to accelerate the repayment of amounts outstanding (including accrued and unpaid interest and fees). Upon a default under the loan agreements, the lender could also foreclose against any collateral securing such obligations, which may be all or substantially all of our assets. If that occurred, we may not be able to continue to operate as a going concern.

We may not be able to compete effectively with larger, better-positioned companies, resulting in lower margins and loss of market share.

We operate in intensely competitive markets that experience rapid technological developments, market consolidation, changes in industry standards, changes in customer requirements, and frequent new product introductions and product improvements by existing and new competitors. If we are unable to anticipate or react to these competitive challenges or if existing or new competitors take or gain additional market share in any of our markets, our competitive position could weaken and we could experience a drop in revenues that could adversely affect our business and operating results. To compete successfully, we must maintain a successful research and development effort to develop new products and services and enhance existing products and services, effectively adapt to changes in the technology or product rights held by our competitors, appropriately respond to competitor strategies as such strategies become apparent, and effectively adapt to technological changes and changes in the ways that our information is accessed, used, and stored within our enterprise and consumer markets. If we are unsuccessful in responding to our competitors or to changing technological and customer demands, we could experience a negative effect on our competitive position and our financial results.

We compete with a variety of companies who have significantly greater revenues and financial resources, partners, resellers and distribution channels than GlobalSCAPE as well as greater personnel and technical resources. For example, the EFT Server solution suite competes with products from Sterling Commerce-IBM, Axway and several other vendors, and WAFS competes with Riverbed Technology and Cisco. Large companies may be able to develop new technologies, across multiple solution spaces, and on more operating systems, more quickly than we can, to offer a broader array of products, and to respond more quickly to new opportunities, industry standards or customer requirements. For example, Sterling Commerce receives substantial maintenance contract revenue annually, providing them with significant resources for product research, development and marketing.

Additional competitors may enter the market and also may have significantly greater capabilities and resources than we do. Some existing competitors also may be able to adopt more aggressive pricing strategies. For example, Ipswitch provides an older version of its consumer file transfer protocol program for free for non-commercial use, and Microsoft includes file transfer protocol functionality in its Internet browser, which it also distributes for free. Increased competition may result in lower operating margins and loss of market share.

We may incur losses as we attempt to expand our business.

We intend to expand our business and therefore expect to expend additional resources on continuing research and development, developing our sales force and a more robust reseller program, marketing, gaining traction in newly entered markets such as secure content mobility and cloud services, and potentially entering other new or adjacent markets.

If we do not successfully develop and introduce the new solutions to the market, are unable to improve our direct and channel sales results, or are unable to enter expected new markets, we may not be able to achieve the revenue growth associated with the business expansion expenditures and may not be profitable.

Maintenance revenue growth could decline.

Our revenues derived from maintenance and support services have increased over the last three years as a result of a growing base of installed products and our continued focus on M&S contract renewals. Declines in our

 

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license sales, adverse changes in our foreign currency exchange rates, increased discounting in maintenance renewal sales and/or a reduction in the extent to which our customers renew maintenance contracts would lead to declines in our maintenance revenue growth rates. As maintenance revenue makes up a substantial portion of our total revenue, any decline in our maintenance revenue could have an adverse impact on our business and financial results.

Our products are complex and operate in a wide variety of computer configurations, which could result in errors or product failures.

Addressing MFT, WAFS, CDP, Managed E-mail Attachment, cloud services, secure content mobility, and endpoint security market needs typically requires very complex products. Therefore, undetected errors, failures, or bugs may occur, especially when products are first introduced or when new versions are released. Our products are often installed and used in large-scale computing environments with different operating systems, system management software, and equipment and networking configurations, which may cause errors or failures in our products or may expose undetected errors, failures, or bugs in our products. Our customers’ computing environments also are often characterized by a wide variety of standard and non-standard configurations that make pre-release testing for programming or compatibility errors very difficult and time-consuming. In addition, despite testing by us and others, errors, failures, or bugs may not be found in new products or releases until after commencement of commercial shipments. In the past, we have discovered software errors, failures, and bugs in certain of our product offerings after their introduction and have experienced delayed or lost revenues during the time required to correct these errors.

Errors, failures, or bugs in products released by us could result in negative publicity, product returns, loss of or delay in market acceptance of our products, loss of competitive position, or claims by customers or others. Many of our end-user customers use our products in applications that are critical to their businesses and may have a greater sensitivity to defects in our products than to defects in other, less critical, software products. In addition, if an actual or perceived breach of information integrity or availability occurs in one of our end-user customer’s systems, regardless of whether the breach is attributable to our products, the market perception of the effectiveness of our products could be harmed. Alleviating any of these problems could require significant expenditures of our capital and other resources and could cause interruptions, delays, or cessation of our product licensing, which could cause us to lose existing or potential customers and could adversely affect our operating results. For example, it took longer than originally expected to make the necessary improvements to our WAFS solution and therefore WAFS revenues through 2009 were lower than originally anticipated.

Turmoil and uncertainty in U.S. and international economic markets could adversely affect our business and operating results.

Demand for our products depends in large part upon the level of capital and maintenance expenditures by many of our customers. The economic downturn in recent years has adversely impacted spending on information technology projects as prospects and customers reduce, sometimes greatly, their discretionary spending to focus on preserving mandatory spending budgets.

These adverse impacts to customer spending may be directly, and adversely, reflected in our future business and operating results because we believe a substantial part of the MFT spending budget is considered discretionary by our prospects and customers. The perception of MFT solutions spending as discretionary is further reinforced by the existence of low cost, or even free, products that deliver some subset of the capabilities found in our solutions. Given the recent economic downturn, some customers may have decided to defer spending for our solutions or may have elected to obtain low cost or free “good enough” products as an interim measure. The potential adverse impacts of such decisions may persist for an extended period of time, even well into a period of economic recovery, given that many prospects will not change their IT infrastructure for a considerable period of time once that infrastructure has been installed and is operating adequately.

 

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Adverse financial results from another economic downturn and uncertainty could include flat, or even decreasing, sales, lower gross and net margins, and impairment of current or future goodwill and long-lived assets. In addition, some of our customers could delay paying their obligations to us. Potentially reduced sales and margins and customer payment problems could limit our ability to fund research and development, marketing, sales, and other activities necessary to sustain and expand our market position.

Finally, like many other companies, our stock price decreased during the onset of the economic downturn. If investors have concerns that our business, financial condition and results of operations will be negatively impacted by a continued or worsened worldwide economic downturn, our stock price could decrease again.

Regardless of economic conditions, fluctuations in demand for our products and services are driven by many factors and a decrease in demand for our products could adversely affect our financial results.

We are subject to fluctuations in demand for our products and services due to a variety of factors, including competition, product obsolescence, technological change, budget constraints of our actual and potential customers, level of broadband usage, awareness of security threats to IT systems, and other factors. While such factors may, in some periods, increase product sales, fluctuations in demand can also negatively impact our product sales. If demand for our products declines, our revenues as well as our gross and net margins could be adversely affected. CuteFTP, in particular, competes in some ways with social media services for image and video sharing. As social media has increased exponentially in popularity, sales of our CuteFTP product line have continued to decline.

Sales to the U.S. Government make up a portion of our business and changes in government defense spending could have consequences on our financial position, results of operations and business.

In some recent years (2007 and 2009, for example) Government sales have accounted for 10% or more of our total sales. Our revenues from the U.S. Government largely result from contracts awarded to us under various U.S. Government programs, primarily defense-related programs with the Department of Defense (“DoD”). The funding of our programs is subject to the overall U.S. Government budget and appropriation decisions and processes which are driven by numerous factors, including geo-political events and macroeconomic conditions, and are beyond our control. The overall level of U.S. defense spending has increased in recent years for numerous reasons, including increases in funding of operations in Iraq and Afghanistan and the DoD’s modernization initiatives. Looking forward, we expect overall defense spending to remain relatively flat in the near term, given the military withdrawal from Iraq in December 2011 and the expected drawdown of military operations in Afghanistan. However, projected defense spending levels are uncertain and become increasingly difficult to predict for periods beyond the near-term due to numerous factors, including the external threat environment, funding for ongoing operations in Afghanistan, future priorities of the Administration and the overall health of the U.S. and world economies and the state of governmental finances.

Significant changes in defense spending could have long-term consequences for our size and structure. In addition, changes in government priorities and requirements could impact the funding, or the timing of funding, of our programs which could negatively impact our results of operations and financial condition. Larger government contracts, such as the Army contracts we were awarded in 2007 and 2009, typically have long sales cycles. Therefore, closure of such contracts is difficult to predict, increasing uncertainty in our projections.

U.S. Government contracts generally also permit the government to terminate the contract, in whole or in part, without prior notice, at the government’s convenience or for default based on performance. If one of our contracts is terminated for convenience, we would generally be entitled to payments for our allowable costs and would receive some allowance for profit on the work performed. If one of our contracts is terminated for default, we would generally be entitled to payments for our work that has been accepted by the government. A termination arising out of our default could expose us to liability and have a negative impact on our ability to obtain future contracts and orders. Furthermore, on contracts for which we are a subcontractor and not the prime contractor, the U.S. Government could terminate the prime contract for convenience or otherwise, irrespective of our performance as a subcontractor.

 

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Finally, because we are a DoD contractor, certain GlobalSCAPE items and/or transactions may be subject to the International Traffic in Arms Regulations (“ITAR”) if our software or services are specifically designed or modified for defense purposes. Companies engaged in manufacturing or exporting ITAR-controlled goods and services (even if these companies do not export such items) are required to register with the U.S. State Department. Failure to comply with these requirements could result in fines and sanctions which could negatively impact our results of operations and financial condition.

If we fail to manage our sales and distribution channels effectively or if our partners choose not to market and sell our products to their customers, our operating results could be adversely affected.

We sell our products to customers primarily through our direct sales force and through resellers. Sales through these different channels involve distinct risks, including the following:

Direct Sales. Most of our revenue is derived from sales by our direct sales force to end-users. Special risks associated with this sales channel include:

 

   

Longer sales cycles associated with direct sales efforts;

 

   

Difficulty in hiring, retaining, and motivating our direct sales force;

 

   

Substantial amounts of training for sales representatives to become productive, including regular updates to cover new and revised products; and

 

   

Reliance on leads obtained from paid advertising (for example, Google ads) could materially impact direct sales should advertising effectiveness decline due to non-attributable declines in leads, unforeseen search engine algorithm changes, or other occurrences that may adversely impact the lead generation aspects of the direct sales cycle. In addition, increased competition may materially impact the costs associated with such advertising.

Indirect Sales Channels. A significant portion of our revenue is derived from sales through indirect channels, including distributors and partners that sell our products to end-users and other resellers. This channel involves a number of risks, including:

 

   

Our lack of control over the timing of delivery of our products to end-users;

 

   

Our resellers and distributors currently are not subject to minimum sales requirements or any obligation to market our products to their customers;

 

   

Our reseller and distributor agreements are generally nonexclusive and may be terminated at any time without cause; and

 

   

Our resellers and distributors frequently market and distribute competing products and may, from time to time, place greater emphasis on the sale of these products due to pricing, promotions, and other terms offered by our competitors.

We cannot be certain that our distribution channel partners will continue to market or sell our products effectively. If we are not successful, we may lose sales opportunities, customers and revenues.

If we lose key personnel we may not be able to execute our business plan.

Our future success depends on the continued services of key members of our management team. These individuals are difficult to replace because of the intense competition for similarly skilled people. In addition, new members of the management team may not be productive for weeks or months as they learn about our solutions, our personnel, and the administrative practices within GlobalSCAPE.

 

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Failure to maintain proper and effective internal controls, could affect our ability to produce accurate financial statements, which could result in the restatement of our financial statements or adversely affect our operating results, our ability to operate our business and our stock price.

Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. We maintain a system of internal control over financial reporting, which is defined as a process designed by, or under the supervision of, our principal executive officer and principal financial officer, or persons performing similar functions, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

If we are unable to establish and maintain appropriate internal financial reporting controls and procedures, it could cause us to fail to meet our reporting obligations, result in the restatement of our financial statements, harm our operating results, subject us to regulatory scrutiny and sanction, cause investors to lose confidence in our reported financial information and have a negative effect on the market price for shares of our Common Stock.

Our ability to develop our software will be seriously impaired if we are not able to use our foreign subcontractors.

We rely on foreign subcontractors to help us develop some aspects of some of our software. If these programmers decided to stop working for us, or if we were unable to continue using them because of political or economic instability, we would have difficulty finding comparably skilled developers in a timely manner. In addition, we would likely have to pay considerably more for the same work, especially if we used U.S. personnel. If we could not replace the contract programmers, it would take us significantly longer to develop certain products and product upgrades.

It may be difficult for us to recruit and retain software developers and other technical and management personnel because we are a relatively small company.

We compete intensely with other software development and distribution companies internationally and IT departments supporting larger businesses to recruit and hire from a limited pool of qualified personnel. Some qualified candidates prefer to work for larger, better known companies or in another geographic area. In order to attract and retain personnel in a competitive marketplace, we believe that we must provide a competitive compensation package, including cash and equity-based compensation. The volatility in our stock price may from time to time adversely affect our ability to recruit or retain employees. In addition, we may be unable to obtain required stockholder approvals of future increases in the number of shares available for issuance under our equity compensation plans. Also, accounting rules require us to treat the issuance of employee stock options and other forms of equity-based compensation as compensation expense. As a result, we may decide to issue fewer equity-based incentives and may be impaired in our efforts to attract and retain necessary personnel. If we are unable to hire and retain qualified employees, or conversely, if we fail to manage employee performance or reduce staffing levels when required by market conditions, our business and operating results could be adversely affected.

Key personnel have left our Company in the past and there likely will be additional departures of key personnel from time to time in the future. The loss of any key employee could result in significant disruptions to our operations, including adversely affecting the timeliness of product releases, the successful implementation and completion of company initiatives, the effectiveness of our disclosure controls and procedures and our internal control over financial reporting, and the results of our operations. In addition, hiring, training, and successfully integrating replacement sales, engineering, and other personnel could be time consuming, may cause additional disruptions to our operations, and may be unsuccessful, which could negatively impact future revenues.

 

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Our operations potentially are vulnerable to security breaches that could harm the quality of our products and services or disrupt our ability to deliver our products and services.

Information security is a dynamic discipline that historically has faced a threat that develops and emerges in sometimes-unpredictable ways. Third parties may breach our system and information security and damage our products and services or misappropriate confidential customer information. This might cause us to lose customers, or even cause customers to make claims against us for damages. In addition, we may be required to expend significant resources to protect against potential or actual security breaches and/or to address problems caused by such breaches.

Improper disclosure of personal data could result in liability and harm our reputation.

While we have derived the majority of our historical revenues from on premise delivery of our products, we are increasingly offering our products on third party hosted platforms As we continue to execute our strategy of increasing the number and scale of our cloud-based offerings, we store and process increasingly large amounts of personally identifiable information of our customers. At the same time, the continued occurrence of high-profile data breaches provides evidence of an external environment increasingly hostile to information security. This environment demands that we continuously improve our design and coordination of security controls. Despite these efforts, it is possible our security controls over personal data, our training of employees and vendors on data security, and other practices we follow may not prevent the improper disclosure of personally identifiable information. Improper disclosure of this information could harm our reputation, lead to legal exposure to customers, or subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. We believe customers using our subscription services will increasingly want efficient, centralized methods of choosing their privacy preferences and controlling their data. Perceptions that our products or services do not adequately protect the privacy of personal information could inhibit sales of our products or services, and could constrain consumer and business adoption of cloud-based solutions.

We utilize “open source” software in some of our products.

The open source software community develops software technology for free use by anyone. We incorporate a limited amount of open source code software into our products. For example, we have relied on open source technology for the encryption features in our CuteFTP Pro, EFT Server, and Mail Express solutions. We may use more open source code software in the future.

Our use, in some instances, of open source code software may impose limitations on our ability to commercialize our solutions and may subject us to possible intellectual property litigation. Open source code may impose limitations on our ability to commercialize our products because, among other reasons, open source license terms may be ambiguous and may result in unanticipated obligations regarding our solution, and open source software cannot be protected under trade secret law. In addition, it may be difficult for us to accurately determine the developers of the open source code and whether the acquired software infringes third-party intellectual property rights. As a result, we could be subject to suits by parties claiming ownership of what we believe to be open source software. From time to time companies that incorporate open source software into their products have been subject to such claims.

Claims of infringement or misappropriation against us could be costly for us to defend and could require us to re-engineer our solution or to seek to obtain licenses from third parties in order to continue offering our solution. We also might need to discontinue the sale of our solution in the event re-engineering could not be accomplished on a timely or cost-effective basis. If any such claim, attempted remediation, or solution discontinuance occur, our business and operating results could be harmed.

 

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Our products may expose customers to invasion of privacy, causing customer dissatisfaction.

Our EFT Server suite, Mail Express, and TappIn solutions are intended to facilitate information sharing, sometimes by providing outsiders access to a customer’s computer. Such access potentially may make the customer vulnerable to security breaches, which could result in the loss of their privacy or property. Similarly, appShield is intended to block execution of malicious software, typically serving as a last line of defense alongside traditional antivirus solutions. Invasions of privacy or other customer harm occurring in an environment where our solutions are operating could result in customer dissatisfaction and possible claims against us for any resulting damages.

Increased customer demands on our technical support services may adversely affect our relationships with our customers and our financial results.

We offer technical support services with many of our products. We may be unable to respond quickly enough to accommodate short-term increases in customer demand for support services. We also may be unable to modify the format of our support services to compete with changes in support services provided by competitors or successfully integrate support for our customers. Further customer demand for these services could increase our costs and, without corresponding increasing revenues, adversely affect our operating results.

We are subject to governmental export and import controls that could subject us to liability or impair our ability to compete in international markets.

All products that are exported, re-exported or that are worked on by foreign nationals are subject to export controls. Such controls include prohibitions on end uses, end users and country prohibitions. In addition, incorporation of encryption technology into our products can increase the level of U.S. export controls. The encryptions export controls were modified last year. We are subject to these requirements as certain of our products include the ability for the end user to encrypt data. Therefore, our products may be exported outside the United States or revealed to foreign nations only with the required level of export controls/restrictions. Restrictions applicable to our products may include: the requirement to have a license to export the technology; the requirement to have software licenses approved before export is allowed; and outright bans on the licensing of certain encryption technology to particular end users or to all end users in a particular country. In addition, various countries regulate the import of certain technology and have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries.

There can be no assurance that we will be successful in obtaining or maintaining the licenses and other authorizations required to export our products from applicable government authorities. Any change in export or import regulations or related legislation, shift in approach to the enforcement or scope of existing regulations, or change in the list of countries to which we cannot export, changes in persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations. Changes in our products or changes in export and import regulations may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products throughout their global systems or, in some cases, prevent the export or import of our products to certain countries altogether. Any change in export or import regulations or related legislation, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations.

Export laws and regulations can be extremely complex in their application. If we are found not to have complied with applicable export control laws, we may be sanctioned, fined or penalized by, among other things, having our ability to obtain export licenses curtailed or eliminated, possibly for an extended period of time. Our failure to receive or maintain any required export licenses or authorizations or our penalization for failure to comply with applicable export control laws would hinder our ability to sell our products, could result in financial

 

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penalties, and could materially adversely affect our business, financial condition, and results of operations. Any failure on our part or the part of our distributors to comply with encryption or other applicable export control requirements which could harm our business and operating results.

Finally, import and export regulations of encryption/decryption technology vary from country to country. We may be subject to different statutory or regulatory controls in different foreign jurisdictions, and as such, our technology may not be permitted in these foreign jurisdictions. Violations of foreign regulations or regulation of international transactions could prevent us from being able to sell our products in international markets. Our success depends in large part to having access to international markets. A violation of foreign regulations could limit our access to such markets and have a negative effect on our results of operations.

As our international sales grow, we could become increasingly subject to additional risks that could harm our business.

We conduct significant sales and customer support, in countries outside of the United States. During the year ended December 31, 2011, approximately 31% of our sales were to purchasers outside the United States. Our continued growth and profitability could require us to further expand our international operations. To successfully expand international sales, we must establish additional foreign operations, hire additional personnel and recruit additional international resellers. In addition, there is significant competition for entry into high growth markets, such as China. Our international operations are subject to a variety of risks, which could cause fluctuations in the results of our international operations. These risks include:

 

   

compliance with foreign regulatory and market requirements;

 

   

variability of foreign economic, political and labor conditions;

 

   

changing restrictions imposed by regulatory requirements, tariffs or other trade barriers or by U.S. export laws;

 

   

longer accounts receivable payment cycles;

 

   

potentially adverse tax consequences;

 

   

difficulties in protecting intellectual property;

 

   

burdens of complying with a wide variety of foreign laws; and

 

   

as we generate cash flow in non-U.S. jurisdictions, if required, we may experience difficulty transferring such funds to the U.S. in a tax efficient manner.

Risks Related to Stock Ownership

Our stock price is/may be volatile.

The trading price of our common stock has been and could continue to be subject to wide fluctuations in response to certain factors, including:

 

   

U.S. and global economic conditions leading to general declines in market capitalizations, with such declines not associated with operating performance;

 

   

Quarter-to-quarter variations in results of operations;

 

   

Our announcements of new products;

 

   

Our announcements of acquisitions;

 

   

Our announcements of significant new customers or contracts;

 

   

Our competitors’ announcements of new products;

 

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Our product development or release schedule;

 

   

General conditions in the software industry; and

 

   

Investor perceptions and expectations regarding our products, plans and strategic position and those of our competitors and customers.

In addition, the public stock markets experience extreme price and trading volume volatility particularly in high-technology sectors of the market. This volatility has significantly affected the market prices of securities of many technology companies for reasons often unrelated to the operating performance of the specific companies. The broad market fluctuations may adversely affect the market price of our common stock.

Accounting charges may cause fluctuations in our annual or quarterly financial results.

Our financial results may be affected by non-cash and other accounting charges, including:

 

   

Amortization of intangible assets, including acquired technology and product rights;

 

   

Acquisition expenses;

 

   

Impairment of goodwill and intangibles;

 

   

Stock-based compensation expense;

 

   

Restructuring charges; and

 

   

Impairment of long-lived assets

Anti-takeover provisions in our charter and Delaware law could inhibit others from acquiring us.

Some of the provisions of our certificate of incorporation and bylaws and in Delaware law could, together or separately:

 

   

Discourage potential acquisition proposals;

 

   

Delay or prevent a change in control; and

 

   

Limit the price that investors may be willing to pay in the future for shares of our common stock.

In particular, our certificate of incorporation and bylaws prohibit stockholders from voting by written consent or calling meetings of the stockholders. We are also subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any interested stockholder, as defined in the statute, for a period of three years following the date on which the stockholder became an interested stockholder.

Our directors and executive officers continue to have substantial control over us.

Our directors and executive officers, together with their affiliates and related persons, beneficially owned, in the aggregate, approximately 44% of our outstanding common stock at December 31, 2011. As a result, these stockholders would have the ability to control GlobalSCAPE and direct its policies including the outcome of matters submitted to our stockholders for approval, such as the election of directors and any acquisition or merger, consolidation or sale of all or substantially all of our assets. In addition, our certificate of incorporation and bylaws provide for our Board of Directors to be divided into three classes of directors serving staggered three-year terms. As a result, approximately one-third of our Board of Directors will be elected each year.

 

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Stockholders’ ownership of our stock may be significantly diluted, affecting the value of the stock.

There were options for 4,490,895 shares outstanding under our employee and director stock option plans as of March 1, 2012, of which 2,407,029 were vested. We have filed a registration statement under the Securities Act, covering stock issued upon the exercise of options by non-affiliates, and we may file a registration statement covering options held by affiliates as well. If we do not file a registration statement covering affiliates, affiliates who exercise their options may choose to sell the stock under an exemption from registration, such as Rule 144 under the Securities Act. The exercise of these options and sale of the resulting stock could depress the value of our stock.

Risks Related to Intellectual Property

We are vulnerable to claims that our products infringe third-party intellectual property rights particularly because our products are partially developed by independent parties.

From time to time we experience claims that our products infringe third-party intellectual property rights. We may be exposed to future litigation based on claims that our products infringe the intellectual property rights of others. This risk is exacerbated by the fact that some of the code in our products is developed by independent parties or licensed from third parties over whom we have less control than we exercise over internal developers. In addition, we expect that infringement claims against software developers will become more prevalent as the number of products and developers grows and the functionality of software programs in the market increasingly overlaps. Companies in the technology industry, and other patent and trademark holders seeking to profit from royalties in connection with grants of licenses, own large numbers of patents, copyrights, trademarks, service marks, and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. In addition, we may be the target of aggressive and opportunistic enforcement of patents by third parties, including non-practicing entities.

Responding to and defending against such claims may cause us to incur significant expense and divert the time and efforts of our management and employees. Successful assertion of such claims could require that we pay substantial damages or ongoing royalty payments, prevent us from selling our products and services, damage our reputation, or require that we comply with other unfavorable terms, any of which could materially harm our business. In addition, we may decide to pay substantial settlement costs in connection with any claim or litigation, whether or not successfully asserted.

While it is not possible to predict the outcome of patent litigation incident to our business, defense costs may be significant and we believe the costs associated with this litigation or other claims of infringement could generally have a material adverse impact on our results of operations, financial position or cash flows. Regardless of the merit of such claims, responding to infringement claims can be expensive and time-consuming.

For any intellectual property rights claim against us or our customers, we may have to pay damages and indemnify our customers against damages.

Claims of infringement could require us to re-engineer our products or seek to obtain licenses from third parties in order to continue offering its products. In addition, an adverse legal decision affecting our intellectual property, or the use of significant resources to defend against this type of claim could place a significant strain on our financial resources and harm our reputation.

We may not be able to protect our intellectual property rights.

Our software code, and trade and service marks are some of our most valuable assets. Given the global nature of the internet and our business, we are vulnerable to the misappropriation of this intellectual property, particularly in foreign markets, such as China and Eastern Europe, where laws or law enforcement practices are less developed. The global nature of the internet makes it difficult to control the ultimate destination or security

 

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of our software making it more likely that unauthorized third parties will copy certain portions of our proprietary information or reverse engineer the proprietary information used in its programs. If our proprietary rights were infringed by a third-party, and we did not have adequate legal recourse, our ability to earn profits, which are highly dependent on those rights, would be severely diminished.

Other companies may own, obtain or claim trademarks that could prevent, limit or interfere with our use of our trademarks.

Our various trademarks are important to our business. If we were to lose the use of any of our trademarks, our business would be harmed and we would have to devote substantial resources towards developing an independent brand identity. Defending or enforcing our trademark rights at a local and international level could result in the expenditure of significant financial and managerial resources.

 

Item 1B. Unresolved Staff Comments

None

 

Item 2. Properties

Our corporate office is located in an office building in northwest San Antonio. The annual rent on the eleven year lease of the 21,495 square foot facility averages $327,000. We believe the current facility in San Antonio is suitable for our current business needs and that suitable additional space will be available on acceptable terms if needed.

TappIn’s office at December 31, 2011 was located in Freemont, Washington which is close to Seattle, Washington. The annual rent on the lease averages $12,000 and the lease expired on December 31, 2011. TappIn will be moving into their new office space in downtown Seattle, Washington in March, 2012. The new location will be a 5,287 square foot office space which is on the fifth floor of a 42,307 square foot building. The annual rent on the lease averages $126,000. We believe the new facility in Seattle is suitable for our current business needs.

 

Item 3. Legal Proceedings

GlobalSCAPE has been named as one of a number of defendants in two different patent infringement suits. The first was filed by Content Delivery Solutions LLC in the United States District Court for the Western District of Texas Austin Division. The complaint alleges that GlobalSCAPE infringed on a patent that addresses products or services for resuming interrupted transmission of a file over a network. The second was filed by Achates Reference Publishing, Inc. in the United States District Court for the Eastern District of Texas Marshall Division. The complaint alleges that GlobalSCAPE infringed on a patent that addresses product activation functionality. Both of these matters have just been brought forth and, while GlobalSCAPE believes that it has meritorious defenses to both plaintiffs’ claims and intends to defend the lawsuits vigorously, it is early in its process and it is not possible to reasonably determine the outcome of these suits. Accordingly, it is not possible at this time to assess whether or not we need to reserve for potential settlements.

 

Item 4. Mine Safety Disclosures

Not Applicable.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity

Our common stock is listed on the NYSE Amex under the symbol “GSB” The following table sets forth the quarterly high and low closing sale prices for our common stock for the last two fiscal years.

 

     Common Stock Price  
     2011      2010  
     High      Low      High      Low  

First Quarter (ending March 31)

   $ 3.14       $ 1.98       $ 1.85       $ 1.35   

Second Quarter (ending June 30)

   $ 2.86       $ 1.92       $ 3.12       $ 1.27   

Third Quarter (ending September 30)

   $ 2.38       $ 1.42       $ 3.01       $ 2.06   

Fourth Quarter (ending December 31)

   $ 2.17       $ 1.50       $ 2.64       $ 1.78   

Annual

   $ 3.14       $ 1.42       $ 3.12       $ 1.27   

On March 15, 2012, the last reported sales price of our common stock on the NYSE Amex was $2.28 per share. As of March 15, 2012, we had approximately 2,069 shareholders of record of our common stock.

We do not intend to declare or pay cash dividends in the foreseeable future and our loan agreements do not allow us to pay any dividends. Our management anticipates that all earnings and other cash resources, if any, will be retained for investment in our business.

 

Item 6. Selected Financial Data

The following selected financial data is derived from the Financial Statements included in this annual report. This data is qualified in its entirety by and should be read in conjunction with the more detailed Financial Statements and related notes included in this annual report and with Item 8, Financial Statements and Supplementary Data. Historical results may not be indicative of future results.

On December 2, 2011 we acquired TappIn, Inc. This acquisition was accounted for as a stock purchase and, accordingly, the operating results of that business have been included in the Financial Statements included in this annual report since the date of acquisition.

 

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Statement of Operations Data:

 

($ in thousands)    2011      2010      2009      2008     2007  

Total revenues

   $ 20,894       $ 18,565       $ 16,451       $ 15,792      $ 18,360   

Operating expenses:

             

Cost of revenues

     1,723         601         336         189        250   

Selling, general and administrative

     14,466         12,815         10,798         10,944        10,049   

Research and development

     3,124         3,016         2,805         2,819        1,919   

Impairment of goodwill

     0         0         0         5,773        0   

Impairment of long-lived assets

     0         0         0         3,244        0   

Depreciation and amortization

     790         852         724         957        280   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total operating expenses

     20,103         17,284         14,663         23,926        12,498   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Income (loss) from operations

     791         1,281         1,788         (8,134     5,862   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ 635       $ 881       $ 1,400       $ (7,660   $ 3,642   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss) per common share—basic

   $ 0.04       $ 0.05       $ 0.08       $ (0.44   $ 0.21   

Net income (loss) per common share—diluted

   $ 0.03       $ 0.05       $ 0.08       $ (0.44   $ 0.20   

Balance Sheet Data:

 

             
($ in thousands)    2011      2010      2009      2008     2007  

Cash and cash equivalents

   $ 8,861       $ 11,087       $ 7,026       $ 6,319      $ 5,214   

Working captial

   $ 1,662       $ 8,607       $ 5,540       $ 4,435      $ 5,074   

Total assets

   $ 39,308       $ 20,547       $ 16,173       $ 12,220      $ 20,362   

Long term debt, less current portion

   $ 5,667       $ —         $ —         $ —        $ —     

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our financial statements for the years ended December 31, 2011, 2010 and 2009 and related notes included elsewhere in this document.

Overview

We provide secure information exchange capabilities for consumers and enterprise through the development and distribution of software, delivery of managed and hosted solutions, and provision of associated services. Since our organization in 1996, we have evolved from a company focused primarily on personal file transfer products, sold over the Internet, to a solution provider deriving over 90 percent of revenue from sales to small and medium business, or SMB, and enterprise customers worldwide. Today, we have thousands of enterprise customers and more than one million individual consumers in over 150 countries. In addition, our solutions are used by more than 20,000 U.S. Army users deployed worldwide.

Historically, we have operated primarily in the Managed File Transfer, or MFT, industry, with the majority of our revenue derived from sales of on-premises software licenses and associated maintenance and support contracts. Beginning in 2009, we began an evolution from an ‘MFT company’ into adjacent solution spaces applicable to what we refer to as Total Path Security. The Total Path Security framework addresses data and information security in motion (for example, with traditional MFT solutions delivered as on-premises software or as a cloud service) and at rest (for example, with endpoint security solutions such as appShield). Our solution portfolio facilitates delivery of critical information such as financial data, medical records, customer files and other similar documents while supporting a range of information protection approaches to meet privacy and other security requirements. Most recently, in December 2011, we announced the acquisition of TappIn, Inc. (or “TappIn”). TappIn provides technology that allows users to access their digital files and media such as pictures,

 

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documents, videos and music stored on a computer using a web-browser, tablet or mobile smartphone (including Apple iPhone and iPad, Google Android and Windows Phone 7) without having to upload, organize and sync files between devices or pay for additional cloud storage. We also continue to plan for our entry into the antivirus segment of the endpoint security market through development of appShield, a software application control (or “whitelisting”) product.

Our evolution from an ‘MFT Company’ into adjacent solution spaces reflects ongoing, fundamental changes in how consumers and businesses access and exchange information. For example, there has been an exponential increase in Internet-enabled mobile devices such as smartphones and tablet computers. This, in turn, has driven a movement toward ‘Bring Your Own Device’ (or “BYOD”), an operating model in which business users increasingly are using their mobile devices to access and exchange employer information while also using those same devices for personal applications. The continued growth of cloud-based services is another fundamental market driver, as individual consumers and businesses become increasingly comfortable with these services for at least some personal and business applications.

As we consider key market drivers in aggregate, we believe there is a current and growing market opportunity for providing on-premises, cloud-based, and mobile access to personal and business information while addressing the security and compliance issues that are important considerations for our customers as they access and exchange such information. While on-premises solutions will remain an important part of our portfolio for the foreseeable future, we believe increasing demand for secure content mobility and adoption of cloud-based solutions are long-term trends that increasingly will shape the market outlook and demand for our solutions.

Key Business Metrics

We have structured our business model to sell an appropriate mix of software licenses (for on-premises use), maintenance and support (“M&S”), cloud-based subscription solutions, and professional services. We review a number of key business metrics on an ongoing basis to help us monitor our performance and to identify material trends which may affect our business. The measures that we believe are the primary indicators of our performance are:

 

   

Revenue Growth;

 

   

Recurring Revenue Growth;

 

   

Aggregate Contract Value; and

 

   

EBITDA.

We have developed an internal management dashboard that summarizes certain business metrics and also supports drill-down analyses of some sales, marketing, and support activities that also provide indicators of our business performance.

Revenue Growth

Since 1996, we have transitioned from a consumer products company (mostly focused on CuteFTP) to an enterprise solutions provider with growing revenue contribution from cloud-based solutions and professional services. We have grown revenue consistently throughout this transition, even as revenue from our consumer products declined from more than 50 percent of revenue as recently as 2005 to less than 10 percent today. We believe our ability to sustain revenue growth while continuing our business transformation is the most significant metric for our business.

 

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Although we often have grown revenue sequentially, quarter over quarter, in recent years we view annual revenue growth as the more important metric, especially considering the ongoing evolution of our solution portfolio. We believe annual “core” revenue growth, excluding very large, exceptional deals, is a key metric for monitoring our continued success in developing our business in future periods. Given our diverse solution portfolio, and especially with the addition of subscription services, we review our revenue mix and changes in revenue, across all solutions, on a regular basis to identify key trends and adjust resource allocations.

Our annual revenue increased by 13.3% in 2011, a slight increase over the 12.9% increase realized in 2010. We believe this increase in revenue growth rate, though modest, is significant because it occurred as we continued to add additional subscription revenue and build aggregate contract value. We believe our annual revenue growth rate could have been higher in 2011, had we focused only on sales of on-premises software licenses which would have had a more immediate positive impact on our 2011 revenue, but at the expense of revenue growth in future periods. In addition, we believe there is a clear market trend toward increasing adoption of cloud-based solutions and we believe establishing traction in this market segment is a significant factor in our continued ability to grow revenue in future years.

Recurring Revenue Growth

Recurring revenue includes revenue recognized from our M&S contracts, managed and hosted solutions, and other subscription services such as TappIn by GlobalSCAPE. Maintenance and support contracts for our products are sold for fixed periods of time and are typically for one year, although some agreements are for longer terms. We recognize revenue from these agreements on a monthly basis over the life of the contract. Managed and hosted solutions, such as MIX and Hosted EFT Server, are sold as one, two, or three-year subscriptions, with the services invoiced and recognized on a monthly basis. TappIn subscriptions typically are sold for one-year terms, with the revenue also recognized on a monthly basis.

Recurring revenue provides a more predictable revenue stream in future periods and, we believe, is more highly valued by institutional investors and other market participants. We review recurring revenue trends periodically to determine the progress of our M&S and cloud solution sales, and customer satisfaction with our ongoing solution development and support activities. We also assess how aggregate contract value (see below) will factor into possible recurring revenue in future periods.

We have grown recurring revenue in recent years from 37 percent in 2009, to 42 percent in 2010 and 46 percent in 2011. We believe the level of deferred revenue is an important indicator of our success in satisfying and retaining existing customers, as well as in establishing longer-term relationships with new customers. If we do not deliver the support needed by end users of our products, then they may not renew their maintenance and support agreements. If end users stop using our products, they also typically will not renew their maintenance and support agreements. Similarly, if customers are not satisfied with our delivery of managed solutions, they may terminate their subscriptions, adversely impacting future recurring revenue. An increase in deferred revenues thus indicates growth in our installed base and satisfaction with our products, maintenance and support services, and managed solutions. We expect deferred revenue to continue to grow in 2012 both in absolute terms and as a percentage of total revenue.

Aggregate Contract Value Growth

Aggregate contract value (or “ACV”) is the sum of:

 

1. Deferred Revenue carried on the balance sheet (e.g., from maintenance and support and professional services), plus

 

2. Subscription services, remaining MAT contract payments, and any other non-cancellable contracted sales that have not yet been recognized into revenue or carried on the balance sheet as deferred revenue.

Our ACV results from sales of certain managed solutions and professional services. Specifically, managed solutions contribute to ACV when they are sold and subsequently invoiced on a monthly basis (rather than

 

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invoiced in their entirety in advance). The McLane Advanced Technologies professional services contract also contributes to ACV because we submit invoices to the customer monthly, as the services are delivered and recognizable into revenue. We have grown ACV from $6.7 million as of December 31, 2010 (consisting only of our deferred revenue balance) to approximately $8.8 million as of December 31, 2011. We expect ACV may grow in future periods as we increase sales and renewals of maintenance and support contracts and sales of managed solutions and possibly receive additional long-term professional services contracts (or the customer exercises the last option year on the MAT contract).

ACV is not a measure of financial performance under accounting principles generally accepted in the United States (“GAAP”) and should not be considered a substitute for deferred revenue; however, management uses this metric to assess the effectiveness of sales and business development activities, and how that effectiveness will factor into future revenue. We have maintained increased visibility into ACV in recent years because, with the addition of subscription services and increased sales of professional services, we believe sales growth may significantly outpace revenue growth in the near term. ACV, together with recurring revenue and deferred revenue trends, provides greater insight into how bookings will factor into revenue over specific periods. The following is a reconciliation of ACV to deferred revenue at December 31, 2011 ($ in thousands):

 

     December 31,  
     2011      2010  

Deferred Revenue

   $ 7,600       $ 6,700   

Subscription services + MAT contract payments + Other non-cancellable contracted sales not recognized as revenue or recorded as deferred revenue

     1,200         —     
  

 

 

    

 

 

 

Total ACV

   $ 8,800       $ 6,700   
  

 

 

    

 

 

 

Adjusted EBITDA

Management utilizes Adjusted EBITDA or Earnings Before Interest, Taxes, Total Other Income (Expense), Depreciation and Amortization and Stock-based compensation expense to monitor spending and profitability of the Company. We monitor and review selling, general, and administrative (“SG&A”) and R&D expenses to assess conformance with established budget expectations and identify specific variances. Identifying and, if necessary, addressing variances above budget is important for the very clear purpose of staying within budget ceilings. However, even variances below budget may indicate imbalances in resource allocations or deviation of operating activities from established expectations. We have increased SG&A expenses in recent years, primarily to enhance our executive team and make other investments necessary to grow our business. Similarly, we have sustained our R&D investments to provide a continuing basis for specifying and developing new solutions like our recently announced cloud-based offerings and appShield.

 

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Adjusted EBITDA is not a measure of financial performance under accounting principles generally accepted in the United States (“GAAP”) and should not be considered a substitute for net income. We define Adjusted EBITDA as Net Income, plus Income Taxes, Total Other Income (Expense), Depreciation and Amortization, and stock-based compensation expense. Adjusted EBITDA has limitations as an analytical tool, and when assessing our operating performance, Adjusted EBITDA should not considered in isolation, or as a substitute for net income or other income statement data prepared in accordance with GAAP. The following is a reconciliation of Adjusted EBITDA to net income for the periods indicated.

 

     Year Ended  
     December 31,
2011
    December 31,
2010
    December 31,
2009
 
     ($ in thousands)  

Net Revenue

   $ 20,894      $ 18,565      $ 16,451   

Income from operations

     791        1,281        1,788   

Net income:

     635        881        1,400   

Plus: Income taxes

     169        410        321   

Plus: Total other (income) expense

     (13     (10     67   

Plus: Depreciation and amortization

     790        852        724   

Plus: Stock-based compensation expense

     1,003        1,006        1,021   
  

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 2,584      $ 3,139      $ 3,533   
  

 

 

   

 

 

   

 

 

 

Adjusted EBITDA in 2011 was adversely impacted by approximately $540,000 in non-recurring, charges related to the acquisition of TappIn. We also had a significant income tax credit in 2011 as reflected in the table above.

Generally, we expect Adjusted EBITDA to increase back to our recent historical norms or even increase, as a percentage of revenue, in future years after a potential transition period due to the impact of the TappIn acquisition.

Solution Perspective and Trends

The following is a summary description of our solutions and associated business trends:

Managed File Transfer Solutions (On Premises and Cloud-based)

Our MFT solutions allow customers to move large files (even multi-terabyte in size) and large numbers of files securely. We also facilitate management, monitoring, and reporting on the file transfers and deliver advanced workflow capabilities to move data and information into and throughout an enterprise.

The CuteFTP product is the best known of our file transfer solutions. CuteFTP is a client-side software application that permits users to upload and download files, to or from an FTP server or host computer, with support for various file transfer and security protocols such as FTP, SSL, and SSH, plus open PGP encryption. While CuteFTP still has significant brand recognition in the market, it currently accounts for approximately 6 percent of our revenue, down from almost 60 percent as recently as 2005. We believe subsequent market availability of free FTP utilities plus the emergence of social media and proliferation of means for sharing non-sensitive data such as photos and videos, for example, are the proximate cause of the decline in CuteFTP revenue. However, we are planning to release a major upgrade of CuteFTP in 2012 and believe this potentially may slow the rate of decrease in CuteFTP revenue in the second half of 2012 and into 2013.

We derive most, approximately 75 percent, of our revenue from software license sales of our Enhanced File Transfer Server solution suite. The Enhanced File Transfer Server solution suite provides a common, scalable MFT platform that accommodates a broad family of add-on modules to provide SMB and enterprise customers

 

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with increased security, automation, and performance when compared to traditional FTP-based and e-mail delivery systems. The add-on modules allow customers to select the solution configuration most applicable to their requirements for auditing and reporting, encryption, ad hoc and web-based file transfers, operability in or through a DMZ network, and integration with back-end business processes, including workflow automation capabilities. We continue to develop the Enhanced File Transfer solution suite, for example to increase performance, provide additional administration flexibility, and support cross-platform implementation with our DMZ Gateway solution. Revenue for this product line has grown on a sustained basis in recent years from approximately $12.5 million per year in 2009 to approximately $15.9 million in 2011.

Since 2010, we have executed a partner agreement with Rackspace Hosting that allows us to deliver cloud-based MFT solutions for the secure exchange of business-to-business (“B2B”) data, including large files and sensitive data. We also established additional hosting partner arrangements in 2011 that extended our cloud-based delivery services to include additional capacity in the United Kingdom and Canada. Our cloud-based solutions allow customers to outsource all or part of their complex and demanding information exchange needs to reduce costs, improve operational efficiencies, track and audit transactions, and provide a greater level of security.

The cloud-based solutions established an additional delivery method for Enhanced File Transfer Server capabilities, and potentially for other solution capabilities. Through our cloud services, we can offer new and existing customers “pay as you go”, flexible pricing under one, two, and three-year contracts that help them eliminate upfront capital expenditures. This subscription revenue provides us with a growing revenue stream visible into future periods.

Wide Area File Services and Continuous Data Protection Solution

We obtained the original technology used in our Wide Area File Services and Continuous Data Protection software through the acquisition of Availl, Inc in 2006. Together, WAFS and CDP allow users to synchronize files among distributed teams, sending only the changed data, quickly and transparently to end user users, with continuous real-time backup. This approach ensures currency of data at each supported site and also significantly reduces bandwidth usage compared to traditional information sharing process that support collaboration across multiple locations.

Through the 2009 timeframe, we devoted considerable attention to improving the performance and overall quality of the WAFS solution after the Availl acquisition. Sales of the WAFS/CDP family of solutions contributed approximately 10 percent of our revenue in 2009 and 2010, but declined to approximately 8 percent of total revenue in 2011, while also declining in absolute terms from approximately $1.9 million in 2010 to $1.6 million in 2011.

We released WAFS 4, a major upgrade of the solution, in September 2011. WAFS 4 introduced a new user interface, support for Unicode characters (to facilitate greater international sales), and other significant enhancements. However, some customers experienced difficulties during their upgrades, slowing WAFS adoption and sales traction for this solution. We have responded to these difficulties with additional solution enhancements and support process enhancements that will support a return to historical sales levels for WAFS.

Managed E-mail Attachment Solution

Our managed e-mail attachment solution, Mail Express, is a client-server application that allows users to send and receive e-mail attachments, up to 25 GB, with enhanced security and visibility compared to typical e-mail solutions. The Mail Express application also provides flexible, customer-defined administration privileges to allow e-mail administrators and even end users to configure specific parameters for handling e-mail attachments in accordance with corporate policy.

 

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We initially launched the Mail Express solution in December 2008 and have continued to make enhancements, including releasing Mail Express 3 in August 2010. Market adoption of Mail Express initially was slower than expected, but began to increase in 2010 with the Mail Express 3 release. Mail Express sales continued to increase in 2011. Going forward, we believe we have developed, and are maintaining, a competitive long-term solution for securely sharing and managing even very large e-mail attachments.

Secure Content Mobility Solution

Our TappIn by GlobalSCAPE service, acquired in December 2011, allows users to access and securely share all files stored on an office or home computer from any web browser and all popular mobile devices, including Apple iPhone and iPad, Google Android and Windows Phone. TappIn provides an easy, secure method to access and share documents, photos, videos, and music across multiple devices, regardless of time or location. The service is differentiated from typical cloud-based repositories like Dropbox or Box because there is no requirement to move content from native storage into the cloud. Directly accessing content in situ provides substantial benefits including increased security, avoidance of cloud content storage costs, and ease of operation because there is no need to determine which subset of content to ‘push’ into a cloud service for subsequent access.

The TappIn service is delivered through direct and indirect sales. Direct sales include Internet sales made through an online cart and TappIn subscriptions included in bundled offerings like the Secure Mobile Access Module for EFT Server, announced in February 2012. Indirect sales include those potentially made through original equipment manufacturing (OEM) relationships in which the TappIn service may be integrated with third party hardware or software. TappIn expects to deliver an enhanced, professional edition of the service in the second half of 2012. We expect the professional edition will have greater appeal to business users and potential OEM partners.

We believe secure content mobility is a rapidly emerging central feature of our served markets, including our primary MFT market. Exponential growth in smartphones and tablets, combined with rapid growth in retained content and Bring Your Own Device expectations, will drive strong growth in this market segment. The TappIn acquisition provides the Company with an initial capability in the secure content mobility market; we expect to grow this component of our revenue at a rate faster than our legacy revenue growth through the next several years.

Endpoint Security Solution

We continue to plan for entry into the consumer antivirus segment of the endpoint security market with our appShield solution. The appShield solution uses application whitelisting technology to block execution of malicious software with much greater effectiveness than traditional antivirus software. The traditional approach to antivirus software operation is to develop specific signatures for malware, detect the presence of files matching those defined signatures, and then block or quarantine the assessed malware. Application whitelisting inverts the traditional approach by allowing the end user or an administrator to explicitly designate which software applications will be allowed to run. The resulting ‘whitelist’ then governs software execution privileges. If an executable is not on the whitelist, it will not run.

There is growing market awareness that traditional antivirus solutions cannot keep pace with the proliferation of malware threats which are increasing significantly in sophistication and exponentially in number. According to recent industry analyses, traditional antivirus software continues to be only 25 to 50 percent effective and also can have substantial adverse performance impacts on the host system. Therefore, we believe application control in the form of whitelisting has the potential to take increasing market share from traditional antivirus software in future years.

Our appShield solution is the result of a joint development agreement established with CoreTrace Corporation in December 2009. CoreTrace develops and markets an enterprise software application control

 

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solution, known as Bouncer, that has been adopted by numerous businesses and agencies in the commercial and government sectors. We have designed and are implementing an easy-to-use interface that integrates with CoreTrace’s enterprise whitelisting technology to deliver this innovative application control solution to the consumer market.

Delivery of appShield has been considerably delayed from original expectations. The delays have been the result of software integration and workflow challenges associated with building on CoreTrace’s Bouncer enterprise whitelisting solution to produce a product appropriate for consumer adoption and other market applications. We currently plan on introducing appShield to market later in 2012.

Professional Services

Professional services have represented an increasing part of our business in recent years, growing from $127 thousand, or less than one percent of revenue, in 2009 to $1.8 million or 8.4% of revenue in 2011. We have made a concerted effort to increase our professional services revenue in the commercial and government market sectors as part of our corporate evolution as an enterprise solution provider.

From a commercial perspective, we continue to bundle “packaged” (or relatively tightly prescribed) and custom services with many of our enterprise and SMB software sales. Within the government market, we continue to retain several full-time engineers on a McLane Advanced Technologies (MAT) industry team that won a large U.S. Army order during 2010. These professional services engagements allow us to better ensure successful solution implementation and also provide us with increased visibility into ongoing customer requirements. Our increase in delivery of these services also brings us into closer alignment with expected typical professional services contributions to enterprise sales opportunities. While we have increased our professional services delivery in each of the last three years, from 2009 through 2011, total 2012 professional services revenue is dependent, to a significant extent, on the MAT contract option year which may, or may not, be executed for government fiscal year 2013.

Our increased professional services lead to a corresponding increase in our cost of revenues (or cost of goods sold), because the services necessarily are labor intensive. For this reason, professional services typically have significantly lower margins than product sales or subscription services. However, we believe professional services allow us to better establish and maintain our solution implementations, while also providing our customers with the training and education services that help them make more complete use of our solution capabilities. In addition, for large contracts like the engineering services provided to the Army, such professional services provide significant past performance that facilitates additional business. Over time, we believe the return on investment from increased professional services outweighs the potential near-term impacts on operating margins.

Liquidity and Capital Resources

The Company has a strong working capital position resulting from net profits from operations over 28 of the last 31 quarters. At December 31, 2011, our net working capital position was approximately $1.7 million. We had cash available of $8.9 million and we continue to generate cash from operating activities. We rely on cash on hand and cash flows from operations to fund our operations and believe that these will be our principal sources of operating capital in 2012.

Our capital requirements principally relate to our need to enhance our existing products and to develop new products, which primarily consist of research and development expenses and expenses for people and the elements that support their work. In 2011, we enhanced our product offerings through the acquisition of TappIn, a secure mobile file transfer technology company. This acquisition was funded by $2.0 million in cash and $7.0 million in borrowings under a new five-year term loan. Under the terms of the merger agreement with TappIn, the former stockholders of TappIn could be paid an additional $8.0 million upon achieving certain revenue milestones and delivery of a new edition of the acquired technology milestone.

 

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Because our principal sources of capital are cash on hand and cash flow from operations, to the extent that sales decline, our cash flow from operations will also decline. If sales decline or if our liquidity is otherwise under duress, management could substantially reduce personnel and personnel-related costs, reduce or substantially eliminate capital expenditures and/or reduce or substantially eliminate research and development expenditures. We may also sell equity or debt securities or enter into credit arrangements in order to finance future acquisitions or licensing activities, to the extent available.

Net cash provided by operating activities was $2.8 million, $2.7 million and $4.7 million in 2011, 2010 and 2009, respectively. The increase in 2011 was primarily due to the net impact of increases in accounts receivable and deferred revenues. The decrease in 2010 was largely due to a non-recurring $2.7 million order from the U.S. Army received in April 2009. The remainder of the change in cash provided by operating activities in 2011 was due to increases in deferred taxes, and a receivable from CoreTrace. The CoreTrace receivable of $761,000 consists of loans to CoreTrace plus related interest in 2011.

Net cash provided by (used in) investing activities was ($12.4) million in 2011, $1.0 million in 2010 and ($4.0) million in 2009. The cash used in investing activities in 2011 primarily related to the TappIn acquisition of $9.2 million, the purchase of a $3 million certificate of deposit to secure a portion of the debt related to the TappIn acquisition and $201,000 in property and equipment purchases. The cash provided by investing activities for 2010 was from short-term investment redemptions, net of property and equipment purchases. Cash used in investing activities in 2009 was for an investment of $2.3 million in CoreTrace, a $1.2 million net investment in short term certificates of deposit, and $530,000 which was used for additional furniture and fixtures and leasehold improvements as renovations were made to our office.

Net cash provided by financing activities was $7.4 million in 2011, $329,000 in 2010 and $43,000 in 2009. The cash provided in 2011 primarily related to the proceeds of $7.0 million in debt borrowed to fund the TappIn acquisition and $339,000 related to proceeds received from the exercise of stock options. Net cash provided by financing activities in 2010 related to proceeds the Company received from the exercise of stock options as well as tax benefits related to stock option expense.

Loan Agreements. In order to finance the closing payment in the TappIn acquisition, GlobalSCAPE entered into two Business Loan Agreements dated December 2, 2011 with the Bank of San Antonio. The Loan Agreements provide for a $4.0 million term loan which bears interest at 4.75% per annum and is secured by substantially all of GlobalSCAPE’s consolidated assets and a $3.0 million term loan which bears interest at 4.25% per annum and is secured by a certificate of deposit with the Bank of San Antonio of $3.0 million which bears interest at 2.0% per annum. Both loans mature on December 2, 2016. Interest and principal are payable in 60 equal monthly installments on the first day of each calendar month beginning January 2, 2012. The loans may be prepaid at any time without premium or penalty.

The Loan Agreements contain customary covenants including covenants relating to maintaining legal existence and good standing, complying with applicable laws, delivery of financial statements, payment of taxes and maintaining insurance. GlobalSCAPE and its subsidiaries are also prohibited from selling any of their assets other than in the ordinary course of business, acquiring any other entities, changing the types of business they are engaged in, incurring indebtedness other than that permitted by the Loan Agreements, incurring any liens on their assets other than those permitted by the Loan Agreements, making certain investments or paying any dividends on, or acquiring, any shares of their capital stock. The Loan Agreements contain three financial covenants. GlobalSCAPE and its subsidiaries must maintain:

 

   

Debt Service Coverage (defined as net income+depreciation+interest+non-cash charges divided by the current portion of long-term debt +interest) of 1.25 beginning the first quarter of 2013;

 

   

Debt to tangible net worth of 4.0 :1 beginning the first quarter of 2013; and

 

   

Liquid assets (cash and marketable securities) of $4.0 million during 2012, $3.2 million in 2013 and $2.2 million in 2014.

 

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The Loan Agreements also contain customary events of default including the failure to make payments of principal and interests, the breach of any covenants, the occurrence of a material adverse change, and certain bankruptcy and insolvency events.

Contractual Obligations. At December 31, 2011, our principal commitments consisted of obligations outstanding under loan arrangements, operating leases as well as royalty agreements with third parties, federal income tax and trade accounts payable. The commitments related to royalty agreements are contingent on sales volumes. We plan to continue to expend significant resources on product development in future periods and may also use our cash to acquire or license technology, intellectual property, products or businesses related to our current business strategy.

The following table summarizes our contractual obligations at December 31, 2011, consisting of future minimum payments under operating leases and long term debt obligations:

 

     Payments Due by Fiscal Year  
     2012      2013 - 2015      2016 - 2018      2019 and
thereafter
     Total  

Contractual Obligations

              

Building Lease

   $ 363       $ 1,053       $ 1,080       $ 120       $ 2,616   

Equipment Leases

     2                  2   

Long term Debt, principal and interest

     1,565         4,702         1,568            7,835   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 1,930       $ 5,755       $ 2,648       $ 120       $ 10,453   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

New Accounting Pronouncements

In September 2011, the Financial Accounting Standards Board (“FASB”) amended its guidance regarding testing goodwill for impairment. Because of concerns raised about recurring costs and the complexity of estimating the fair value of reporting units on an annual basis, the FASB decided to simplify how a company is required to test goodwill for impairment. Companies now have the option to first assess qualitative factors to determine whether it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount. If after considering the totality of events and circumstances an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it will not have to perform the two-step, quantitative impairment test. This guidance is effective for fiscal years beginning after December 15, 2011, however, early adoption is permitted. We have adopted this guidance as of December 31, 2011, and the implementation of this guidance does not have a material effect on our financial statements.

In October 2009, the Financial Accounting Standards Board (“FASB”) amended its guidance regarding the accounting model for revenue arrangements that include both tangible products and software elements. This guidance requires that hardware components of a tangible product containing software components always be excluded from the software revenue recognition. This guidance also provides information on how to allocate consideration to deliverables in an arrangement that includes both tangible products and software. This guidance is effective in fiscal years beginning on or after June 15, 2010. We have evaluated the effect of the adoption of this guidance as of December 31, 2010, and it does not have a material effect on our financial statements.

In October 2009, the FASB amended its guidance regarding revenue recognition on multiple-deliverable arrangements. This guidance amends the criteria for separating consideration in multiple-deliverable arrangements. This guidance also establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on VSOE if available, third-party evidence if VSOE is not available, or estimated selling price if neither VSOE nor third party evidence is available. This amendment also replaces the term fair value in the revenue allocation guidance with selling price to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant. This guidance eliminates the residual method of allocation and requires arrangement consideration be

 

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allocated at the inception of the arrangement to all deliverables using the relative selling price method. The guidance also requires the best estimate of selling price be determined in a manner that is consistent with that used to determine the price to sell the deliverable on a standalone basis. Finally, this guidance significantly expands the disclosures related to multiple-deliverable revenue arrangements. This guidance is effective in fiscal years beginning on or after June 15, 2010. We have evaluated the effect of the adoption of this guidance as of December 31, 2010, and it does not have a material effect on our financial statements.

Critical Accounting Policies

Our financial statements and accompanying notes are prepared in accordance with U.S. GAAP. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by management’s application of accounting policies. Critical accounting policies for us include revenue recognition, impairment of goodwill, impairment of long-lived assets, accounting for research and development costs, allowance for doubtful accounts, accounting for income taxes, and accounting for stock-based compensation.

Revenue Recognition

We recognize revenue in accordance with generally accepted accounting principles that have been prescribed for the software industry.

Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or service has been rendered, the fee is fixed and determinable, and collectability is probable. In making these judgments, we evaluate these criteria as follows:

 

   

Evidence of an arrangement. We consider a non-cancelable written agreement signed by us and the customer to be persuasive evidence of an arrangement.

 

   

Delivery has occurred. We consider delivery to have occurred when a compact disc or other medium containing the licensed software is provided to a common carrier or in the case of electronic delivery, the customer is given electronic access to the licensed software. If an arrangement includes undelivered products or services that are essential to the functionality of the delivered product, delivery is not considered to have occurred until these products or services are delivered.

 

   

Fixed or determinable fee. We consider the fee to be fixed or determinable unless the fee is subject to refund or adjustment or is not payable within normal payment terms. If the fee is subject to refund or adjustment, we recognize revenue when the refund or adjustment right lapses or the return is estimable. For arrangements with extended payment terms, we recognize revenue as amounts become due and payable or as cash is collected. We grant a limited right of return to our customers.

 

   

Collection is deemed probable. We conduct a credit review for all transactions at the inception of an arrangement to determine the creditworthiness of the customer. Collection is deemed probable if, based upon our evaluation; we expect that the customer will be able to pay amounts under the arrangement as payments become due. If we determine that collection is not probable, revenue is deferred and recognized upon cash collection.

The Company also enters into perpetual software license agreements through direct sales to customers and indirect sales with distributors and resellers. The license agreements generally include product maintenance and support agreements, for which the related revenue is deferred and recognized ratably over the term of the agreements. In any given period if the amount of revenue that is deferred, which is equal to the total of that period’s maintenance and support sales, is greater than the amount recognized, then revenue will decrease and vice versa.

 

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In arrangements that include multiple elements, including perpetual software licenses and maintenance and/or services, and packaged products with content updates, we allocate and defer revenue for the undelivered items based on vendor specific objective evidence, or VSOE, of the fair value of the undelivered elements, and recognize the difference between the total arrangement fee and the amount deferred for the undelivered items as revenue. Our deferred revenue consists primarily of the unamortized balance of enterprise product maintenance, consumer product support, and arrangements where VSOE does not exist. Deferred revenue totaled approximately $7.6 million as of December 31, 2011, of which approximately $1.4 million was classified as “Other long term liabilities” in the balance sheets. VSOE of each element is based on the price for which the undelivered element is sold separately. We determine fair value of the undelivered elements based on historical evidence of our stand-alone sales of these elements to third parties or from the stated renewal rate for the undelivered elements. When VSOE does not exist for undelivered items such as maintenance, then the entire arrangement fee is recognized ratably over the performance period.

We recognize hosting revenue, including setup fees on a monthly basis, over the contractual term of the customer contract. We believe customers generally will continue to utilize our services beyond the initial contract term which typically ranges from one to three years. As a result, setup fees are recognized ratably over the estimated average life of a customer relationship. Amounts that have been invoiced are recorded in accounts receivable and either deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.

While the above noted accounting standards govern the basis for revenue recognition, judgment and the use of estimates are required in connection with the allocation of revenue between software license revenue and maintenance and support revenue, as well as the amount of deferred revenue to be recognized in each accounting period. Changes to the elements in a software arrangement, the ability to identify VSOE for those elements, the fair value of the respective elements, and increasing flexibility in contractual arrangements could materially impact the amount recognized in the current period and deferred over time.

Valuation of goodwill and intangible assets

Goodwill. We assess goodwill and intangible assets with indefinite life for impairment within our reporting units annually or more often if events or changes in circumstances indicate that the carrying value may not be recoverable. During 2011, the FASB issued final guidance on goodwill impairment testing providing companies with the option to perform a qualitative assessment in lieu of the annual quantitative impairment analysis. For the year ended December 31, 2011, the Company chose to adopt this new guidance, which is effective for fiscal years beginning after December 15, 2011, while early adoption is permitted. This qualitative assessment analyzed the financial performance of the company, the performance of the WAFS reporting unit, market conditions, specific company events and the excess of fair value over carrying value in the most recent quantitative assessment. The results of this qualitative assessment concluded that it is not more likely than not that the fair value of the WAFS reporting unit is less than its carrying value.

If an entity does not pass the qualitative assessment test, it must then perform the traditional two-step impairment test on goodwill. In the first step, we compare the fair value of each reporting unit to its carrying value. If the fair value of the reporting unit exceeds the carrying value of the equity assigned to that unit, goodwill is not considered to be impaired and we are not required to perform further testing. If the carrying value of the equity assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step of the impairment test in order to determine the implied fair value of that reporting unit’s goodwill. If the carrying value of the reporting unit’s goodwill exceeds its implied fair value, then we would record an impairment loss equal to the excess.

To determine the reporting units’ fair value in the prior year evaluation, we used the income approach under which we calculated the fair value of each reporting unit based on the estimated discounted future cash flows of that unit. Our cash flow assumptions were based on historical and forecasted revenue, operating costs, growth rates and other relevant factors. If management’s estimates of future operating results change, or if there are

 

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changes to other assumptions, the estimate of the fair value of our goodwill could change significantly. Such change could result in goodwill impairment charges in future periods, which could have a significant impact on our operating results and financial condition.

In December 2010, the Company performed its annual impairment analysis, for the WAFS reporting unit. For this analysis, we estimated the fair value of goodwill using the discounted cash flows methodology. The principal factors used in the discounted cash flow analysis requiring judgment were the projected results of operations, weighted average cost of capital (“WACC”), working capital requirements, and terminal value assumptions. This analysis required the input of several critical assumptions including future growth rates, cash flow projections, WACC, rate of return, and terminal value assumptions. In 2010 a significant change was made in the terminal value assumption. In prior years, it was assumed that the reporting unit would have an end of life in approximately five years. In 2010 the Company re-assessed this assumption and determined that the reporting unit would continue in perpetuity. The WACC takes into account the relative weights of each component of the Company’s capital structure (equity and debt) and represents the expected cost of new capital. The results of the analysis shows a carrying value of $2,341,000 as of December 1, 2010, compared to a fair value of $4,893,000. The fair value is more than double the carrying value and thus no impairment was recorded as of December 31, 2010.

Intangible Assets. We assess the impairment of other identifiable intangible assets whenever events or changes in circumstances indicate that an asset’s carrying amount may not be recoverable. Based upon the existence of one or more indicators of impairment, we measure any impairment of long-lived assets based on a projected undiscounted cash flow method using assumptions determined by our management to be commensurate with the risk inherent in our current business model. Our estimates of cash flows require significant judgment based on our historical results and anticipated results and are subject to many triggering factors which could change and cause a material impact to our operating results or financial condition.

Allowance for Doubtful Accounts

We regularly assess the collectability of outstanding customer invoices and, in so doing; we maintain an allowance for estimated losses resulting from the non-collection of customer receivables. In estimating this allowance, we consider factors such as: historical collection experience; a customer’s current creditworthiness; customer concentration; age of the receivable balance; and general economic conditions that may affect a customer’s ability to pay. Actual customer collections could differ from our estimates and exceed our related loss allowance.

Stock-based Compensation

We account for stock-based compensation by measuring the fair value of the award at the grant date and recognizing expense over the requisite service period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating expected dividends and measuring volatility. In addition, judgment is also required in estimating the amount of share-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted.

Income Taxes

We recognize taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events in our financial statements. Accruals for uncertain tax positions are recognized only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns, including uncertain tax positions and the realizability of

 

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deferred tax assets, which is dependent on the timing of the underlying deductions and the Company’s ability to generate future taxable income. Variations in the actual outcome of these future tax consequences could materially impact our financial position, results of operations, or cash flows.

Results of Operations

Comparison of Year Ended December 31, 2011 to Year Ended December 31, 2010

 

     2011      2010      $ Change     % Change  
     ($ in thousands)  

Total revenues

   $ 20,894       $ 18,565       $ 2,329        13

Cost of revenues

     1,723         601         1,122        187

Selling, general and administrative

     14,466         12,815         1,651        13

Research and development

     3,124         3,016         108        4

Depreciation and amortization

     790         852         (62     -7
  

 

 

    

 

 

    

 

 

   

 

 

 

Total operating expenses

     20,103         17,284         2,819        16
  

 

 

    

 

 

    

 

 

   

 

 

 

Income from operations

     791         1,281         (490     -38

Other income, net

     13         10         3        30

Income tax expense

     169         410         (241     -59
  

 

 

    

 

 

    

 

 

   

 

 

 

Net Income

   $ 635       $ 881       $ (246     -28
  

 

 

    

 

 

    

 

 

   

 

 

 

Revenue. We derive our revenue primarily from sales of software licenses, maintenance and support, professional services and subscription-based offerings. Software license revenue primarily consists of revenue from sales of our enterprise solutions, such as Enhanced File Transfer Server and WAFS, and is typically recognized upon shipment and maintenance and support revenue includes unspecified software license updates and product support. Maintenance and support revenue is recognized ratably over the contractual period, which is typically one year, but can be up to three years. Professional services revenue includes a variety of customization, implementation, and integration services, as well as delivery of education and training associated with our solutions, all of which are recognized as the services are performed. In 2010, we added subscription revenues related to the sales of our Managed Solutions which include Mail Express, Managed Information Exchange (MIX) and Hosted Enhanced File Transfer (Hosted EFT Server). Subscription revenue is recognized on a monthly basis as the services are billed over the contract period, which ranges from one to three years.

Revenues increased from $18.6 million in 2010 to $20.9 million in 2011. The increase of approximately $2.3 million or 13% in revenues was largely due to an increase in maintenance and support sales, an increase in the number of new EFT Server Enterprise licenses sold, and an increased contribution from professional services. The increase in maintenance and support sales was driven by an increase in sales of new multi-year agreements and an increase in Platinum Support sales.

The following table reflects revenue by product ($ in thousands) including the related maintenance and support ($9,424 or 45.1% of revenue in 2011 and $7,762 or 41.8% of revenue in 2010) for each product:

 

     Revenue for the Year Ended December 31,  

Product

   2011     2010  

EFT Server Enterprise

   $ 12,167         58.2   $ 10,913         58.8

EFT Server

     3,665         17.6     3,616         19.5

CuteFTP Professional

     983         4.7     1,245         6.7

CuteFTP Home

     226         1.1     277         1.5

Wide Area File Services/CDP

     1,533         7.3     1,869         10.1

Professional Services

     1,772         8.5     438         2.4

Other

     548         2.6     207         1.1
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Operating Revenues

   $ 20,894         100.0      $ 18,565         100.0   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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Total revenue from our EFT Server and EFT Server Enterprise solutions increased by 9%, to $15.8 million in 2011 from $14.5 million in 2010. EFT Server Enterprise revenues increased by 12% from $10.9 million in 2010 to $12.2 million in 2011, mainly due to an increase in maintenance and support contract renewals. Revenues from new license sales and new maintenance and support contracts remained relatively flat from 2010 to 2011 as a result of pricing pressure on EFT Server Enterprise, a promotion during 2011 which discounted the price of EFT Server Enterprise for customers upgrading from EFT Server and an increase in the number of customers purchasing cloud-based solutions rather than installed solutions. EFT Server revenue increased by 2% from $3.6 million in 2010 to $3.7 million in 2011. This increase was mainly due to an increase in the average price of new license products and in maintenance and support contracts. In total, our EFT Server and EFT Server Enterprise products represented approximately 75.7% of our total revenues in 2011 as compared to 78.3% in 2010.

Revenues from CuteFTP decreased by 20.6% from $1.5 million in 2010 to $1.2 million in 2011 and accounted for approximately 5.8% of total revenues in 2011 and 8.2% in 2010. This decline continues the general reduction in CuteFTP product revenues, both in absolute terms and as a percentage of revenues, experienced since 2006. The consumer FTP product market has substantial low-cost, and even free, solutions that have put increasing pressure on CuteFTP product revenues. Additional pressure on this product line comes from social media companies and services that allow consumers to share images and video. Our reliance on the current CuteFTP products will continue to decline as we emphasize sales of our more complex enterprise products and potentially enter adjacent markets. However, we intend to release a new version of CuteFTP in 2012. This new version may slow, or even reverse, the recent decline in CuteFTP revenue.

Wide Area File Services and Continuous Data Protection product revenues decreased by 18% from $1.9 million in to 2010 to $1.5 million in 2011 and accounted for approximately 7.3% of total revenues in 2011 as compared to 10.1% in 2010. The decrease was due principally to a decrease in the average price of the WAFS licenses and a decrease in the number of WAFS maintenance and support renewals sold. The Wide Area File Services and Continuous Data Protection products are largely used by architecture, engineering and construction firms to transfer large documents between offices. The decline in WAFS revenue in 2011 may be attributable in part to the current economic outlook in the architecture, engineering, and construction sectors. In addition, we released WAFS 4 in the second half of 2011. This new release included a new user interface, support for Unicode characters, and other significant enhancements from the prior Version 3 software. Some customers experienced difficulty while upgrading from WAFS 3 versions to WAFS 4, which also led to delays in closing some sales opportunities while we identified and remediated the customer issues. We have developed an update to WAFS 4 and intend to release that software by mid-2012. We believe the updated software will allow us to return to prior historical levels of WAFS sales performance, depending on prevailing economic conditions in the primary market sectors served by WAFS.

Professional services increased by 305% from $438,000 in 2010 to $1.8 million in 2011and accounted for 8.5% of revenues in 2011 as compared to 2.4% of revenue in 2010. The growth in professional services was driven largely by $1.1 million in revenue earned on the MAT contract during 2011. Our level of participation on the MAT contract may change during U.S. Government’s FY2012 depending on a variety of factors, including availability of government budget authorization for the SAMS-E program and our evolving work share of the contract. However, we believe we can continue to increase deliveries of our commercial (non-government) professional services as we increasingly bundle those services with new sales of our enterprise solutions and as we sell repeat services to prior customers.

Products and services included in the “Other” revenue increased by 165% from $207,000 in 2010 to $548,000 in 2011. This category primarily consist of Mail Express, Managed Information Exchange (MIX) and Hosted Enhanced File Transfer (Hosted EFT Server) sales. Other revenue accounted for 2.6% of revenue in 2011 as compared to 1.1% in 2010. The increase in “Other” revenue was largely due to an increase in MIX and Hosted EFT Server revenue and Mail Express revenue. We believe the MIX and Hosted EFT Server revenue increases are particularly significant as they reflect the growing trend toward cloud based rather than installed solutions. In addition, these subscription services contribute to aggregate contract value and provide a predictable revenue stream in future periods.

 

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During 2011, we also continued to recognize increasing revenue from maintenance and support contracts. Maintenance and support revenues increased by 21.5%, to $9.4 million in 2011 from $7.8 million in 2010. Our deferred revenue balance increased from $6.7 million at December 31, 2010 to $7.6 million at December 31, 2011 as a result of higher maintenance and support sales (including renewals) over a 12 month period, growing sales of our hosted and managed solutions, and increased sales of professional services engagements which were invoiced (and, in many cases, paid) but were not yet delivered. The increase also reflects increased sales of our Platinum Support services, which provide after-hours support and other benefits to customers contracting for this level of service instead of our standard support services. As our enterprise products become a larger portion of our total revenues, we believe maintenance and support revenues will continue to increase. However, if sales of our on-premise enterprise products decrease, then new sales of maintenance and support contracts will decrease as well given the typical bundling of M&S contracts with enterprise software solution sales. Maintenance and support pricing is reflective of the license cost of the products and the additional support it takes to maintain and support the products and customers. With higher maintenance and support revenues, we will recognize additional deferred revenue as we earn the revenue over the life of the maintenance and support agreement.

Cost of Revenues. Cost of revenues consists primarily of royalties, a portion of our bandwidth costs, hosted service expenses for our Managed Solutions, travel expenses associated with professional services delivery and cost of goods sold. Cost of revenues increased by approximately 187% from $601,000 in 2010 to $1.7 million in 2011. This increase was largely caused by an increase in royalties of $120,000, the addition of hosted server expenses of approximately $210,000 and other cost of goods sold of $851,000. The increase in royalties was due to increased sales of a licensed technology. The hosted server expenses are associated with the MIX and Hosted EFT Server solution which launched in July, 2010 and February 2011, respectively. The other cost of goods sold primarily was from labor costs associated with the professional services performed for the MAT contract. Our cost of revenues may continue to increase during 2012 and into future periods, depending largely on the scope of our future participation in sizable professional services projects like the MAT contract.

Selling, General and Administrative. Selling, general and administrative expenses as a percentage of revenue were 69% in 2011 and 70% in 2010. Although SG&A expenses as a percentage decreased by 1%, they increased by $1.7 million or 12% in absolute terms with $543,000 of these expenses being related to the TappIn acquisition. The increase in selling, general and administrative expenses related to salaries and wages (and related payroll taxes), commission expenses, legal fees, accounting fees and other professional fees were offset by decreases in consulting fees, and bad debt expense.

The increase of approximately $673,000 in salaries and wages and related payroll taxes was due to an overall increase in staffing as compared to 2010. Commission expense increased by approximately $335,000 when compared to 2010 and was due to an overall increase in sales of 13%. The increase in legal fees in 2011 of approximately $156,000 was mainly due to the TappIn acquisition. Accounting fees increased by approximately $87,000 when compared to 2010 due to audit and valuation fees incurred with the TappIn acquisition. Other professional fees increased by approximately $452,000 of which $315,000 was related to investment banking fees incurred with the TappIn acquisition. The remaining increase in other professional fees was due to the retention of a firm to consult with the Company, resulting in a research and development tax credit received by the Company.

The decrease in consulting fees of approximately $146,000 in 2011 as compared to 2010 was mainly due to the transition of one consultant to full-time employee status and an additional reduction in our use of outside consulting to assist with government sales. The reduction in bad debt expense of approximately $183,000 as compared to 2010 was due to decrease in accounts receivable balances over 90 days old.

Research and Development. Research and development expenses increased by approximately 4% from $3 million in 2010 to $3.1 million in 2011. The increase of approximately $108,000 mainly consists of a $95,000 increase in external research and development. The increase in external research and development was mainly due to expenses related to WAFS testing.

 

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Depreciation and Amortization. Depreciation and amortization expense consists of depreciation expense related to our fixed assets and amortization of capitalized development costs and intangible assets. Depreciation and amortization expense decreased by approximately $62,000 or 7%, year over year. This decrease was due to software which became fully depreciated.

Other Income (Expense), Net. Other income/expense increased approximately $3,000 or 30% from 2010 to 2011. Other income of approximately $38,000 in 2011 was from interest earned on the CoreTrace promissory note. This income was offset by interest expense of approximately $25,000 for the $7 million note used for the TappIn acquisition. Other income in 2010 was from interest on short-term investments and interest on a Texas margins tax refund. We expect our expenses to increase significantly due to the loans obtained in December 2011 in conjunction with the TappIn acquisition.

Income Taxes. Our effective income rates were approximately 21% and 32% for 2011 and 2010, respectively. For 2011, the most significant item that affected our effective income tax rate was the $358,000 research and development credit which related to years 2008, 2009 and 2010. The other item that affects the effective tax rate in 2011 was the deduction for domestic production activities (“DPAD”) which was offset by non-deductible incentive stock option expense, and state income taxes and acquisition costs.

Comparison of Year Ended December 31, 2010 to Year Ended December 31, 2009

 

     2010      2009     $ Change     % Change  
     ($ in thousands)              

Total revenues

   $ 18,565       $ 16,451      $ 2,114        13

Cost of revenues

     601         336        265        79

Selling, general and administrative

     12,815         10,798        2,017        19

Research and development

     3,016         2,805        211        8

Depreciation and amortization

     852         724        128        18
  

 

 

    

 

 

   

 

 

   

 

 

 

Total operating expenses

     17,284         14,663        2,621        18
  

 

 

    

 

 

   

 

 

   

 

 

 

Income from operations

     1,281         1,788        (507     -28

Other income (expense), net

     10         (67     77     

Income tax expense

     410         321        89        28
  

 

 

    

 

 

   

 

 

   

 

 

 

Net Income

   $ 881       $ 1,400      $ (519     -37
  

 

 

    

 

 

   

 

 

   

 

 

 

Revenue. We derive our revenue primarily from sales of our software licenses and from maintenance and support and professional services. We also recognize revenue from delivery of professional services and from subscription-based offerings. Software license revenue primarily consists of revenue from sales of our enterprise solutions, such as Enhanced File Transfer Server and WAFS, and is typically recognized upon shipment. Maintenance and support revenue includes unspecified software license updates and product support. Maintenance and support revenue is recognized ratably over the contractual period, which is typically one year, but can be up to three years. Professional services revenue includes a variety of customization, implementation, and integration services, as well as delivery of education and training associated with our solutions, all of which are recognized as the services are performed. In addition, during 2010 we added subscription revenues related to the sales of our Managed Solutions. Subscription revenue is recognized on a monthly basis as the services are billed over the contract period, which ranges from one to three years. Our professional services and subscription services did not contribute materially to our 2010 revenue, although professional services revenue grew substantially as compared to prior years.

Revenues increased from $16.5 million in 2009 to $18.6 million in 2010. The increase of approximately $2.1 million or 13% in revenues was largely due to an increase in average sales price, an increase in maintenance and support sales, and increased contribution from professional services.

 

 

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The following table reflects revenue by product including the related maintenance and support for each product ($ in thousands):

 

     Revenue for the Year Ended December 31,  

Product

   2010     2009  

EFT Server Enterprise

   $ 10,913         58.8   $ 7,997         48.5

EFT Server

     3,616         19.5     4,518         27.4

CuteFTP Professional

     1,245         6.7     1,459         8.8

CuteFTP Home

     277         1.5     443         2.7

Wide Area File Services/CDP

     1,869         10.1     1,876         11.4

Profeesional Services

     438         2.4     127         0.8

Other

     207         1.1     69         0.4
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Revenues

   $ 18,565         100.0      $ 16,489         100.0   
  

 

 

    

 

 

   

 

 

    

 

 

 

Maintenance and support (net of deferred revenues)

   $ 7,762         41.8   $ 6,026         36.5

Total revenue from our EFT Server and EFT Server Enterprise solutions increased by 16%, to $14.5 million in 2010 from $12.5 million in 2009. This increase in revenue was largely due to an increase in average sales price and an increase in maintenance and support renewal sales for these solutions. We also believe increasing numbers of customers are upgrading from EFT Server to EFT Server Enterprise, in line with the solution suite approach announced with the release of EFT Server 6.0 in 2009. These upgrades and new sales of EFT Server Enterprise increased sales of that solution by 36%, from approximately $8 million in 2009 to almost $11 million in 2010, more than offsetting the 20% decline in revenue from the more entry-level EFT Server. We believe the decline in revenue for EFT Server also reflects a sales promotion we ran in the second half of 2010 during which we delivered EFT Server for free, while upselling add-on modules and M&S contracts. Increased discussion of add-on modules with sales prospects and prior customers also may have contributed to the increased sales of EFT Server Enterprise (which supports a range of add-on modules in addition to those available for use with the base Enterprise File Transfer Server). The year to year increase in total EFT Server sales (including EFT Server Enterprise) is noteworthy because it comes despite the inclusion of a large, non-recurring U.S. Army order for EFT Server in 2009. In total, our EFT Server and EFT Server Enterprise products represented approximately 78% of our total revenues in 2010 as compared to 76% in 2009.

Revenues from CuteFTP decreased by 20% from $1.9 million in 2009 to $1.5 million in 2010 and accounted for approximately 12% of total revenues in 2009 and 8% in 2010. This decline continues the general reduction in CuteFTP product revenues, both in absolute terms and as a percentage of revenues, experienced since 2006. The consumer FTP product market has substantial low-cost, and even free, solutions that have put increasing pressure on CuteFTP product revenues. Additional pressure on this product line comes from social media companies and services that allow consumers to share images and video. Our reliance on the current CuteFTP products will continue to decline as we emphasize sales of our enterprise products and potentially achieve greater penetration into adjacent markets such as cloud services and endpoint security.

Wide Area File Services and Continuous Data Protection product revenues remained at $1.9 million for 2009 and 2010 and accounted for approximately 11% and 10% of total revenues in 2009 and 2010, respectively. The Wide Area File Services and Continuous Data Protection products are largely used by architecture, engineering and construction firms to transfer large documents between offices.

Products and services included in the “Other” revenue category primarily consist of professional services, training and Mail Express product sales. This revenue increased by approximately 308% to $645,000 in 2010 from $158,000 in 2009. Other revenue accounted for 3.5% of total revenue in 2010 as compared to 1% in 2009. This increase was largely due to the introduction of our new Solution Quickstart service which accounted for $224,000 of the total increase. Other notable increases were in Mail Express, training services, and two new professional service offerings: Product Customerization and Systems Integration and Business Process and Workflow. This category also includes the subscription revenue related to our Managed Solutions.

 

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Because of the more complex nature of the EFT Server, EFT Server Enterprise, Wide Area File Services and Continuous Data Protection products, and Mail Express, purchasers of those products require increased maintenance and support. Our maintenance and support revenues increased by 29% from $6.1 million in 2009 to $7.8 million in 2010. As our enterprise products become a larger portion of our total revenues, we believe maintenance and support revenues will continue to increase, as well as represent a higher proportion of our total revenue as more enterprise product customers purchase support compared to our consumer product customers. Maintenance and support pricing is reflective of the license cost of the products and the additional support it takes to maintain and support the products and customers. With higher maintenance and support revenues, we will recognize additional deferred revenue as we earn the revenue over the life of the maintenance and support agreement.

Cost of Revenues. Cost of revenues consists primarily of royalties, a portion of our bandwidth costs, hosted service expenses for our Managed Solutions, and travel expenses associated with professional services delivery. Cost of revenues increased by approximately 79% between periods from $336,000 in 2009 to $601,000 in 2010. This increase was largely caused by an increase in royalties of $ 131,000, the addition of hosted server expenses of approximately $72,000 and an increase in training expense of approximately $47,000. The increase in royalties was due to increased sales of a licensed technology. The hosted server expenses are associated with the new MIX solution which launched in July, 2010, and the increase in training expenses was mostly due to travel expenses related to customer onsite training.

Selling, General and Administrative. Selling, general and administrative expenses consist primarily of personnel and related expenses, marketing, customer support, facility costs, bad debt and professional fees. Selling, general and administrative expenses increased by approximately 19% from $10.8 million in 2009 to $12.8 million in 2010. This increase of approximately $2.0 million was mainly due to increases in several accounts: salaries and wages and related payroll taxes, commission expense, bonus expense, recruiting expense, health insurance, legal fees, consulting fees, travel and bad debt. These increases were offset by decreases in accounting professional fees and advertising expense. As a percentage of revenue, SG&A increased from 66% of revenue in 2009 to 69% of revenue in 2010.

The increase of approximately $1.1 million in salaries and wages and related payroll taxes was due to an overall increase in staffing of 11 people, mainly in the sales, support, and marketing departments. The increase in commission expense of approximately $118,000 was due to an overall increase in sales of 11%. In addition, commissions on MIX sales are paid based on the full value of the contract at the time of signing. Bonus expense increased by approximately $200,000 when compared to 2009 due to the addition of three people to the bonus pool and increased salaries, as our bonus plans are typically structured as a percentage of base salary. Recruiting expenses increased by approximately $73,000 from the prior year and consisted of fees paid to external recruiting agencies for the hiring of three software engineers, a systems administrator and a server support analyst. Health insurance increased by approximately $101,000 due to the increase in staffing. The increase of $169,000 in legal fees was largely due to the Uniloc litigation which has been resolved, as well as increased trademark and other intellectual property work. Consulting fees increased by approximately $74,000 due to the hiring of two consultants. One consultant was hired to develop international business and the other consultant was hired to assist with initial development of the MIX solution. Travel expenses increased approximately $88,000 largely due to an increase in international travel. This travel was related to strengthening our channel relationships, attending trade shows, as well as overall business development. The increase in bad debt expense of approximately $181,000 was due to the increase in accounts receivable as well as a slight increase in the percentages used to estimate bad debt.

The decrease in accounting professional fees in 2010 of approximately $74,000 was mainly due to additional audit work performed in 2009 for the year 2008 audit which did not recur in 2010 and additional analysis performed regarding goodwill impairment in 2009 which also did not recur in 2010. Advertising expense decreased by approximately $370,000 due to the continued optimization of Google search ads. We have reduced the amount that we spend on search terms without affecting the quality of the of sales leads that are generated by the search results.

 

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Research and Development. Research and development expenses increased by approximately 10% from $2.8 million in 2009 to $3.1 million in 2010. The increase of approximately $262,000 mainly consists of a $126,000 increase in external research and development and a $121,000 increase in salaries and wages and related payroll taxes. The increase in external research and development was due to the hiring of a third party to test new software and the hiring of additional offshore developers. The increase in salaries and wages was due to the hiring of new software engineers in 2010 and was offset by a role change for one member of our management team who moved into a more sales-oriented role in October 2009. His compensation was formerly reported within research and development, but is now reported within selling, general, and administrative expenses.

Depreciation and Amortization. Depreciation and amortization expense consists of depreciation expense related to our fixed assets and amortization of capitalized development costs and intangible assets. Depreciation and amortization expense increased by approximately $77,000 or 11%, year over year. This increase was due to property additions in 2010 and the second half of 2009.

Other Income (Expense), Net. Other income/expense increased approximately $77,000 or 115% from 2009 to 2010. Other income in 2010 was from interest on short-term investments and interest on a Texas margins tax refund. Other expense in 2009 was a loss on fixed assets which was offset by interest on short-term investments. The 2009 loss on fixed assets of approximately $85,000 was largely due to not being able to sell the furniture that we removed during the renovation of our office space and having to completely write off the net book value of the property. In addition, we wrote off approximately $32,000 of internal use software which was purchased in 2008 due to a subsequent decision to not implement the software.

Income Taxes. Our effective income rates were approximately 32% and 19% for 2010 and 2009, respectively. The effective tax rate was less in 2009 due to a significant deduction received relating to the tax treatment of stock options. For 2010, the most significant item that affected our effective income tax rate relates to the deduction for domestic production activities (“DPAD”) which was offset by non-deductible incentive stock option expense, and state income taxes. The rate on the DPAD deduction increased from 6% to 9% in 2010.

 

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Item 8. Financial Statements and Supplementary Data

GlobalSCAPE, Inc.

Index to Consolidated Financial Statements

Years ending December 31, 2011, 2010 and 2009

Contents

 

Report of Independent Registered Public Accounting Firm

     61   

Consolidated Financial Statements

  

Consolidated Balance Sheets

     62   

Consolidated Statements of Operations

     63   

Consolidated Statements of Stockholders’ Equity

     64   

Consolidated Statements of Cash Flows

     65   

Consolidated Notes to Financial Statements

     66   

 

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Report of Independent Registered Public Accounting Firm

Board of Directors and Shareholders

GlobalSCAPE, Inc.

We have audited the accompanying consolidated balance sheets of GlobalSCAPE, Inc. (a Delaware corporation) and its wholly owned subsidiary (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of GlobalSCAPE, Inc. and its wholly owned subsidiary as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.

/s/ GRANT THORNTON LLP

Houston, Texas

March 29, 2012

 

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GlobalSCAPE, Inc.

Consolidated Balance Sheets

(in thousands except share amounts)

 

     December 31,
2011
    December 31,
2010
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 8,861      $ 11,087   

Accounts receivable (net of allowance for doubtful accounts of $170 and $237 in 2011 and 2010, respectively)

     3,433        3,124   

CoreTrace receivable

     761        298   

Federal income tax receivable

     244        94   

Current deferred tax asset

     938        881   

Prepaid expenses

     239        319   
  

 

 

   

 

 

 

Total current assets

     14,476        15,803   

Fixed assets, net

     1,067        1,286   

Long term investments

     3,000        —     

Investment—CoreTrace

     2,278        2,278   

Intangible assets, net

     4,815        531   

Goodwill

     12,712        619   

Other assets

     30        30   
  

 

 

   

 

 

 

Total assets

   $ 38,378      $ 20,547   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Current liabilities:

    

Accounts payable

   $ 591      $ 250   

Accrued expenses

     1,396        1,392   

Tappin earn out, current portion

     3,303        —     

Long term debt, current portion

     1,276        —     

Deferred revenue

     6,248        5,554   
  

 

 

   

 

 

 

Total current liabilities

     12,814        7,196   

Deferred tax liability

     573        7   

Other long term liabilities

     1,437        1,185   

Tappin earn out, non-current portion

     3,694        —     

Long term debt, non-current portion

     5,724        —     

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, 18,691,947 and 18,346,982 shares issued at December 31, 2011 and December 31, 2010, respectively

     19        18   

Additional paid-in capital

     13,478        12,137   

Treasury stock, 403,581 shares, at cost, at December 31, 2011 and December 31, 2010

     (1,452     (1,452

Retained earnings

     2,091        1,456   
  

 

 

   

 

 

 

Total stockholders’ equity

     14,136        12,159   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 38,378      $ 20,547   
  

 

 

   

 

 

 

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

 

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GlobalSCAPE, Inc.

Consolidated Statements of Operations

(in thousands, except per share amounts)

 

     For the Year Ended December 31,  
     2011     2010      2009  

Operating Revenues:

       

Software licenses

   $ 9,149      $ 10,158       $ 10,229   

Maintenance and support

     9,424        7,762         6,026   

Professional services

     1,772        438         127   

Other

     549        207         69   
  

 

 

   

 

 

    

 

 

 

Total revenues

     20,894        18,565         16,451   

Operating Expenses:

       

Cost of revenues

     1,723        601         336   

Selling, general and administrative expenses

     14,466        12,815         10,798   

Research and development expenses

     3,124        3,016         2,805   

Depreciation and amortization

     790        852         724   
  

 

 

   

 

 

    

 

 

 

Total operating expenses

     20,103        17,284         14,663   
  

 

 

   

 

 

    

 

 

 

Income from operations

     791        1,281         1,788   

Other (expense) income:

       

Interest expense

     (25     —           —     

Interest income

     38        10         18   

Loss on sale of assets

     —          0         (85
  

 

 

   

 

 

    

 

 

 

Total other (expense) income

     13        10         (67
  

 

 

   

 

 

    

 

 

 

Income before income taxes

     804        1,291         1,721   

Provision for income taxes

     169        410         321   
  

 

 

   

 

 

    

 

 

 

Net income

   $ 635      $ 881       $ 1,400   
  

 

 

   

 

 

    

 

 

 

Net income per common share—basic

   $ 0.04      $ 0.05       $ 0.08   
  

 

 

   

 

 

    

 

 

 

Net income per common share—diluted

   $ 0.03      $ 0.05       $ 0.08   
  

 

 

   

 

 

    

 

 

 

Weighted average shares outstanding:

       

Basic

     18,081        17,540         17,248   
  

 

 

   

 

 

    

 

 

 

Diluted

     18,747        18,260         17,691   
  

 

 

   

 

 

    

 

 

 

 

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

 

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GlobalSCAPE, Inc.

Consolidated Statements of Stockholders’ Equity

(in thousands, except per share amounts)

 

     Common Stock      Additional
paid-in
Capital
    Treasury
Stock
    Retained
Earnings
    Total  
     Shares      Amount           

Balance at December 31, 2008

     17,630,952       $ 18       $ 9,738      $ (1,452   $ (825   $ 7,479   

Shares issued upon exercise of Stock Options

     55,300         —           43        —          —          43   

Stock-based compensation expense

     —           —           1,021        —          —          1,021   

Net Income

     —           —           —          —          1,400        1,400   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2009

     17,686,252       $ 18       $ 10,802      $ (1,452   $ 575      $ 9,943   

Shares issued upon exercise of Stock Options

     602,650         —           232        —          —          232   

Tax benefit from stock-based compensation

           97            97   

Stock-based compensation expense

     —           —           1,006        —          —          1,006   

Issuance of vested restricted stock

     58,080         —           —          —          —          —     

Net Income

     —           —           —          —          881        881   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2010

     18,346,982       $ 18       $ 12,137      $ (1,452   $ 1,456      $ 12,159   

Shares issued upon exercise of Stock Options

     291,545         1         351        —          —          352   

Tax (deficiency) from stock-based compensation

           (13         (13

Stock-based compensation expense

     —           —           1,003        —          —          1,003   

Issuance of vested restricted stock

     53,420         —           —          —          —          —     

Net Income

     —           —           —          —          635        635   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2011

     18,691,947       $ 19       $ 13,478      $ (1,452   $ 2,091      $ 14,136   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

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

 

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GlobalSCAPE, Inc.

Consolidated Statements of Cash Flows

(in thousands)

 

     For the Year Ended
December 31,
 
     2011     2010     2009  

Operating Activities:

      

Net income

   $ 635      $ 881      $ 1,400   

Adjustments to reconcile net income to net cash provided by operating activities:

      

Bad debt expense (recoveries)

     (62     121        (60

Depreciation and amortization

     790        852        724   

Loss on disposition of assets

     —          —          85   

Stock-based compensation

     1,003        1,006        1,021   

Deferred taxes

     (352     (698     (424

Excess tax deficiency (benefit) from exercise of share based compensation

     13        (97     —     

Changes in operating assets and liabilities:

      

Accounts receivable

     (78     (1,083     (70

CoreTrace receivable

     (463     (298     —     

Prepaid expenses

     108        (187     (12

Federal income taxes

     (52     40        (17

Other assets

     —          23        (5

Accounts payable

     341        (66     (197

Accrued expenses

     1        628        203   

Deferred revenues

     690        1,483        2,225   

Deferred compensation

     —          —          (216

Other long-term liabilities

     252        106        19   
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     2826        2,711        4,676   
  

 

 

   

 

 

   

 

 

 

Investing Activities:

      

Proceeds from sale of property and equipment

     —          —          1   

Purchase of property and equipment

     (201     (184     (530

Purchase of TappIn, Inc.

     (9,190     —          —     

Investment in CoreTrace

     —          —          (2,278

Purchase of short-term investments

     —          (350     (1,705

Purchase of long-term investments

     (3,000     —          —     

Redemption of short-term investments

     —          1,555        500   
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     (12,391     1,021        (4,012

Financing Activities:

      

Proceeds from exercise of stock options

     352        232        43   

Tax (deficiency) benefit from stock-based compensation

     (13     97        —     

Proceeds from note payable

     7,000        —          —     
  

 

 

   

 

 

   

 

 

 

Net cash provided by financing activities

     7339        329        43   

Net (decrease) increase in cash

     (2,226     4,061        707   

Cash at beginning of period

     11,087        7,026        6,319   
  

 

 

   

 

 

   

 

 

 

Cash at end of period

   $ 8,861      $ 11,087      $ 7,026   
  

 

 

   

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

      

Cash paid during the period for:

      

Interest

   $ —        $ —        $ —     
  

 

 

   

 

 

   

 

 

 

Income taxes

   $ 1,225      $ 1,128      $ 764   
  

 

 

   

 

 

   

 

 

 

Noncash—TappIn earn out

   $ 6,997      $ —        $ —     
  

 

 

   

 

 

   

 

 

 

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

 

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GlobalSCAPE, Inc.

Notes to Consolidated Financial Statements

December 31, 2011 and 2010

 

1. Nature of Business and Corporate Structure

GlobalSCAPE, Inc. (“GlobalSCAPE” or the “Company”) provides secure information exchange capabilities for consumers and enterprises through the development and distribution of software, delivery of managed and hosted solutions, and provision of associated services. Since our organization in 1996, we have evolved from a company focused primarily on personal file transfer products, sold over the Internet, to a solution provider deriving over 90 percent of revenue from sales to small and medium business and enterprise customers worldwide.

TappIn, Inc. (“TappIn) provides technology that allows users to access their digital files and media such as pictures, documents, videos and music stored on a computer using a web-browser, tablet or mobile smartphone (including Apple iPhone and iPad, Google Android and Windows Phone 7) without having to upload, organize and sync files between devices or pay for additional cloud storage. TappIn is a wholly-owned subsidiary of GlobalSCAPE that was acquired on December 2, 2011. Results for TappIn are included in our accounting as of December 31, 2011 and in the results of operations since the date of acquisition.

 

2. Significant Accounting Policies

Principles of Consolidation

The accompanying consolidated financial statements of GlobalSCAPE, Inc. and its wholly-owned subsidiary are prepared in conformity with generally accepted accounting principles in the United States (“U.S.”). All significant intercompany accounts and transactions have been eliminated.

Revenue Recognition

The Company markets and distributes software products; revenue is recognized when the following conditions have been met:

 

   

Persuasive evidence of an arrangement exists

 

   

Delivery has occurred or services have been rendered

 

   

Fixed or determinable amount

 

   

Collection is reasonably assured

If the Company determines that any one of the four criteria is not met, we will defer recognition of revenue until all the criteria are met.

License revenue is derived primarily from the licensing of various products and technology. Generally license revenue is recognized upon delivery of the product, assuming all other conditions for revenue recognition noted above have been met.

The Company also enters into perpetual software license agreements through direct sales to customers and indirect sales with distributors and resellers. The license agreements generally include product maintenance and support agreements, for which the related revenue is deferred and recognized ratably over the term of the agreements. In any given period if the amount of revenue that is deferred, which is equal to the total of that period’s maintenance and support sales, is greater than the amount recognized, then revenue will decrease and vice versa.

 

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In arrangements that include multiple elements, including perpetual software licenses and maintenance and/or services, revenue is allocated and deferred for the undelivered items based on vendor specific objective evidence (“VSOE”). When VSOE of fair value exists for all elements in a multiple element arrangement, revenue is allocated to each element based on the relative fair value of each of the elements. VSOE of fair value is established by the price charged when the same element is sold separately. In a multiple element arrangement whereby VSOE of fair value of all undelivered elements exists but VSOE of fair value does not exist for one or more delivered elements, revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue, assuming collection is probable. Deferred revenue consists primarily of the unamortized balance of product maintenance.

We recognize hosting revenue, on a monthly basis, over the contractual term of the customer contract. We believe our customers generally will continue to utilize our services beyond the initial contract term which typically ranges from one to three years. As a result, setup fees are recognized ratably over the estimated average life of a customer relationship. Amounts that have been invoiced are recorded in accounts receivable and either deferred revenue or revenue, depending on whether the revenue recognition criteria have been met. These amounts are included in the “Other” line item on the Consolidated Statement of Operations.

Concentrations of Credit Risk and Significant Customers

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. Cash is deposited in demand accounts in federally insured domestic institutions to minimize risk. The Company provides credit, in the normal course of business, to a number of companies and performs ongoing evaluations of its credit risk. The Company requires no collateral from its customers. Management estimates the allowance for uncollectible accounts based on their historical experience and credit evaluation. In 2011 and 2010, no single customer accounted for more than 10% of revenues. In 2009, one customer accounted for approximately 14.9% of revenues. As of December 31, 2011, 2010 and 2009 there were no customers that represented 10% of our outstanding receivables.

Other Concentrations

Sales in Foreign Markets. In 2011, 2010 and 2009, approximately 31%, 31% and 29%, respectively, of the Company’s revenues were generated from sales to customers who provided addresses in foreign countries. However, the majority of revenues in each of these years were received in U.S. dollars so there is limited exchange rate risk with respect to the sale of our products. The sales to customers with foreign addresses were concentrated mostly in Canada, Australia and Western Europe. In 2011, 2010 and 2009, sales to the United Kingdom accounted for approximately 8%, 10%, and 9%, respectively, of total revenues.

Labor. GlobalSCAPE utilizes offshore developers for some portion of the coding phase of software development. If GlobalSCAPE were unable to continue using these developers because of political or economic instability, GlobalSCAPE may have difficulty finding comparably skilled developers or may have to pay considerably more for the same work, which would have a material adverse impact on results of operations.

Use of Estimates

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

 

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Cash and cash equivalents

Cash includes all cash and highly liquid investments with original maturities of three months or less. Approximately $7.1 million of our December 31, 2011 cash balance is fully insured through December 2012 under Section 343 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. As of December 31, 2011, approximately $1.8 million of our cash balance was held in an interest bearing account and therefore, was uninsured.

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. Expenditures for maintenance and repairs are charged to operations as incurred. Furniture, fixtures and equipment have a useful life of 5 to 7 years, computer equipment and software have 3 years and leasehold improvements are depreciated over the shorter of the lease term or the estimated useful life of the asset.

Royalty Costs

Royalties that the Company pays on software products licensed from third parties, which it resells, are expensed as a cost of sale when the software product is sold or earlier if the recoverability of any prepaid royalties is in doubt. The Company has distribution agreements with Xnet Communications GmbH, ComponentOne LLC, Veridis SA, Bitvise Limited, and Network Automation, Inc. The GlobalSCAPE software products associated with each of the companies are Cute FTP Mac Pro, CuteFTP and Enhanced File Transfer Server. The Company incurred approximately $466,000, $346,000, and $215,000 in royalty expense in 2011, 2010 and 2009, respectively.

Advertising Costs

The Company expenses advertising costs as incurred. Advertising expenses charged to operations for the years ended December 31, 2011, 2010 and 2009 were approximately $582,000, $624,000, and $994,000, respectively, and are included in selling, general and administrative expenses. Advertising costs are principally for the purchase of keywords for internet searches, graphic designs and business announcement services.

Income Taxes

The Company accounts for income taxes using the asset and liability method. The asset and liability method provides that the deferred tax assets and liabilities are recorded 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 when pre-tax income is generated.

We must also assess the likelihood that deferred tax assets will be realized from future taxable income and, based on this assessment; establish a valuation allowance, if required. Our determination of our valuation allowance is 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. To the extent we establish a valuation allowance or change the valuation allowance in a period, we reflect the change with a corresponding increase or decrease to our tax provision in our statement of operations.

We account for uncertainty in income taxes using a two-step process to determine the amount of tax benefit to be recognized. First, the tax position must be evaluated to determine the likelihood that it will be sustained upon external examination. If the tax position is deemed “more-likely-than-not” to be sustained, the tax position is then assessed to determine the amount of benefit to recognize in the financial statements. The amount of the benefit that may be recognized is the largest amount that has a greater than 50% likelihood of being realized upon ultimate settlement. Unrecognized tax benefits represent tax positions for which reserves have been established.

 

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Research and Development

Research and development expenses include all direct costs, primarily salaries for personnel and expenditures with external development sources, related to the development of new products and significant enhancements to existing products and are expensed as incurred until such time as technological feasibility is achieved. For the years 2011, 2010 and 2009, the Company incurred approximately $ 3.1 million, $3.0 million, and $2.8 million, respectively, on research and development.

Stock-Based Compensation

Compensation cost relating to share-based payment transactions is recognized in the financial statements. The cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employee’s requisite service period (generally the vesting period of the equity award).

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model. Expected volatility is based on historical volatility of GlobalSCAPE stock. The Company uses the simplified method to derive an expected term. The expected term represents an estimate of the time options are expected to remain outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. treasury yield curve in effect at the time of grant. The following table sets forth the assumptions used to determine compensation cost for our stock options.

 

     Year Ended
December 31,
2011
    Year Ended
December 31,
2010
    Year Ended
December 31,
2009
 

Expected volatility

     77     83     95

Expected annual dividend yield

     0        0        0   

Risk free rate of return

     2.46     2.60     2.13

Expected option term (years)

     6.00        5.00        6.01   

Refer to Note 8—Stock Options and Stock Based Compensation for additional disclosures regarding our stock compensation programs.

Goodwill and Other Intangible Assets

Goodwill and certain indefinite-lived assets are not amortized, but are evaluated at least annually for impairment. The determination of whether the carrying value of goodwill and other intangible assets have been impaired requires the Company to make estimates and assumptions about future business trends and growth. If an event occurs that would cause the Company to revise its estimates and assumptions used in analyzing the value of goodwill or other intangibles, such revision could result in an impairment charge that could have a material impact on the Company’s financial condition or results of operations.

Goodwill is tested for impairment annually in December or whenever an event occurs or circumstances change that may reduce the fair value of the reporting unit below its book value. Typically, the impairment test is conducted for each reporting unit in which goodwill is recorded by comparing the fair value of the reporting unit with its carrying value. Fair value is determined primarily by computing the future discounted cash flows expected to be generated by the reporting unit. If the carrying value exceeds the fair value, goodwill may be impaired. If this occurs, the fair value of the reporting unit is then allocated to its assets and liabilities in a manner similar to a purchase price allocation in order to determine the implied fair value of the goodwill of the reporting unit. The implied fair value is then compared with the carrying amount of the goodwill of the reporting unit and, if it is less, the Company would recognize an impairment loss.

For the year ended December 31, 2011, the Company adopted the new guidance per ASU 2011-08 regarding impairment testing as referred to in recent accounting pronouncements and Note 6 Goodwill and Other Intangible Assets. This new guidance provides companies with the option to first assess qualitative factors to determine whether it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount. If the entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it will not have to perform the two-step, quantitative impairment test.

 

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Impairment of Long-Lived Assets

The Company evaluates its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of these assets is measured by comparison of their carrying amounts to future undiscounted cash flows that the assets are expected to generate. If long-lived assets are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceed their fair market values and is recorded in the period that the determination is made.

Capitalized Software Development Costs

Capitalization of software development costs for external use begins upon the establishment of technological feasibility and ceases when the product is available for general release. The establishment of technological feasibility and the ongoing assessment of recoverability of capitalized software development costs require considerable judgment by management concerning certain external factors including, but not limited to, technological feasibility, anticipated future gross revenue, estimated economic life and changes in software and hardware technologies. Capitalization of software development costs for internal use begins during the application development stage. These software development costs are amortized using the straight-line method over a three-year period. The Company reviews costs throughout the year and no software development costs were capitalized in 2011, 2010 and 2009.

Other Long-Term Liabilities

Other long-term liabilities relate to deferred payments of rent expense and the long term portion of revenue deferred from the sale of maintenance and support agreements. The total amount of base lease payments is being charged to expense on the straight-line method over the term of the lease.

Earnings Per Share

Earnings per Share—basic and diluted are presented for all periods presented. Earnings per share—basic is computed using the weighted-average number of common shares outstanding during the periods. Earnings per share—diluted is computed 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 options are considered potentially dilutive common shares for the purpose of computing earnings per common share. In applying the treasury stock method to non vested options 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. Below is a reconciliation of the numerators and denominators of basic and diluted earnings per share for each of the following years (in thousands except share amounts):

 

     Year ended December 31,  
     2011 (1)      2010 (2)      2009 (3)  

Numerators

        

Numerators for basic and diluted earnings per

        

Net income

   $ 635       $ 881       $ 1,400   

Denominators

        

Denominators for basic and diluted earnings

        

Weighted average shares outstanding basic

     18,081         17,540         17,248   

Dilutive potential common shares

        

Stock options and awards

     665         720         443   

Denominator for dilutive earnings per share

     18,747         18,260         17,691   

Net income per common share—basic

   $ 0.04       $ 0.05       $ 0.08   

Net income per common share—diluted

   $ 0.03       $ 0.05       $ 0.08   

 

(1) For the year ended December 31, 2011, 271,067 options and all of the warrants have been excluded in computing dilutive shares, as the effect would be anti-dilutive.

 

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(2) For the year ended December 31, 2010, 180,972 options and all of the warrants have been excluded in computing dilutive shares, as the effect would be anti-dilutive.

 

(3) For the year ended December 31, 2009, 1,508,496 options and all of the warrants have been excluded in computing dilutive shares, as the effect would be anti-dilutive.

Recent accounting pronouncements

In September 2011, the Financial Accounting Standards Board (“FASB”) amended its guidance regarding testing goodwill for impairment. The guidance provides companies with the option to first assess qualitative factors to determine whether it is more likely than not (a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount. If after considering the totality of events and circumstances an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it will not have to perform the two-step, quantitative impairment test. This guidance is effective for fiscal years beginning after December 15, 2011, however, early adoption is permitted. We have evaluated the effect of the adoption of this guidance as of December 31, 2011, and it did not have a material effect on our financial statements.

In October 2009, the Financial Accounting Standards Board (“FASB”) amended its guidance regarding the accounting model for revenue arrangements that include both tangible products and software elements. This guidance requires that hardware components of a tangible product containing software components always be excluded from the software revenue recognition. This guidance also provides information on how to allocate consideration to deliverables in an arrangement that includes both tangible products and software. The implementation of this guidance is effective in fiscal years beginning on or after June 15, 2010. This guidance did not have a material impact on our financial statements.

In October 2009, the FASB amended its guidance regarding revenue recognition on multiple-deliverable arrangements. The objective of the guidance is to enable companies to account for products or services separately rather than as a combined unit. Specifically this guidance addresses how to separate deliverables and how to measure and allocate arrangement consideration to one or more units of accounting. This guidance does not affect arrangements for which industry-specific allocation and measurement guidance exists, such as for long-term construction contracts or for software transactions. This guidance is effective in fiscal years beginning on or after June 15, 2010. The implementation of this guidance did not have a material impact on our financial statements.

In August 2009, the FASB amended its guidance regarding the fair value measurement of liabilities. The guidance provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, the entity is required to measure fair value using a valuation technique that uses the quoted price of the identical liability when traded as an asset, the quoted prices for similar liabilities when traded as assets, a present value technique, or a market approach. The guidance also clarifies that when using the quoted price in an active market for the identical liability or the quoted price for the identical liability traded as an asset, these valuations are Level 1 fair value measurements. This guidance is effective as of the date of issuance. The implementation of this guidance did not have a material impact on our financial statements.

Reclassifications

Prior year balances in the Consolidated Statements of Operations have been adjusted to reflect a separate line item for professional services revenue, which was previously included in other revenues.

 

3. Investments

Accounting guidance defines fair value as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in

 

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the principal or most advantageous market for that asset or liability. The fair value should be calculated based on assumptions that market participants would use in pricing the asset or liability, not an assumption specific to the entity. In addition, the fair value of liabilities should include consideration of non-performance risk, including our own credit risk.

The Company’s investments currently consist of an investment in a software company, which is accounted for under the cost method. The current carrying amount of this cost-method investment is $2.3 million. The investment was made on December 30, 2009 and the Company believes that the current carrying amount approximates fair value and has not evaluated it for impairment as there have been no indicators that would indicate the value of the investment has declined below cost.

This investment is reflected in the accompanying financial statements, at cost, which approximate fair value because of the short term maturity of these instruments.

 

4. Accounts Receivable

Accounts receivable, which are primarily from sales of software licenses, are presented net of an allowance for doubtful accounts. The activity of the Company’s allowance for the years ended December 31, 2011, 2010 and 2009 is presented in the following table:

 

Year Ended December 31,

   Balance at
Beginning
of Period
     Charged to
(Income)
or Expense
    Deductions (1)     Balance
End of
Period
 

2011

   $ 237       $ (62   $ (5   $ 170   

2010

   $ 217       $ 121      $ (101   $ 237   

2009

   $ 331       $ (60   $ (54   $ 217   

 

 

(1) Represents amounts written off as uncollectible accounts receivable.

 

5. Fixed Assets

Fixed assets, at cost, consist of the following:

 

     December 31,  
     2011     2010  

Furniture and equipment

   $ 575      $ 556   

Software

     736        637   

Equipment

     742        638   

Leasehold improvements

     556        549   

Software development costs

     168        168   
  

 

 

   

 

 

 
     2,777        2,548   

Less accumulated depreciation

     (1,710     (1,262
  

 

 

   

 

 

 
   $ 1,067      $ 1,286   
  

 

 

   

 

 

 

 

6. Goodwill and Other Intangible Assets

For the year ended December 31, 2011, the Company performed its annual impairment test of the WAFS reporting unit in accordance with new FASB guidance per ASU 2011-08. This new guidance allows companies the option to perform a qualitative assessment in lieu of the annual quantitative impairment analysis. ASU 2011-08 is effective for fiscal years beginning after December 15, 2011, however, early adoption is permitted. This qualitative assessment analyzed the financial performance of the company, the performance of the WAFS reporting unit, market conditions, specific company events and the excess of fair value over carrying value in the most recent quantitative assessment. The results of this qualitative assessment concluded that it is not more likely than not that the fair value of the WAFS reporting unit is less than its carrying value.

 

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For the year ended December 31, 2010, the Company performed its annual impairment test of the WAFS reporting unit, which is the reporting unit where all of the Company’s goodwill was allocated, in accordance with the traditional quantitative impairment analysis. This analysis required the input of several critical assumptions, including:

 

   

Long term earnings and cash flow projections based on the Company’s strategic budgeting process, subject to future revenue growth rates and operating costs.

 

   

Weighted average cost of capital (“WACC”), which takes into account the relative weights of each component of the Company’s consolidated capital structure (equity and debt).

 

   

The U.S. Treasury 20-year rate was used as the risk free interest rate.

 

   

The assumed life of the reporting unit. Due to stable sales and increased market acceptance, the Company assumed that the reporting unit would continue as a going concern into perpetuity. As such, the Gordon Growth Model was applied to cash flows past the discrete projections.

Based on the quantitative calculation using the assumptions above, the fair value of the reporting unit exceeded its carrying value and therefore no impairment was recorded as of December 31, 2010. Due to the many variables inherent in the estimation of a business’s fair value and the relative size of the recorded goodwill, differences in assumptions may have a material effect on the results of the Company’s impairment analysis.

On December 2, 2011, the Company completed the acquisition of TappIn resulting in the recording of additional intangible assets and goodwill as a new reporting unit. TappIn intangible assets included developed technology of $2.77 million and customer relationships of $1.86 million. Goodwill associated with the TappIn acquisition aggregated to $11.34 million. As part of the purchase accounting for TappIn, including the purchase price allocation analysis, the Company performed a traditional quantitative assessment of the value of the related tangible and intangible assets. This analysis included the input of several critical assumptions, including long term earnings and cash flow projections, weighted average cost of capital, the risk free interest rate and the assumed life of the reporting unit.

Intangible assets, net at December 31, 2011 and 2010, consisted of the following:

 

2011

  Life (Years)      Gross Carrying
Amount
     Accumulated
Amortization
     Net  

Software—Availl

    5       $ 1,775       $ (1,576)       $ 199   

Customer list—Availl

    5         180         (153)         27   

Patent—Availl

    18         7         (4)         3   

Customer Relationship-TappIn

    10         1,863         (15)         1,848   

Developed Technology-TappIn

    7         2,771         (33)         2,738   
    

 

 

    

 

 

    

 

 

 

Total

     $ 6,596       $ (1,781)       $ 4,815   
    

 

 

    

 

 

    

 

 

 

2010

  Life (Years)      Gross Carrying
Amount
     Accumulated
Amortization
     Net  

Software

    5       $ 1,775       $ (1,311)       $ 464   

Customer list

    5         180         (117)         63   

Patent

    18         7         (3)         4   
    

 

 

    

 

 

    

 

 

 

Total

     $ 1,962       $ (1,431)       $ 531   
    

 

 

    

 

 

    

 

 

 

 

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Estimated future amortization of intangible assets is as follows ($ in thousands):

 

Years Ending December 31

   Estimated
Amortization  Expense
 

2012

   $ 808   

2013

     583   

2014

     583   

2015

     583   

2016

     583   

Thereafter

     1,675   
  

 

 

 

Total

   $ 4,815   
  

 

 

 

Acquired intangibles are amortized on a straight-line basis over their weighted average lives. Intangible assets amortization expense was approximately $350,000, $302,000, and $301,000 for the years ended December 31, 2011, 2010, and 2009, respectively.

 

7. Debt

In connection with the acquisition of TappIn, the Company entered into two loan agreements dated December 2, 2011 with The Bank of San Antonio for $4 million and $3 million, respectively. The notes executed in connection with these agreements each have a term of 5 years and require monthly principal and accrued interest installment payments of $75,028 and $55,589, respectively. The notes have fixed interest rates of 4.75% on the $4 million note and 4.25% on the $3 million note. Both notes are collateralized by substantially all of the assets of the Company. The $3 million term loan note is further secured by a $3 million Certificate of Deposit through The Bank of San Antonio. The notes may be prepaid without penalty.

The Loan Agreements contain customary covenants including covenants relating to maintaining legal existence and good standing, complying with applicable laws, delivery of financial statements, payment of taxes and maintaining insurance. GlobalSCAPE and its subsidiaries are also prohibited from selling any of their assets other than in the ordinary course of business, acquiring any other entities, changing the types of business they are engaged in, incurring indebtedness other than that permitted by the Loan Agreements, incurring any liens on their assets other than those permitted by the Loan Agreements, making certain investments or paying any dividends on, or acquiring, any shares of their capital stock. The Loan Agreements contain three financial covenants. GlobalSCAPE and its subsidiaries must maintain:

 

   

Debt Service Coverage (defined as net income+depreciation+interest+non-cash charges divided by the current portion of long-term debt +interest) of 1.25 beginning the first quarter of 2013;

 

   

Debt to tangible net worth of 4.0 :1 beginning the first quarter of 2013; and

 

   

Liquid assets (cash and marketable securities) of $4.0 million during 2012, $3.2 million in 2013 and $2.2 million in 2014.

The Loan Agreements also contain customary events of default including the failure to make payments of principal and interests, the breach of any covenants, the occurrence of a material adverse change, and certain bankruptcy and insolvency events.

 

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Scheduled future principal payments under the loan agreements as of December 31, 2011, are as follows: (in thousands):

 

Years Ending December 31

   Estimated
Principal
 

2012

   $ 1,276   

2013

     1,335   

2014

     1,397   

2015

     1,462   

2016

     1,530   

Thereafter

     0   
  

 

 

 

Total

   $ 7,000   
  

 

 

 

 

8. Stock Options and Stock Based Compensation

GlobalSCAPE has stock-based compensation plans available to grant incentive stock options, non-qualified stock options and restricted stock to employees and non-employee members of the Board of Directors.

In June 2010, GlobalSCAPE’s stockholders approved the GlobalSCAPE, Inc. 2010 Employee Long-Term Equity Incentive Plan (“2010 EIP”). The 2010 EIP authorizes the issuance of up to three million shares of common stock for stock-based incentives including stock options and restricted stock awards. The exercise price, term and other conditions applicable to each stock option or stock award granted under the 2010 EIP are determined by the Compensation Committee of the Board of Directors. The exercise price of stock options is set on the grant date and may not be less than the fair market value per share of our stock on that date (at market close). The stock options will expire after ten years. As of December 31, 2011, there were 1,475,500 options issued and outstanding of which 1,293,500 options were granted in 2011, and 64,350 are vested under the 2010 EIP. The Employee Long-Term Equity Incentive Plan options generally become exercisable over a three-year period (vesting 33%, 33% and 34% per year, respectively) and expire after ten years.

Under the GlobalSCAPE, Inc. 2000 Stock Option Plan (the “Employee’s Plan”), which was approved by the Board of Directors and became effective on May 17, 2001, a maximum of 3,660,000 shares of GlobalSCAPE common stock may be awarded. During the year ended December 31, 2011, no stock options were granted under this plan and on December 31, 2011, a total of 2,422,820 stock options were outstanding of which 2,042,323 were vested. The exercise price, term and other conditions applicable to each stock option granted under the Employee’s Plan are determined by the Compensation Committee. 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 on that date (at market close). The Employee’s Plan options generally become exercisable over a three-year period (vesting 33%, 33% and 34% per year, respectively) and expire after ten years.

Under the GlobalSCAPE, Inc. 2006 Non-Employee Directors Long-term Equity Incentive Plan (the “Director’s Plan”), which was approved by the stockholders and became effective on June 1, 2007, a maximum of 500,000 shares of GlobalSCAPE common stock may be awarded, of which 228,500 still remain available for issuance as of December 31, 2011. During the year ended December 31, 2011, through this plan no stock options were granted and restricted stock awards for 80,000 shares of common stock were granted. At December 31, 2011, a total of 160,000 stock options were outstanding under this plan of which 160,000 were vested. The exercise price, term and other conditions applicable to each stock option granted under the Director’s Plan are determined by the Compensation Committee of the Board of Directors. The exercise price of stock options is set on the grant date and may not be less than the fair market value per share of our stock on that date (at market close). The most recently awarded Director’s Plan options become exercisable over a one-year period and expire after ten years. The fair value of the restricted stock awards is based upon the market value of the underlying common stock as of the date of grant. Restricted stock awards are amortized over their applicable vesting period, one year, using the straight-line method. The Director’s Plan provides that each year, at the first regular meeting of the Board of Directors following the Company’s annual stockholders meeting, each non-employee director

 

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shall be granted awards of 20,000 shares of common stock for participation in the Board and Committee meetings during the prior year. The maximum annual award for any one person is 20,000 shares of common stock.

The following table summarizes information about restricted stock activity through the year ended December 31, 2011.

 

     Number of
Shares
     Weighted Average
Grant-Date Fair
Value
 

Outstanding at December 31, 2009

     58,080         1.24   

2010

     

Granted

     53,420         2.01   

Vested

     58,080         1.24   
  

 

 

    

Outstanding at December 31, 2010

     53,420         2.01   

2011

     

Granted

     80,000         2.16   

Vested

     53,420         2.01   
  

 

 

    

Outstanding at December 31, 2011

     80,000         2.16   

The total fair value of restricted stock that vested in 2011 and 2010 was $107,000 and $116,000, respectively.

There was approximately $1,003,000, $1,006,000, and $1,021,000 of compensation cost related to stock options and restricted stock awards recognized in operating results for the years ended December 31, 2011, 2010, and 2009, respectively.

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model. Expected volatility is based on historical volatility of GlobalSCAPE stock. We used the simplified method to derive an expected term. The expected term represents an estimate of the time options are expected to remain outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. treasury yield curve in effect at the time of grant.

The following table summarizes information about stock option activity through the year ended December 31, 2011.

 

     Number of
Options
     Weighted
Average Exercise
Price
     Weighted Average
Remaining Contractual
Terms (years)
     Average
Intrinsic
Value ($M)
 

Outstanding at December 31, 2008

     2,926,267       $ 1.70       $ 8.31       $ —     

2009

           

Granted

     961,760         1.27         

Forfeitures

     179,400         2.35         

Exercised

     55,300         0.77         
  

 

 

          

Outstanding at December 31, 2009

     3,653,327         1.57         7.89         1.25   

2010

           

Granted

     390,000         2.02         

Forfeitures

     180,350         1.74         

Exercised

     602,650         0.39         
  

 

 

          

Outstanding at December 31, 2010

     3,260,327         1.83         7.63         1.48   

2011

           

Granted

     1,293,500         2.00         

Forfeitures

     203,962         2.28         

Exercised

     291,545         1.21         
  

 

 

          

Outstanding at December 31, 2011

     4,058,320         1.91         6.39         0.54   

Exercisable at December 31, 2011

     2,266,673         1.91         6.39         0.43   

 

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The weighted average fair value of options granted during the year ended December 31, 2011 was $1.08. The total intrinsic value of options (which is the amount by which the stock price exceeded the exercise price of the options on the date of exercise) exercised during the year ended December 31, 2011 was $185,258. During the year ended December 31, 2011, the amount of cash received from the exercise of stock options was approximately $352,000.

At December 31, 2011, there was $1.7 million of total unrecognized compensation cost related to non-vested stock option awards which is expected to be recognized over a weighted-average period of 2.36 years. There were 376,409 options that vested during the year ended December 31, 2011 and the total fair value of these awards was $946,000.

At December 31, 2011, there was $73,000 of total unrecognized compensation cost related to non-vested restricted stock option awards which is expected to be recognized over a weighted-average period of 5 months. There were 53,420 options that vested during the year ended December 31, 2011 and the total fair value of these awards was $115,000.

The following table shows information about outstanding stock options at December 31, 2011.

 

            Options Outstanding      Options Exercisable  

Range of Exercise Prices

   Options
Outstanding
     Weighted
Average
Remaining
Contractual
Life
     Weighted
Average
Exercise
Price
     Number
of Options
     Weighted
Average
Exercise
Price
 

$0.15 - $0.33

     59,400         3       $ 0.26         59,400       $ 0.26   

$0.85 - $1.35

     752,040         7.1       $ 1.07         537,729       $ 1.07   

$1.41 - $2.14

     2,166,180         8.40       $ 1.60         981,994       $ 1.60   

$2.16 - $4.10

     1,080,700         6.80       $ 3.15         687,550       $ 3.14   

 

9. Common Stock and Warrants

On November 13, 2006, the Company entered into a securities purchase agreement with accredited investors and granted warrants to purchase 1,352,000 shares of our common stock to the investors with an exercise price of $3.15 per share. The warrants have a 5-year term and are exercisable until May 2012.

 

10. Income Taxes

The components of income tax expense (benefit) for the years ended December 31, 2011, 2010 and 2009 are as follows:

 

     Federal     State     Total  

2011

      

Current

   $ 460      $ 61      $ 521   

Deferred

     (352     0        (352
  

 

 

   

 

 

   

 

 

 

Total

   $ 108      $ 61      $ 169   
  

 

 

   

 

 

   

 

 

 

2010

      

Current

   $ 1,055      $ 53      $ 1,108   

Deferred

     (697     (1     (698
  

 

 

   

 

 

   

 

 

 

Total

   $ 358      $ 52      $ 410   
  

 

 

   

 

 

   

 

 

 

2009

      

Current

   $ 754      $ (9   $ 745   

Deferred

     (417     (7     (424
  

 

 

   

 

 

   

 

 

 

Total

   $ 337      $ (16   $ 321   
  

 

 

   

 

 

   

 

 

 

 

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Deferred income taxes 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 the Company’s deferred tax assets and liabilities are related to the following:

 

     2011      2010  

Deferred tax assets:

     

Allowance for doubtful accounts

   $ 58       $ 81   

Compensation and benefits

     70         71   

Share based compensation

     810         714   

Deferred revenue

     387         356   

TappIn net operating loss

     543      

Other

     1         16   
  

 

 

    

 

 

 

Total gross deferred tax assets

     1,869         1,238   

Deferred tax liabilities:

     

Intangible assets

     1,356         121   

Depreciation

     148         243   
  

 

 

    

 

 

 

Total gross deferred tax liabilities

     1,504         364   

Net deferred tax asset

   $ 365       $ 874   
  

 

 

    

 

 

 

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Based on the expectation of future taxable income and that the deductible temporary differences will offset existing taxable temporary differences, management believes it is more likely than not that we will realize the benefits of those deductible differences at December 31, 2011 and 2010.

A reconciliation of income tax expense (benefit) and the amount computed by applying the statutory federal income rate (34%) to income before income taxes is as follows ($ in thousands):

 

     2011     2010     2009  

Taxes computed at federal statutory rate

   $ 291      $ 428      $ 585   

Increase (decrease) in taxes resulting from:

      

Share based compensation

     60        74        100   

Uncertain tax position

     —          (90     —     

Domestic production activities deduction

     (75     (98     (53

Research and development credit

     (358     —          0   

State taxes, net of federal benefit

     40        34        19   

Conversion of ISO’s to NQSO

     —          —          (287

Acquisition costs

     185        —          —     

Other

     26        62        (43
  

 

 

   

 

 

   

 

 

 

Actual tax expense

   $ 169      $ 410      $ 321   
  

 

 

   

 

 

   

 

 

 

The full amount of the unrecognized tax benefits disclosed in 2009 were reduced in 2010 due to the lapse of the statute of limitations. We have adopted a policy to record interest and penalty expense related to income taxes as interest and other expense. The Company files a federal income tax return and state income tax returns in New Hampshire, Massachusetts and Texas. The Company is no longer subject to U.S. Federal tax examinations for the years before 2007 and state income tax exams for the years before 2006. Years open to examination for state returns vary based on the jurisdiction. The Company’s tax return for the year ending December 31, 2007 was audited by the Internal Revenue Service during 2009. The audit was completed in January 2010 and no adjustments were required.

 

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11. Employee Benefit Plan

The Company has a 401(k) plan that covers substantially all employees with at least six months of service. Under the plan, employees may elect to contribute a percentage of their annual salary subject to the Internal Revenue Code maximum limitations. The plan provides for employer matching and discretionary contributions, the amounts of which are to be determined annually by the Board of Directors. The Company made contributions to the plan of $88,000, $81,000, and $43,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

 

12. Related Party Transaction

In September 2010, it was determined that our cost method investee, CoreTrace, would need additional funding of $4 million. This funding would be provided in the form of a bridge loan in two payments of $2 million each. The Company agreed to participate in the additional funding proportionate to its investment interest and in October 2010 loaned CoreTrace approximately $300,000, with 6% interest and a maturity date of June 30, 2012. The second payment of the total funding was made in April 2011 for approximately $300,000 and bears interest at 6% and will also be due June 30, 2012. The notes also allow for automatic or voluntary conversion into additional equity shares of CoreTrace. In the event of a “Qualified Financing” as defined in the agreement, the loan balance would be automatically converted into shares upon closing. The agreement also allows for voluntary conversion into equity shares in the event of a “Non-Qualified Financing” as defined in the agreement or if the loan remains outstanding on October 15, 2011.

Additional funding was provided to CoreTrace in August 2011, December 2011 and March 2012 for approximately $75,000, $89,000, and $150,000, respectively, on a senior, secured basis. These notes bear interest at 6% per annum, mature on June 30, 2012 and are secured by all of CoreTrace’s assets.

 

13. Commitments and Contingencies

Minimum rental commitments under operating leases at December 31, 2011, are as follows:

 

Years Ending December 31

      

2012

   $ 369   

2013

     349   

2014

     349   

2015

     355   

2016

     360   

Thereafter

     840   
  

 

 

 

Total

   $ 2,622   
  

 

 

 

Operating lease expense amounted to approximately $356,000 in 2011, $363,000 in 2010 and $357,000 in 2009.

In January 2010, GlobalSCAPE was named as one of a number of defendants by Uniloc USA, Inc. and Uniloc (Singapore) Private Limited in a complaint filed in the United States District Court for the Eastern District of Texas Tyler Division for patent infringement of a single U.S. patent. The complaint alleged that GlobalSCAPE infringed on a patent that utilizes a system for activating software products through a registration process. In September 2010, the complaint was dismissed with prejudice and the Company did not make any payment in conjunction with the dismissal.

GlobalSCAPE has been named as one of a number of defendants in two different patent infringement suits. The first was filed by Content Delivery Solutions LLC in the United States District Court for the Western District of Texas Austin Division. The complaint alleges that GlobalSCAPE infringed on a patent that addresses products

 

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or services for resuming interrupted transmission of a file over a network. The second was filed by Achates Reference Publishing, Inc. in the United States District Court for the Eastern District of Texas Marshall Division. The complaint alleges that GlobalSCAPE infringed on a patent that addresses product activation functionality. Both of these matters have just been brought forth and, while GlobalSCAPE believes that it has meritorious defenses to both plaintiffs’ claims and intends to defend the lawsuits vigorously, it is early in its process and it is not possible to reasonably determine the outcome of these suits. Accordingly, it is not possible at this time to assess whether or not we need to reserve for potential settlements.

 

14. Acquisition

In December 2011, the Company completed the acquisition of all of the issued and outstanding shares of the capital stock of HomePipe Networks, Inc., by means of a merger of GlobalSCAPE’s wholly owned subsidiary, Plumber Acquisition Corporation, with and into HomePipe. The initial purchase price was $9.0 Million in cash, which was partially funded by two loans totaling $7 million established with the Bank of San Antonio. The former HomePipe stockholders are also entitled to receive up to an additional $8 million in cash or, at the election of GlobalSCAPE and the former stockholders of HomePipe, GlobalSCAPE common stock depending upon the achievement of certain product and revenue targets for HomePipe for 2012, 2013 and 2014. At the effective time of the merger, HomePipe’s name was changed to TappIn, Inc.

TappIn provides technology that allows users to access their digital files and media such as pictures, documents videos and music stored on a computer using a web-browser, tablet or mobile smartphone (included Apple, iPhone, and IPad, Google, Android and Windows Phone7) without having to upload, organize and sync files between devices or pay for additional cloud storage.

The total purchase price for the acquisition was allocated to tangible and intangible assets and liabilities based on their estimated fair values as of the date of acquisition. The Company allocated the purchase price to identifiable intangible assets including developed technology and customer relationships, with the remainder being allocated to goodwill. Goodwill is not deductible for tax purposes.

The table below summarizes the estimated fair value of the assets acquired and the liabilities assumed at the date of the TappIn acquisition transaction. The Company has completed valuations of the tangible and intangible assets reflecting the following allocation of the purchase price.

 

Accounts receivable

   $ 169,000   

Current assets

     28,000   

Property and equipment, net

     20,000   

Intangibles

     4,634,000   

Goodwill

     11,343,000   

Assumed liabilities

     (3,000

Deferred revenue

     (4,000
  

 

 

 

Net assets acquired

   $ 16,187,000   
  

 

 

 

Reconciliation of net assets acquired to total consideration as follows:

 

Cash consideration per purchase agreement

   $ 2,000,000   

Cash provided through debt financing

     7,000,000   

Contingent consideration

     6,997,000   

Additional cash paid for net working capital

     190,000   
  

 

 

 

Total Purchase Price

   $ 16,187,000   
  

 

 

 

 

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Pro Forma Results of Operations

The following unaudited pro forma consolidated results of operations for the years ended December 31, 2011 and December 31, 2010 are presented as if the TappIn acquisition had been completed on January 1, 2010.

 

     Year Ended
December 31, 2011
    Year Ended
December 31, 2010
 

Revenues

   $ 21,170,000      $ 18,569,000   

Net loss

   $ (1,276,000   $ (997,000

Basic and diluted net loss per share

   $ (0.07   $ (0.06

The pro forma consolidated results of operations include adjustments to:

 

   

Include the results of TappIn for the periods presented;

 

   

Include the incremental amortization expense associated with the finite-lived intangible assets from January 1, 2010;

 

   

Include additional interest expense related to financing the acquisition as if the notes began on January 1, 2010;

 

   

Include acquisition expenses associated with the purchase of TappIn as if the purchase occurred January 1, 2010; and

 

   

Reflects the pro forma tax adjustments resulting from the acquisition as if the purchase occurred January 1, 2010.

The pro forma information is not necessarily indicative of the results of operations that would have occurred had the transaction been made at the beginning of the periods presented or the future results of the combined operations.

15. Quarterly Consolidated Financial Information (unaudited)

 

     Fiscal Year 2011  
     1st Quarter      2nd Quarter      3rd Quarter      4th Quarter  

Total revenues

   $ 4,644       $ 5,710       $ 5,417       $ 5,123   

Total operating expenses

   $ 4,552       $ 4,995       $ 4,886       $ 5,669   

Other income (expense)

   $ —         $ 13       $ 9       $ (10

Net income (loss) before provision for income taxes

   $ 92       $ 728       $ 540       $ (556

Net income (loss)

   $ 59       $ 471       $ 611       $ (505

Net income (loss) per share: