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

Significant Accounting Policies

Principles of Consolidation

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

Reclassification of Expenses

We have revised the classification of certain of our operating expenses. To ensure comparability between periods, we revised the previous period financial statements presented to conform to the method of presentation in the current period financial statements. These reclassifications had no impact on the net income for the periods presented or total stockholders’ equity at September 30, 2018.

Revenue Recognition

Products and Services

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

·~~Persuasive evidence of an arrangement exists.~~

·~~Delivery has occurred or services have been rendered.~~

·~~The amount of the sale is fixed or determinable.~~

·~~Collection of the sale amount is reasonably assured.~~

~~Index~~

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

software products and services:

●

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

●

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

●

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

●

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

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

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

●

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

●

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

●

M&S – We provide these services to purchasers of perpetual software licenses under agreements with terms generally ranging from one to three years. We require up-front payment of our M&S fee in an amount that covers the entire term of the agreement. We record as deferred revenue amounts paid that relate to future periods during which we will provide the M&S service. We reduce deferred revenue and recognize revenue ratably in future periods as we deliver the M&S service.

●

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

Index

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

Deferred Revenue Classification and Activity

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

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Deferred revenue, beginning of period	$	16,013		$	16,160		$	17,050		$	17,445
Deferred revenue resulting from new contracts with customers		4,764			4,769			14,321			14,214
Deferred revenue at the beginning of the period that was amortized to revenue		(5,113	)		(4,554	)		(14,727	)		(14,370	)
Deferred revenue arising during the period that was amortized to revenue		(528	)		(456	)		(1,508	)		(1,370	)
Deferred revenue, end of period	$	15,136		$	15,919		$	15,136		$	15,919

Multi-Element Transactions

At the time ~~our~~ customers purchase ~~these products,~~perpetual software licenses, they also typically purchase M&S although it is not mandatory. We do not sell separate M&S to subscribers to our SaaS solutions as M&S is provided as part of their SaaS subscription. Customers may also purchase a product maintenance and support, or M&S, agreement. These transactions are multiple element software sales for which we assess the presence of vendor specific objective evidence (“VSOE”) of the fair value of the undelivered elements to determine the portion of these sales to recognize as revenue upon delivery of the software product and the portion of these sales to record as deferred revenueprofessional services at the time the product is delivered. We amortize the deferred revenue component to revenue in future periods as we deliver the related future services to the customer. For transactions, if any, for which we cannot establish VSOEthey purchase perpetual software licenses or a SaaS subscription. Each of the ~~fair value~~components of these multi-element transactions is a separately identifiable performance obligation.

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

We sell, as ~~deferred revenue and amortize that amount to revenue in future periods as we deliver the related future services to the customer.~~

~~Our deferred revenue consists primarily~~stand-alone transactions, renewals of ~~revenue to be earned in the future as we deliver services under~~pre-existing M&S agreements. We bill our customers in advance for M&S services and record accounts receivable and deferred revenue in the same amount at the time we issue an invoice. We commence recognition of the deferred revenue as revenue only after the M&S period begins.

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

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

We ~~recognize revenue from these services as they are completed and accepted by our customers.~~

allocate discounts proportionally to all of the components of a multi-element transaction.

Sales Tax

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

~~Reclassification of Expenses~~

~~In preparing~~

Allowance for Sales Returns

We provide an allowance for sales returns. We estimate this allowance based upon our ~~financial statements for~~historical experience and the ~~year ended December 31, 2015, we revised the manner in which we present cost of revenues and other elements of our statement of operations in response to the changing~~ nature of recent transactions with customers. This amount is included in accrued liabilities in our ~~business and~~condensed consolidated balance sheet.

Index

Contract Assets

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

Incremental Costs of Obtaining a Contract to Deliver Goods and ~~nature of certain expenses we incur.~~

~~Cost of Revenue~~

~~Cost of revenue was expanded from one line to three lines to correspond with the associated revenue classifications. Amortization of capitalized software development~~Services

We incur incremental costs ~~was moved from depreciation and amortization and included~~ in the ~~cost~~form of ~~license revenue. Other costs included in cost of license revenue are~~sales commissions paid to our sales personnel and royalties ~~we pay to use technology in our~~on certain products ~~that is developed by others and fees~~ paid to third ~~party service providers who support~~parties. These are costs we would not incur if we did not obtain a contract to deliver our ~~cloud based~~goods and ~~SaaS solutions. Cost of M&S revenue and cost of professional services revenue consist primarily of salaries and related personnel~~services. We account for these costs as follows:

●

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

●

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

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

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

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

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

At September 30, 2018, $598,000 was recorded in prepaid and current other assets and $507,000 was recorded in other assets in our ~~employees who deliver~~condensed consolidated balance sheet.

The following tables present our reported results under ASC 606 and a reconciliation to results using the related service to our clients. These costs were previously included in the general and administrative classification. Also included in the cost of professional services revenue are the fees of third party service providers.

~~Selling, General and Administrative~~

~~We separated selling, general and administrative expenses into two line items – sales and marketing and general and administrative.~~

~~Depreciation and Amortization~~

After reclassifying amortization of capitalized software development costs to cost of license revenue, the remaining depreciation and amortization costs were included in general and administrative expense and the depreciation and amortization line on our statement of operations was removed.

historical accounting method:

Index

~~Effect of the reclassifications~~

The reclassifications were between cost of revenues and operating expenses and had no effect on revenue, income from operations, net income or earnings per share. The following tables illustrate the effects of these reclassifications on previously reported amounts for the quarter and the nine months ended September 30, 2015 ($ in thousands):

Quarter Ended September 30, 2015
Reclassification of Previously Reported Amounts

As
Previously
Reported

Cost
of
Revenues

Capitalized
Software Cost
Amortization

Personnel
Costs
Depreciation
Selling,
General
& Administrative

As
Now
Reported

Operating Revenues:
Software licenses $ 2,852 $ 2,852
Maintenance and support 4,142 4,142
Professional services 653 653
Total revenues 7,647 7,647

Cost of Revenues:
Software licenses 195 367 562
Maintenance and support 341 341
Professional services 263 342 605
Total cost of revenues - 1,508

Gross profit - 6,139

Operating Expenses
Sales and marketing - 2,289 2,289
General and administrative - 1,449 1,449
Cost of Revenues 458 (458 ) -
Selling, general and administrative 4,355 (683 ) 66 (3,738 ) -
Research and development 646 646
Depreciation and amortization 433 (367 ) (66 ) -
Total operating expenses 5,892 4,384

Income from operations 1,755 1,755
Other income (expense), net 17 17
Income before income taxes 1,772 1,772
Income tax expense 542 542
Net income $ 1,230 $ 1,230
Comprehensive income $ 1,230 $ 1,230

Net income per common share -
Basic $ 0.06 $ 0.06
Diluted $ 0.06 $ 0.06

GlobalSCAPE, Inc.

Condensed Consolidated Balance Sheet

(in thousands)

As of September 30, 2018

(unaudited)

	As Reported			Effect of ASC 606			ASC 605 Historical
Assets
Current assets:
Cash and cash equivalents	$	9,630					$	9,630
Certificates of deposit, short term		1,530						1,530
Accounts receivable, net		4,853			(75	)		4,778
Federal income tax receivable		740			50			790
Prepaid and other current assets		3,173			(598	)		2,575
Total current assets		19,926			(623	)		19,303

Capitalized software development costs, net		3,384						3,384
Goodwill		12,712						12,712
Deferred tax asset, net		330			161			491
Property and equipment, net		442						442
Other assets		577			(508	)		69
Total assets	$	37,371		$	(970	)	$	36,401

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		1,982						1,982
Accrued expenses		3,378			(75	)		3,303
Deferred revenue		12,341						12,341
Total current liabilities		17,701			(75	)		17,626

Deferred revenue, non-current portion		2,795						2,795
Other long term liabilities		128						128

Stockholders' Equity:
Preferred stock		-						-
Common stock		22						22
Additional paid-in capital		25,106						25,106
Treasury stock		(18,714	)					(18,714	)
Retained earnings		10,333			(895	)		9,438
Total stockholders’ equity		16,747			(895	)		15,852

Total liabilities and stockholders’ equity	$	37,371		$	(970	)	$	36,401

Index

GlobalSCAPE, Inc.

Condensed Consolidated Statement of Operations and Comprehensive Income

(in thousands, except per share amounts)

For the Three Months Ended September 30, 2018

(unaudited)

	As Reported			Effect of ASC 606			ASC 605 Historical

Operating revenues:
Software licenses	$	2,843					$	2,843
Maintenance and support		5,488						5,488
Professional services		649						649
Total revenues		8,980			-			8,980
Costs of revenues
Software licenses		721			(28	)		693
Maintenance and support		514						514
Professional services		264						264
Total costs of revenues		1,499			(28	)		1,471
Gross Profit		7,481			28			7,509
Operating expenses
Sales and marketing		2,261			(23	)		2,238
General and administrative		1,589						1,589
Legal and professional		1,510						1,510
Severance		381						381
Research and development		368						368
Total operating expenses		6,109			(23	)		6,086
Income from operations		1,372			51			1,423
Interest income (expense), net		(93	)					(93	)
Income before income taxes		1,279			51			1,330
Income tax expense		281			11			292
Net income	$	998		$	40		$	1,038
Comprehensive income	$	998		$	40		$	1,038

Net income per common share - basic	$	0.05		$	0.00		$	0.05

Net income per common share - diluted	$	0.05		$	0.00		$	0.05

Nine Months Ended September 30, 2015
Reclassification of Previously Reported Amounts

As
Previously
Reported

Cost
of
Revenues

Capitalized
Software Cost
Amortization

Personnel
Costs
Depreciation
Selling,
General
& Administrative

As
Now
Reported

Operating Revenues:
Software licenses $ 8,590 $ 8,590
Maintenance and support 12,269 12,269
Professional services 1,531 1,531
Total revenues 22,390 22,390

Cost of Revenues:
Software licenses 739 912 1,651
Maintenance and support 1,057 1,057
Professional services 327 930 1,257
Total cost of revenues - 3,965

Gross profit - 18,425

Operating Expenses
Sales and marketing - 7,060 7,060
General and administrative - 4,629 4,629
Cost of Revenues 1,066 (1,066 ) -
Selling, general and administrative 13,472 (1,987 ) 204 (11,689 ) -
Research and development 1,832 1,832
Depreciation and amortization 1,116 (912 ) (204 ) -
Total operating expenses 17,486 13,521

Income from operations 4,904 4,904
Other income (expense), net 51 51
Income before income taxes 4,955 4,955
Income tax expense 1,585 1,585
Net income $ 3,370 $ 3,370
Comprehensive income $ 3,370 $ 3,370

Net income per common share -
Basic $ 0.16 $ 0.16
Diluted $ 0.16 $ 0.16

Index

GlobalSCAPE, Inc.

Condensed Consolidated Statement of Operations and Comprehensive Income

(in thousands, except per share amounts)

For the Nine Months Ended September 30, 2018

(unaudited)

	As Reported		Effect of ASC 606			ASC 605 Historical

Operating revenues:
Software licenses	$	7,726				$	7,726
Maintenance and support		15,872					15,872
Professional services		1,549					1,549
Total revenues		25,147		-			25,147
Costs of revenues
Software licenses		2,225		(42	)		2,183
Maintenance and support		1,574					1,574
Professional services		880					880
Total costs of revenues		4,679		(42	)		4,637
Gross Profit		20,468		42			20,510
Operating expenses
Sales and marketing		8,229		(92	)		8,137
General and administrative		4,883					4,883
Legal and professional		4,235					4,235
Severance		488					488
Research and development		1,654					1,654
Total operating expenses		19,489		(92	)		19,397
Income from operations		979		134			1,113
Interest income (expense), net		63					63
Income before income taxes		1,042		134			1,176
Income tax expense		386		50			436
Net income	$	656	$	84		$	740
Comprehensive income	$	656	$	84		$	740

Net income per common share - basic	$	0.03	$	0.00		$	0.03

Net income per common share - diluted	$	0.03	$	0.00		$	0.03

Index

GlobalSCAPE, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

For the Nine Months Ended September 30, 2018

(unaudited)

	As Reported			Effect of ASC 606			ASC 605 Historical

Operating Activities:
Net Income	$	656			84		$	740
Items not involving cash at the time they are recorded in the statement of operations:
Provision (recoveries) for doubtful accounts receivable		(64	)					(64	)
Depreciation and amortization		1,641						1,641
Share-based compensation		972						972
Deferred taxes		61						61
Subtotal before changes in operating assets and liabilities		3,266			84			3,350
Changes in operating assets and liabilities:
Accounts receivable		1,136			(75	)		1,061
Prepaid and other current assets		(1,868	)		(134	)		(2,002	)
Deferred revenues		(1,914	)					(1,914	)
Accounts payable		82						82
Accrued expenses		1,707			75			1,782
Other assets		116						116
Accrued interest receivable		-						-
Other long-term liabilities		(48	)					(48	)
Federal income tax receivable		82			50			132
Net cash provided by operating activities		2,559			-			2,559
Investing Activities:
Software development costs		(1,057	)					(1,057	)
Purchase of property and equipment		(143	)					(143	)
Redemption of Certificates of Deposit		14,264						14,264
Net cash provided by investing activities		13,064			-			13,064
Financing Activities:
Proceeds from exercise of stock options		341						341
Purchase of treasury stock		(17,262	)					(17,262	)
Dividends paid		(655	)					(655	)
Net cash used in financing activities		(17,576	)		-			(17,576	)
Net increase in cash		(1,953	)					(1,953	)
Cash at beginning of period		11,583			-			11,583
Cash at end of period	$	9,630		$	-		$	9,630

Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	-					$	-
Income tax payments	$	238					$	238

Index

Cash and cash equivalents

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

~~Short Term Investments~~

Short-term investments consist of certificates of deposit held with financial institutions with contractual maturity dates less than one year from the balance sheet date. The Company has the intent and ability to hold these investments until their maturity dates and therefore accounts for them as held-to-maturity. These certificates of deposit are stated at amortized cost, which approximates the fair value of these investments.

~~Index~~

Property and Equipment

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

Expenditures for maintenance and repairs are expensed as incurred.

Goodwill

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

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

Macroeconomic conditions.

Industry and market considerations.

Cost factors and trends for labor and other expenses of operating our business.

Our overall financial performance and outlook for the future.

Trends in the quoted market value and trading of our common stock.

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

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

As of December 31, ~~2015,~~2017, after assessing the totality of the relevant events and circumstances, we determined it not more likely than not that the fair value of our reporting unit was less than its carrying amount. Accordingly, we concluded there was no impairment of goodwill as of that date. There have been no material events or changes in circumstances since that time indicating that the carrying amount of goodwill may exceed its fair market value and that interim testing needed to be performed.

Capitalized Software Development Costs

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

Research and Development

We expense research and development costs as incurred.

Index

Advertising Expense

We expense advertising costs as incurred as a component of our sales and marketing expenses. Advertising expense was ~~$480,315~~approximately $172,000 and ~~$334,352~~$480,000 in the ~~2016~~2018 quarter and the ~~2015~~2017 quarter, respectively, and ~~$1,447,078~~$750,000 and ~~$1,116,894~~$1,508,000 in the ~~2016~~2018 nine months and ~~2015~~2017 nine months, respectively.

Share-Based Compensation

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

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

We estimate expected volatility based on historical volatility of our common stock.

We primarily use ~~primarily~~ the simplified method to derive an expected term which represents an estimate of the time options are expected to remain outstanding. We use this method because our options are plain-vanilla options, and we believe our historical option exercise experience is not adequately indicative of our future expectations.

We base the risk-free rate for periods within the contractual life of the option on the U.S. treasury yield curve in effect at the time of grant.

We estimate a dividend yield based on our historical and expected future dividend payments.

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

Income Taxes

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

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

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

Earnings Per Share

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

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

Index

~~Recent accounting pronouncements~~

~~In June 2016,~~

Recently Issued Accounting Pronouncements

FASB has issued the ~~Financial Accounting Standards Board, or FASB, issued~~ Accounting Standard ~~Update (ASU)~~Updates, or ASU described below that we believe may be relevant to our business and to the preparation of our condensed consolidated financial statements.

ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting (issued September 2017) – This update provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. It states that in these situations, modification accounting should be applied unless the fair value of the modified award is the same as the fair value of the original award immediately before the original award was modified, the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award was modified, and the classification of the modified award as equity or a liability is the same as the classification of the original award immediately before the original award was modified. This update is effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. We adopted this pronouncement in the first quarter of 2018 and do not expect this pronouncement to have a material effect on how we account for the changes to the terms or conditions of a share-based payment award.

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

ASU 2016-15, Statement of Cash Flows – Classification of Certain Cash Receipts and Cash ~~Payments.~~ Payments (issued June 2016) - This pronouncement provides guidance as to the treatment of transactions in a statement of cash flows with respect to eight specific cash flow issues. During ~~2015~~2017 and ~~2016,~~the first nine months of 2018, we had no transactions of the type cited in ~~the statement~~our Condensed Consolidated Statement of Cash Flows and do not anticipate having any such transactions in the foreseeable future. Accordingly, we do not expect this pronouncement to have a material effect on how we present items in our consolidated statement of cash flows.

~~In June 2016, the FASB issued~~

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

~~In March 2016, the FASB issued ASU 2016-09,~~ ~~Improvements to Employee Share-Based Payment Accounting~~. When implemented, this standard will discontinue the recording in equity of tax benefits or tax deficiencies that arise from differences between share-based payment compensation expense recorded for financial statement purposes and that expense deductible for tax purposes. This new standard requires that the tax effect of all such differences be recorded and reported in the statement of operations. This standard also requires that tax-related cash flows resulting from share-based payments be reported as operating activities in the statement of cash flows which is a change from the current requirement to present such tax-related items as an inflow from financing activities and an outflow from operating activities. In accordance with this standard, we will implement it beginning with our interim and annual financial statements for 2017. The extent of the effect of this standard on our financial statements for 2017 and later depends upon the level of stock option exercise activity we experience in 2017 and later. The amounts involved in accounting for tax benefits or deficiencies from share-based compensation that are the subject of ASU 2016-09 are presented in our 2016 and earlier consolidated statements of cash flows and consolidated statements of stockholders’ equity on lines that are captioned tax benefit or tax deficiency from share-based compensation.

~~In February 2016, the FASB issued~~

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

Index

~~In November 2015, the FASB, issued~~

ASU ~~No. 2015-17,~~ ~~Income Tax: Balance Sheet Classification of Deferred Taxes~~. ASU 2015-07 requires that all deferred tax assets and liabilities for a tax jurisdiction, along with any related valuation allowance, be classified as noncurrent on the balance sheet. We have implemented this ASU in the accompanying financial statements in the manner described in the Note 6 below.

~~In May 2014, FASB issued ASU No.~~ 2014-09, ~~entitled~~ Revenue from Contracts with Customers ~~(Topic 606)~~.(issued May 2014) - The core principle of this guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects consideration to which the entity expects to be entitled in exchange for those goods or services. We have implemented these new principles using the modified retrospective transition method and recorded an increase (tax effected) to retained earnings at January 1, 2018 of $979,000. We also recorded as an asset deferred expense of approximately $1.2 million. We are ~~subject~~accounting for these costs we incur to ~~this guidance effective~~obtain a contract as follows:

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

● If these costs are associated with services for which we recognize revenue over time (primarily sales of M&S and SaaS subscriptions) for which we believe it is likely that the ~~year ending December 31, 2018, and~~contract for those services will be renewed for additional terms in the ~~quarterly periods during that year. We do not expect the amounts or timing of revenue~~future, provided we ~~report in those future periods under this guidance~~deem these costs to be ~~materially affected relative~~recoverable, we record these costs as deferred expense asset and amortize that cost to ~~current guidance.~~

~~Index~~

~~Use of Estimates~~

~~The preparation of consolidated financial statements in accordance with GAAP requires~~expense as follows:

o For 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~~portion of the ~~date~~cost that we determine benefits us primarily only over the ~~financial statements are published, and~~term of the ~~reported amounts~~specific underlying contract currently in force (such as the term of ~~revenues and expenses during~~an M&S contract), we will recognize expense ratably each month over that term.

o For the ~~reporting period. Uncertainties with respect~~portion of the cost that we determine benefits us over an overall customer relationship that is likely to ~~such estimates and assumptions are inherent~~span a period of time that is longer than an initial contract term (for example, an M&S contract renewed for multiple terms in the ~~preparation~~future), we will recognize expense ratably monthly over the estimated life of the ~~Company’s financial statements. It is possible~~customer relationship.

We have reviewed all recently issued accounting pronouncements. The pronouncements that ~~the actual results could differ from these estimates and assumptions, which could~~we have already adopted did not have a material effect on ~~the reported amounts~~our financial condition, results of operations, cash flows or reporting thereof, and except as otherwise noted above, we do not believe that any of the ~~Company’s~~pronouncements that we have not yet adopted will have a material effect upon our financial ~~position and~~condition, results of ~~operation.~~

operations, cash flows or reporting thereof.

~~Capitalized Software Development Costs~~

Certificates of Deposit

Our certificate of deposit is held at a bank and will mature in October 2018. Certificates of deposit with contractual maturity dates less than one year from the balance sheet date are presented as current assets. Certificates of deposit with contractual maturity dates beyond one year from the balance sheet date are presented as non-current assets.

We measure these investments on a recurring basis using Level 1 of the fair value hierarchy prescribed by GAAP which results in them being presented at original cost plus accrued interest earned. There is no amortization of original cost associated with our certificates of deposit.

5.	Accounts Receivable, Net

We bill customers and issue invoices when we have delivered goods or services. In addition, when customers agree to purchase or renew M&S services, we bill and invoice customers at that time which could be before the date we begin delivering those services. In that event, we exclude from accounts receivable (and from the related deferred revenue, see Note 3) the invoices we have issued for which the M&S services commencement date is in the future and which have not been paid by the customer as of the date of our condensed consolidated financial statements. We continually assess the collectability of our accounts receivable. If we deem it less than probable that we will collect an amount due us, we write-off that balance against our allowance for doubtful accounts. Accordingly, we determine our accounts receivable, net, as follows ($ in thousands):

	September 30, 2018			December 31, 2017
Total invoices issued and unpaid	$	5,324		$	6,644
Less: Unpaid invoices relating to M&S contracts with a start date subsequent to the balance sheet date		(371	)		(441	)
Gross accounts receivable		4,953			6,203
Allowance for doubtful accounts		(100	)		(278	)
Accounts receivable, net	$	4,853		$	5,925

Index

6. Capitalized Software Development Costs, Net

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

September 30, December 31,
2016 2015
Gross capitalized cost $ 7,012 $ 5,714
Accumulated amortization (3,051 ) (1,732 )
Net balance $ 3,961 $ 3,982

Three Months Ended September 30, Nine Months Ended September 30,
2016 2015 2016 2015
Amount capitalized $ 452 $ 506 $ 1,298 $ 1,613
Amortization expense (450 ) (367 ) (1,319 ) (912 )

Released Unreleased
Products Products
Gross capitalized amount at September 30, 2016 $ 5,700 $ 1,312

Future amortization expense:
Three months ending December 31, 2016 452
Year ending December 31,
2017 1,433
2018 699
2019 65
Total $ 2,649

	September 30,			December 31,
	2018			2017
Gross capitalized cost	$	10,235		$	9,179
Accumulated amortization		(6,851	)		(5,393	)
Capitalized software development costs, net	$	3,384		$	3,786

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Amount capitalized	$	264		$	527		$	1,057		$	1,464
Amortization expense		(460	)		(484	)		(1,459	)		(1,404	)

	Released			Unreleased
	Products			Products
Gross capitalized amount at September 30, 2018	$	9,624		$	611
Accumulated amortization		(6,851	)		-
Net capitalized cost at September 30, 2018	$	2,773		$	611

Future amortization expense:
Three months ending December 31, 2018		431
Year ending December 31,
2019		1,367
2020		857
2021		118
Total	$	2,773

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

7. Deferred Revenue

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

	September 30, 2018			December 31, 2017
Total invoiced for M&S contracts for which revenue will be recognized in future periods	$	15,507		$	17,491
Less: Unpaid invoices relating to M&S contracts with a start date subsequent to the balance sheet date		(371	)		(441	)
Total deferred revenue	$	15,136		$	17,050

Deferred revenue, current portion	$	12,341		$	13,315
Deferred revenue, non-current portion		2,795			3,735
Total deferred revenue	$	15,136		$	17,050

Index

Stock Options, Restricted Stock and ~~Share-Based~~Stock-Based Compensation

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

Three Months Ended September 30, Nine Months Ended September 30,
2016 2015 2016 2015
Share-based compensation expense $ 221 $ 167 $ 721 $ 482

~~Index~~

	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
Share-based compensation expense	$	110	$	381	$	972	$	1,053

Stock Options

~~The GlobalSCAPE, Inc.~~

We have granted stock options to our officers and employees under long-term equity incentive plans that originated in 2000, 2010 and 2016. During the 2018 quarter, we granted stock options only under the 2016 Employee Long-Term Equity Incentive Plan ~~is our current stock-based incentive plan for our employees.~~ (the “2016 Plan”).

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

·	~~It 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 are determined by the Compensation Committee of ~~the~~our Board of Directors.

●

The exercise price of stock options is set on the grant date and may not be less than the fair market value per share of our stock at market close on that date.

●

Stock options we issue generally become exercisable ratably over a three-year period, ~~and~~ expire ten years from the date of ~~grant.~~grant, and are exercisable for a period of ninety days after the end of employment.

~~We issued no restricted~~

●

Upon exercise of a stock ~~awards under this plan during~~option, we issue new shares from the ~~2016 or 2015 periods.~~shares of common stock we are authorized to issue.

·	~~As of September 30, 2016, stock-based incentives for up to 167,335 shares remained available for issuance in the future under this plan.~~

We currently issue stock-based awards to our officers and employees only under the 2016 Plan which authorizes the issuance of up to 5,000,000 shares of common stock for stock-based incentives including stock options and restricted stock awards. As of September 30, 2018, stock-based incentives for up to 3,955,830 shares remained available for issuance in the future under the 2016 Plan.

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

Our stock option activity has been as follows:

				Weighted
				Average		Weighted Average		Aggregate
				Exercise		Remaining		Intrinsic
	Number of			Price		Contractual		Value
	Shares			Per Share		Term in Years		(000's)

Outstanding at December 31, 2017		2,585,210		$	3.34		6.77	$	1,015
Granted		504,737		$	3.67
Forfeited		(809,142	)	$	3.56
Exercised		(146,150	)	$	2.34
Outstanding at September 30, 2018		2,134,655		$	3.40		6.59	$	1,413

Exercisable at September 30, 2018		1,163,958		$	3.09		4.60	$	1,115

Index

Number of
Shares

Weighted
Average
Exercise
Price
Per Share

Weighted Average
Remaining
Contractual
Term in Years

Aggregate
Intrinsic
Value
(000's)

Outstanding at December 31, 2015 2,091,325 $ 2.45 6.09 $ 3,277
   Granted 1,055,300 $ 3.58
   Forfeited (372,045 ) $ 3.14
   Exercised (165,135 ) $ 2.02
Outstanding at September 30, 2016 2,609,445 $ 2.83 6.29 $ 2,015

Exercisable at September 30, 2016 1,351,760 $ 2.26 3.59 $ 1,814

Additional information about our stock options is as follows:

Three Months Ended September 30, Nine Months Ended September 30,
2016 2015 2016 2015
Weighted average fair value of options granted $ 1.61 $ 1.42 $ 1.63 $ 1.38
Intrinsic value of options exercised $ 78,607 $ 105,450 $ 261,061 $ 386,408
Cash received from stock options exercised $ 70,320 $ 98,706 $ 333,329 $ 416,680

Number of options that vested 42,390 93,290 308,736 274,824
Fair value of options that vested $ 42,565 $ 97,679 $ 418,877 $ 296,886

Unrecognized compensation expense related to non-vested options at end of period $ 1,609,593 $ 753,846 $ 1,609,593 $ 753,846
Weighted average years over which non-vested option expense will be recognized 2.3 2.0 2.3 2.0

~~Index~~

As of September 30, 2016

Range of
Exercise Prices

Underlying
Shares
Outstanding
Options Outstanding Options Exercisable

Weighted
Average
Remaining
Contractual
Life

Weighted
Average
Exercise
Price

Number of
Underlying
Shares

Weighted
Average
Exercise
Price

$ 0.85 - $1.43 168,600 3.16 $ 1.16 168,600 $ 1.16
$ 1.47 - $2.32 612,995 4.05 $ 1.82 607,255 $ 1.82
$ 2.34 - $3.52 1,319,850 7.29 $ 3.13 445,905 $ 2.74
$ 3.53 - $4.21 508,000 7.44 $ 3.83 130,000 $ 4.10
Total options 2,609,445 1,351,760

	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
Weighted average fair value of options granted	$	1.57	$	1.94	$	1.56	$	1.67
Intrinsic value of options exercised	$	205,111	$	9,284	$	205,111	$	351,893
Cash received from stock options exercised	$	341,489	$	13,440	$	341,489	$	471,789

Number of options that vested		72,748		28,570		511,900		430,724
Fair value of options that vested	$	139,406	$	44,843	$	861,904	$	698,442

Unrecognized compensation expense related to non-vested options at end of period	$	1,286,260	$	1,994,289	$	1,286,260	$	1,994,289
Weighted average years over which non-vested option expense will be recognized		2.15		2.11		2.15		2.11

Plan	Shares outstanding
2000 Stock Option Plan		25,000
2010 Employee LT Equity Incentive Plan		1,066,319
2016 Employee LT Equity Incentive Plan		1,043,336
Total shares outstanding at September 30, 2018		2,134,655

As of September 30, 2018
			Options Outstanding				Options Exercisable
			Weighted
			Average		Weighted				Weighted
	Underlying		Remaining		Average		Number of		Average
Range of	Shares		Contractual		Exercise		Underlying		Exercise
Exercise Prices	Outstanding		Life		Price		Shares		Price
$1.43 - $2.32		289,350		2.14	$	1.86		289,350	$	1.86
$2.34 - $3.52		708,636		5.77	$	3.29		506,860	$	3.23
$3.53 - $5.30		1,135,002		8.25	$	3.86		366,081	$	3.85
$5.44 - $5.44		1,667		0.24	$	5.44		1,667	$	5.44
Total options		2,134,655						1,163,958

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

Three Months Ended September 30, Nine Months Ended September 30,
2016 2015 2016 2015
Expected volatility 54 % 56 % 55 % 57 %
Expected annual dividend yield 1.50 % 2.40 % 1.50 % 2.40 %
Risk free rate of return 1.18 % 1.75 % 1.46 % 1.59 %
Expected option term (years) 6.00 6.00 6.00 6.00

~~Based upon our dividend payment activity in recent years, beginning with the first quarter of 2015, we added an expected annual dividend yield to these assumptions.~~

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Expected volatility		48	%		50	%		48	%		49	%
Expected annual dividend yield		1.50	%		1.50	%		1.50	%		1.50	%
Risk free rate of return		2.80	%		1.95	%		2.75	%		1.94	%
Expected option term (years)		6.00			6.00			6.00			6.00

Restricted Stock Awards

~~In May 2015, we adopted the~~

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

●

The exercise price, term and other conditions applicable to each stock option or stock award granted are determined by the Compensation Committee of ~~the~~our Board of Directors.

●

Restricted stock awards are initially issued as restricted shares with a legend restricting transferability of the shares until the recipient satisfies the vesting provision of the award, which is generally continuing service for one year subsequent to the date of the ~~award.~~award, after which time the restrictive legend is removed from the shares.

Index

●

Restricted shares participate in dividend payments and may be voted.

●

As of September 30, ~~2016,~~2018, stock based incentives for up to ~~340,000~~280,000 shares remained available for issuance in the future under ~~this plan.~~the 2015 Directors Plan.

~~Our restricted stock awards activity has been as follows:~~

Number of
Shares

Grant Date
Fair Value
Per Share

Total
Fair Value of
Shares That
Vested

Restricted Shares Outstanding at December 31, 2015 80,000 $ 3.34
Shares granted with restrictions 80,000 $ 3.31
Shares vested and restrictions removed (80,000 ) $ 3.34 $ 276,000
Restricted Shares Outstanding at September 30, 2016 80,000 $ 3.31

Unrecognized compensation expense for non-vested shares as of September 30,2016
Expense to be recognized in future periods $ 156,999
Weighted average number of months over which expense is expected to be recognized 7

~~Index~~

Income Taxes

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

Three months ended September 30, Nine months ended September 30,
2016 2015 2016 2015
Current Deferred Total Current Deferred Total Current Deferred Total Current Deferred Total
Federal $ 688 $ (81 ) $ 607 $ 797 $ (254 ) $ 543 $ 1,214 $ (21 ) $ 1,193 $ 1,812 $ (313 ) $ 1,499
Foreign 12 - 12 6 - 6 37 $ 22 33 - $ 33
State 72 (4 ) 68 (4 ) (3 ) (7 ) 133 (15 ) $ 133 60 (7 ) $ 53
Total $ 772 $ (85 ) $ 687 $ 799 $ (257 ) $ 542 $ 1,384 $ (36 ) $ 1,348 $ 1,905 $ (320 ) $ 1,585

~~Current taxes per our federal income tax return are presented in these financial statements as follows ($ in thousands):~~

Three months ended September 30, Nine months ended September 30,
2016 2015 2016 2015

Current federal income tax expense in the statement of operations $ 687 $ 542 $ 1,348 $ 1,585

Tax (deficiency) from stock-based compensation recorded in additional paid-in capital (13 ) (15 ) (26 ) (59 )

Current taxes per our federal income tax return $ 674 $ 527 $ 1,322 $ 1,526

	Three months ended September 30,												Nine months ended September 30,
	2018						2017						2018						2017
	Current		Deferred		Total		Current		Deferred		Total		Current		Deferred		Total		Current		Deferred			Total
Federal	$	166	$	43	$	209	$	29	$	146	$	175	$	243	$	51	$	294	$	733	$	33		$	766
State		67		5		72		10		9		19		82		10		92		109		(5	)	$	104
Total	$	233	$	48	$	281	$	39	$	155	$	194	$	325	$	61	$	386	$	842	$	28		$	870

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

September 30, December 31,
2016 2015
Deferred tax assets:
   Share-based compensation $ 718 $ 677
   Deferred revenue 1,185 1,154
   Net operating loss carryforward 106 151
   Compensation and benefits 164 168
   Allowance for doubtful accounts 114 111
   Other 52 33
Total deferred tax assets 2,339 2,294

Deferred tax liabilities:
   Intangible assets 1,356 1,339
   Depreciation 7 15
Total gross deferred tax liabilities 1,363 1,354

Net deferred tax assets $ 976 $ 940

~~Index~~

As of September 30, 2016, we had federal income tax net operating loss carryforwards of $312,000 available to offset future federal taxable income, if any. These carryforwards became available through our acquisition of TappIn, Inc. in 2011. These carryforwards expire in 2030 and 2031.

As of September 30, 2016, we had federal income tax capital loss carryforwards of $1,100,000 (tax effected) which resulted from the reduction of our investments in and notes receivable from CoreTrace Corporation in 2012. We can realize capital loss carryforwards to the extent we have capital gains in future periods against which this capital loss can be deducted. We believe it uncertain that we will have sufficient capital gains in the future to support this deduction and accordingly have not reflected this item as a deferred tax asset in the schedule above. This carryforward expires in 2017.

	September 30,			December 31,
	2018			2017
Deferred tax assets:
Deferred revenue	$	829		$	775
Share-based compensation		302			351
Compensation and benefits		55			111
Texas franchise tax R&D credit		189			185
Prepaid expenses not deductible for tax		-			84
Allowance for doubtful accounts		37			58
Net operating loss carryforward		5			20
Deferred state income taxes		51			61
Federal R&D credits		-			-
Accrued expenses not deducted for tax		5			9
Valuation allowance		(189	)		(185	)
Total deferred tax assets		1,284			1,469

Deferred tax liabilities:
Intangible assets		721			805
Book expenses deductible for tax purposes		232			-
Depreciable Assets		1			13
Total gross deferred tax liabilities		954			818

Net deferred tax assets	$	330		$	651

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

As of September 30, 2018, we had federal income tax net operating loss carryforwards of $23,000 available to offset future federal taxable income. We expect to fully utilize this net operating loss in 2018. If not used, this net operating loss expires in 2038.

Index

As of September 30, 2018, we had Texas Research and Development tax credit carryforwards of $189,000. We believe it is uncertain that we will have sufficient Texas Franchise Tax in the future to support ~~deduction or~~ utilization of these carryforward credits. Accordingly, we have provided a valuation allowance for the ~~items giving rise to our deferred tax assets indicates it is more-likely-than-not that we will realize the deferred tax assets listed in the table above.~~

We claim research and experimentation tax credits, or R&D tax credits, on certain of our tax returns and have included the effect of those credits in our provision for income taxes. Because our 2008, 2009 and 2010 tax returns were under routine examination by the Internal Revenue Service and because we believed it more-likely-than-not the examination could result in $125,000 of such credits we claimed not being allowed by the Internal Revenue Service, we recorded a reserve for an uncertain tax position in thefull amount of ~~$125,000~~these credit carryforwards. These carryforwards expire in 2012 related to this item. The Internal Revenue Service completed its routine examination of our 2008, 2009 and 2010 income tax returns in 2015 and those results have been included in our provision for income taxes in 2015. We continue to maintain a reserve for an uncertain tax position in the amount of $110,000 for our 2011years 2034 through ~~2016 tax returns related to the R&D tax credit.~~

2038.

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

2016 2015
Balance at beginning of year $ 90 $ 125
Increases for tax positions related to the current year 9 -
Increases for tax positions related to prior years 11 48
Decreases for tax positions related to prior years - (51 )
Decreases due to settlements related to prior years - (32 )
Balance at September 30 and December 31, respectively $ 110 $ 90

	Nine Months Ended September 30,
	2018			2017
Balance at beginning of period	$	158		$	121
Increases for tax positions related to the current year		10			16
Increases for tax positions related to prior years		-			16
Decreases for tax positions where the statue has expired		(48	)		-
Balance at end of period	$	120		$	153

Our unrecognized tax benefit is related to research and development credits taken on our U.S. income tax returns in 2012, 2013, 2015, 2016, and 2017 and the ~~extent they arise,~~uncertainty related to the realization of a portion of those credits based on prior experience. We believe it reasonably possible that we will not recognize any of our unrecognized tax benefits at least through December 31, 2018. If we realized and recognized any of our unrecognized tax benefits, such benefits would reduce our effective tax rate in the year of recognition.

We record interest and penalty ~~expenses~~expense related to income taxes as ~~components of~~interest and other expense, ~~in our statement of operations. We incurred~~respectively. At September 30, 2018, no ~~such expenses in 2016, 2015~~interest or ~~2014.~~

penalties had been or were required to be accrued. We file ~~state~~income tax returns in the US and in various ~~states. The taxes resulting from these filings~~state jurisdictions with varying statues of limitations. We are ~~included in~~no longer subject to income tax ~~expense.~~

examination by tax authorities for years prior to 2011 with respect to our federal income tax returns and years prior to 2013 with respect to most of our state income tax returns. We do not file, and are not required to file, any foreign income tax returns.

Our income tax expense (benefit) reconciles to an income tax expense resulting from applying an assumed statutory federal income rate of 21% for the 2018 quarter and 2018 nine months and 34% for the 2017 quarter and 2017 nine months to income before income taxes as follows ($ in thousands):

Three months ended September 30, Nine months ended September 30,
2016 2015 2016 2015
Income tax expense (benefit) at federal statutory rate $ 710 $ 603 $ 1,397 $ 1,685

Increase (decrease) in taxes resulting from:
State taxes, net of federal benefit 44 (5 ) 72 33
Incentive stock options 25 0 60 0
Other (1 ) (13 ) 20 8
R&D tax credit uncertain tax position (net) 10 110 21 59
Research and development credit (55 ) (123 ) (119 ) (123 )
Domestic production activities deduction (46 ) (30 ) (103 ) (77 )
Income tax expense (benefit) per the statement of operations $ 687 $ 542 $ 1,348 $ 1,585

	Three months ended September 30,						Nine months ended September 30,
	2018			2017			2018			2017
Income tax expense at federal statutory rate	$	269		$	160		$	219		$	828
Increase (decrease) in taxes resulting from:
State taxes, net of federal benefit		58			16			89			67
Stock based compensation		14			37			164			121
Other		2			7			7			19
R&D tax credit uncertain tax position (net)		(45	)		6			(38	)		32
Research and development credit		(17	)		(30	)		(55	)		(177	)
Domestic production activities deduction		-			(2	)		-			(20	)
Income tax expense per the statements of operations	$	281		$	194		$	386		$	870

On June 21, 2018, in South Dakota v Wayfair Inc., the United States Supreme Court held that states may charge sales tax on purchases made from out-of-state sellers, even if the seller does not have a physical presence in the taxing state. We are evaluating our state income tax filings with respect to the recent Wayfair decision. Currently, we file state income tax returns in those states in which we have a physical presence and/or are otherwise required by a state to register to do business.

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~~In November 2015, the FASB issued Accounting Standards Update (ASU) No. 2015-17,~~ ~~Income Tax: Balance Sheet Classification of Deferred Taxes~~. ASU 2015-07 requires that all deferred tax assets and liabilities for a tax jurisdiction, along with any related valuation allowance, be classified as noncurrent on the balance sheet. We have implemented this ASU in the accompanying financial statements. This implementation resulted in the previously reported current deferred tax asset of $313,000 as of September 30, 2015, being reclassified and combined with the previously reported non-current deferred asset of $699,000 as of that date to yield a non-current deferred tax asset balance of $1,012,000 being reported as of September 30, 2015, in the accompanying financial statements.

10.

Earningsper Common Share

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

Three Months Ended Nine Months Ended
September 30, September 30,
2016 2015 2016 2015
Net income $ 1,399 $ 1,230 $ 2,761 $ 3,370

Weighted average shares outstanding - basic 21,122 20,892 21,061 20,782
Stock options 552 548 579 512
Weighted average shares outstanding - diluted 21,674 21,440 21,640 21,294

Net income per common share - basic $ 0.07 $ 0.06 $ 0.13 $ 0.16
Net income per common share - diluted $ 0.06 $ 0.06 $ 0.13 $ 0.16

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2018		2017		2018		2017

Numerator for basic and diluted earnings per share:
Net income	$	998	$	276	$	656	$	1,564

Denominators
Denominators for basic and diluted earnings per share:
Weighted average shares outstanding - basic		21,688		21,792		21,746		21,672

Dilutive potential common shares
Stock options and awards		252		455		298		473
Denominator for diluted earnings per share		21,940		22,247		22,044		22,145

Net income per common share - basic	$	0.05	$	0.01	$	0.03	$	0.07
Net income per common share – diluted	$	0.05	$	0.01	$	0.03	$	0.07

As a result of our implementation of ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (issued March 2016), the estimated proceeds resulting from equity compensation deductible for federal income tax purposes being greater than the associated stock-based compensation expense are no longer considered as part of the treasury stock method used in computing diluted earnings per share. This change had no material effect on our earnings per share computations.

11.

Dividends

~~During 2016, our Board of Directors declared quarterly~~

We paid dividends during the 2018 nine months and 2017 nine months as follows:

March 31, 2016 June 30, 2016 September 30, 2016
Dividend per share of common stock $ 0.015 $ 0.015 $ 0.015
Dividend record date
February 23, 2016 May 23, 2016 August 23, 2016
Dividend payment date March 3, 2016 June 1, 2016 September 9, 2016

Three Months Ended

March 31, 2018

March 31, 2017

June 30, 2018

June 30, 2017

September 30, 2017

Dividend per share of common stock

0.015

Dividend record date

March 9, 2018

February 23, 2017

June 8, 2018

May 23, 2017

August 23, 2017

Dividend payment date

March 23, 2018

March 8, 2017

June 22, 2018

June 8, 2017

September 8, 2017

12.

Commitments and Contingencies

Severance Payments

We have agreements with key personnel that provide for severance payments to them in the event of a ~~change~~“change in ~~control~~control” of the Company, as defined in those agreements, and their employment is terminated in connection with that change in control. In such event, our aggregate severance payments to those employees would be ~~$1.6~~approximately $1.3 million.

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Legal and Regulatory Matters

As previously disclosed in the Company’s Current Report on Form 8-K filed on November 15, 2017, on August 9, 2017, a securities class action complaint, Anthony Giovagnoli v. GlobalSCAPE, Inc., et. al., Case No. 5:17-cv-00753, was filed against the Company in the United States District Court for the Western District of Texas. On November 6, 2017, the Court appointed Irfan Rahman as lead plaintiff, and he filed the First Amended Complaint on July 26, 2018. The Amended Complaint names the Company, Matthew Goulet, James Albrecht, Thomas Brown, David Mann, Frank Morgan, and Thomas Hicks as defendants for allegedly making materially false and misleading statements regarding, inter alia, the Company’s previously reported financial statements. The Amended Complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Rule 10b-5 promulgated thereunder. The Amended Complaint seeks unspecified damages, costs, attorneys’ fees, and equitable relief. The parties reached a settlement and submitted a Stipulation of Settlement to the Court on September 13, 2018. Under this settlement, the Company’s and Individual Defendants’ insurance carrier will provide the Class with a cash payment of $1,400,000, which includes the cash amount of any attorney’s fees or litigation expenses that the Court may award Lead Plaintiff’s counsel and costs Lead Plaintiff may incur in administering and providing notice of the settlement. In exchange, Lead Plaintiff has agreed that the settlement will include a dismissal of the Class Action with prejudice and a release of all claims against the Company and the Individual Defendants by the Class. This settlement was preliminarily approved by the Court on October 2, 2018. The Court has scheduled a hearing on December 18, 2018 to determine whether an Order and Final Judgment of the settlement should be entered. The settlement will not become effective until finally approved by the Court. The Company has accrued the $1,400,000 expense in the third quarter of 2018 and has also accrued a receivable of $1,400,000 as this settlement will be funded by our insurance carrier.

On October 12, 2018, the Company received a letter from a stockholder demanding that the Company take action to remedy alleged harm caused to the Company, including to remedy alleged breaches of fiduciary duties by certain current and/or former directors and executive officers of the Company (“the Derivative Demand”). The stockholder alleges, inter alia, that certain current and former directors and executive officers violated their fiduciary duties beginning at least in July 2016, causing GlobalSCAPE to suffer damages by overstating financial results for the fourth quarter of 2016.

On October 20, 2017, the Company received a demand letter from a stockholder seeking the inspection of books and records of the Company pursuant to Section 220 of the Delaware General Corporation Law (the “Section 220 Demand”). This stockholder’s stated purpose for the demand is, inter alia, to investigate whether the Company’s Board of Directors and officers engaged in an illegal scheme to misrepresent the Company’s performance by falsely reporting accounts receivable, license revenue, total current assets and total assets, total stockholders’ equity, and total liabilities for the year ended December 31, 2016, as well as the Board’s independence to consider a stockholder derivative demand. The Company intends to fully respond to the Section 220 Demand to the extent required under Delaware law.

The Board has established a special litigation committee (“Special Litigation Committee”) consisting of Dr. Thomas Hicks and Frank Morgan to analyze and investigate claims that could potentially be asserted in stockholder derivative litigation related to facts connected to the claims and allegations asserted in the litigation related to the Restatement, the Section 220 Demand, and the Derivative Demand (the “Potential Derivative Litigation”). The Special Litigation Committee will determine what actions are appropriate and in the best interests of the Company, and decide whether it is in the best interests of the Company to pursue, dismiss, or consensually resolve any claims that may be asserted in the Potential Derivative Litigation. The Board determined that each member of the Special Litigation Committee is disinterested and independent with respect to the Potential Derivative Litigation. Among other things, the Special Litigation Committee has the power to retain counsel and advisors, as appropriate, to assist it in the investigation, to gather and review relevant documents relating to the claims, to interview persons who may have knowledge of the relevant information, to prepare a report setting forth its conclusions and recommended course of action with respect to the Potential Derivative Litigation, and to take any actions, including, without limitation, directing the filing and prosecution of litigation on behalf of the Company, as the Special Litigation Committee in its sole discretion deems to be in the best interests of the Company in connection with the Potential Derivative Litigation. The Special Litigation Committee’s findings and determinations shall be final and not subject to review by the Board and in all respects shall be binding upon the Company.

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

Index

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

13.

~~10.~~

Concentration of Business Volume and Credit Risk

In order to leverage the resources of third parties, we make our products available for purchase by end users through third-party, channel distributors even though those end users can also purchase those products directly from us. ~~During~~In the ~~2016~~2018 quarter and 2017 quarter, we earned approximately ~~17% of our revenue from such sales through our largest, third party, channel distributor. During the 2015 quarter there was no single customer that exceeded 10% of sales. During the 2016 nine months~~12% and ~~2015 nine months, we earned approximately~~ 14% ~~and 10%~~, respectively, of our revenue from such sales through our largest ~~third party,~~third-party channel distributor.

During the 2018 nine months and 2017 nine months, we earned approximately 13% and 14%, respectively, of our revenue from such sales through our largest, third-party channel distributor. As of September 30, ~~2016,~~2018, approximately ~~40%~~17% of our accounts receivable were due from this ~~third party,~~ channel distributor ~~discussed above and from one other customer, the latter of which did not constitute more than 10% of our revenue for any of the periods presented. Payment~~with payment for substantially all such amounts ~~has~~having been received subsequent to that date.

~~11.~~

~~Segment and Geographic Disclosures~~

14. Segment and Geographic Disclosures

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

Revenues derived from customers and partners located inoutside the United States accounted for approximately ~~83% and 78%~~30% of our total revenues in ~~2016~~the 2018 quarter and ~~2015~~2017 quarter, ~~respectively,~~ and ~~78%~~29% and ~~76% of our total revenues~~26% for ~~both~~ the ~~2016~~2018 nine months and ~~2015~~2017 nine ~~months. The remaining revenues were~~months, respectively. Revenue derived from customers and partners ~~located~~ in ~~foreign countries with each~~the United Kingdom were 13% of our revenue in the 2017 quarter. Each individual foreign country ~~accounting~~accounts for less than 10% of total ~~revenues~~revenue in ~~all periods.~~the 2018 quarter. We attribute revenues to countries based on the country in which the customer or partner is located. None of our property and equipment was located in a foreign country as of September 30, ~~2016 and 2015.~~

2018.

Index

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

This Quarterly Report on Form 10-Q (this “Quarterly Report”), and any documents incorporated by reference herein contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act”) and Section 21E of the ~~Securities and~~Securitas Exchange Act of 1934, as ~~amended.~~amended (the “Exchange Act”). “Forward-looking statements” are those statements that are not of historical fact but describe management’s beliefs and expectations. We have identified many of the forward-looking statements in this Quarterly Report by using words such as “anticipate,” “believe,” “could,” “estimate,” “may,” “expect,” “potentially” and “intend.” Although we believe these expectations are reasonable, our operations involve a number of risks and uncertainties, including those described in the “Risk Factors” section of our ~~2015~~Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (the “2017 Form 10-K”) and other documents filed with the Securities and Exchange ~~Commission.~~Commission (the “SEC”). Therefore, GlobalSCAPE’s actual results of operations and financial condition in the future could differ materially from those discussed in this Quarterly Report.

In the following discussion, our references to the ~~2016~~2018 quarter and the ~~2015~~2017 quarter refer to the three months ended September 30, ~~2016~~2018 and ~~2015,~~2017, respectively. Our references to the ~~2016~~2018 nine months and the ~~2015~~2017 nine months refer to the nine months ended September 30, ~~2016~~2018 and ~~2015,~~2017, respectively.

Overview

~~We develop~~

GlobalSCAPE, Inc., together with its wholly-owned subsidiary (collectively referred to as the “Company”, “GlobalSCAPE”, “we”, “us” or “our”), develops and ~~sell~~sells computer software that provides secure information exchange, data transfer and sharing capabilities for enterprises and consumers. We have been in business for more than twenty years ~~and have~~having sold our products to thousands of enterprises and more than one million individual consumers ~~throughout the world.~~

globally.

Our primary business is selling and supporting managed file transfer ~~or MFT,~~(“MFT”) software for enterprises. ~~The brand name~~MFT software facilitates the transfer of ~~our~~data from one location to another across a computer network within a single enterprise or between multiple computer networks in multiple enterprises.

Our MFT ~~product platform is~~products are based upon our Enhanced File Transfer ~~or EFT.~~

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

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

our EFT platform in two ways:

●

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

●

As a software-as-a-service (“SaaS”), under which they pay us ongoing fees to access the capabilities of the EFT platform in the cloud. Through 2017, EFT Cloud was our SaaS offering of the EFT platform which users accessed for a flat monthly subscription fee. In January 2018, we introduced EFT Arcus, our SaaS offering for which users pay a base monthly subscription fee plus an additional variable amount based upon their metered usage of EFT Arcus resources.

We ~~also~~ sell other products that are synergistic to our EFT platform including Mail Express, ~~scConnect,~~ WAFS, and CuteFTP. Collectively, these products ~~constitute~~constituted less than ~~10%~~5% of our total ~~revenue.~~revenue in the three months and nine months ended September 30, 2018. Customers pay a one-time fee to purchase these products under a perpetual software license. Some customers also purchase an M&S contract. We do not offer a SaaS version of these products and have no plans to do so.

Index

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

~~As a corporation, we~~

We have won multiple awards for performance and reputation, including:

●

In ~~2016:~~2018:

Gold winner in the IT World Network Product Guide Awards

Recognized for two Info Security Products Guide 2018 Global Excellence Awards for distinguished achievements in product innovation in categories that included:

■

BYOD/Security Category (Gold Winner) – EFT Workspaces v 7.4.2.

■

Innovations in Compliance Category (Bronze Winner) – EFT v 7.4.2.

Named to The Channel Company’s list of CRN Channel Chiefs as top leaders in the IT channel for the 5th consecutive year.

Awarded a 5-star rating in The Channel Company’s 2018 CRN Partner Program Guide for the 4^th consecutive year.

●

In 2017:

Named to the CRN 2017 Cloud Partner Program Guide which recognizes partner programs with distinguished margins, sales support and cloud resources

Received three awards from the 2017 Golden Bridge Awards for distinguished technology achievements which included:

■

Cloud/SaaS Innovations (Gold Winner) – EFT on Amazon Web Services or Microsoft Azure.

■

Managed File Transfer Innovations (Gold Winner) – The EFT Accelerate module.

■

Governance, Risk and Compliance Innovations (Bronze Winner) – EFT platform.

Received two awards from the Network Product Guide 2017 IT World Awards for achievements in product excellence that included:

■

Governance, Risk and Compliance (Gold Winner) – EFT.

■

Cloud Security (Silver Winner) – EFT Cloud Services.

Recognized as a ~~2016 Top Workplace~~Best Place to Work in IT by ~~San Antonio Express-News, marking Globalscape’s~~Computerworld for the fourth consecutive year and sixth ~~recognition~~time overall.

Recognized for three Info Security Products Guide 2017 Global Excellence Awards for distinguished achievements in product innovation in categories that included:

■

Innovation in Compliance (Gold Winner) – Enhanced File Transfer.

■

Cloud/SaaS Solutions (Gold Winner) – EFT Cloud Services.

■

BYOD Security (Bronze Winner) – EFT Workspaces.

Honored as a ~~Top Workplace~~Best Company to Work for in ~~San Antonio.~~

-	~~Named as Leader in Secure Information Exchange Services 2016 –~~ Texas by Best Companies Group (BCG), Texas Monthly, the ~~Corp America 2016 Small Cap Awards.~~Texas Association of Businesses (TAB), and Texas SHRM.

-	~~Earned awards from~~ ~~Info Security Guide~~ ~~in several categories, including:~~

o -	~~EFT Workspaces – Gold Winner in BYOD Security.~~

o	~~Enhanced File Transfer – Silver Winner in Compliance.~~

o	~~EFT Cloud Services – Bronze Winner in Cloud Security.~~

o	~~Mail Express – Bronze Winner in Email Security and Management.~~

-	Received a 5-Star rating in The Channel Company’s CRN ~~2016~~2017 Partner Program Guide for the ~~second~~third year in a row.

~~Named by~~ ~~Texas Monthly~~ ~~magazine as one of~~

Honored with the ~~best companies to work for in Texas for the sixth year in a row with a ranking of #16 in the medium size category.~~

-	~~Honored as the HR Employer of the Year and~~2017 Total Rewards & Benefits Excellence ~~in Engagement Strategy in North America~~Award by the HRO Today Services and Technology Association.

~~Index~~

~~Recognized by the~~ ~~San Antonio Business Journal~~

Selected as a ~~2016 Best Place to Work, making this the fifth time GlobalSCAPE has received this honor.~~

-	~~Named by~~ ~~Computerworld~~ ~~as one of the best companies to work for in IT for the third consecutive year with a ranking of #3~~finalist in the ~~small company category.~~ 2017 Cybersecurity Product Awards Secure File Transfer: EFT Enterprise.

·	~~In 2015:~~

Listed as a Champion in the Ad-Hoc Mid-Market category and a Leader in the Ad-Hoc Enterprise use case by Info-Tech Research Group within its Managed File Transfer Vendor Landscape report. This is the second consecutive time that Info-Tech Research Group has named GlobalSCAPE a Champion within this report.

-	~~Named one of the best places to work in the information technologies small business category by~~ ~~Computerworld~~ ~~for the fourth time.~~

-	~~Named as one of San Antonio’s best places to work by the~~ ~~San Antonio Business Journal~~ ~~for the fifth time in the medium size category.~~

-	~~Received a 5-Star rating in The Channel Company’s CRN 2015 Partner Program Guide.~~

-	~~Named by~~ ~~Texas Monthly~~ ~~magazine as one of the best companies to work for in Texas for the fifth year in a row with a ranking of #3 in the medium size category.~~

-	~~Named to the~~ ~~San Antonio Business Journal’s~~ ~~2015 Fast Track list for companies with $10 million or more in revenue.~~

-	~~Named by the~~ ~~San Antonio Express News~~ ~~as the #1 Top Workplace for 2015 in the small company category, and recognized as one of the Top Workplaces for the fifth time.~~

-	~~Two members of the channel leadership team recognized as The Channel Company’s 2015~~ ~~CRN~~ ~~Channel Chiefs.~~

-	~~Two channel team members named to The Channel Company’s 2015~~ ~~CRN~~ ~~Women of the Channel list.~~

-	~~Recognized by the Golden Bridge Business and Innovation Awards as a Gold Winner in the Managed File Transfer – Innovations category for EFT Workspaces.~~

-	Recognized by the Info Security Products Guide’s Global Excellence Awards as a Gold Winner within the Compliance category for Enhanced File Transfer (EFT) and as a Bronze Winner within the Email Security and Management category for Mail Express.

-	~~Recognized by the Network Products Guide awards as a Gold Winner in Compliance Data Centers for EFT v7.0 and a Silver Winner in Email, Security and Management with Mail Express v4.~~

Key Business Metrics

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

Index

Revenue Growth

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

●

Ongoing innovation of ~~and focus on,~~ our ~~core~~ EFT platform to address the expanding needs of our existing customers and ~~its expansion into broader segments of the market.~~to enhance our products’ appeal to new customers.

~~Developing emerging technologies~~

●

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

~~Continuing~~

●

Enhancing our sales and marketing programs to improve identification of potential demand for our products and to increase the ~~evolution of enhanced demand generation activities including marketing, customer-focused, and partner-focused programs.~~ rate at which we are successful in selling our products.

We remain alert for attractive opportunities to collaborate with others or perhaps combine other revenue-producing technologies with ours to expand our product offerings and reach. To ~~support product innovation,~~that end, we ~~continue~~continually assess products and services offered by others that might be synergistic with our existing products. We may elect to ~~enhance our software engineering group and our focus on optimizing~~take advantage of those opportunities through cooperative marketing agreements or licensing arrangements or by acquiring an ownership position in the ~~manner in which we assess~~enterprise offering the ~~development of new technologies, our approach to managing those projects, and the timelines over which we do that work.~~

~~Index~~

opportunity.

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

·	~~Increasing sales staff capacity as needed to address our markets.~~

· ●	Aligning our sales group to enhance its industry and geographic focus.

●

Implementing new sales and marketing campaigns.

·	~~Using third party digital marketing experts with search engine optimization expertise to enhance our efforts in this area.~~

· ●	~~Evolving our lead generation programs to increase our sales staff’s exposure to potential purchasers.~~

·	Enhancing our support of channel partners and engaging them to sell our products through training, orientation and marketing programs.

~~As part of growing revenue in total, we are focused on increasing license revenue both in terms of absolute dollars and as a percent of total revenue.~~

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

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

See ~~Comparison~~“Comparison of the Consolidated Statement of Operations for the Three Months Ended September 30, ~~2016~~2018 and ~~2015~~ 2017” and ~~Comparison~~“Comparison of the Consolidated Statement of Operations for the Nine Months Ended September 30, ~~2016~~2018 and ~~2015~~ 2017”for a discussion of trends in our revenue growth that we monitor using this metric.

~~Bookings (Non-GAAP Measurement)~~

~~Bookings is a~~

In the past, we reported bookings and potential future revenue as key business metrics. With the refinement of our revenue growth key business metric discussed above, we ~~use~~no longer rely on bookings or potential future revenue as key business metrics. We have determined that our revenue growth metric is the primary metric upon which we rely to measure the success of ~~our~~ sales and marketing programs and ~~the effectiveness of~~ our ~~sales and marketing teams. Bookings are a measure of the value of our arrangements with customers~~outlook for ~~purchases of software licenses, software-as-a-service, M&S, and professional services. Our bookings consist of:~~

·	~~Invoiced amounts for products and services we have delivered and for which we recognize revenue currently.~~

·	~~Invoiced amounts for products and services we will deliver in the~~ future ~~and for which we will recognize revenue in those future periods.~~

·	~~Arrangements to provide customers with software-as-a-service for which we will invoice over the course of an agreed-upon period of time in the future.~~

·	~~Statements of work under which customers have engaged us to deliver professional services for which we will invoice in the future as we complete that work.~~

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

~~Index~~

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

Three Months Ending September 30, Nine Months Ending September 30,
2016 2015 2016 2015

Bookings $ 10,296 $ 9,869 $ 26,256 $ 24,011
Products and services sold for which we will recognize revenue at a future date when the goods and services are delivered to and accepted by the customer (8,967 ) (6,772 ) (20,945 ) (15,455 )
Products and services delivered to and accepted by the customer for which revenue recognition had been deferred at the time of booking 7,424 4,550 19,110 13,834
Revenue $ 8,753 $ 7,647 $ 24,421 $ 22,390

Bookings increased during the 2016 quarter compared to the 2015 quarter and during the 2016 nine months compared to the 2015 nine months primarily as a result of our product development and sales and marketing activities discussed above under ~~Revenue Growth~~.

Adjusted EBITDA

(Non-GAAP Measurement)

We utilize Adjusted EBITDA (Earnings Before Interest, Taxes, Total Other Income/Expense, Depreciation, Amortization, other than amortization of capitalized software development costs, and Share-Based Compensation Expense) to provide us a view of income and expenses ~~and cash flow from our operations~~ that is supplemental and secondary to our primary assessment of net income as presented in our ~~condensed~~ consolidated statement of operations and comprehensive income ~~and of cash flow from operating activities as presented on our condensed consolidated statement of cash flows.~~(loss). We use Adjusted EBITDA to provide another perspective for measuring profitability ~~and cash flow from our core operating activities~~ that ~~is before considering~~does not include the effects of ~~expenses that typically do not require us to pay them in~~ the current period (such as depreciation, amortization and share-based compensation), that is prior to considering the cost of financing our business and the effects of income taxes, and that is prior to the effects on our cash of changes in certain balance sheet items such as accounts receivable and accounts payable. following items:

Index

●

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

●

The cost of financing our business; and

●

The effects of income taxes.

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

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

Previously, this key business metric was named Adjusted EBITDA Excluding Infrequent Items. We have not had any infrequent items in recent periods and do not expect any in the foreseeable future. As a result, we have removed the infrequent item component from this key business metric.

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

Three Months Ended Nine Months Ended
September 30, September 30,
2016 2015 2016 2015
Net Income $ 1,399 $ 1,230 $ 2,761 $ 3,370
Add (subtract) items to determine adjusted EBITDA:
Income tax expense 687 542 1,348 1,585
Interest (income) expense, net (28 ) (17 ) (88 ) (51 )
Depreciation and amortization:
Total depreciation and amortization 513 433 1,522 1,116
Amortization of capitalized software development costs (450 ) (367 ) (1,319 ) (912 )
Stock-based compensation expense 221 167 721 482
Adjusted EBITDA $ 2,342 $ 1,988 $ 4,945 $ 5,590

~~Index~~

~~Adjusted EBITDA reconciles as follows to net cash provided by operating activities on our condensed consolidated statement~~

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2018			2017			2018			2017
Net Income	$	998		$	276		$	656		$	1,564
Add (subtract) items to determine Adjusted EBITDA:
Income tax expense		281			194			386			870
Interest (income) expense, net		93			(75	)		(63	)		(221	)
Depreciation and amortization:
Total depreciation and amortization		522			547			1,641			1,604
Amortization of capitalized software development costs		(460	)		(484	)		(1,459	)		(1,404	)
Share-based compensation expense		110			381			972			1,053
Adjusted EBITDA	$	1,544		$	839		$	2,133		$	3,466

See “Comparison of ~~cash flow:~~

Nine Months Ended
September 30,
2016 2015
Adjusted EBITDA $ 4,945 $ 5,590
Add (subtract) items to reconcile to cash flow from operations:
Income tax expense (1,348 ) (1,585 )
Interest income (expense), net 88 51
Amortization of capitalized software development costs 1,319 912
Bad debt expense 67 147
Deferred taxes (36 ) (320 )
Excess tax benefit from share-based comp 5 (49 )
Accounts receivable (2,856 ) (1,690 )
Prepaid expenses 86 154
Other Assets 30 37
Accounts payable (217 ) (757 )
Accrued expenses (52 ) 10
Deferred revenue 1,081 531
Other long term liabilities (10 ) (5 )
Income tax receivable and payable 571 403
Net cash provided by operating activities $ 3,673 $ 3,429

~~See~~ the ~~section below comparing our results~~Consolidated Statement of ~~operations~~Operations for the ~~2016 quarter~~Three Months Ended September 30, 2018 and 2017” and “Comparison of the ~~2015 quarter~~Consolidated Statement of Operations for the Nine Months Ended September 30, 2018 and ~~the 2016 nine months and 2015 nine months~~2017” for discussion of the variances between periods in the components comprising Adjusted EBITDA.

Software Products and Services

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

globally.

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

●

Transfer of transactional information within an enterprise on a repetitive basis from one geographic location to another, such as a transfer of deposit and withdrawal information throughout the day from a branch of a bank to a central data processing center at another location.

●

Movement of accumulated information within an enterprise from one data processing application to another on a periodic basis, such as a transfer of bi-weekly payroll information from a payroll system that is used to pay employees to a job cost system that is used to manage the cost of a project.

●

Exchange of information between enterprises to facilitate the completion of one or more business transactions, such as a retailer transmitting inventory purchasing requirements produced by its material requirements planning system to an order entry system at a supplying vendor.

Index

We earn over 90% of our revenue from the sale of MFT products and services that are part of our EFT platform. We have multiple revenue streams from ~~our MFT products~~the EFT platform that include:

●

Perpetual software licenses under which customers pay a one-time fee for the right to install our products in their information systems environment on computers they manage and either own or otherwise procure from a cloud services provider, including deploying our products at a cloud services provider in a bring-your-own-license, or BYOL, environment. Our brand name for this product is EFT. Historically, most of the revenue we have earned from our EFT platform products has been from sales of EFT perpetual software licenses and related M&S.

●

Cloud-based, SaaS ~~hosted~~ solutions tothat we sell on an ongoing subscription basis. Through the end of 2017, EFT Cloud was our SaaS offering of the EFT platform which users accessed for a flat monthly subscription fee. In January 2018, we introduced EFT Arcus, our ~~customers subscribe and~~SaaS offering of the EFT platform going forward, for which users pay us a ~~recurring,~~base monthly subscription fee ~~to access the service.~~plus an additional variable amount based upon their metered usage of EFT Arcus resources.

●

M&S.

●

Professional services for product ~~customization~~installation, integration and ~~integration.~~training.

~~Index~~

We ~~also~~focus on selling our EFT platform products in a business-to-business environment. The majority of the resources we will expend in the future for product research, development, marketing and sales will focus on this product line. We expect to expend minimal resources developing and selling our other products. We believe our EFT platform products and business capabilities are well-positioned to compete effectively in the market for these products. For a more comprehensive discussion of the products we sell and the services we offer, see below.

In June 2017, we introduced a data integration product that we planned to sell under the brand name Kenetix. We licensed the technology for this product from a third party. We experienced issues with the third-party technology and suspended marketing of the product. We have settled the dispute with the third-party and have accrued a liability in these financial statements in the amount of the settlement, including any anticipated settlement fees.

We earn less than 5% of our revenue from selling other products that can be synergistic to our ~~MFT products.~~EFT platform. These products have capabilities that:

●

Support information sharing and exchange capabilities using traditional email systems.

●

Enable enterprise file synchronization and sharing.

●

Enhance the ability to replicate, share and backup files within a wide area network or local area network, thereby allowing users to access their data at higher speeds than possible with most alternate approaches.

●

Support file transfers by individuals and small businesses.

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

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

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

Managed File Transfer – Enhanced File Transfer Platform

Enhanced File Transfer, or EFT, is the brand name of our core MFT product platform. ~~EFT was a Silver Winner in the Compliance category and Gold Winner in the BYOD category of the 2016 Info Security Products Guide Global Excellence Awards.~~

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

Index

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

General features and capabilities of the EFT platform include:

●

State-of-the-art, enterprise-level security when transferring information within or between computer networks as well as for collaboration with business partners, customers, and employees. EFT also provides automation that supports effective integration of back-end systems. It has built-in regulatory compliance, governance, and visibility controls to provide a means of safely maintaining information. EFT offers a high level of performance and scalability to support operational efficiency and maintain business continuity. Administrative tools ~~are provided at various levels of granularity to allow~~provide for complete control and monitoring of file transfer activities.

●

Transmission of critical information such as financial data, medical records, customer files, vendor files, personnel files, transaction activity, and other similar documents between diverse and geographically separated network infrastructures while supporting a range of information protection approaches to meet privacy, compliance and ~~other~~ security requirements. In addition to enabling the secure, flexible transmission of critical information using servers, ~~desktop, and notebook~~ computers and a wide range of network-enabled mobile devices, our products also provide customers with the ability to monitor and audit file transfer activities.

●

Compliance with government regulations and industry standards relating to the protection of information while allowing users to reduce information systems and technologies costs, increase efficiency, track and audit transactions, and automate processes. Our solutions also provide data replication, acceleration of file transfer, ~~sharing/~~sharing and collaboration, and continuous data backup and ~~recovery to our customers.~~recovery.

~~Index~~

~~The EFT platform provides a common, scalable MFT environment that accommodates a broad family~~

During 2017 and the 2018 nine months, we continued to improve the features and capabilities of accompanying modules to provide enterprises with increased security, automation, and performance when compared to traditional FTP-based and e-mail delivery systems. Various, optional modules allow users to select the solution configuration most applicable to their requirements for auditing and reporting, encryption, ad hoc and web-based file transfers, operability in or through a DMZ network, and integration with back-end business processes, including workflow automation capabilities.

~~During the past several quarters, we have released new versions of our~~ EFT platform and ~~new modules which added~~announced several ~~enhancements and capabilities including:~~

product upgrades that included:

~~Accelerate, which is an accelerated file transfer module that boosts the speed~~

●

EFT Insight, a new reporting platform to strengthen data governance and ~~efficiency of secure~~provide near real-time visibility into business-critical data ~~transfers~~flows and ~~allows for the fast transfer of large files over disparate geographic distances.~~exchanges.

●

Cloud storage support capabilities with the Cloud Connector Module.

●

Remote Agent Module for streamlining and centrally managing the data exchanges with branch offices and remote locations.

●

Major enhancements for clustering and High Availability configuration.

●

Over a dozen major features in the Workspaces ~~which is a file-sharing~~ module ~~that allows employees~~ to ~~create their own groups~~enhance sharing and ~~assign permissions for those groups, much like a virtual data room, to provide~~collaboration capabilities.

●

Enhanced Web Transfer Client user access to ~~files for which they themselves have access on the EFT server. This functionality is accomplished without compromising the~~improve user experience.

●

Improved SFTP security ~~control,~~setting configuration to enable more visibility into security settings and ~~governance of those files.~~help administrators ensure compliance.

·	~~Active-active high availability, or HA, which maximizes uptime and performance of critical information technology systems.~~

· ●	~~Enhanced compatibility of web transfer client file transfers through HTML5 support in addition~~ Major update to the ~~existing Java Runtime Environment.~~Advanced Workflow Engine (“AWE”) module.

~~Increased scalability~~

●

New security features, including DMZ Gateway module enhancements and ~~business continuity with more flexible, uninterrupted file transfer service.~~updates.

·	~~Improved facilitation of PCI DSS version 3.0 compliance with updates to security components, such as PGP and AS2.~~

·	~~Addition of new Content Integrity Control providing an Internet Content Adaptation Protocol (ICAP) connector to anti-malware scanners and data loss prevention (DLP) solutions.~~

·	~~Integration with SMS PASSCODE for Mobile-Based 2 Factor Authentication.~~

·	~~Enhanced and expanded event rule functionality which improves the ability to integrate our products with client business processes and backend systems~~

~~We continue to enhance the~~

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

~~Most EFT~~Platform – Delivery Offerings

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

If a customer prefers to use the capabilities of EFT in a SaaS fashion, we offer EFT Cloud Services. The EFT platform delivered in this manner has the same features and functionality as our EFT platform installed at a customer site. EFT Cloud Services allows users to reduce their upfront cost and achieve other recognized benefits of cloud-based managed file transfer SaaS subscription solutions, including strong service level agreements for information technologies infrastructure reliability and performance.

~~EFT Cloud Services provides a flexible continuum of features and functions that gives the user the ability to pick and choose the extent to which they want to own or outsource~~ the capabilities of our EFT platform. EFT Cloud Services gives organizations the flexibility of either a hybrid cloud or virtual environment with the security of an on-premises managed file transfer solution. Users of EFT Cloud Services have the option to work with a variety of top hosting providers that best fit their needs. We offer flexible subscription pricing under one, two, and three-year contracts that can help our customers minimize or eliminate upfront capital expenditures and possibly reduce their ongoing operating costs.

We earn most of our revenue from our products and services related to our EFT platform. Currently, most of this revenue is from sales of perpetual software licenses, paid as a one-time fee, along with an M&S contract that creates recurring revenue. Subscription revenue from EFT Cloud Services is increasing but is not yet a material portion of the total revenue from our EFT platform. Most of the resources we expend, and expect to expend in the future, relate to development, marketing, sales and support of the EFT platform in ~~a business-to-business environment.~~

two ways:

●

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

●

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

Index

Secure Information Sharing and Exchange Solution – Mail Express

Mail Express is a solution that provides secure information sharing and exchange capabilities leveraging traditional email workflow. It is a stand-alone product installed in a client-server environment that allows users to send and receive secure, encrypted ~~e-mail~~email and attachments of virtually unlimited size. ~~Mail Express was a Bronze Winner in the Email Security and Management category of the 2015 Info Security Products Guide Global Excellence Awards.~~

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

~~File Synchronization and Sharing Solution - scConnect~~

scConnect, is our on-premises, enterprise file synchronization and sharing solution. It provides users with the ability to share and access data anytime on any device, while providing information technology department administrators with the tools necessary to maintain the security of sensitive enterprise information and to control and monitor user access and activity. scConnect enables secure collaboration without involving third-party servers.

We continue to develop the features and functions of scConnect. As part of our development of this product, we intend to eventually integrate its capabilities into the functionality of our EFT platform.

Wide Area File Services Solution - WAFS

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

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

File Transfer Solution for Consumers - CuteFTP

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

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

·	~~Support for Unicode (UTF-8) characters that allows greater international use.~~

·	~~Web Distributed Authoring and Versioning (WebDAV) support to facilitate collaboration between users in editing and managing documents and files stored on World Wide Web servers.~~

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

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

~~Index~~

product.

Professional Services

We offer a wide range of professional services to complement our on-premises and SaaS ~~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 solution health checks. In addition, we may provide longer-term engineering services, including supporting multi-year contracts, if necessary, to support certain solution implementations and integrations.

can include:

●	System integration and implantation

●	Business process and workflow planning

●	Policy development

●	Education and training

●	Solution health checks

Maintenance and Support

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

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

Employees

~~As of October 31, 2016, we had 126 full-time employees~~

Our workforce is organized as follows:

	September 30,
Department	2018		2017
Sales and Marketing		36		56
Engineering		9		30
Professional Services		5		6
Customer Support		24		23
Management and Administration		16		19
Total		90		134

Index

	~~Number of~~
~~Department~~	~~Employees~~
~~Sales and Marketing~~		44
~~Engineering~~		28
~~Professional Services~~		12
~~Customer Support~~		22
~~Management and Administration~~		20
~~Total~~		~~126~~

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

The Company expects for the realignment to result in a significant reduction in total expenses. Furthermore, to the extent that it can be successfully implemented without negatively impacting revenues or growth opportunities, the realignment offers an opportunity for the Company to realize significant increases in operating earnings in future periods, although there can be no assurance that any such increase will occur.

Solution Perspective and Trends

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

Three Months Ended September 30, Nine Months Ended September 30,
2016 2015 2016 2015
Amount
% of Total
Revenue
Amount
% of Total
Revenue
Amount
% of Total
Revenue
Amount
% of Total
Revenue

Revenue by Type

Software licenses $ 3,373 38.6 % $ 2,852 37.3 % $ 8,565 35.1 % $ 8,590 38.4 %
Maintenance and support 4,713 53.8 % 4,142 54.2 % 13,843 56.7 % 12,269 54.8 %
Professional services 667 7.6 % 653 8.5 % 2,013 8.2 % 1,531 6.8 %
Total Revenue $ 8,753 100.0 % $ 7,647 100.0 % $ 24,421 100.0 % $ 22,390 100.0 %

Revenue by Product

EFT Enterprise and Standard $ 8,212 93.8 % $ 6,905 90.3 % $ 22,678 92.9 % $ 19,983 89.2 %
Wide Area File Services 209 2.4 % 236 3.1 % 658 2.7 % 764 3.4 %
CuteFTP 124 1.4 % 240 3.1 % 480 2.0 % 665 3.0 %
Other 208 2.4 % 266 3.5 % 605 2.4 % 978 4.4 %
Total Revenue $ 8,753 100.0 % $ 7,647 100.0 % $ 24,421 100.0 % $ 22,390 100.0 %

	Three Months Ended September 30,										Nine Months Ended September 30,
	2018					2017					2018					2017
			Percent of					Percent of					Percent of					Percent of
	Amount		Total			Amount		Total			Amount		Total			Amount		Total

Revenue By Type
License	$	2,843		31.7	%	$	2,488		30.3	%	$	7,726		30.7	%	$	7,768		30.9	%
M&S		5,488		61.1	%		5,360		65.2	%		15,872		63.1	%		15,702		62.5	%
Professional Services		649		7.2	%		368		4.5	%		1,549		6.2	%		1,652		6.6	%

Total Revenue	$	8,980		100.0	%	$	8,216		100.0	%	$	25,147		100.0	%	$	25,122		100.0	%

Revenue by Product Line
License
EFT Platform	$	2,767		97.3	%	$	2,388		96.0	%	$	7,479		96.8	%	$	7,338		94.5	%
Other		76		2.7	%		100		4.0	%		247		3.2	%		430		5.5	%

Total License Revenue		2,843		100.0	%		2,488		100.0	%		7,726		100.0	%		7,768		100.0	%

M&S
EFT Platform		5,270		96.0	%		5,100		95.1	%		15,202		95.8	%		14,893		94.8	%
Other		218		4.0	%		260		4.9	%		670		4.2	%		809		5.2	%

Total M&S Revenue		5,488		100.0	%		5,360		100.0	%		15,872		100.0	%		15,702		100.0	%

Professional Services (all EFT Platform)		649		100.0	%		368		100.0	%		1,549		100.0	%		1,652		100.0	%

Total Revenue
EFT Platform		8,686		96.7	%		7,856		95.6	%		24,230		96.4	%		23,883		95.1	%
Other		294		3.3	%		360		4.4	%		917		3.6	%		1,239		4.9	%

Total Revenue	$	8,980		100.0	%	$	8,216		100.0	%	$	25,147		100.0	%	$	25,122		100.0	%

Index

Revenue from our EFT platform products increased 10.6% for the 2018 quarter compared to the 2017 quarter and 1.5% for the 2018 nine months compared to the 2017 nine months. Revenue for our other product lines decreased 18.3% for the 2018 quarter compared to the 2017 quarter and 26.0% for the 2018 nine months compared to the 2017 nine months, which is consistent with our expectations as discussed below. For a more detailed discussion of these revenue trends, see “Comparison of the Consolidated Statement of Operations for the Three Months Ended September 30, 2018 and 2017” and “Comparison of the Consolidated Statement of Operations for the Nine Months Ended September 30, 2018 and 2017”.

We earn revenue primarily from the following activities:

License revenue from sales of our EFT ~~and Mail Express~~platform products that we deliver as either perpetually-licensed software installed at the customer’s premises, for which we earn the full amount of the license revenue at the time the license is delivered, or as a cloud-based service under our EFT Cloud Services ~~brand~~or EFT Arcus brands delivered using a SaaS model, for which we earn monthly subscription revenue as these services are ~~delivered over a contract period that is typically one year.~~

delivered.

License revenue from sales of our Mail Express, WAFS and CuteFTP products that are installed at the customer’s premises under a perpetual license for which we earn the full amount of the license revenue at the time the license is delivered.

M&S revenue under contracts to provide ongoing product support and software updates to our ~~customers who have purchased license software which we~~customers. We recognize revenue ratably over the contractual period, which is typically one year, but can be up to three years.

Professional services revenue from a variety of ~~customization,~~ implementation and integration services, as well as delivery of education and training associated with our solutions, which we recognize as the services are performed and accepted by the ~~client~~.client.

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

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

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

~~Over the past few years, we~~

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

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

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

·	~~Increasing sales staffing and capabilities as needed to address our markets.~~

· ●	Aligning our sales group to enhance its industry and geographic focus.

●

Implementing new sales and marketing campaigns.

·	~~Evolving our lead generation programs to increase our sales staff’s exposure to potential purchasers.~~

· ●	Enhancing our support of channel partners and engaging them to sell our products through training, orientation and marketing programs.

Index

Our total revenue increased 15% in the 2016 quarter compared to the 2015 quarter and 9% in the 2016 nine months compared to the 2015 nine months. For a more complete discussion of these revenue trends, see ~~Comparison of the Statement of Operations for the Three Months Ended September 30, 2016 and 2015~~ ~~and~~ ~~Comparison of the Statement of Operations for the Nine Months Ended September 30, 2016 and 2015.~~

Liquidity and Capital Resources

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

September 30, 2016 December 31, 2015 September 30, 2015
Cash and cash equivalents $ 17,421 $ 15,885 $ 12,858
Short term investments 3,303 3,254 3,233
Total cash, cash equivalents and long term investments $ 20,724 $ 19,139 $ 16,091

Working capital $ 14,138 $ 11,162 $ 6,515
Deferred revenue, current portion 13,005 12,000 11,848
Working capital plus current deferred revenue (non-GAAP presentation) $ 27,143 $ 23,162 $ 18,363

~~Deferred revenue, unlike the other liability components~~

	September 30, 2018			December 31, 2017
Cash and cash equivalents	$	9,630		$	11,583
Short term certificates of deposit		1,530			4,291
Long term certificates of deposit		-			11,503
Total cash, cash equivalents and certificates of deposit	$	11,160		$	27,377

Current assets	$	19,926		$	23,296
Current liabilities		(17,701	)		(16,886	)
Working capital	$	2,225		$	6,410

At September 30, 2018, our certificate of ~~our working capital, is an obligation we will satisfy by providing services~~deposit in the future to our customers as part of our ongoing operating activities from which we have historically generated cash flow. Our deferred revenue does not involve a disbursement of cash as a direct payment of that liability. Accordingly, we assess our working capital using both the GAAP computation that includes all current liabilities as well as assessing it excluding the current portion of deferred revenue. Working capital plus the current portion of deferred revenue is not a measure of financial position under GAAP, has limitations as an analytical tool and whenassets matures in October 2018.

When assessing our ~~financial position~~liquidity and ~~should not be considered a substitute for working~~ capital ~~computed in accordance with GAAP.~~

resources, we consider the following factors:

●

We may access and monetize our certificates of deposit at any time without risk of loss of the original amounts invested. If we were to redeem these certificates of deposit prior to their maturity, we may incur a penalty and forfeit certain amounts of accrued interest, but we view such amounts as not material.

●

Deferred revenue, unlike the other liability components of our working capital, is an obligation we will satisfy by providing services in the future to our customers as part of our ongoing operating activities from which we have historically generated cash flow. Our deferred revenue does not involve a disbursement of cash as a direct payment of that liability although we will incur operating expenses in the future as we deliver those M&S services.

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

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

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

Cash Provided (Used) During the Nine Months Ended September 30,

2016 2015
Operating activities $ 3,673 $ 3,429
Investing activities (1,515 ) (1,769 )
Financing activities (622 ) (160 )

~~Index~~

	Cash Provided (Used) During the Nine Months Ended September 30,
	2018			2017
Operating activities	$	2,559		$	4,773
Investing activities		13,064			(1,713	)
Financing activities		(17,576	)		(508	)

Our cash provided by operating activities ~~increased~~decreased during the ~~2016~~2018 nine months compared to the ~~2015~~2017 nine months primarily due to the following factors:

●

Accounts ~~payable decreased $217,000~~receivable decreasing $1.1 million during the ~~2016~~2018 nine months compared to decreasing ~~$757,000~~$1.8 million during the 2017 nine months due primarily to more cash collected from customers in the 2015 nine months. The change in the amount of the decrease was primarily due to the payment during the 2015 nine months of certain large obligations to third-party software developers which was not repeated in the 20162017 nine months as a result of ~~our~~ increased ~~use of internal resources~~collection activities that concentrated on older, smaller outstanding receivables, which was not necessary in 2018.

Index

●

Accounts payable increasing $82,000 during the 2018 nine months compared to ~~develop our products and~~increasing $448,000 during the 2017 nine months due to normal variations in the timing of payments to our vendors.

~~Income tax receivable and payable increased $571,000 in~~

●

Deferred revenue decreasing $1.9 million during the ~~2016~~2018 nine months compared to decreasing $1.5 million during the 2017 nine months due primarily to a decrease in multi-year renewals.

●

Prepaid and other current assets increasing ~~$403,000~~$1.9 million in the ~~2015~~2018 nine ~~months. The change~~months compared to decreasing $163,000 in the ~~amount of the increase was~~2017 nine months due primarily to a ~~result of changes~~receivable from our insurance carrier relating to legal expense and securities class action complaint described in ~~the level of our taxable income between periods and normal variations in the timing of our tax payments.~~Footnote 12.

~~Offset by:~~

●

Net income after considering ~~adjustments to reconcile net~~items not involving cash at the time they are recorded in the statement of operations and comprehensive income, ~~to net cash provided by operating activities,~~ as set forth on our Condensed Consolidated Statements of Cash ~~Flow, decreased $609,000. See~~Flows, decreasing from $4.8 million in the ~~section below under~~ 2017 nine months to $2.6 million in the 2018 nine months. “See Comparison of the Consolidated Statement of Operations for the Nine Months Ended September 30, ~~2016~~2018 and ~~2015~~2017” for a discussion of the changes in the components of these amounts.

Offset by:

~~Accounts receivable increased $2.8~~

●

Accrued expenses increasing $1.7 million in the ~~2016~~2018 nine months ~~which provided less cash than the $1.7 million increase~~compared to increasing $404,000 in the ~~2015~~2017 nine ~~months. This increase was~~months due primarily to ~~an increase~~the accrual of a $1.4 million future payment related to the settlement of the securities class action complaint described in ~~software licenses sold~~footnote 12 and ~~bookings~~the accrual of ~~multi-year M&S contracts during~~one-time severance payments and termination costs in association with the ~~2016~~reduction in force.

●

Federal income tax receivable decreasing $82,000 in the 2018 nine months compared to increasing $759,000 in the 2017 nine months due primarily to paying $1.3 million more in income tax payments in the 2017 nine months as compared to the ~~2015~~2018 nine months.

The amount of cash we used for investing activities during the ~~2016~~2018 nine months ~~decreased~~increased compared to the ~~2015~~2017 nine months ~~with~~due primarily to:

●

The redemption of the majority of our certificates of deposit which caused an increase of $14.3 million in the 2018 nine months, for which no comparable event in the 2017 nine months occurred.

Offset by:

●

A decrease in the purchase of property and equipment as a result of remodeling of our sales and engineering office spaces in the 2017 nine months, for which there was no comparable event in the 2018 nine months.

●

A decrease in our software development costs capitalized due to the reduction in force which significantly reduced the headcount in our engineering department.

Financing activities used more cash during the ~~primary component of that decrease relating to software development costs that were capitalized. This decrease was~~2018 nine months than during the 2017 nine months primarily due to:

~~Increased use~~

●

The purchase of $17.2 million of our ~~employees as an internal resource to do this work~~common stock, predominantly through our tender offer.

●

A decrease in proceeds received from the ~~2016~~exercise of stock options during the 2018 nine months compared to the ~~2015~~2017 nine months ~~when we relied more~~as a result of a moratorium on ~~the use~~issuing shares of ~~higher cost, third-party software developers.~~common stock in 2018, which was lifted in August of 2018.

Offset by:

~~Enhancement~~

●

No dividend payment in the third quarter of ~~relationships with those third-party developers we continue~~2018 compared to ~~use by replacing legacy arrangements carrying higher costs with more cost effective and efficient arrangements.~~a dividend payment of approximately $328,000 in the third quarter of 2017.

·	~~Shortages of qualified software engineers and qualified technical personnel that caused some of our open positions that arise during the normal course of business to take longer to fill.~~

Index

Our financing activities used more cash in the 2015 nine months than the 2016 nine months primarily due to the payment of three cash dividends in the 2016 nine months compared to the payment of two cash dividends in the 2015 nine months.

Contractual Obligations and Commitments

As of September 30, ~~2016,~~2018, our contractual obligations and commitments consisted primarily of the following items:

●

An obligation to deliver services in the future to satisfy our right to earn our deferred revenue of ~~$16.7~~$15.1 million. Those future services primarily relate to our obligations under M&S ~~contracts for which we have invoiced our customers.~~contracts. We will recognize this deferred revenue as revenue over the remaining life of those contracts which generally ranges from one to three years. Deferred revenue, unlike the other liability components of our working capital, is an obligation we will satisfy ~~through~~by providing services in the future to our customers as part of our ongoing operating activities from which we have historically generated cash flow. Our deferred revenue does not involve a disbursement of cash as a direct payment of that ~~liability.~~liability although we will incur operating expenses in the future as we deliver those M&S services.

��

Trade accounts payable and accrued liabilities which include our contractual obligations to pay software royalties to third parties that vary in amount based on our sales volume of products upon which royalties are payable.

●

Operating lease for our office space.

●

Federal and state taxes.

~~Index~~

Our non-cancellable, contractual obligations at September 30, ~~2016,~~2018, consisted primarily of the ~~lease for our office space with amounts due as follows~~following ($ in thousands):

Amounts Due for the Period

Three Months Ending
December 31,
2016
Fiscal Years

2017 - 2018 2019 - 2020 Thereafter Total

Operating leases $ 90 $ 720 $ 120
$
-

$
930

	Amounts Due for the Period
	Three Months Ending December 31,		Fiscal Years
	2018		2019		2020		Thereafter		Total

Operating leases	$	90	$	120	$	0	$	0	$	210

As of September 30, ~~2016,~~2018, we had no interest-bearing obligations in the form of loans, notes payable or similar debt instruments.

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

Comparison of the Condensed Consolidated Statement of Operations for the Three Months Ended September 30 ~~2016~~, 2018 and ~~2015~~

Three Months Ended September 30,
2016 2015 $ Change
$ in thousands

Total revenues $ 8,753 $ 7,647 $ 1,106
Total cost of revenues 1,770 1,508 262
Gross profit 6,983 6,139 844
Operating expenses
Sales and marketing 2,759 2,289 470
General and administrative 1,638 1,449 189
Research and development 528 646 (118 )
Total operating expenses 4,925 4,384 541
Income from operations 2,058 1,755 303
Other income (expense), net 28 17 11
Income before income taxes 2,086 1,772 314
Income tax expense 687 542 145
Net income $ 1,399 $ 1,230 $ 169

2017

	Three Months Ended September 30,
	2018			2017		$ Change
	$ in thousands

Total revenues	$	8,980		$	8,216	$	764
Total cost of revenues		1,499			1,573		(74	)
Gross profit		7,481			6,643		838
Operating expenses
Sales and marketing		2,261			3,079		(818	)
General and administrative		1,589			1,573		16
Legal and professional		1,510			1,002		508
Severance		381			-		381
Research and development		368			594		(226	)
Total operating expenses		6,109			6,248		(139	)
Income from operations		1,372			395		977
Other income		(93	)		75		(168	)
Income before income taxes		1,279			470		809
Income tax expense		281			194		87
Net income	$	998		$	276	$	722

In the discussion below, ~~we refer to~~ the ~~three months ended September 30, 2016, as the “2016 quarter” and the three months ended September 30, 2015, as the “2015 quarter”. The~~ percentage changes cited ~~in our discussions~~ are based on the ~~2016~~2018 quarter amounts compared to the ~~2015~~2017 quarter amounts.

Index

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

Three Months Ended September 30,
2016 2015
$ in thousands
Amount
% of Total
Revenue
Amount
% of Total
Revenue

Revenue by Type

Software licenses $ 3,373 38.6 % $ 2,852 37.3 %
Maintenance and support 4,713 53.8 % 4,142 54.2 %
Professional services 667 7.6 % 653 8.5 %
Total Revenue $ 8,753 100.0 % $ 7,647 100.0 %

Revenue by Product

EFT Enterprise and Standard $ 8,212 93.8 % $ 6,905 90.3 %
Wide Area File Services 209 2.4 % 236 3.1 %
CuteFTP 124 1.4 % 240 3.1 %
Other 208 2.4 % 266 3.5 %
Total Revenue $ 8,753 100.0 % $ 7,647 100.0 %

~~Trends in Revenue by Type~~

~~Software Licenses~~ -

	Three Months Ended September 30,
	2018					2017
			Percent of					Percent of
	Amount		Total			Amount		Total

Revenue By Type
License	$	2,843		31.7	%	$	2,488		30.3	%
M&S		5,488		61.1	%		5,360		65.2	%
Professional Services		649		7.2	%		368		4.5	%

Total Revenue	$	8,980		100.0	%	$	8,216		100.0	%

Revenue by Product Line
License
EFT Platform	$	2,767		97.3	%	$	2,388		96.0	%
Other		76		2.7	%		100		4.0	%

		2,843		100.0	%		2,488		100.0	%
M&S
EFT Platform		5,269		96.0	%		5,100		95.1	%
Other		219		4.0	%		260		4.9	%

		5,488		100.0	%		5,360		100.0	%

Professional Services (all EFT Platform)		649		100.0	%		368		100.0	%

Total Revenue
EFT Platform		8,685		96.7	%		7,856		95.6	%
Other		295		3.3	%		360		4.4	%

	$	8,980		100.0	%	$	8,216		100.0	%

Our ~~software license~~total revenue increased ~~18.3%~~9.3%. ~~Most of this increase came~~Revenue from ~~our sales of~~ our EFT platform products and services increased 10.6%. Revenue from our other products that consist of Mail Express, WAFS, CuteFTP, and TappIn decreased to comprising 3.3% of our total revenue, which is a trend that is in line with our ongoing de-emphasis of those products.

EFT Platform Products

License revenue from our EFT platform products increased 15.9%. This increase was ~~a result~~primarily due to an increase in the number of large transactions, including transactions that were expected to originally close in the ~~following factors:~~previous quarter.

Index

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

~~In mid-2016, we reviewed how we were allocating~~

●

Aligning our ~~resources across all of our product lines. Based on that review, we initiated changes that were in place throughout the 2016 quarter~~sales group to enhance ~~our focus on our EFT platform that is our flagship product~~its industry and from which we earn a substantial portion of our revenue. While these changes initially prioritized attention to our product research and development activities, we identified corporate-wide synergies from a similar focus on how we were expending resources in our marketing and sales activities. As a result, the attention we paid to our EFT platform gained momentum across all departments resulting in our overall resources being more optimally used to translate sales leads into completed transactions and revenue for that product line. As a result, we realized 25.1% growth in revenue from our EFT platform perpetual license sales.geographic focus.

Revenue from delivery of our EFT platform through a cloud-based SaaS solution grew 52.8%. We achieved this growth by promoting our ability to offer the features and functions of our EFT platform through a SaaS delivery method without materially impacting our perpetual license sales. We believe this flexibility allows us to address the full range of users, whether they prefer a SaaS solution or an on-premises solution, without negatively compromising our ability to earn revenue from both.

●

We made an investment in early 2016 to enhance the talent level of our sales force. During the 2016 quarter, we began to realize the benefits of them completing their first full sales cycles of substance and converting our sales pipeline into revenue. These efforts, combined with the refocus on our EFT platform discussed above, allowed our

Implementing new sales and marketing ~~teams~~campaigns.

●

Enhancing our support of channel partners and engaging them to ~~achieve greater efficiencies that led~~sell our products through training, orientation and marketing programs.

M&S revenue from our EFT platform products increased 3.3% primarily due to:

●

Ongoing license sales since a majority of license sales are accompanied by an M&S contract. The change in M&S revenue typically lags behind the related change in license revenue because license sales are recognized as revenue in full in the period the license is delivered while the related M&S revenue is recognized in future periods as those services are delivered.

●

Sustaining high renewal rates of M&S contracts by customers who initially purchased these services in earlier periods. We believe these renewals result from our programs designed to ~~increased revenue.~~provide high-quality and responsive M&S services to our customers.

~~M&S Revenue~~ –

Our professional services revenue was $281,000 more for the 2018 quarter compared to the 2017 quarter which is an increase of 76.4%. This increase was primarily due an increase in software license sales, which typically results in higher professional service revenue.

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

~~Index~~

~~M&S revenue increased 13.8% primarily as a result of ongoing license sales for EFT Enterprise and Standard that are almost always accompanied by an M&S contract and sustained high renewal rates of~~

Our M&S contracts byare typically for one year, with some customers ~~who initially purchased these services~~buying two or three year contracts. Customers pay the M&S fee for the entire term of the agreement at the time the contract begins. We recognize that amount as revenue ratably in ~~earlier periods. We believe these renewal rates result from our programs designed to provide high-quality and responsive M&S service to our customers.~~

future periods over the term of the contract.

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

~~Our M&S contracts~~

Other Products

In mid-2016, we announced that our focus would be on our EFT platform products. At the same time, we announced that while we would continue selling our Mail Express, WAFS, CuteFTP, and TappIn products that collectively constitute less than 3.3% of our total revenue in the quarter, in the future we would de-emphasize these stand-alone products that are ~~typically~~not part of our EFT platform. Accordingly, during the second half of 2016, we began to curtail our product development and engineering resources for one year, with some customers buying two or three year contracts. The customer pays us the M&S fee for the entire term of the agreement at the time the contract begins. We recognize that amount as revenue ratably in future periods over the term of the contract.

~~Professional Services Revenue~~ ~~- Professional services revenue increased 2.1%. This increase was due to~~these products and significantly reduced our sales and marketing ~~programs designed to increase the frequency of sales of professional services and~~activities supporting them. As a result, our enhanced focus on managing our queue of professional services projects so as to deliver our work product to our customers sooner and in-turn accelerate our ability to recognize revenue from these projects.

~~Trends in Revenue by Product~~

~~EFT Enterprise and Standard~~ - We earn a substantial portion of our revenue selling our EFT platform products and providing M&S and professional services related to those products. We believe these products present the best opportunity for increasing our revenue. Our software license, M&S and professional services revenue from our EFT platform increased 18.9% for the reasons discussed above under ~~Trends in Revenue by Type.~~

~~WAFS, CuteFTP and Other~~ ~~- The total of~~ license and M&S revenue from ~~WAFS decreased 11.4%, from CuteFTP decreased 48.3% and from other~~those products ~~decreased 21.8%. Revenue from these products is less than 10% of~~collectively declined 18.1% in the 2018 quarter compared to the 2017 quarter. Our future focus will be on our ~~total revenue, and~~EFT platform such that we ~~earn no significant professional services~~expect to see a continuing decline in revenue from these ~~products. These decreases in revenue were~~other, however although we do expect them to continue to produce a ~~result of our primary focus being on the development, marketing and sales of our EFT platform products as discussed above under~~ ~~Solution Perspective and Trends~~.

modest contribution margin.

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

Index

Cost of license revenue primarily consists ~~primarily~~ of:

●

Amortization of capitalized software development costs we incur when producing our software products. ~~This amortization~~Amortization begins when a product is ready for general release to the ~~public.~~public and generally is an expense that is not directly variable relative to revenue.

●

Royalties we pay to use software developed by others for certain features of our ~~products.~~products that is generally an expense that is variable relative to revenue.

●

Fees we pay to third parties who provide services supporting our SaaS and cloud-based subscription ~~solutions.~~solutions that generally have components that are both variable and not variable relative to revenue.

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

Cost of software license revenue decreased 0.6% and as a percent of software license revenue was ~~26%~~25.4% in the ~~2016~~2018 quarter compared to ~~20%~~29.1% in the ~~2015~~2017 quarter. ~~This increase was~~These decreases were primarily due to lower royalty expense, which can fluctuate based upon the ~~result~~mix of products sold, offset by slight increases in third-party hosting fees for our ~~release of new software~~SaaS products and ~~new versions~~an increase in amortization of ~~existing products in periods subsequent to the 2015 quarter and the resulting commencement of amortizing the~~ capitalized software development costs for those products. This additional expense amortization that began subsequent to the 2015 quarter increased cost of revenue in the 2016 quarter as compared to the 2015 quarter. On an absolute dollar basis, cost of revenue for software licenses increased 55% during the 2016 quarter due to the factors cited above and due to higher software license revenue.

~~Index~~

costs.

Cost of M&S revenue as a percent of M&S revenue was ~~substantially unchanged.~~9.4% in the 2018 quarter as compared to 8.3% in the 2017 quarter. Cost of revenue for M&S in absolute dollars increased by ~~6% due to an increase~~15.2%. These increases were a combination of increasing our headcount in M&S revenue. The cost of delivering M&S can vary slightly up or down from period-to-period, but we believe such changes are typically not indicative of long term trends or permanent changes in our cost of delivering M&S. Our gross margin on these services generally remains greater than 90% as a result of a consistent application of our customer support ~~delivery protocols~~department and ~~practices.~~

the decision by the U.S. Army to consolidate certain of their operations resulting in the non-renewal of their M&S contract in September of 2017.

Cost of professional services revenue as a percent of that revenue was ~~80%~~40.6% in the ~~2016~~2018 quarter as compared to ~~93%~~109.2% in the ~~2015~~2017 quarter. This variation resulted from the varying scope and mix of the professional services we deliver that can change from period-to-period in response to the circumstances of the customer environments in which we are working. Varying customer requirements for our professional services, combined with our desire to ensure that we maintain our high standard of delivering quality, timely services, caused us to engage third-party service providers to a greater extent inBecause the ~~2015 quarter compared to the 2016 quarter, for which the~~ cost ~~is higher than the cost of using our own personnel. Cost~~ of revenue for professional services is highly variable relative to our revenue from our services, this cost in absolute dollars decreased ~~12% for the reasons discussed above.~~

34.3% due to a decrease in our professional services headcount.

Sales and Marketing. We believe it ~~most~~ meaningful to view cost of sales and marketing as a percent of revenues since many of those costs, particularly sales commissions, are variable relative to revenue. These expenses were ~~31.5%~~25.2% of total revenue for the ~~2016~~2018 quarter compared to ~~29.9%~~37.5% of total revenue for the ~~2015~~2017 quarter. In absolute dollars these expenses ~~increased 21%. These variations were~~decreased 26.6% due primarily ~~due to:~~

·	~~Increasing the size of our sales, marketing and product strategy teams and increased compensation rates due to competitive demands in the marketplace.~~

·	~~Increasing marketing activities related to competitive intelligence and channel development.~~

·	~~An increase in revenue which resulted in a higher absolute dollar amount of sales commissions paid to employees although the commission rate as a percent of sales did not change materially.~~

to decreased marketing expenses related to a decrease in our spending for content syndication and reduced headcount.

General and Administrative. These expenses increased ~~13%~~1.0% primarily due to ~~a continuing severance obligation to our former chief executive officer and legal~~ fees related to our 2018 Shareholder Meeting which was held in October of 2018, whereas our 2017 Shareholder Meeting was held in May of 2017.

Legal and Professional. These expenses increased 50.7% primarily due to increases in professional fees and related expenses associated with the ~~matter discussed below~~previously disclosed internal investigation, the restatement of certain of our financial statements and related litigation described in ~~Part II. Other Information Item 1. Legal Proceedings~~.

note 12 of the notes to our condensed consolidated financial statements.

Severance. These expenses increased $381,000 due to the one-time severance payments and termination benefits associated with the reduction in force.

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

Three Months Ended September 30,
2016 2015
R&D expenditures capitalized $ 452 $ 506
R&D expenditures expensed 528 646
Total R&D expenditures (non-GAAP measurement) $ 980 $ 1,152

~~Total research and development expenditures decreased 14.9% due to:~~

·	~~Increased use of our employees as an internal resource to do this work in the 2016 quarter compared to the 2015 quarter when we relied more on the use of higher cost, third-party software developers.~~

·	~~Enhancement of relationships with those third-party developers we continue to use by replacing legacy arrangements carrying higher costs with more cost effective and efficient arrangements.~~

·	~~Shortages of qualified software engineers and qualified technical personnel that caused some of our open positions that arise during the normal course of business to take longer to fill.~~

	Three Months Ended September 30,
	2018		2017
R&D expenditures expensed	$	368	$	594
R&D expenditures capitalized		264		527
Total R&D expenditures (non-GAAP measurement)	$	632	$	1,121

Index

Our total R&D expenditures decreased 43.6% during the 2018 quarter as compared with the 2017 quarter primarily due fewer employed software engineers and technical personnel.

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

Interest Income (Expense), Net. Interest income (expense), net has historically consisted primarily of interest income earned on certificates of deposit. In the 2018 quarter the amount is an expense due to the forfeiture of approximated $155,000 in accrued interest. This forfeiture was the result of redeeming a long term certificate of deposit before its scheduled maturity date in order to fund the purchase of shares related to the tender offer.

Income Taxes. Our effective rate differed from the federal statutory tax rate of 21% in the 2018 quarter and 34% in the 2017 quarter primarily due to:

●

Certain expenses in our consolidated financial statements, such as a portion of meals and entertainment expenses and stock based compensation that are not deductible on our federal income tax return.

●

State income taxes included in income tax expense in our consolidated financial statements.

Offset by:

●

The domestic production activities deduction (in the 2017 quarter) and the research and development credit which are tax credit incentives that serve to reduce the rate at which we pay federal income taxes in exchange for us conducting certain aspects of our business in a manner promoted by the Internal Revenue Code.

Comparison of the Condensed Consolidated Statement of Operations for the NineMonths Ended September 30, 2018 and 2017

	Nine Months Ended September 30,
	2018		2017		$ Change
	$ in thousands

Total revenues	$	25,147	$	25,122	$	25
Total cost of revenues		4,679		4,637		42
Gross profit		20,468		20,485		(17	)
Operating expenses
Sales and marketing		8,229		9,564		(1,335	)
General and administrative		4,883		4,607		276
Legal and professional		4,235		1,550		2,685
Severance		488		21		467
Research and development		1,654		2,530		(876	)
Total operating expenses		19,489		18,272		1,217
Income from operations		979		2,213		(1,234	)
Other income		63		221		(158	)
Income before income taxes		1,042		2,434		(1,392	)
Income tax expense		386		870		(484	)
Net income	$	656	$	1,564	$	(908	)

Index

In the discussion below, the percentage changes cited are based on the 2018 nine month amounts compared to the 2017 nine month amounts.

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

	Nine Months Ended September 30,
	2018					2017
			Percent of					Percent of
	Amount		Total			Amount		Total

Revenue By Type
License	$	7,726		30.7	%	$	7,768		30.9	%
M&S		15,872		63.1	%		15,702		62.5	%
Professional Services		1,549		6.2	%		1,652		6.6	%

Total Revenue	$	25,147		100.0	%	$	25,122		100.0	%

Revenue by Product Line
License
EFT Platform	$	7,479		96.8	%	$	7,338		94.5	%
Other		247		3.2	%		430		5.5	%

		7,726		100.0	%		7,768		100.0	%
M&S
EFT Platform		15,202		95.8	%		14,893		94.8	%
Other		670		4.2	%		809		5.2	%

		15,872		100.0	%		15,702		100.0	%

Professional Services (all EFT Platform)		1,549		100.0	%		1,652		100.0	%

Total Revenue
EFT Platform		24,230		96.4	%		23,883		95.1	%
Other		917		3.6	%		1,239		4.9	%

	$	25,147		100.0	%	$	25,122		100.0	%

Our total revenue was relatively flat for the 2018 nine months as compared to the 2017 nine months. Revenue from our EFT platform products and services increased 1.5%. Revenue from our other products that consist of Mail Express, WAFS, CuteFTP, and TappIn decreased to comprising 3.6% of our total revenue, which is a trend that is in line with our ongoing de-emphasis of those products.

EFT Platform Products

License revenue from our EFT platform products increased 1.9%. This increase was primarily due to an increase in the number of large transactions, including transactions that were expected to close in 2017.

Index

M&S revenue from our EFT platform products increased 2.1% primarily due to:

●

Ongoing license sales since a majority of license sales are accompanied by an M&S contract. The change in M&S revenue typically lags behind the related change in license revenue because license sales are recognized as revenue in full in the period the license is delivered. The related M&S revenue is recognized in future periods as those services are delivered.

●

Sustaining high renewal rates of M&S contracts by customers who initially purchased these services in earlier periods. We believe these renewals result from our programs designed to provide high-quality and responsive M&S services to customers.

Professional services revenue decreased $103,000 primarily due to a lower headcount in our professional services department which resulted in fewer resources available to deliver services.

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

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

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

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

Cost of license revenue consists primarily of:

●

Amortization of capitalized software development costs we incur when producing our software products. Amortization begins when a product is ready for general release to the public and generally is an expense that is not directly variable relative to revenue.

●

Royalties we pay to use software developed by others for certain features of our products that is generally an expense that is variable relative to revenue.

●

Fees we pay to third parties who provide services supporting our SaaS and cloud-based subscription solutions that generally have components that are both variable and not variable relative to revenue.

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

Cost of software license revenue was relatively flat and as a percent of software license revenue was 28.8% in the 2018 nine months and 2017 nine months. An increase in amortization of capitalized software development cost and third-party hosting fees for our SaaS products was offset by lower royalty expense.

Cost of M&S revenue as a percent of M&S revenue was 9.9% in the 2018 nine months as compared to 8.2% in the 2017 nine months. Cost of revenue for M&S in absolute dollars increased by 22.7%. These increases were a combination of increasing our headcount in our customer support department and the decision by the U.S. Army to consolidate certain of their operations resulting in the non-renewal of their M&S contract in September of 2017.

Index

Cost of professional services revenue as a percent of that revenue was 56.8% in the 2018 nine months as compared to 67.8% in the 2017 nine months. This variation resulted from the varying scope and mix of the professional services we deliver that can change from period-to-period in response to the circumstances of the customer environments in which we are working. Because the cost of revenue for professional services is highly variable relative to our revenue from our services, this cost in absolute dollars decreased 21.4% due to a decrease in our professional services revenue for the reasons discussed above.

Sales and Marketing. We believe it meaningful to view cost of sales and marketing as a percent of revenues since many of those costs, particularly sales commissions, are variable relative to revenue. These expenses were 32.7% of total revenue for the 2018 nine months compared to 38.1% of total revenue for the 2017 nine months. In absolute dollars these expenses decreased 14.0%, due primarily to a decrease in the headcount of our sales representatives, a change in the way in which we compensate our sales people and decreased marketing expenses due to a decrease in our spending for content.

General and Administrative. These expenses increased 6.0% primarily due to a one-time share based compensation expense related to modification of certain stock options of our former Chief Financial Officer, offset by a credit to bad debt expense as a result of reducing the balance in our allowance for doubtful accounts to better reflect our potential exposure.

Legal and Professional.These expenses increased 173.2% or $2.7 million due to an increase of professional fees and related expenses associated with the previously disclosed internal investigation, the restatement of certain of our financial statements and related litigation described in note 12 of the notes to our condensed consolidated financial statements

Severance. These expenses increased $467,000 due mainly to the one-time severance payments and termination benefits associated with the reduction in force.

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

	Nine Months Ended September 30,
	2018		2017
R&D expenditures expensed	$	1,654	$	2,530
R&D expenditures capitalized		1,057		1,464
Total R&D expenditures (non-GAAP measurement)	$	2,711	$	3,994

Our total R&D expenditures decreased 32.1% primarily due to a reduction of expenses related to fewer software engineers and technical personnel.

~~Other~~

Interest Income (Expense), ~~Net.~~ ~~The other expense (net) in both quarters consists~~Net. Interest income has historically consisted primarily of interest income earned on certificates of deposit. The reduction in income in 2018 is due to the forfeiture of approximated $155,000 in accrued interest. This forfeiture was the result of redeeming a long ~~and short~~ term ~~investments.~~certificate of deposit before its scheduled maturity date in order to fund the purchase of shares relate to the tender offer.

Index

Income Taxes. Our effective tax rate ~~was 32.9% for the 2016 quarter and 30.6% for the 2015 quarter. These rates~~ differed from athe federal statutory tax rate of 21% for the 2018 nine months and 34% for the 2017 nine months primarily due to:

·	The domestic production activities deduction in both quarters, and the research and development credit, that are items considered in our federal income tax return that are not part of our income before taxes on our financial statements.

~~Offset by:~~

· ●	Certain expenses in our consolidated financial statements, such as a portion of meals and entertainment expenses and stock based compensation that are not deductible on our federal income tax return.

●

State income taxes included in income tax expense in our financial statements.

Our effective rate was higher in the 2016 quarter compared to the 2015 quarter primarily due to the research and development tax credit being lower in 2016 than 2015 and also the granting of only incentive stock options in 2016, for which we generally do not ever take a deduction on the tax return, as compared to the granting of only non-qualified stock options in 2015 for which we take a deduction on the tax return when the option is exercised.

~~Comparison of the Statement of Operations for the Nine Months Ended September 30, 2016 and 2015~~

Nine Months Ended September 30,
2016 2015 $ Change
$ in thousands

Total revenues $ 24,421 $ 22,390 $ 2,031
Total cost of revenues 5,137 3,965 1,172
Gross profit 19,284 18,425 859
Operating expenses
Sales and marketing 8,453 7,060 1,393
General and administrative 5,083 4,629 454
Research and development 1,727 1,832 (105 )
Total operating expenses 15,263 13,521 1,742
Income from operations 4,021 4,904 (883 )
Other income (expense), net 88 51 37
Income before income taxes 4,109 4,955 (846 )
Income tax expense 1,348 1,585 (237 )
Net income $ 2,761 $ 3,370 $ (609 )

~~Index~~

In the discussions below, we refer to the nine months ended September 30, 2016, as the “2016 nine months” and the nine months ended September 30, 2015, as the “2015 nine months”. The percentage changes cited in our discussions are based on the 2016 nine month amounts compared to the 2015 nine month amounts.

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

Nine Months Ended September 30,
2016 2015
$ in thousands
Amount
% of Total
Revenue

Amount

% of Total
Revenue

Revenue by Type

Software licenses $ 8,565 35.1 % $ 8,590 38.4 %
Maintenance and support 13,843 56.7 % 12,269 54.8 %
Professional services 2,013 8.2 % 1,531 6.8 %
Total Revenue $ 24,421 100.0 % $ 22,390 100.0 %

Revenue by Product

EFT Enterprise and Standard $ 22,678 92.9 % $ 19,983 89.2 %
Wide Area File Services 658 2.7 % 764 3.4 %
CuteFTP 480 2.0 % 665 3.0 %
Other 605 2.4 % 978 4.4 %
Total Revenue $ 24,421 100.0 % $ 22,390 100.0 %

~~Trends in Revenue by Type~~

~~Software Licenses~~ ~~- Software license revenue decreased 0.3%. Most of this change was driven by our sales of our EFT platform products and was a result of the following factors~~

Offset by:

During the six months ended June 30, 2016, we reviewed how we had been allocating our product research and development resources across all of our products. We determined that we had been allocating resources to the development of our EFT platform at a level less than that necessary to allow our sales and marketing activities to continue to yield growth in license revenue from that product during the six months ended June 30, 2016. As a result, software license revenue decreased 9.5% for this period as compared to the six months ended June 30, 2015.

●

Based on the review described above, we initiated changes that were in place throughout the 2016 quarter to enhance our focus on our EFT platform that is our flagship product and from which we earn a substantial portion of our revenue. While these changes initially prioritized attention to our product research and development activities, we identified corporate-wide synergies from a similar focus on how we were expending resources in our marketing and sales activities. Our enhanced attention to our EFT platform gained momentum across all departments resulting in our overall resources being more optimally used to translate sales leads into completed transactions and revenue for that product line. As a result, we realized 25.1% growth in revenue from our EFT platform perpetual license sales during the 2016 quarter which substantially offset the decrease in software license revenue for first six months of 2016 yielding the 0.3% decrease in software license revenue for the 2016 nine months.

Revenue from delivery of our EFT platform through a cloud-based SaaS solution grew 39.3%. The dollar amount of this revenue is not yet material to our total revenue. We achieved this growth by promoting our ability to offer the features and functions of our EFT platform through a SaaS delivery method without materially impacting our perpetual license sales. We believe this flexibility allows us to address the full range of users, whether they prefer a SaaS solution or an on-premises solution, without negatively compromising our ability to earn revenue from both.

~~Index~~

We made an investment in early 2016 to enhance the talent level of our sales force. During the 2016 nine months, we began to realize the benefits of them completing their first full sales cycles of substance and converting our sales pipeline into revenue. These efforts, combined with the refocus on our EFT platform discussed above, allowed our sales and marketing teams to achieve greater efficiencies that led to increased revenue.

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

M&S revenue increased 12.8% primarily as a result of ongoing license sales for EFT Enterprise and Standard that are almost always accompanied by an M&S contract and sustained high renewal rates of M&S contracts by customers who initially purchased these services in earlier periods. We believe these renewal rates result from our programs designed to provide high-quality and responsive M&S service to our customers.

We typically experience a high renewal rate for M&S services for our enterprise products so long as a customer continues using the licensed product they purchased from us. Ongoing license revenue provides a foundation for future recurring revenue as the purchasers of our licensed products continually renew M&S agreements to support their ongoing product support needs. This pattern of activity can create a cumulative effect for M&S renewals as a result of the cumulative number of licensed software installations sold over multiple years that create M&S renewals in any single year predictably (and in line with our expectations) exceeding the number of new software licenses we sell in a single year. We expect this cumulative effect to continue yielding sustainable M&S revenue as we continue to sell our enterprise software products in future periods.

~~Professional Services Revenue~~ - Professional services revenue increased 31.5% due to our sales and marketing programs designed to increase the frequency of sales of professional services and our enhanced focus on managing our queue of professional services projects so as to deliver our work product to our customers sooner and in-turn accelerate our ability to recognize revenue from these projects.

~~Trends in Revenue by Product~~

~~EFT Enterprise and Standard~~ - We earn a substantial portion of our revenue from selling our EFT platform products and providing M&S and professional services related to those products. We believe these products present the best opportunity for increasing our revenue. Our software license, M&S and professional services revenue from our EFT platform increased 13.5% for the reasons discussed above under ~~Trends in Revenue by Type.~~

~~WAFS, CuteFTP and Other~~ - The total of license and M&S revenue from WAFS decreased 13.9%, from CuteFTP decreased 27.8% and from other products decreased 38.1%. Revenue from these products is less than 10% of our total revenue, and we earn no significant professional services revenue from these products. These decreases in revenue were a result of our primary focus being on the development, marketing and sales of our EFT platform products as discussed above under ~~Solution Perspective and Trends~~.

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

~~Cost of license revenue consists primarily of:~~

·	~~Amortization of capitalized software development costs we incur when producing our software products. This amortization begins when a product is ready for general release to the public.~~

·	~~Royalties we pay to use software developed by others for certain features of our products.~~

·	~~Fees we pay to third parties who provide services supporting our SaaS and cloud-based subscription solutions.~~

~~Index~~

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

Cost of software license revenue as a percent of software license revenue was 27% in the 2016 nine months compared to 19% in the 2015 nine months. This increase were a result of our release of new software products and new versions of existing products in periods subsequent to the 2015 nine months and the commencement of amortizing the capitalized software development costs for those products. This additional expense amortization that began subsequent to the 2015 nine months increased cost of revenue in the 2016 nine months as compared to the 2015 nine months. On an absolute dollar basis, cost of revenue for software licenses increased 39% during the 2016 quarter due to the factors cited above and due to higher software license revenue.

Cost of M&S revenue as a percent of M&S revenue was substantially unchanged. Cost of revenue for M&S in absolute dollars increased by 8% due to an increase in M&S revenue. The cost of delivering M&S can vary slightly up or down from period-to-period, but we believe such changes are typically not indicative of long term trends or permanent changes in our cost of delivering M&S. Our gross margin on these services generally remains greater than 90% as a result of a consistent application of our customer support delivery protocols and practices.

Cost of professional services revenue as a percent of that revenue was 84% in the 2016 nine months as compared to 82% in the 2015 nine months. This variation resulted from the varying scope and mix of the professional services we deliver that can change from period-to-period in response to the circumstances of the customer environments in which we are working. Varying customer requirements for our professional services, combined with our desire to ensure that we maintain our high standard of delivering quality, timely services, caused us to engage third-party service providers to a greater extent in the 2016 nine months compared to the 2015 nine months for which the cost is higher than the cost of using our own personnel. Cost of revenue for professional services in absolute dollars decreased 34% for the reasons discussed above.

~~Sales and Marketing.~~ We believe it most meaningful to view cost of sales and marketing as a percent of revenues since many of those costs, particularly sales commissions, are variable relative to revenue. These expenses were 35% of total revenue for the 2016 nine months compared to 32% of total revenue for the 2015 nine months. In absolute dollars these expenses increased 20%. These variations were primarily due to:

·	~~Increasing the size of our sales, marketing and product strategy teams and increased compensation rates due to competitive demands in the marketplace.~~

·	~~Increasing marketing activities related to competitive intelligence and channel development.~~

·	~~An increase in revenue which resulted in a higher absolute dollar amount of sales commissions paid to employees although the commission rate as a percent of sales did not change materially.~~

~~General and Administrative.~~ These expenses increased 10%. Our chief executive officer resigned during the 2016 nine months. The severance arrangement related to this resignation included a modification of certain stock options held by him to accelerate their vesting and to extend the period during which they can be exercised and also ongoing severance payments. The stock option modification resulted in a one-time share-based compensation expense. That expense and the ongoing severance payments and legal costs was the primary cause of the increase in this expense. Our legal fees also increased due to the matter discussed below in ~~Part II. Other Information Item 1. Legal Proceedings~~.

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

Nine Months Ended September 30,
2016 2015
R&D expenditures capitalized $ 1,298 $ 1,613
R&D expenditures expensed 1,727 1,832
Total R&D expenditures (non-GAAP measurement) $ 3,025 $ 3,445

~~Index~~

~~Total research and development expenditures decreased 12.2% due to:~~

·	Increased use of our employees as an internal resource to do this work in the 2016 nine months compared to the 2015 nine months when we relied more on the use of higher cost, third-party software developers.

·	~~Enhancement of relationships with those third-party developers we continue to use by replacing legacy arrangements carrying higher costs with more cost effective and efficient arrangements.~~

·	~~Shortages of qualified software engineers and qualified technical personnel that caused some of our open positions that arise during the normal course of business to take longer to fill.~~

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

~~Other Income (Expense), Net.~~ ~~The other expense (net) in both quarters consists primarily of interest income earned on long and short term investments.~~

~~Income Taxes.~~ ~~Our effective tax rate was 32.8% for the 2016 nine months and 32.0% for the 2015 nine months. These rates differed from a federal statutory tax rate of 34% primarily due to:~~

The domestic production activities deduction ~~in both quarters,~~(in the 2017 nine months) and the research and development credit ~~in the 2016 nine months only,~~ that are ~~items considered in our~~tax credit incentives that serve to reduce the rate at which we pay federal income ~~tax return that are not part~~taxes in exchange for us conducting certain aspects of our ~~income before taxes on our financial statements.~~business in a manner promoted by the Internal Revenue Code.

~~Offset by:~~

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

·	~~State income taxes included in income tax expense in our financial statements.~~

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

During the ~~three months ended September 30, 2016~~2018 quarter and 2017 quarter, we earned approximately ~~17%~~12% and 14%, respectively, of our revenue from a single ~~third party,~~third-party channel distributor who purchases products from us and resells them to their customers. During the ~~three months ended September 30, 2015 there was no single customer that exceeded 10% of sales. During the~~2018 nine months ~~ended September 30, 2016,~~ and ~~the~~2017 nine months, ~~ended September 30, 2015,~~ we earned approximately ~~14%~~13% and ~~10%~~14%, respectively, of our revenue from ~~a single third party,~~the same third-party channel ~~distributor who purchases products from us and resells them to their customers.~~distributor. Approximately ~~40%~~17% of our accounts receivable as of September 30, ~~2016,~~2018 were due from this ~~customer and from one other customer, the latter of which did not constitute more than 10% of our revenue. Payment~~distributor. We have since received payment for substantially all ~~such amounts has been received subsequent to that date.~~

of these accounts receivable.

We earned approximately ~~17% and 22%~~30% of our revenue from customers outside the United States during the ~~three months ended September 30, 2016,~~2018 and 2017 quarter, and 29% and 26% for the ~~three months ended September 30, 2015 respectively. We earned approximately 22% and 24% of our revenue from customers outside the United States during the~~2018 nine months ~~ended September 30, 2016,~~ and ~~the~~2017 nine months, ~~ended September 30, 2015~~ respectively. We receive all revenue in U.S. dollars, so we have no material exchange rate risk with regard to ~~the~~our sales. We charge Value Added Taxes to our non-business customers in the European Union. We remit these taxes periodically in pound sterling. The impact of this currency translation has not been material to our business.

~~Index~~

Item 4. Controls and Procedures

~~As of the end of the period covered by this report,~~

Disclosure Controls and Procedures

Our management, including our President and Chief Executive Officer and our Chief Financial Officer, ~~carried out an evaluation of the effectiveness of GlobalSCAPE’s “disclosure~~evaluated our disclosure controls and ~~procedures”~~procedures (as such term is defined in ~~the Securities Exchange Act of 1934~~ Rules 13a-15(e) and 15d-15(e)) under the Exchange Act as of the end of the period covered by this report. Based on this evaluation, our President and Chief Executive Officer and our Chief Financial Officer concluded that ~~the~~due to material weaknesses in our internal control over financial reporting, our disclosure controls and procedures were ~~effective.~~not effective as of September 30, 2018.

As previously reported in our 2017 Form 10-K, filed with the SEC on June 14, 2018, in connection with our assessment of the effectiveness of our internal control over financial reporting at the end of our last fiscal year, management identified the following material weaknesses in our internal control over financial reporting as of December 31, 2017 and is in the process of remediation as of September 30, 2018.

We had material weaknesses in our control environment and monitoring:

●

We did not implement effective oversight of our finance and accounting processes (including organizational structure and reporting hierarchy), which impacted our ability to make appropriate decisions regarding revenue recognition.

Index

●

We did not effectively design and implement appropriate oversight controls over our period-end financial closing and reporting processes, and our review controls were not sufficient to ensure that errors regarding revenue recognition would be detected.

●

We did not effectively monitor (review, evaluate and assess) the risks associated with key internal control activities that provide the revenue information contained in our financial statements.

We had material weaknesses related to internal control monitoring and activities to support the financial reporting process:

●

We did not maintain effective controls over the invoicing process to ensure that proper supporting documentation was received prior to preparing invoices.

●

We did not maintain effective controls over the revenue recognition process to ensure revenue was only recognized when all four criteria of our revenue recognition policy were met.

This section of Item 4, “Controls and Procedures,” should be read in conjunction with Item 9A, “Controls and Procedures,” included in our 2017 Form 10-K, for additional information on Managements Report on Internal Control over Financial Reporting.

Status of Remediation Plan

We designed a remediation plan to strengthen our internal control over financial reporting and haven taken, and will continue to take, remediation steps to address the material weaknesses described above. We also continue to take meaningful steps to enhance our disclosure controls and procedures and our internal controls over financial reporting.

Our remediation plan includes the following:

●

We have clearly defined and communicated to the sales and finance teams the management-approved, standard terms and conditions that may be offered to customers during the sales process and require appropriate management approval of requested deviations from these standard terms and conditions before a sale is consummated with a customer and a sales invoice is created.

●

We have created and implemented a policy communicated to the sales and finance teams clearly stating that all terms and conditions of agreements with customers are to be recorded in writing, communicated to finance and accounting personnel, and recorded in our permanent records prior to the creation of a sales invoice.

●

Beginning in September 2018, we began conducting periodic training sessions and briefings on a quarterly basis to communicate to our sales and finance teams our policies and procedures regarding our standard terms and conditions that we offer to customers and our policies and procedures related to documentation and approval on any deviations from those standard terms and conditions.

●

We have enhanced the breadth and depth of our review of all sales invoices and their underlying supporting documentation. We have performed extensive training sessions with our finance and accounting personnel to review all sales invoices and their underlying supporting documentation to help identify any unusual items which may need further analysis to determine appropriate revenue recognition. We have ensured that all finance and accounting personnel are involved in the recognition of revenue to promote transparency and accuracy.

●

We have established a total invoice dollar amount threshold over which finance and accounting personnel must examine all actual invoices and underlying supporting documentation to confirm the purchase by the customer and the appropriate revenue recognition profile.

~~There were~~

Index

●

We have published guidelines that personnel can reference which set forth the requirements to be met for revenue to be recognized from a sale transaction and will be conducting periodic meetings on a quarterly basis, beginning in the third quarter with the sales and finance teams to educate and remind them of these guidelines.

Our management is monitoring the effectiveness of these and other processes, procedures and controls and will make any further changes deemed appropriate. Our management believes the foregoing actions will effectively remediate the material weaknesses. However, our material weaknesses will not be considered remediated until the above controls are in place for a period of time, the controls are tested and management concludes that these controls are properly designed and operating effectively.

Changes in Internal Control over Financial Reporting

Except as described above with respect to our remediation plan, there have been no changes in our internal ~~controls~~control over financial reporting during the ~~nine months~~quarter ended September 30, ~~2016,~~2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Index

Part II. Other Information

Item 1. Legal Proceedings

~~GlobalSCAPE has been named as one of a number of defendants~~

The information set forth under “Note 12 – Commitments and Contingencies – Legal and Regulatory Matters” to the condensed consolidated financial statements included in a patent infringement suit filed by Digital Reg of Texas, LLC in the United States District Court for the Eastern District of Texas. The complaint alleges that we infringed a patent that regulates access to digital content. In a previous lawsuit this plaintiff brought asserting infringementPart I, Item 1 of this patent against Adobe Systems Inc., several of the claims of this patent were found to be invalid, a decision which Digital Reg appealed to the Federal Circuit. The case against us was stayed until resolution of that appeal. On April 8, 2016, the Federal Circuit confirmed the prior finding that several of the claims of Digital Reg’s patent were invalid. The stay has now been lifted in the suit against us and we have filed a Motion to Dismiss the case based on the findings of the Federal Circuit. We are currently waiting on the court to rule on our Motion to Dismiss. While we are early in this process such that itForm 10-Q is ~~not possible to reasonably determine the outcome of this lawsuit with any certainty, we believe any loss we could incur would be immaterial to our financial position and results of operations.~~

incorporated herein by reference.

Item 1A. Risk Factors.

In addition to the other information set forth in this ~~report,~~Quarterly Report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our ~~2015~~2017 Form 10-K filed with the ~~Securities~~SEC on June 14, 2018. Except as set forth in this Quarterly Report and ~~Exchange Commission on March 3, 2016.~~as provided below, the risks and uncertainties described in “Item 1A. Risk Factors” of our 2017 Form 10-K have not materially changed. These risk factors could materially affect our business, financial condition or future results, but they are not the only risks facing ~~GlobalSCAPE.~~the Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, and/or operating results.

We face risks related to an ongoing investigation by the United States Attorney’s Office for the Western District of Texas.

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

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Period	(a) Total number of shares (or units) purchased		(b) Average price paid per share (or unit)		(c) Total number of shares (or units) purchased as part of publicly accounced plans or programs		(d) Maximum number (or approximate dollar value) of shares (or units) that may yet be purchased under the plans or programs
September 1, 2018 - September 30, 2018		4,011,013	$	4.20		-		-
Total		4,011,013	$	4.20		-		-

The Company commenced on August 22, 2018 a modified dutch tender offer to purchase $15,000,000 of shares of our common stock at a price not greater than $4.50 nor less than $4.00 per share, to expire on September 19, 2018. Based on the final count by American Stock Transfer & Trust Company, the Depositary for the Tender Offer, the Company accepted for purchase 4,011,013 common shares at a purchase price of $4.20 per share, for an aggregate cost of approximately $16.8 million, excluding fees and expenses relating to the Tender Offer. Included within the shares accepted for purchase are 439,585 shares that we elected to purchase pursuant to our right to increase the size of the Tender Offer by up to 2.0% of the Company’s outstanding common stock. As such, the Company used a proration factor of approximately 77.1% of shares from each tendering stockholder. The common shares purchased represent approximately 18.2% of our common stock issued and outstanding as of September 24, 2018. Following consummation of the Tender Offer, we had 17,968,268 common shares outstanding.

Index

Item 6. Exhibits

(a)

~~(a)~~

Exhibits

	~~31.1~~ 31.1*	Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	~~31.2~~ 31.2*	Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	~~32.1~~ 32.1*	Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

	101	Interactive Data File.

	~~101~~ *	~~Interactive Data File.~~ Filed herewith.

Index

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



		GLOBALSCAPE, INC.

November ~~10, 2016~~8, 2018	By:	/s/ ~~James W. Albrecht, Jr.~~Karen J. Young
Date		~~James W. Albrecht, Jr.~~ Karen J. Young
		Chief Financial Officer

Delaware		74-2785449
( State or ~~other jurisdiction~~Other Jurisdiction of ~~incorporation~~ Incorporation or ~~organization)~~ Organization	(	I.R.S. Employer Identification No.)

4500 Lockhill-Selma, Suite 150 San Antonio, Texas		78249
(Address of Principal Executive ~~Office)~~Offices	(	Zip ~~Code)~~Code

Large accelerated filer ☐	☐	Accelerated filer	☐ ☒

Non-accelerated filer	☐ (Do not check if a smaller reporting company)	Smaller reporting company ☒
☒ Emerging growth company ☐

		Page

Part I.	Financial Information

Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets	3 2
	Condensed Consolidated Statements of Operations and Comprehensive Income	4 3
	Condensed Consolidated Statements of Cash Flows	5 4
	Condensed Consolidated Statement of Stockholders’ Equity	5
	Notes to Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19 26

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	39 45

Item 4.	Controls and Procedures	40 45

Part II.	Other Information	41 48

Item 1.	Legal Proceedings	41 48

~~Item1A.~~ Item 1A.	Risk Factors	41 48

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	48

Item 6.	Exhibits	41 49

Signatures		42 50

	September 30,			December 31,
	2016			2015
	(Unaudited)			(Audited)
Assets
Current assets:
Cash and cash equivalents	$	17,421		$	15,885
Short term investments		3,303			3,254
Accounts receivable (net of allowance for doubtful accounts of $335 and $325 in 2016 and 2015, respectively)		8,870			6,081
Federal income tax receivable		104			290
Prepaid and other expenses		425			511
Total current assets		30,123			26,021

Property and equipment, net		463			498
Capitalized software development costs, net		3,961			3,982
Goodwill		12,712			12,712
Deferred tax asset, net		976			940
Other assets		30			60
Total assets	$	48,265		$	44,213

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	622		$	839
Accrued expenses		1,841			1,893
Deferred revenue		13,005			12,000
Income taxes payable		517			127
Total current liabilities		15,985			14,859

Deferred revenue, non-current portion		3,688			3,612
Other long term liabilities		34			44

Commitments and contingencies

Stockholders’ equity:
Preferred stock, par value $0.001 per share, 10,000,000 authorized, no shares issued or outstanding		-			-
Common stock, par value $0.001 per share, 40,000,000 authorized, 21,548,602 and 21,383,467 shares issued at September 30, 2016, and December 31, 2015, respectively		21			21
Additional paid-in capital		20,632			19,583
Treasury stock, 403,581 shares, at cost, at September 30, 2016 and December 31, 2015		(1,452	)		(1,452	)
Retained earnings		9,357			7,546
Total stockholders’ equity		28,558			25,698
Total liabilities and stockholders’ equity	$	48,265		$	44,213

	For the Nine Months Ended September 30,
	2016			2015
Operating Activities:
Net income	$	2,761		$	3,370
Items not involving cash at the time they are recorded in the statement of operations:
Bad debt expense		67			147
Depreciation and amortization		1,522			1,116
Share-based compensation		721			482
Deferred taxes		(36	)		(320	)
Excess tax benefit from share-based compensation		5			(49	)
Subtotal before changes in operating assets and liabilities		5,040			4,746
Changes in operating assets and liabilities:
Accounts receivable		(2,856	)		(1,690	)
Prepaid expenses		86			154
Deferred revenue		1,081			531
Accounts payable		(217	)		(757	)
Accrued expenses		(52	)		10
Other Assets		30			37
Other long-term liabilities		(10	)		(5	)
Income tax receivable and payable		571			403
Net cash provided by operating activities		3,673			3,429
Investing Activities:
Software development costs capitalized		(1,298	)		(1,613	)
Purchase of property and equipment		(168	)		(108	)
Interest reinvested in short and long term investments		(49	)		(48	)
Net cash (used in) investing activities		(1,515	)		(1,769	)
Financing Activities:
Proceeds from exercise of stock options		333			417
Excess tax benefit from share-based compensation		(5	)		49
Dividends paid		(950	)		(626	)
Net cash (used in) financing activities		(622	)		(160	)

Net increase in cash		1,536			1,500
Cash at beginning of period		15,885			11,358
Cash at end of period	$	17,421		$	12,858

Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	-		$	-
Income taxes	$	776		$	1,341

	For the Nine Months Ended September 30,
	2018			2017
Operating Activities:
Net income	$	656		$	1,564
Items not involving cash at the time they are recorded in the statement of operations:
Provision (recoveries) for doubtful accounts receivable		(64	)		15
Depreciation and amortization		1,641			1,604
Share-based compensation		972			1,053
Deferred taxes		61			28
Subtotal before changes in operating assets and liabilities		3,266			4,264
Changes in operating assets and liabilities:
Accounts receivable		1,136			1,798
Prepaid and other current assets		(1,868	)		163
Deferred revenue		(1,914	)		(1,526	)
Accounts payable		82			448
Accrued expenses		1,707			404
Other assets		116			154
Accrued interest receivable		-			(195	)
Other long-term liabilities		(48	)		22
Federal income tax receivable		82			(759	)
Net cash provided by operating activities		2,559			4,773
Investing Activities:
Software development costs capitalized		(1,057	)		(1,464	)
Purchase of property and equipment		(143	)		(249	)
Redemption of Certificates of Deposit		14,264			-
Net cash provided by (used in) investing activities		13,064			(1,713	)
Financing Activities:
Proceeds from exercise of stock options		341			471
Purchase of Treasury Stock		(17,262	)		-
Dividends paid		(655	)		(979	)
Net cash used in financing activities		(17,576	)		(508	)
Net increase (decrease) in cash		(1,953	)		2,552
Cash at beginning of period		11,583			8,895
Cash at end of period	$	9,630		$	11,447

Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	-		$	-
Income tax payments	$	238		$	1,616

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


Balance at December 31, 2016		21,920,912		$	22	$	21,756	$	(1,452	)	$	9,289			29,615

Shares issued upon exercise of stock options		191,500					458								458
Stock-based compensation expense
Stock options							533								533
Restricted stock		80,000					138								138
Common stock cash dividends, $0.030 per share												(652	)		(652	)
Net income												1,288			1,288
Balance at June 30, 2017		22,192,412		$	22	$	22,885	$	(1,452	)	$	9,925		$	31,380

Shares issued upon exercise of stock options		4,300					14								14
Stock-based compensation expense
Stock options							296								296
Restricted stock							85								85
Common stock cash dividends, $0.015 per share												(327	)		(327	)
Net income												276			276
Balance at September 30, 2017		22,196,712		$	22	$	23,280	$	(1,452	)	$	9,874		$	31,724

Stock-based compensation expense
Stock options							428								428
Restricted stock							85								85
Common stock cash dividends, $0.015 per share												(328	)		(328	)
Net income												(193	)		(193	)
Balance at December 31, 2017		22,196,712		$	22	$	23,793	$	(1,452	)	$	9,353		$	31,716

Retained Earnings Adjustment due to ASC 606												979			979
Stock-based compensation expense
Stock options							742								742
Restricted stock		80,000					120								120
Common stock cash dividends, $0.030 per share												(655	)		(655	)
Net Income												(342	)		(342	)
Balance at June 30, 2018		22,276,712		$	22	$	24,655	$	(1,452	)	$	9,335		$	32,560

Purchase of Treasury Stock									(17,262	)					(17,262	)
Cancellation of Restricted Stock		(40,000	)												-
Shares issued upon exercise of stock options		146,150					341								341
Stock-based compensation expense
Stock options							110								110
Net Income												998			998
Balance at September 30, 2018		22,382,862		$	22	$	25,106	$	(18,714	)	$	10,333		$	16,747

	Quarter Ended September 30, 2015
			Reclassification of Previously Reported Amounts
	As Previously Reported		Cost of Revenues			Capitalized Software Cost Amortization			Personnel Costs			Depreciation			Selling, General & Administrative			As Now Reported

Operating Revenues:
Software licenses	$	2,852																$	2,852
Maintenance and support		4,142																	4,142
Professional services		653																	653
Total revenues		7,647																	7,647

Cost of Revenues:
Software licenses				195			367												562
Maintenance and support										341									341
Professional services				263						342									605
Total cost of revenues		-																	1,508

Gross profit		-																	6,139

Operating Expenses
Sales and marketing		-														2,289			2,289
General and administrative		-														1,449			1,449
Cost of Revenues		458		(458	)														-
Selling, general and administrative		4,355								(683	)		66			(3,738	)		-
Research and development		646																	646
Depreciation and amortization		433					(367	)					(66	)					-
Total operating expenses		5,892																	4,384

Income from operations		1,755																	1,755
Other income (expense), net		17																	17
Income before income taxes		1,772																	1,772
Income tax expense		542																	542
Net income	$	1,230																$	1,230
Comprehensive income	$	1,230																$	1,230

Net income per common share -
Basic	$	0.06																$	0.06
Diluted	$	0.06																$	0.06

	Nine Months Ended September 30, 2015
			Reclassification of Previously Reported Amounts
	As Previously Reported		Cost of Revenues			Capitalized Software Cost Amortization			Personnel Costs			Depreciation			Selling, General & Administrative			As Now Reported

Operating Revenues:
Software licenses	$	8,590																$	8,590
Maintenance and support		12,269																	12,269
Professional services		1,531																	1,531
Total revenues		22,390																	22,390

Cost of Revenues:
Software licenses				739			912												1,651
Maintenance and support										1,057									1,057
Professional services				327						930									1,257
Total cost of revenues		-																	3,965

Gross profit		-																	18,425

Operating Expenses
Sales and marketing		-														7,060			7,060
General and administrative		-														4,629			4,629
Cost of Revenues		1,066		(1,066	)														-
Selling, general and administrative		13,472								(1,987	)		204			(11,689	)		-
Research and development		1,832																	1,832
Depreciation and amortization		1,116					(912	)					(204	)					-
Total operating expenses		17,486																	13,521

Income from operations		4,904																	4,904
Other income (expense), net		51																	51
Income before income taxes		4,955																	4,955
Income tax expense		1,585																	1,585
Net income	$	3,370																$	3,370
Comprehensive income	$	3,370																$	3,370

Net income per common share -
Basic	$	0.16																$	0.16
Diluted	$	0.16																$	0.16

Future amortization expense:
Three months ending December 31, 2016		452
Year ending December 31,
2017		1,433
2018		699
2019		65
Total	$	2,649

	Number of Shares			Weighted Average Exercise Price Per Share		Weighted Average Remaining Contractual Term in Years		Aggregate Intrinsic Value (000's)





Outstanding at December 31, 2015		2,091,325		$	2.45		6.09	$	3,277
Granted		1,055,300		$	3.58
Forfeited		(372,045	)	$	3.14
Exercised		(165,135	)	$	2.02
Outstanding at September 30, 2016		2,609,445		$	2.83		6.29	$	2,015

Exercisable at September 30, 2016		1,351,760		$	2.26		3.59	$	1,814

As of September 30, 2016
Range of Exercise Prices		Underlying Shares Outstanding		Options Outstanding				Options Exercisable
				Weighted Average Remaining Contractual Life		Weighted Average Exercise Price		Number of Underlying Shares		Weighted Average Exercise Price




$	0.85 - $1.43		168,600		3.16	$	1.16		168,600	$	1.16
$	1.47 - $2.32		612,995		4.05	$	1.82		607,255	$	1.82
$	2.34 - $3.52		1,319,850		7.29	$	3.13		445,905	$	2.74
$	3.53 - $4.21		508,000		7.44	$	3.83		130,000	$	4.10
Total options			2,609,445						1,351,760

	Number of Shares			Grant Date Fair Value Per Share		Total Fair Value of Shares That Vested
Restricted Shares Outstanding at December 31, 2015		80,000		$	3.34
Shares granted with restrictions		80,000		$	3.31
Shares vested and restrictions removed		(80,000	)	$	3.34	$	276,000
Restricted Shares Outstanding at September 30, 2016		80,000		$	3.31

Unrecognized compensation expense for non-vested shares as of September 30,2016
Expense to be recognized in future periods	$	156,999
Weighted average number of months over which expense is expected to be recognized		7

	2016		2015
Balance at beginning of year	$	90	$	125
Increases for tax positions related to the current year		9		-
Increases for tax positions related to prior years		11		48
Decreases for tax positions related to prior years		-		(51	)
Decreases due to settlements related to prior years		-		(32	)
Balance at September 30 and December 31, respectively	$	110	$	90

	Three Months Ending September 30,						Nine Months Ending September 30,
	2016			2015			2016			2015

Bookings	$	10,296		$	9,869		$	26,256		$	24,011
Products and services sold for which we will recognize revenue at a future date when the goods and services are delivered to and accepted by the customer		(8,967	)		(6,772	)		(20,945	)		(15,455	)
Products and services delivered to and accepted by the customer for which revenue recognition had been deferred at the time of booking		7,424			4,550			19,110			13,834
Revenue	$	8,753		$	7,647		$	24,421		$	22,390

	September 30, 2016		December 31, 2015		September 30, 2015
Cash and cash equivalents	$	17,421	$	15,885	$	12,858
Short term investments		3,303		3,254		3,233
Total cash, cash equivalents and long term investments	$	20,724	$	19,139	$	16,091

Working capital	$	14,138	$	11,162	$	6,515
Deferred revenue, current portion		13,005		12,000		11,848
Working capital plus current deferred revenue (non-GAAP presentation)	$	27,143	$	23,162	$	18,363

	Amounts Due for the Period
	Three Months Ending December 31, 2016		Fiscal Years
	Three Months Ending December 31, 2016		2017 - 2018		2019 - 2020		Thereafter		Total

Operating leases	$	90	$	720	$	120	$	-	$	930