UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
Or
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 000-30617
GlobalSCAPE, Inc.
(Exact name of registrant as specified in its charter)
Delaware | | 74-2785449 |
(State or other jurisdiction of incorporation or
organization) | | (I.R.S. Employer Identification
No.) |
| | |
6000 Northwest Parkway, Suite 100
San Antonio, TX | | 78249 |
(Address of principal executive offices) | | (Zip Code) |
| | |
(210) 308-8267 |
(Registrant’s telephone number, including area code) |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ý Yes o No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). o Yes ý No
The number of shares outstanding of the registrant’s common stock at November 4, 2005 was 13,788,219.
GlobalSCAPE Inc.
Quarterly Report on Form 10-Q
For the Quarter ended September 30, 2005
Index
GlobalSCAPE®, CuteFTP®, CuteSITE Builder®, PureCMS®, CuteZIP®, CuteHTML® and CuteMAP® are registered trademarks of GlobalSCAPE Texas, LP. GlobalSCAPE Secure FTP Server, GlobalSCAPE Transfer Engine, ContentXML and SnapEdit are trademarks of GlobalSCAPE Texas, LP. Other trademarks and tradenames in this quarterly report are the property of their respective owners.
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GlobalSCAPE, Inc.
Balance Sheets
| | December 31,
2004 | | September 30,
2005 | |
| | | | (unaudited) | |
Assets | | | | | |
Current assets: | | | | | |
Cash and cash equivalents | | $ | 572,959 | | $ | 1,384,207 | |
Accounts receivable (net of allowance for doubtful accounts of $15,442 and $15,905 at December 31, 2004 and September 30, 2005, respectively) | | 148,534 | | 581,221 | |
Prepaid expenses | | 91,144 | | 94,609 | |
Total current assets | | 812,637 | | 2,060,037 | |
| | | | | |
Property and equipment: | | | | | |
Furniture and fixtures | | 332,920 | | 332,920 | |
Software | | 245,601 | | 278,740 | |
Equipment | | 608,718 | | 602,827 | |
Leasehold improvements | | 167,762 | | 167,762 | |
| | 1,355,001 | | 1,382,249 | |
Accumulated depreciation and amortization | | 1,207,663 | | 1,223,005 | |
Net property and equipment | | 147,338 | | 159,244 | |
| | | | | |
Other assets: | | | | | |
Other | | 11,882 | | 11,882 | |
Total other assets | | 11,882 | | 11,882 | |
Total assets | | $ | 971,857 | | $ | 2,231,163 | |
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| | December 31,
2004 | | September 30,
2005 | |
| | | | (unaudited) | |
Liabilities and Stockholders’ Equity | | | | | |
Current liabilities: | | | | | |
Accounts payable | | $ | 122,117 | | $ | 93,697 | |
Accrued expenses | | 170,654 | | 208,730 | |
Deferred revenue | | 178,117 | | 344,957 | |
Total current liabilities | | 470,888 | | 647,384 | |
| | | | | |
Long-term liabilities: | | | | | |
Deferred compensation | | — | | 6,349 | |
Other long-term liabilities | | 28,038 | | 19,628 | |
Total long-term liabilities | | 28,038 | | 25,977 | |
| | | | | |
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 shares authorized, 13,773,219 and 13,788,219 shares issued and outstanding at December 31, 2004 and September 30, 2005, respectively | | 13,773 | | 13,788 | |
Additional paid-in capital | | 675,365 | | 682,310 | |
Retained earnings (deficit) | | (216,207 | ) | 861,704 | |
Total stockholders’ equity | | 472,931 | | 1,557,802 | |
Total liabilities and stockholders’ equity | | $ | 971,857 | | $ | 2,231,163 | |
See accompanying notes.
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GlobalSCAPE, Inc.
Statements of Operations
(Unaudited)
| | Three months ended September 30, | | Nine months ended September 30, | |
| | 2004 | | 2005 | | 2004 | | 2005 | |
Operating revenues: | | | | | | | | | |
Software product revenues | | $ | 1,222,118 | | $ | 1,559,126 | | $ | 3,599,400 | | $ | 4,480,679 | |
Maintenance, support and other revenues (net of deferred revenue) | | 48,105 | | 164,559 | | 130,758 | | 484,763 | |
Total operating revenues | | 1,270,223 | | 1,723,685 | | 3,730,158 | | 4,965,442 | |
| | | | | | | | | |
Cost of revenues (exclusive of depreciation and amortization shown separately below) | | 111,556 | | 66,709 | | 304,071 | | 226,086 | |
Selling, general and administrative expenses | | 823,813 | | 1,014,011 | | 2,599,165 | | 2,973,385 | |
Research and development expenses | | 165,743 | | 230,947 | | 552,477 | | 614,756 | |
Depreciation and amortization | | 33,769 | | 22,714 | | 139,782 | | 76,129 | |
Total operating expense | | 1,134,881 | | 1,334,381 | | 3,595,495 | | 3,890,356 | |
Income from operations | | 135,342 | | 389,304 | | 134,663 | | 1,075,086 | |
| | | | | | | | | |
Other income (expense): | | | | | | | | | |
Interest expense | | (371 | ) | 105 | | (1,091 | ) | (620 | ) |
Interest income | | — | | 3,552 | | — | | 3,552 | |
Gain on disposal of assets | | — | | 767 | | — | | 958 | |
Total other income (expense) | | (371 | ) | 4,424 | | (1,091 | ) | 3,890 | |
Income (loss) before income taxes | | 134,971 | | 393,728 | | 133,572 | | 1,078,976 | |
| | | | | | | | | |
Income tax expense (benefit): | | | | | | | | | |
Current: | | | | | | | | | |
Federal | | — | | — | | — | | — | |
State | | — | | — | | — | | 1,065 | |
Deferred: | | | | | | | | | |
Federal | | — | | — | | — | | — | |
State | | — | | — | | — | | — | |
Total income tax provision (benefit) | | — | | — | | — | | 1,065 | |
Net income | | $ | 134,971 | | $ | 393,728 | | $ | 133,572 | | $ | 1,077,911 | |
| | | | | | | | | |
Net income per common share- basic | | $ | 0.010 | | $ | 0.029 | | $ | 0.010 | | $ | 0.078 | |
Net income per common share- assuming dilution | | $ | 0.009 | | $ | 0.025 | | $ | 0.009 | | $ | 0.072 | |
| | | | | | | | | |
Average shares outstanding: | | | | | | | | | |
| | | | | | | | | |
Basic | | 13,773,219 | | 13,776,969 | | 13,633,611 | | 13,774,483 | |
Diluted | | 14,303,786 | | 15,582,248 | | 14,164,178 | | 14,937,374 | |
See accompanying notes.
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GlobalSCAPE, Inc.
Statements of Cash Flows
(Unaudited)
| | Nine months ended September 30, | |
| | 2004 | | 2005 | |
Operating Activities: | | | | | |
Net income | | $ | 133,572 | | $ | 1,077,911 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
Bad debt expense | | (11,504 | ) | 7,775 | |
Depreciation and amortization | | 139,782 | | 76,129 | |
Loss on disposal of assets | | — | | — | |
Changes in operating assets and liabilities: | | | | | |
Accounts receivable | | 75,956 | | (440,462 | ) |
Prepaid expenses | | (45,259 | ) | (3,465 | ) |
Accounts payable | | (81,895 | ) | (28,420 | ) |
Accrued expenses | | 27,397 | | 38,076 | |
Deferred revenues | | 28,949 | | 166,840 | |
Other long-term liabilities | | (8,411 | ) | (2,061 | ) |
Net cash provided by operating activities | | 258,587 | | 892,323 | |
Investing Activities: | | | | | |
Purchase of property and equipment | | (32,991 | ) | (88,035 | ) |
Net cash used in investing activities | | (32,991 | ) | (88,035 | ) |
Financing Activities: | | | | | |
Issuance of common stock | | 3,756 | | 6,960 | |
Bank borrowing (repayment) | | (100,000 | ) | — | |
Principal payments on capital lease obligations | | (15,294 | ) | — | |
Net cash provided by (used in) financing activities | | (111,538 | ) | 6,960 | |
Net increase in cash | | 114,058 | | 811,248 | |
Cash at beginning of period | | 342,433 | | 572,959 | |
Cash at end of period | | $ | 456,491 | | $ | 1,384,207 | |
| | | | | |
Supplemental disclosures: | | | | | |
Interest paid | | $ | 1,091 | | $ | 620 | |
Income taxes paid | | $ | — | | $ | 1,065 | |
See accompanying notes.
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GlobalSCAPE, Inc.
Notes to Financial Statements
Nature of Business
GlobalSCAPE, Inc. (collectively referred to as “GlobalSCAPE” or “the Company”), founded in April 1996, develops and distributes Internet related software. The Company is best known for its popular file transfer program, CuteFTP. The Company derives its revenues primarily from sales of licenses to use its software products. Sales of CuteFTP and CuteFTP Pro accounted for approximately 70% and 53% of total revenues in 2004 and the first nine months of 2005 respectively. The Company is organized and operates as one segment and markets its products primarily through the Internet, an internal sales force and through resellers.
Corporate Structure
All of the Company’s operations are conducted by GlobalSCAPE Texas, LP, a Texas limited partnership. The partners of GlobalSCAPE Texas, LP are two Nevada limited liability companies, which are both wholly-owned subsidiaries of GlobalSCAPE, Inc., a Delaware corporation. GlobalSCAPE, Inc. is approximately 71% owned by Directors, Thomas W. Brown and David L. Mann, with the remainder held publicly. GlobalSCAPE, Inc. is a holding company and conducts no operations, however, the stock of GlobalSCAPE, Inc. is quoted on the OTC Bulletin Board. References to “GlobalSCAPE” or the “Company” refer collectively to all of these entities unless otherwise indicated.
Basis of Presentation
The accompanying unaudited financial statements have been prepared in accordance with Rule 10-01 of Regulation S-X, “Interim Financial Statements.” Accordingly, they do not include all information and footnotes required under generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normally recurring accruals) considered necessary for a fair presentation have been made. The results of operations for any interim period are not necessarily indicative of the results to be expected for the full year.
The Balance Sheet at December 31, 2004 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the financial statements and footnotes included in GlobalSCAPE’s Annual Report on Form 10-K for the year ended December 31, 2004.
Principles of Consolidation
The consolidated financial statements include all subsidiaries. All inter-company transactions and balances have been eliminated.
Liquidity
The Company has improved its positive working capital position through a combination of revenue growth, expense control and improved net income over the last 6 quarters, including the quarter ended Seotember 30, 2005. The Company incurred significant operating losses during the year ended December 31, 2003 and the quarter ended March 31, 2004. In February 2004 GlobalSCAPE reduced its workforce by 20%, laying off 9 of the 45 people then employed by the Company. This workforce reduction was a necessary step in improving the overall financial health of the Company. The Company is meeting its higher revenue targets, further improving the Company’s liquidity position.
The Company is highly dependent on the sale of two software products, CuteFTP Home and CuteFTP Pro, which may be subject to technological and competitive obsolescence. Sales of these two products which represented 70% of the Company’s revenues in the third quarter of 2004, represented 53% of the Company’s revenues in the third quarter of 2005. Although the percentage of total revenue for these two products has decreased, revenue for these two products has increased approximately 1% when
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comparing the first nine months of 2004 to the same period in 2005. Total revenues increased by approximately 36% when comparing the third quarter of 2005 to the same period in 2004. Revenues from the sale of Enhanced File Transfer introduced in late 2004, represented approximately 17% of revenue in the third quarter of 2005. Management is concentrating its efforts to increase market penetration of its Enhanced File Transfer products.
As of September 30, 2005 the Company had cash and cash equivalents of $1,384,207 and had net working capital of $1,412,653. Management believes this level of working capital is adequate to finance the Company’s current level of operations.
The Company renewed a $250,000 revolving line of credit agreement in December 2004, which is due on demand, but if no demand is made, then on March 31, 2006. The interest rate is subject to change and is indexed to the bank’s prime rate. The initial rate is 7.25%. In connection with the line of credit, GlobalSCAPE entered into a Commercial Security Agreement with the bank whereby GlobalSCAPE granted a security interest in all its accounts receivable and equipment. The Company has not borrowed under this agreement in 2005. The credit facility is available to the Company at any time during its term.
Reclassifications
Certain prior period amounts have been reclassified to conform to the current year presentation. These reclassifications had no impact on operating income as previously reported.
Sale / Disposal of Assets
During the first three quarters of 2005, the Company sold or disposed of $29,293 in fixed assets, mainly older computer related equipment.
Stock-Based Compensation
Statement of Financial Accounting Standards 123, Accounting for Stock-Based Compensation (SFAS 123), encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans based on the fair market value of options granted. The Company chose to account for stock based compensation using the intrinsic value method prescribed in APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, compensation expense is recorded to the extent that the current market price of the underlying stock exceeds the exercise price. In December 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard 148, Accounting for Stock Based Compensation - Transition and Disclosure (SFAS 148), which amends SFAS 123. SFAS 148 requires more prominent and frequent disclosures about the effects of stock-based compensation. The Company will continue to account for its stock-based compensation according to the provisions of APB Opinion No. 25.
Pro forma information regarding net income and earnings per share is required by Statement 148, which also requires that the information be determined as if the Company had accounted for its stock options granted subsequent to December 31, 1994 under the fair value method of that Statement. The fair value of these options was estimated at the date of grant using a Black-Scholes option-pricing model.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. The Company’s pro forma information for the three and nine months ended September 30, 2004 and 2005 follows:
| | Three months ended
September 30, | | Nine months ended
September 30, | |
| | 2004 | | 2005 | | 2004 | | 2005 | |
Net Income, as reported | | $ | 134,971 | | $ | 393,728 | | $ | 133,572 | | $ | 1,077,911 | |
Stock-based compensation expense that would have been included in the determination of net income (loss) had the fair value based method been applied to all awards, net of related tax effects | | (3,554 | ) | (7,158 | ) | (15,729 | ) | (15,643 | ) |
Pro forma net income | | $ | 131,417 | | $ | 386,570 | | $ | 117,843 | | $ | 1,062,268 | |
| | | | | | | | | |
Income per share: | | | | | | | | | |
Basic- as reported | | $ | 0.010 | | $ | 0.029 | | $ | 0.010 | | $ | 0.078 | |
Basic- pro forma | | $ | 0.009 | | $ | 0.025 | | $ | 0.008 | | $ | 0.071 | |
| | | | | | | | | |
Diluted- as reported | | $ | 0.009 | | $ | 0.025 | | $ | 0.009 | | $ | 0.072 | |
Diluted- pro forma | | $ | 0.009 | | $ | 0.025 | | $ | 0.008 | | $ | 0.071 | |
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During the third quarter ended September 30, 2005, there were no options granted to employees. There were 15,000 stock options exercised by an employee at an average exercise price of $0.464 per share. Additionally, there were no stock options forfeited in the third quarter 2005.
Earnings per Common Share
Basic and diluted net income per common share is presented in conformity with Statement of Financial Accounting Standards No. 128, “Earnings Per Share” (SFAS 128) for all periods presented. Basic earnings per share is based on the weighted effect of all common shares issued and outstanding, and is calculated by dividing net income (loss) available to common stockholders by the weighted average shares outstanding during the period. Diluted earnings per share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of common shares used in the basic earnings per share calculation plus the number of common shares that would be issued assuming conversion of all potentially dilutive common shares outstanding. Below is a reconciliation of the numerators and denominators of basic and diluted earnings per share for each of the periods presented:
| | Three months ended September 30, | | Nine months ended September 30, | |
| | 2004 | | 2005 | | 2004 | | 2005 | |
Numerators | | | | | | | | | |
Numerators for basic and diluted earnings per share: | | | | | | | | | |
Net income | | $ | 134,971 | | $ | 393,728 | | $ | 133,572 | | $ | 1,077,911 | |
| | | | | | | | | |
Denominators | | | | | | | | | |
Denominators for basic and diluted earnings per share: | | | | | | | | | |
Weighted average shares outstanding – basic | | 13,773,219 | | 13,776,969 | | 13,633,611 | | 13,774,483 | |
| | | | | | | | | |
Dilutive potential common shares | | | | | | | | | |
Stock options (1) | | 530,567 | | 1,805,279 | | 530,567 | | 1,162,891 | |
Denominator for dilutive earnings per share | | 14,303,786 | | 15,582,248 | | 14,164,178 | | 14,937,374 | |
| | | | | | | | | |
Net income per common share | | $ | 0.010 | | $ | 0.029 | | $ | 0.010 | | $ | 0.078 | |
Net income per common share – assuming dilution | | $ | 0.009 | | $ | 0.025 | | $ | 0.009 | | $ | 0.072 | |
(1) For the three and nine months ended September 30, 2005, all outstanding options have been included as dilutive shares. For the three and nine months ended September 30, 2004, 1,288,004 options have not been included in dilutive shares, as the effect would be anti-dilutive.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. “Forward looking statements” are those statements that describe management’s beliefs and expectations about the future. We have identified forward-looking statements by using words such as “anticipate,” “believe,” “could,” “estimate,” “may,” “expect,” and “intend.” Although we believe these expectations are reasonable, our operations involve a number of risks and uncertainties, including those described in the “Risk Factors” section of our Annual Report on Form 10-K and other documents filed with the Securities and Exchange Commission. GlobalSCAPE’s actual results could differ materially from those discussed in any forward-looking statements included in this Quarterly Report.
Overview
GlobalSCAPE develops and distributes Internet related software including File Management, Content Management and Web Development Tools. We distribute our software primarily via download from our Internet website. Our internal direct sales force began exceeding Internet revenue in the second quarter of 2005, achieving a goal set by management. During 2004, approximately 65% of our revenues were generated from customers within the United States, with the remaining 35% concentrated mostly in Western Europe, Canada and Australia. In the third quarter of 2005, approximately 72% of our revenues were generated from customers within the United States. We sell our products on the Internet, through resellers and our internal sales force.
• Content Management Products – Our Content Management Products help non-technical business users update and manage Web Site content without excessive training. The product line includes PublishXML, Our PureCMS product was phased out the the third quarter of 2005.
• File Management Products – Our File Management products are best known for the “CuteFTP” product line. They primarily consist of products that help users move and copy files on the Internet. A substantial portion of our revenues are derived from licensing our File Management products. We offer both individual and enterprise levels of these products. Some of our products encrypt the transfers for security using technology similar to a Web browser. Our File Management product line includes CuteFTP Home, Cute FTP Professional, SecureFTP Server, CuteZIP and Enhanced File Transfer.
• Web Development Products – Our Web Development Products help Web developers create Web sites. They provide a wide range of capabilities such as creating Web sites from a template, direct editing of Web based computer code and creating Web surveys. Our Web Development product line includes CuteSITE Builder, CuteHTML, CuteMAP and Web Survey.
CuteFTP Home and CuteFTP Professional accounted for approximately 70% and 53% of total revenues in the quarters ended September 30, 2004 and 2005, respectively. Revenue from the sales of these two products increased approximately 1% when comparing the third quarter of 2004 to the third quarter of 2005. The decline in the percentage of total revenue was due to an increase in sales of Enhanced File Transfer and Secure Server which accounted for approximately 17% and 22% of total revenues, respectively. We are continuing to improve our Enhanced File Transfer and Secure Server products to meet the needs of our customers who are concerned with secure transfer of files on the Internet. The Company made the decision to focus on the file transfer products, as they are the core of our current revenues and are expected to remain so for the forseeable future.
Substantially all software products ultimately reach a point in their lifecycle in which sales can be expected to plateau or decline. While it cannot be determined with certainty, CuteFTP Home and CuteFTP Professional may have reached such a point in their lifecycles. Management believes that the market for stand-alone FTP clients for home consumers may be declining. However, we have not seen the same decline in the market for secure FTP clients and servers such as CuteFTP Professional and Secure Server and Enhanced File Transfer which we believe better target the needs of businesses.
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Our strategy is to continue enhancing our file transfer products across the board to meet the demands of both individual and enterprise users, while improving our current product line. Our success in 2005 is, to a great extent, dependent on our ability to market and sell our Enhanced File Transfer (EFT) to enterprise users. We introduced Enhanced File Transfer in late 2004; in the second quarter of 2005, EFT represented 21% of our total revenue, in the third quarter 17% of total revenue. We are continuing to address security issues for our customers for future releases and will be releasing additional modules for our Enhanced File Transfer and Secure Server products. We plan on releasing additional versions of our Enhanced File Transfer product this year. In general, our success depends on our ability to introduce new products and the market’s acceptance of these products. We released new versions of CuteFTP, CuteFTP Pro and Secure Server early in 2005 and will again in late 2005. We anticipate continued growth in our secure transfer products.
Liquidity and Capital Resources
The Company continues to improve its positive working capital position through a combination of revenue growth and expense reductions; this has resulted in net income over the last six quarters, including the quarter ended September 30, 2005. The Company incurred significant operating losses during the three years ended December 31, 2003 and in the first quarter of 2004. In February 2004 GlobalSCAPE reduced its workforce by 20%, laying off 9 of the 45 people then employed by the Company. As of September 30, 2005 the Company has employed 39 people.
We rely heavily on cash flows from operations and these cash flows are directly linked to CuteFTP Home and CuteFTP Professional, which accounted for 70% and 53% of our revenues in the nine months ended September 30, 2004 and 2005 respectively. Newer products in the second and third quarters of 2005, namely, Enhanced File Transfer and Secure Server have increased total revenue and reduced the percentage of total revenue previously held by the two FTP products. Total revenues increased 36% when comparing the third quarter of 2005 to the same period in 2004.
Net cash provided by operating activities was $892,323 for the nine months ended September 30, 2005 as compared to $258,587 in the nine months ended September 30, 2004. Cash provided in operations for the nine months ended September 30, 2005, was primarily the result of net income and, to a lesser extent depreciation and amortization, changes in; accounts receivable, accrued expenses, and deferred revenue offset by accounts payable.
Net cash used in investing activities for the nine months ended September 30, 2004 and 2005 was $32,991 and $88,035, respectively. The net cash used in both periods was mainly for the purchase of computer hardware and software.
Net cash provided by (used in) financing activities for the nine months ended September 30, 2004 and 2005 was $(111,538) and $6,960, respectively. The financing activity in the nine months ended September 30, 2004 was related to $15,294 in principal payments on capital lease obligations, a $100,000 repayment of a bank loan and $3,756 in receipts related to the exercise of stock options. The financing activity in the nine months ended September 30, 2005 was related to $6,960 in receipts related to the exercise of stock options.
As of September 30, 2005 we had $1,384,207 in cash and cash equivalents, total current assets of $2,060,037 and current liabilities of $647,384, resulting in working capital of $1,412,653, a $1,157,742 improvement over the working capital of $254,911 at September 30, 2004. Our principal commitments consisted of obligations outstanding under capital and operating leases as well as royalty agreements with third parties and trade accounts payable. We plan to continue to expend significant resources on product development in future periods and may also use our cash to acquire or license technology, products or businesses related to our current business. We expect that operating expenses will continue to be a material use of our cash resources as well. The facility that we currently occupy is expected to be sufficient for our growth for the next twelve months. Consequently, we do not anticipate significant expenditures for leasehold improvements or furniture for the remainder of 2005.
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The following table sets forth the future minimum payments required under contractual commitments at September 30, 2005:
| | Payments Due by Fiscal Year | |
Contractual Obligations | | 2005 | | 2006 | | 2007 | | 2008 | | Thereafter | | Total | |
Operating Lease | | $ | 47,665 | | $ | 190,659 | | $ | 190,659 | | $ | 95,330 | | — | | $ | 524,313 | |
Equipment Leases | | 1,565 | | 6,257 | | 3,105 | | — | | — | | 10,927 | |
Total Cash Obligations | | $ | 49,230 | | $ | 196,916 | | $ | 193,764 | | $ | 95,330 | | — | | $ | 535,240 | |
(1) Amounts for 2005 reflect the future minimum payments for the remaining three months of the fiscal year.
Critical Accounting Policies
Use of Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations are based upon the Company’s financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amount of assets and liabilities. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, allowance for doubtful accounts receivable, long-lived and intangible assets, income taxes, contingencies and litigation. Management bases its estimates on historical experience, observable trends, and various other assumptions that are believed to be reasonable under the circumstances. Management uses this information to make judgments about the carrying values of assets and liabilities that are not readily apparent form other sources. Actual results may differ from the estimates under different assumptions or conditions.
Management believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its financial statements.
Revenue Recognition
Our revenue is generated primarily by licensing our software products and providing support for those products. Revenues are comprised of the gross selling price of the software, including shipping charges and the earned portion of support and maintenance agreements. The Company recognizes revenue in accordance with the American Institute of Certified Public Accountants Statement of Position (“SOP”) 97-2, Software Revenue Recognition, as modified by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.
Revenues from the sale of software products are recognized and completely earned upon shipment or electronic delivery of the product provided that persuasive evidence of an arrangement exists, collection is probable, payment terms are fixed and determinable and no significant obligations remain.
We also sell technical support and maintenance agreements (post contract customer support “PCS”), which are sometimes bundled with the software. When vendor specific objective evidence (“VSOE”) of fair value exists for all elements in a multiple element arrangement, revenue is allocated to each element based on the relative fair value of each of the elements. VSOE of fair value is established by the price charged when the same element is sold separately. In a multiple element arrangement whereby VSOE of fair value of all undelivered elements exists but VSOE of fair value does not exist for one or more delivered elements, revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue, assuming collection is probable. Revenue allocated to PCS is recognized ratably over the contractual term, typically one year.
The Company began selling technical support and maintenance services for some of its software products. Deferred revenue grew to a balance of approximately $178,117 at December 31, 2004 and $344,957 at September 30, 2005. The deferred revenue is due primarily to the sale of technical support and maintenance agreements. If the level of sales of technical support and maintenance agreements remains the
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same or declines, the balance of deferred revenues will stabilize or decline. However, if sales grow, this balance will increase, resulting in the deferred recognition of a significant amount of revenue in future periods. The increase in the first nine months was largely due to the sale of maintenance and support for our enterprise type products.
Allowance for Doubtful Accounts
We provide credit, in the normal course of business, to a number of companies and perform ongoing evaluations of our credit risk. We require no collateral from our customers and we estimate the allowance for uncollectible accounts based on our historical experience and current credit evaluations. No single customer accounted for more than 2% of revenues in 2004. One customer in the first nine months of 2005 accounted for approximately 3.6% of revenues. This customer represented approximately 32% of our trade accounts receivable at September 30, 2005.
Valuation of Long-Lived and Intangible Assets
The Company assesses the impairment of long-lived and intangible assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered important which could trigger an impairment review included the following: significant underperformance relative to historical or projected future cash flows; significant changes in the manner of use of the assets or the strategy for the overall business; and significant negative industry trends. When management determines that the carrying value of long-lived and intangible assets may not be recoverable, impairment is measured based on the excess of the assets’ carrying value over the estimated fair value. No impairment was recognized in 2004 or the first nine months of 2005.
Stock-Based Compensation
The Company has adopted Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation, and elected to use the intrinsic value method in accounting for its stock option plan in accordance with Accounting Principles Board opinion No. 25, Accounting for Stock Issued to Employees and related interpretations under which compensation expense is recorded to the extent that the current market price of the underlying stock exceeds the exercise price.
During the third quarter of 2005, there were no options granted to employees. During the nine months ended September 30, 2005, 15,000 options were exercised at an average price of $0.464 per share, by an employee. There were no options forfeited in the third quarter of 2005.
In December 2004, FASB issued Statement No. 123-R, Share-Based Payment, which establishes accounting standards for transactions in which an entity receives employee services in exchange for (a) equity instruments of the entity or (b) liabilities that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of equity instruments. Effective in the third quarter of 2005, SFAS 123-R will require us to recognize the grant-date fair value of stock options and equity based compensation issued to employees in the statement of operations. The statement also requires that such transactions be accounted for using the fair –value-based method, thereby eliminating use of the intrinsic value method of accounting in APB No. 25, Accounting for Stock Issued to Employees, which was permitted under Statement 123, as originally issued. This change in accounting will be required in the first quarter of 2006 and will result in increased compensation expense for stock options over their vesting period.
Research and Development
Research and development expenses include all direct costs, primarily salaries for personnel and expenditures with external development sources, related to the development of new products and significant enhancements to existing products and are expensed as incurred until such time as technological feasibility is achieved. For the nine months ended September 30, 2004 and 2005, we spent approximately $552,000 and $615,000, respectively, on research and development. No research and development expenses were capitalized in either of these periods and all previously capitalized research and development expenses were fully amortized at December 31, 2002.
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Income Taxes
GlobalSCAPE accounts for income taxes using the liability method in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. The liability method provides that the deferred tax assets and liabilities are recorded based on the difference between the book and tax basis 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 are carried on the balance sheet with the presumption that they will be realizable in future periods when pre-taxable income is generated.
Statement of Financial Accounting Standards (SFAS) No. 109 requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Based on these criteria, management has concluded that no income tax benefits are to be recorded related to the net income for the nine months ended September 30, 2005, because we cannot be certain of the future period recoverability of tax assets generated from any available net operating losses.
Comparison of the Three Months ended September 30, 2004 and 2005
| | 2004 | | 2005 | | $ Change | | % Change | |
Software product revenues | | $ | 1,270,223 | | $ | 1,723,685 | | $ | 453,462 | | 36 | % |
Cost of revenues | | 111,556 | | 66,709 | | (44,847 | ) | (40 | )% |
Selling, general and administrative Expenses | | 823,813 | | 1,014,011 | | 190,198 | | 23 | % |
Research and development expenses | | 165,743 | | 230,947 | | 65,204 | | 39 | % |
Depreciation and amortization | | 33,769 | | 22,714 | | (11,055 | ) | (33 | )% |
Total operating expense | | 1,134,881 | | 1,334,381 | | 199,500 | | 18 | % |
Income (loss) from operations | | 135,342 | | 389,304 | | 253,962 | | 188 | % |
Other Income (expense) | | (371 | ) | 4,424 | | 4,795 | | 1292 | % |
Income tax expense | | — | | | | | | | |
Net income (loss) | | $ | 134,971 | | $ | 393,728 | | $ | 258,757 | | 192 | % |
Revenue. For the three months ended September 30, 2004 and 2005, total revenues increased $453,462 or 36% from $1,270,223 to $1,723,685 largely due to the increased revenue from our Secure Server product and the Enhanced File Transfer product which was released in late 2004. Revenues from Cute FTP Home declined approximately 12% and CuteFTP Pro declined approximately 1%. Combined revenues from CuteFTP and CuteFTP Pro declined approximately 5% over the comparable period and accounted for approximately 53% of total revenues for the three months ended September 30, 2005.
Cost of Revenues. Cost of revenues consists primarily of production, packaging and shipping costs for boxed copies of software products as well as a portion of our bandwidth costs, certain licensing expenses and royalties. Cost of revenues decreased $44,847 or 40% between periods from $111,556 for the three months ended September 30, 2004 to $66,709 for the three months ended September 30, 2005 due to decreased royalty expenses that the Company pays on software products licensed from third parties, which it resells, and are expensed as a cost of sale when the software product is sold or earlier if the recoverability of any prepaid royalties is in doubt. The Company has distribution agreements with Hannon Hill Corp., Trellix Corp., Perseus Development Corp., Beehive Software, Inc., Visicom Media, Inc., and Xnet Communications GmbH. The GlobalSCAPE software products associated with each of the companies are PureCMS / Publish XML, CuteSITE Builder, Web Survey, Mac FTP, CuteHTML Pro, and Mac FTP Pro, respectively. , The decline in cost of revenues is due to decreased royalty expenses related to the products we are currently selling.
Selling, General and Administrative. Selling, general and administrative expenses consist primarily of personnel and related expenses, marketing, customer support, rents, bad debt and professional fees. For the three months ended September 30, 2004 and 2005, selling, general and administrative
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expenses were $823,813 and $1,014,011 respectively, an increase of $190,198 or 23%. This increase is largely due to higher sales commissions on increased revenues.
Research and Development. Research and development expenses increased $65,204 or 39% between periods, from $165,743 to $230,947. The increase was due mainly to increased expenditures for external development resources for our Secure Server and Enhanced File Transfer products. The Company plans to continue further development on these products.
Depreciation and Amortization. Depreciation and amortization expense consists of depreciation expense related to our fixed assets, amortization of the trademark associated with our purchase of CuteFTP and in prior periods, amortization of capitalized development costs. Depreciation and amortization expense decreased from $33,769 to $22,714, a decrease of 33%. This decrease was due to a reduction in depreciation expense as fixed assets come to the end of their depreciable lives as well as a slowdown in additions to fixed assets in current periods relative to prior periods.
Other Income, Expense. For the three months ended September 30, 2004 and 2005, interest expense decreased from $371 to ($105), respectively. The majority of interest expense incurred during these periods was related to financing of insurance premiums. A gain on the sale of fixed assets of $767 was realized during the three months ended September 30, 2005. Interest income of $3,552 was recorded on funds in a Working Capital Management Account for the 2005 third quarter.
Income Taxes. Although we recorded net income for the three months ended September 30, 2004 and 2005, we did not recognize a tax liability related to this net income. The amount of current tax expense generated from quarterly taxable income was offset by a reduction in the valuation allowance posted in prior periods against deferred tax assets. As discussed in our Annual Report on Form 10K, we cannot be certain of the future period recoverability of tax assets generated from available net operating losses.
Net Income. GlobalSCAPE recorded net income of $134,971 and $393,728 for the three months ended September 30, 2004 and 2005, respectively. The positive results in the third quarter 2005 were largely the result of increased sales revenue.
Comparison of the Nine Months ended September 30, 2004 and 2005
| | 2004 | | 2005 | | $ Change | | % Change | |
Software product revenues | | $ | 3,730,158 | | $ | 4,965,442 | | $ | 1,595,284 | | 47 | % |
Cost of revenues | | 304,071 | | 226,086 | | (77,985 | ) | (26 | )% |
Selling, general and administrative Expenses | | 2,599,165 | | 2,973,385 | | 374,220 | | 14 | % |
Research and development expenses | | 552,477 | | 614,756 | | 62,279 | | 11 | % |
Depreciation and amortization | | 139,782 | | 76,129 | | (63,653 | ) | (46 | )% |
Total operating expense | | 3,595,495 | | 3,890,356 | | 294,861 | | 8 | % |
Income from operations | | 134,663 | | 1,075,086 | | 940,423 | | 698 | % |
Other Income (expense) | | (1,091 | ) | 3,890 | | 4,981 | | 456 | % |
Income tax expense | | — | | (1,065 | ) | (1,065 | ) | 100 | % |
Net income | | $ | 133,572 | | $ | 1,077,911 | | $ | 944,339 | | 707 | % |
Revenue. For the nine months ended September 30, 2004 and 2005, total revenues increased $1,595,284 or 47% from $3,370,158 to $4,965,442. Revenues from CuteFTP Home and CuteFTP Professional increased 1% between periods overall. Total revenues increased mainly due to the increases in sales of our Secure Server and Enhanced File Transfer products which accounted for approximately 22% and 17% of combined total revenue, respectively for the nine months ended September 30, 2005. Secure Server represented 14% of revenue in the nine months ended 2004. Enhanced File Transfer was released in December 2004. Our concentration of revenue will continue to come from the FTP, Secure Server and Enhanced File Transfer. Our other products show an overall decline of approximately 14% and represented a total of approximately 17% and 11% of total revenue for the nine month periods ended September 2004 and 2005, respectively.
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Cost of Revenues. Cost of revenues consists primarily of production, packaging and shipping costs for boxed copies of software products as well as a portion of our bandwidth costs, certain licensing expenses and royalties. Cost of revenues decreased $77,985 or 26% between periods from $304,071 to $226,086 for the nine months ending September 30, 2004 and 2005, respectively, due to decreased royalty expenses related to the products we are currently selling.
Selling, General and Administrative. Selling, general and administrative expenses consist primarily of personnel and related expenses, marketing, customer support, rents, credit card transaction fees, bad debt and professional fees. For the nine months ended September 30, 2004 and 2005, selling, general and administrative expenses increased $374,220 or 14%. The increase is largely due to the increase in expenditures for salaries and sales commissions on higher revenues, and expense related to public relations and lead generation.
Research and Development. Research and development expenses increased $62,579 or 11% between periods, from $552,477 to $614,756. The increase was due to additional development cost mainly for our Enhanced File Transfer product and modules.
Depreciation and Amortization. Depreciation and amortization expense consists of depreciation expense related to our fixed assets, amortization of the trademark associated with our purchase of CuteFTP and in prior periods, amortization of capitalized development costs. Depreciation and amortization expense decreased from $139,782 to $76,129, a decrease of 46%. This decrease was mainly due to the purchase of CuteFTP being fully amortized as of September 30, 2003 and due to a reduction in depreciation expense as fixed assets come to the end of their depreciable lives.
Other Income, Expense. For the nine months ended September 30, 2004 and 2005, interest expense decreased from $1,091 to $620, respectively. The majority of interest expense incurred during these periods was related to financing of insurance premiums. During the nine months ended September 30, 2005, we recognized a gain on the disposal of fixed assets in the amount of $958. The Company received interest income on its working capital management account of $3,552 in the nine months ended September 30, 2005.
Income Taxes. Although we recorded net income for the nine months ended September 30, 2004 and 2005, we did not recognize a tax liability to this net income. The amount of current tax expense generated for the nine months ending September 30, 2005 was offset by a reduction in our valuation allowance posted in our prior period deferred tax assets. As discussed in our Annual Report on Form 10K, we cannot be certain of the future recoverability of tax assets generated from available net operating losses.
Net Income. GlobalSCAPE incurred a net income of $133,572 and net income of $1,077,911 for the nine months ended September 30, 2004 and 2005, respectively. The net income in the nine months ended September 30, 2004 was largely due to the layoff of 9 people in February 2004, lower depreciation and amortization expense and the result of expense cuts in the first quarter of 2004 and realized in the second and third quarters of 2004. The net income for the nine months ended September 30, 2005 is an improvement of approximately $944,339 over the same period in 2004 and due mainly to the success of our Enhanced File Transfer product released in late 2004 along with increased sales of our Secure Server product.
Inflation
Increases in inflation generally result in higher interest rates and operating costs. Our greatest exposure is to the cost of salaries and general and administrative expenses. To date we believe that inflation has not had a significant impact on our operations.
Seasonality
We believe our sales are subject to seasonal variations. We experience significantly less sales volume during national holidays and weekends when compared to normal business days.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
To date, 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.
In the nine months ended September 30, 2005, approximately 33% of our revenues came from customers outside the United States. All revenues are received in U.S. dollars so we have no exchange rate risk with regard to the sale. However, as of July 1, 2003, the European Union (EU) enacted Value Added Taxes (VAT) on electronic purchases. These taxes are charged to our non-business customers in the EU and, in our case, are remitted quarterly in pound sterling. We expect that the impact of this currency translation will not be material to our business.
Item 4. Controls and Procedures
a) Evaluation of disclosure controls and procedures. Within the 90 days prior to the filing date of this report, our President and Chief Financial Officer carried out an evaluation of GlobalSCAPE’s disclosure controls and procedures (as defined SEC Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) and concluded that the controls and procedures are effective in recording, processing, summarizing and reporting the information required to be disclosed by GlobalSCAPE in the reports it files with the SEC under the Exchange Act within the time periods specified in the SEC’s rules and forms.
b) Changes in internal controls. There were no material changes in GlobalSCAPE’s internal controls subsequent to the evaluation described above.
Part II. Other Information.
Item 1. Legal Proceedings
We are not currently involved in any material legal proceedings.
Item 2. Changes in Securities and Use of Proceeds
None in the third quarter of 2005.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
None in the third quarter of 2005.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certificate pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
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31.2 Certificate pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certificate pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
None in third quarter of 2005.
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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 4, 2005 | | By: | /s/ Charles R. Poole | |
Date | | | Charles R. Poole |
| | | President and Chief Operating Officer |
| | | |
November 4, 2005 | | By: | /s/ Thomas F. Farar | |
Date | | | Thomas F. Farar |
| | | Chief Financial Officer |
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