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GSB > SEC Filings for GSB > Form 10-K on 28-Mar-2013All Recent SEC Filings

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Form 10-K for GLOBALSCAPE INC


28-Mar-2013

Annual Report


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

The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our financial statements for the years ended December 31, 2012, 2011 and 2010, and related notes included elsewhere in this document.

Overview

We provide secure information exchange capabilities for consumers and enterprises through the development and distribution of software, delivery of managed and hosted solutions and provisioning of associated services. We have thousands of enterprise customers and more than one million individual consumers in over 150 countries. Our solutions are used by more than 20,000 U.S. Army users deployed worldwide.

We operate primarily in the Managed File Transfer, or MFT, industry. We are evolving our MFT focus into adjacent solution spaces, including creating what we refer to as Total Path Security. The Total Path Security framework addresses data and information management, movement, security and accessibility across a broad range of environments encompassing data and information in motion (for example, with traditional MFT solutions delivered as on-premises software or as a cloud service) and at rest (for example, through securely deleting or purging files or securely accessing stored data from mobile tablet or smartphone devices using our TappIn solution).

Our solution portfolio facilitates transmission of critical information such as financial data, medical records, customer files, vendor files, personnel files and other similar documents between diverse and geographically separated network infrastructures while supporting a range of information protection approaches to meet privacy and other security requirements. Our products provide the ability to monitor these activities, as well as access the underlying data, securely and flexibly through a wide range of network-enabled, mobile devices, including tablets and smartphones.

Our solutions enable compliance with government regulations relating to the protection of information while allowing users to reduce IT costs, increase efficiency, track and audit transactions and automate processes. Our solutions also provide data replication, acceleration of file transfer, sharing/collaboration and continuous data backup and recovery to our customers. We believe we are strongly positioned to provide secure transfer, sharing, and replication of files that need to be transmitted inside the user's firewall to distributed offices, or outside the user's firewall to business and trading partners, including network-enabled, mobile devices.

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


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

Our managed cloud-based subscription solutions are a notable part of our future revenue model plans because they provide recurring revenue which potentially builds over time, as compared to sales of on-premises software licenses which must be reconstituted every period. While we are in the early stages of growing our subscription services, we already have added capability to deliver these services in additional geographies, such as the United Kingdom and Canada, where country-specific compliance requirements may necessitate in-country service delivery

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

Key Business Metrics

Key Business Metrics

We review a number of key business metrics on an ongoing basis to help us monitor our performance and to identify material trends which may affect our business. The measures that we believe are the primary indicators of our performance are:

Revenue growth

Recurring revenue growth

Aggregate contract value growth

Adjusted EBITDA excluding infrequent items

Revenue Growth

Since 1996, we have transitioned from a consumer products company (mostly focused on the CuteFTP product line) to an MFT enterprise solutions provider with a focus on increasing the revenue contribution from cloud-based solutions, enabling secure mobile access to data and delivering professional services while continuing to grow our core MFT business. We have grown revenue consistently throughout this transition such that our enterprise solutions sales have grown from less than 50% of our revenue as recently as 2005 to now comprising more than 90% of our sales with our CuteFTP consumer products accounting for less than 5% of revenue for the year ended December 31, 2012. We believe our ability to sustain revenue growth while continuing this business evolution is the most significant metric for our business.

Although we often have grown revenue sequentially quarter over quarter in recent years, we view annual revenue growth as the more important metric, especially considering the ongoing evolution of our solution


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portfolio. We believe annual "core" revenue growth, excluding larger, exceptional transactions, is a key metric for monitoring our continued success in developing our business in future periods. Given our diverse solution portfolio and the addition of subscription services, we review our revenue mix and changes in revenue, across all solutions, on a regular basis to identify key trends and adjust resource allocations.

We believe attaining additional traction in the cloud-based managed solutions and secure content mobility market segments, realizing the potential of new software solutions, and our ability to continue developing and enhancing our existing software solutions are significant factors in our continued ability to sustain or possibly increase our revenue growth in future years.

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

Similarly, we believe market adoption of secure content mobility solutions, such as those provided by TappIn, will increase in future periods as use of personal computing devices, such as smart phones and tablets, continues to grow exponentially and as businesses increasingly embrace BYOD operating models.

See the section below comparing our results of operations for the years ended December 31, 2012, 2011 and 2010, for discussion of the revenue trends we have experienced.

Recurring Revenue Growth.

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

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

See the section below comparing our results of operations for the years ended December 31, 2012, 2011 and 2010, for discussion of the recurring revenue trends we have experienced.


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Aggregate Contract Value Growth.

Aggregate contract value, or ACV, is a measure of future revenue potential we have in place under non-cancellable contracts for product sales, maintenance and support, managed solutions, and professional services for which we will recognize revenue in future periods. ACV is the sum of:

Deferred revenue resulting from payments we have already received for services to be provided in the future.

Amounts we are due to be paid under non-cancellable contracts for future services we will provide under those contracts.

Our ACV growth as illustrated in the table below is a result of sales success in numerous areas of our business. While we expect ACV may grow in future periods as we potentially continue to increase our volume of non-cancellable contracts for future delivery of our products and services, it could also decrease for a number of reasons including existing customers electing not to renew their maintenance and support contracts or a large professional services contract, such as those we have in place to provide services to the U.S. Army, not being renewed for additional terms as provided in certain of those contracts.

ACV is not a measure of financial performance under generally accepted accounting principles in the United States ("GAAP") and should not be considered a substitute for deferred revenue. We use this metric to assess the effectiveness of sales and business development activities and how that effectiveness will factor into future revenue. We have maintained increased visibility into ACV in recent years because with the addition of subscription services and increased sales of professional services, we believe sales growth may significantly outpace revenue growth in the near term. ACV, together with recurring revenue and deferred revenue trends, provides greater insight into how bookings will factor into revenue over specific periods. We determine ACV related to non-cancellable contracts for future delivery of our products and services as follows:

                                                                      December 31,
                                                                   2012          2011
                                                                      (thousands)
Amounts we have billed and/or been paid in advance
(presented as deferred revenue in our financial statements)      $  9,773       $ 7,632
Amounts we will bill and be paid in the future (will appear
in our financial statements when we are paid and/or when we
provide the products and services)                                    797         1,200

Total ACV                                                        $ 10,570       $ 8,832

Non-GAAP Financial Measures

In addition to our financial statements prepared in accordance with GAAP, we use certain supplemental, non-GAAP measures (as defined by the Securities and Exchange Commission) to monitor the financial performance of our core operating activities prior to consideration of significant events that occur infrequently. Those non-GAAP measures include:

Non-GAAP operating expenses

Non-GAAP operating income

Non-GAAP net income

Non-GAAP earnings per share

Each of these non-GAAP financial measures excludes the effects of the affiliated entity asset impairment and the TappIn earnout liability not paid that are part of our Consolidated Statements of Operations and


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Comprehensive Income prepared in accordance with GAAP. We exclude these items when determining our non-GAAP financial measures because we do not consider them part of our core operating results when assessing our operational performance, allocating resources to our business activities and preparing operating budgets. We believe that by comparing our non-GAAP financial measures across historical periods, our operating results can be evaluated exclusive of the effects of certain items that may not be indicative of our core operations.

While we believe these non-GAAP financial measures provide useful supplemental information, there are limitations associated with the use of these non-GAAP financial measures. These non-GAAP financial measures are 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 these non-GAAP financial measures. Each of the excluded items listed above individually and collectively can have a material impact on operating expenses, operating income, net income and earnings per share. As a result, these non-GAAP financial measures have limitations and should not be considered in isolation from, or as a substitute for, financial statements prepared in accordance with GAAP.

                                                      Year Ended December 31,
                                               2012                2011           2010
                                                (In 000's except per share amounts)
  Non-GAAP Operating Expenses
  GAAP total operating expenses            $     24,766        $     20,103     $ 17,284
  Affiliated entity asset impairment             (3,264 )                -            -
  TappIn earnout liability not earned             1,343                  -            -

  Non-GAAP operating expenses              $     22,845        $     20,103     $ 17,284

  Non-GAAP (Loss) Income From Operations
  GAAP (loss) income from operations       $     (1,394 )      $        791     $  1,281
  Affiliated entity asset impairment              3,264                  -            -
  TappIn earnout liability not earned            (1,343 )                -            -

  Non-GAAP income from operations          $        527        $        791     $  1,281

  Non-GAAP Net Income (Loss)
  GAAP net (loss) income                   $     (1,800 )      $        635     $    881
  Affiliated entity asset impairment              3,264                  -            -
  TappIn earnout liability not earned            (1,343 )                -            -

  Non-GAAP net income                      $        121        $        635     $    881

  Non-GAAP Earnings Per Share
  Non-GAAP net income                      $        121        $        635     $    881
  Weighted average share outstanding:
  Basic                                          18,358              18,081       17,540
  Diluted                                        19,016              18,747       18,260
  Non-GAAP net income per common share:
  Basic                                    $       0.01        $       0.04     $   0.05
  Diluted                                  $       0.01        $       0.03     $   0.05

The affiliated entity asset impairment effect on non-GAAP net income of $3.3 million is the gross affiliated entity asset impairment associated with the write-off of our investment in, and our notes receivable from, CoreTrace Corporation. There is no related federal income tax effect reflected here because this item is a capital loss for federal income tax purposes for which we are uncertain as to whether we will generate sufficient capital gains in the future against which this capital loss can be applied.

The TappIn earnout liability not paid of $1.3 million is the gross amount of the liability relieved. There is no related federal income tax effect because the elimination of the liability for this payment is not a taxable event for federal income tax purposes.


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See our comparison of results for the years ended December 31, 2012, 2011 and 2010, below for our discussion of variations in the underlying elements comprising the amounts above.

Adjusted EBITDA Excluding Infrequent Items

Management utilizes Adjusted EBITDA (Earnings Before Interest, Taxes, Total Other Income/Expense, Depreciation, Amortization and Share-Based Compensation Expense) Excluding Infrequent Items to measure profitability and cash flow from the Company's core operating activities. We monitor and review cost of revenues, selling, general, and administrative, or SG&A, expenses and research and development, or R&D, expenses to assess conformance with established budget expectations and to identify specific variances. Identifying and, if necessary, addressing variances above budget is important for the purpose of staying within budget ceilings. However, even variances below budget may indicate imbalances in resource allocations or deviation of operating activities from established expectations.

We exclude infrequent items because when they occur, they typically do not directly impact profitability and cash flow resulting from the Company's core activities. For the year ended December 31, 2012, the reduction to zero of the carrying value of our investment in, and notes receivable, from CoreTrace Corporation and the TappIn earnout liability not paid were infrequent items.

Adjusted EBITDA Excluding Infrequent Items is not a measure of financial performance under GAAP and should not be considered a substitute for net income. Adjusted EBITDA Excluding Infrequent Items has limitations as an analytical tool and when assessing our operating performance. Adjusted EBITDA Excluding Infrequent Items should not be considered in isolation or as a substitute for net income or other income statement data prepared in accordance with GAAP.

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

                                                       Year Ended December 31,
                                                    2012         2011         2010
     Net (loss) income                            $ (1,800 )    $   635      $   881
     Add (subtract) items to determine adjusted
     EBITDA:
     Income tax expense                                217          169          410
     Other expense                                     189          (13 )        (10 )
     Depreciation and amortization                   1,217          790          852
     Stock-based compensation expense                  915        1,003        1,006
     Affliated entity asset impairment               3,264           -            -
     TappIn earnout liability not paid              (1,303 )

     Adjusted EBITDA                              $  2,699      $ 2,584      $ 3,139

See the section below comparing our results of operations for the years ended December 31, 2012, 2011 and 2010, for discussion of the variances between periods in the components comprising Adjusted EBITDA.


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                        Solution Perspective and Trends

The following is a summary description of our products and solutions. Our
discussion of the business trends of our products is based on the following
profile of our revenue components ($ in thousands):



                                                        Revenue for the Year Ended December 31,
                                          2012                           2011                           2010
                                              Percent of                     Percent of                     Percent of
                                 Amount         Total           Amount         Total           Amount         Total
Revenue by Product
EFT Server Enterprise           $ 14,742             63.1 %    $ 12,167             58.2 %    $ 10,913             58.8 %
EFT Server                         3,367             14.4 %       3,665             17.5 %       3,616             19.5 %
Wide Area File Services/CDP        1,577              6.7 %       1,533              7.3 %       1,869             10.1 %
Professional Services              1,547              6.6 %       1,772              8.5 %         438              2.4 %
CuteFTP                            1,059              4.5 %       1,209              5.8 %       1,522              8.2 %
Other                              1,080              4.6 %         548              2.6 %         207              1.1 %

Total Operating Revenues        $ 23,372            100.0 %    $ 20,894            100.0 %    $ 18,565            100.0 %

Maintenance and Support
Included in Total Operating
Revenue                         $ 11,298               48 %    $  9,424               45 %    $  7,762               42 %

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

Our MFT products and solutions allow customers to move large files and large numbers of files securely. We facilitate management, monitoring, and reporting on the file transfers and deliver advanced workflow capabilities to move data and information into and throughout an enterprise.

We earn most of our software license revenue from sales of our EFT Standard Edition and EFT Enterprise Edition products and solutions. These products and solutions provide a common, scalable MFT platform that accommodates a broad family of add-on modules to provide SMB and enterprise customers with increased security, automation, and performance when compared to traditional FTP-based and e-mail delivery systems. The add-on modules allow customers to select the solution configuration most applicable to their requirements for auditing and reporting, encryption, ad hoc and web-based file transfers, operability in or through a DMZ network, and integration with back-end business processes, including workflow automation capabilities. We continue to develop these products and solutions by, for example, improving their speed and responsiveness of performance, providing additional administration flexibility supporting cross-platform implementation with our DMZ Gateway solution, implementing business activity monitoring, and providing additional language support. We have sustained the year-to-year increase in our revenue from these products and solutions as a result of our ongoing development of this product line that has continued to enhance its appeal in the marketplace.

CuteFTP is a '"client side" software product, installed on a user's local computer, that enables file transfers from or to an FTP server. The target market for the CuteFTP product includes corporate IT professionals who use it to transfer data between locations via the Internet and individual Web site operators who use it to upload their Web pages to their Web hosting provider, among others. While CuteFTP still has significant brand recognition in the market, the revenue dollars we earn from this product line and its percent of our total revenue has declined in recent years. We believe market availability of free FTP utilities and the emergence of social media with imbedded capabilities for sharing non-sensitive data such as photos and videos are examples of the primary causes of the decline in CuteFTP revenue. We released our current CuteFTP Version 9 in November 2012. The Version 9 release includes a number of updates, including support for Unicode (UTF-8) characters that will allow greater international use and 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. In creating the Version 9 release, we also simplified our CuteFTP product line by consolidated all the features of


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our previous multi-product CuteFTP product line for Windows operating systems into the single new version. We also continue to offer CuteFTP Version 3.1 software for Mac platforms. We believe this product Version 9 product, as well as our continued offering of Version 3.1 for Mac platforms, can appeal to users wanting features more robust than offered in free alternatives and potentially may slow the rate of decrease in CuteFTP's level of contribution to our revenue in the future.

We have a partner agreement with Rackspace Hosting, Inc., a world leader in the hosting and cloud computing industry that began in 2010. We have a similar agreement with PEER 1 Hosting to meet the growing European demand for our services. Through these relationships, we deliver cloud-based, managed file transfer solutions for the secure exchange of business-to-business data, including large files and sensitive data. Our cloud-based solutions allow customers to outsource all or part of their complex and demanding information . . .

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