Item 1. Business
Company Overview
GlobalSCAPE develops and distributes secure file management software that enables users to safely send data over the internet. Our products guarantee the privacy of critical information such as financial data, medical records, customer files and other similar documents. In addition, our products ensure compliance with government regulations relating to the protection of information while allowing users to reduce IT costs, increase efficiency, track and audit transaction and automate processes. We also develop and distribute Web content management and Web development tools.
We started in 1996 with the distribution of CuteFTP, a file transfer protocol client program, and have achieved significant success and popularity with this product. We built on this success by steadily adding complementary products and believe we now have a reputation as a provider of easy-to use, affordable software for both individual and enterprise users. Since 2000, we have focused on enhancing our portfolio of products to meet the increasing demand for data security, and for solutions that permit non-technical personnel to contribute content to their organizations’ Web sites. Our software is used worldwide across a wide range of industries. Through the end of 2005, we had sold approximately 1,300,000 software licenses and our customer base includes individual consumers, small to medium-sized businesses, as well as some of the largest corporations in the world.
During 2005, approximately 67% of our revenues were generated from customers within the United States, with the remaining 33% concentrated mostly in Western Europe, Canada and Australia. Virtually all of our 2005 revenues were derived from sales of software licenses and support agreements. The combined sales of CuteFTP and CuteFTP Pro accounted for 69% and 50% of our revenues in 2004 and 2005, respectively. Our combined sales of our Secure Server and Enhanced File Transfer products grew from 14% of our revenues in 2004 to 43% in 2005.
Industry Background
The internet has become an integral part of operations for companies of all sizes, not only for e-commerce, but also as a means of managing information between central and remote locations and with employees, partners and suppliers. Corporate information managers must protect business assets, ensure that policies and processes meet regulations governing the management of sensitive information, and ensure that the right people have access to the right information at the right time. Global operations, diverse business partners and networks further emphasize the need for common standards to ensure compatibility, scalability and cost-effective integration.
Organizations that use the internet for data transfer are also faced with a daunting array of security challenges stemming from various regulatory and business requirements for data privacy and confidentiality. Regulatory and privacy requirements include legislation such as the Health Insurance Portability and Accountability Act (HIPAA), California Senate Bill (SB) 1386, and the Gramm-Leach-Bliley Act (GLBA) in the US, and the European Union’s Privacy Directive, some of which impose severe penalties for improper disclosure of confidential information. Additionally, industry best-practices and self-imposed business requirements include intellectual property and trade secrets protection and controls regarding disclosure of proprietary information to minimize corporate risk from the devastating consequences of security breaches. As corporate Web operations mature, we believe we will see an increasing demand for solutions to facilitate secure file transfers on the internet and for solutions that streamline the management of Web content.
Products
Our current products include Windows®-based, Mac based, browser-based and server software applications.
FTP Client Programs
File transfer protocol, or FTP, is the language used for file transfers from computer to computer across the World Wide Web. FTP is most commonly used to download a file from a server using the internet or to upload a file to a server.
CuteFTP. CuteFTP is a “client-side” program, meaning that it permits a user to request a file from or send a file to an FTP server or host computer. The user base for this program ranges from corporate MIS professionals who use it to transfer data between locations via the internet, to individual Web site operators who use it to upload their Web pages to their Web hosting provider. CuteFTP simplifies use of file transfer protocol by hiding the technical processes behind a user-friendly, graphical interface, which allows users to “drag ‘n drop” files between computers. It includes an automatic reconnection feature that resumes broken transfers, a transfer queue and a built in HTML editor that allows remote editing of Web pages. CuteFTP has won several awards, including the CNet Editors’ Choice award, and has been favorably reviewed in leading online and print trade journals such as PC Magazine, WindowsNT, Yahoo Internet Life, CNet’s Download.com and Tucows, as being the most powerful, easy-to-use file transfer protocol program available. We offer CuteFTP in German, French, Spanish, Japanese and Traditional and Simplified Chinese. CuteFTP was first released in February 1995 by its original author, and was first distributed as a commercial product by GlobalSCAPE in April 1996. In October 2003, GlobalSCAPE released CuteFTP Mac, our easy-to use FTP client for the Macintosh operating system. CuteFTP Mac incorporates many of the popular features of CuteFTP for Windows, while adhering to Apple’s Aqua® interface and usability guidelines.
CuteFTP Pro. CuteFTP Pro is a secure FTP client program designed for advanced users and information technology professionals. CuteFTP Pro incorporates standards for encrypted transfers using Secure Socket Layer (SSL), HTTP, and SSH2, as well as advanced S/KEY password encryption. It includes various features attractive to advanced users such as multi-part and concurrent file transfers to maximize transfer speed, scheduled file transfers, automated site backups and scripting ability for automating FTP tasks. CuteFTP Pro has been favorably reviewed by leading online publications including CNet’s Download.com, ZDNet and PC Review. CuteFTP Pro was released in March 2001 and CuteFTP MAC Pro was released in April 2004.
File Transfer Servers
FTP transfers require two software programs: a client program to start a transfer and a server to accept the connection. FTP servers are designed to provide businesses with increased security and speedier file transport when compared to e-mail.
Secure FTP Server. Secure FTP Server complements CuteFTP Pro and other professional FTP clients by enabling encrypted transfers using Secure Socket Layer (SSL), Secure Shell (SSH2) and advanced S/KEY password encryption. When used with CuteFTP Pro, Secure FTP Server offers a complete digital certificate management system, giving system administrators the ability to create, sign, import, export and add digital certificates, as well as kick off back-end processes. The latter functionality can be used as a partial or total replacement for more complex enterprise-level electronic data interchange systems (EDI). Additional features include full remote management capability, the ability to operate multiple FTP sites with unique directory structures from a single server and manage user accounts with advanced restriction settings for maximum security and control. Secure FTP Server has been favorably reviewed by leading online publications including Server Watch and File Forum. GlobalSCAPE Secure FTP Server was first released in January 2002.
Enhanced File Transfer Server. Enhanced File Transfer Server is a hardened file server for enterprise-level solutions. Building on Secure FTP Server with digital certificate management, Secure Socket Layer (SSL) and S/KEY password encryption, remote administration, multiple site hosting and management, and extensive automation with a full featured event rule library and Component Object Model (COM) extensions, Enhanced File Transfer Server adds repository encryption, additional protocol support, SSH security, data offload capabilities, and automated notification. This product offers modules designed to be the solutions for our customer’s different needs. Enhanced File Transfer Server was first released by GlobalSCAPE in November 2004. The latest version, EFT Server 4 helps customers achieve regulatory compliance with legislation such as HIPAA, Sarbanes-Oxley and Gramm-Leach by providing security functionalities such as secure authentication, secure data transfers, secure storage and advanced encryption and signing. Enhanced File Transfer Server offers modules that can be added on to the product such as DMZ Gateway and Secure SMTP Gateway. DMZ Gateway, when combined with the EFT Server, adds a multi-layered security solution that allows implementing the highest levels of security for data storage and retrieval, authentication and firewall transversal. Using a two-way connection originating from the back-end (internal) EFT server, the DMZ Gateway acts as a communication proxy to process requests that replaces inherently insecure inbound connections from the DMZ to your network. GlobalSCAPE’s Secure SMTP Gateway transparently secures outbound emails by holding sensitive messages and sending an email notification to the recipient, who can then retrieve the message and any attachments over a secured HTTPS channel.
Web Content Management
Content management generally refers to software that streamlines the process for managing information on a Web site or intranet.
PublishXML. PublishXML is our Web content management solution. PublishXML is designed to solve basic problems endemic to maintaining current information on a Web site such as bottlenecks in the IT department, lack of control and accountability, and miscommunication between content authors and Web developers. GlobalSCAPE markets the product on its website and provides all leads to Hannon-Hill
Corp. Hannon-Hill acts as the sales agent for this product, and revenues from the sales are split based upon an agreement between the parties with all invoicing and collections being processed by GlobalSCAPE. Using PublishXML, developed by Hannon-Hill, a company’s Web administrator may give non-technical personnel the ability to directly revise designated content. For example, the marketing department could modify pricing, product descriptions and graphics while the human resources department updated its job postings, all without the involvement of technical personnel. Access by non-technical personnel is limited, however, so that the Web site administrator’s ability to protect the overall infrastructure and design of the site is not compromised. The program is browser-based with a Windows-like interface, so users can easily access and work on Web sites, eliminating the need for special training. Changes are made to a copy of an organization’s Web site in a staging area and published to the live site only after group leaders or Web site administrators approve the content for publishing. Additional features include WYSIWYG (what you see is what you get) editing, visual comparison of proposed changes to the live site, e-mail notification of changes and activity, site statistics, versioning and archiving. PublishXML works with any Web site development tool including popular applications such as Front Page and Dreamweaver, and can be implemented without deconstructing (re-building) the existing Web site. The program is scaled to meet the needs of small to medium-sized businesses, but can be used by large organizations for intranet or independent Web site management. PublishXML was released in April 2004.
Internet Products
We offer a variety of software products which can be purchased and downloaded directly from our automated website. These products include products that range in price from $19.99 to $249.00 for a single license. Products for web page content management and design include CuteSITE Builder, CuteHTML, CuteHTML Pro and CuteMAP. We also offer a file compression product, CuteZIP, and a product for conducting online surveys, Web Survey.
These products are easy to install and use, making them good products to attract users to our website.
History and Recent Developments
GlobalSCAPE was organized as a Delaware corporation in April 1996 when we obtained the right to distribute CuteFTP from its original author. In 1998, we purchased all rights to CuteFTP from its author and in 1999 began developing and selling complementary products under the “Cute” brand such as CuteHTML and CuteMAP. In September 2000, ATSI distributed approximately 27% of its GlobalSCAPE common stock to its shareholders. As a result of this partial spin off, we became a reporting company under the Securities Exchange Act of 1934. In June 2002, ATSI sold its remaining interest in the company to a San Antonio based joint venture.
Significant developments during 2005 included:
• February 2005: We announced availability of our Enhanced File Transfer product at the HIMMS trade show for healthcare organizations.
• March 2005: The latest versions of CuteFTP Home and CuteFTP Professional were released.
• April 2005: The latest version of PureCMS Content Management software was released as a Hannon-Hill product. Hannon-Hill acts as our sales agent for PureCMS and PublishXML.
• July 2005: We released the latest version of EFT Server and the new DMZ Gateway software.
• August 2005: We released Secure SMTP Gateway, a new email security software.
• September 2005: We announced the sale of Secure FTP Server to the U.S. Army.
Strategy
Our goal is to build upon our successful market position in FTP, as we have for the past 10 years, in order to provide business users with secure solutions for their growing file transfer needs. We continue to enhance and develop high quality, affordable software that enables organizations and individuals to easily create, move and manage Web and file-based data in a secure, collaborative environment. We have successfully established a brand in the market for internet software productivity tools with our file management products, CuteFTP and CuteFTP Pro. We believe that the next phase of our growth will come through the continued development of our Secure FTP Server and Enhanced File Transfer products involving secure file transfer to meet the growing demand for file security when transferring information across the internet due to changes in regulations in various industries and the demand of users for secure solutions. GlobalSCAPE believes that our products represent a low cost solution for businesses for their secure file transfer requirements because we don’t require the purchase of a whole suite of products. Our Secure FTP Server and Enhanced File Transfer products offer modules to form the solutions a business needs, and they only need to purchase what solves their particular needs. Maintenance and support agreements are purchased with most of our higher-end server products by businesses. We will also continue to market our content management solutions that help non-technical professionals manage their organization’s Web sites without reliance on information technology professionals.
Key elements of our strategy are:
Continue to enhance and develop security features of our products. Corporate and individual users are increasingly concerned with security. We have added the Enhanced File Transfer (EFT) enterprise solution to our product line for businesses to meet the needs of security issues when transferring files in and out of their servers across the internet. We intend to continue to develop and add features throughout 2006 to meet the demand for file transfer security in EFT and our other well known FTP products, CuteFTP Home and CuteFTP Professional and Secure FTP Server. We intend to make the FTP, EFT and Secure FTP Server lines of business our main focus in 2006.
Pursue strategic product and acquisition opportunities. In 2005, we added modules and further developed our Secure FTP Server and EFT products. We will continue to look for opportunities to develop, acquire or add synergistic products or technologies that enhance the success of these products.
Continue sales of PublishXML. We have invested considerable time and effort in the marketing of PublishXML, our content management product introduced in April 2004. We continue to believe that the demand for Web content management solutions is strong. We have released new versions of this product and continue to evaluate all aspects of our management of this product, including pricing, ease of installation and use, program functionality, and marketing and sales strategies. We intend to continue to pursue sales and distribution of this product. In order to concentrate our efforts in this area on PublishXML, we discontinued the sale of PureCMS through our sales agreement with Hannon-Hill in 2005.
Continue to develop a more robust reseller channel. During 2005, we continued our emphasis on the development of our third party reseller channels by hiring sales people with reseller sales backgrounds and developing relationships with new resellers. In particular, we attempt to reach “value-added” resellers such as system design consultants. We believe sales will be significantly enhanced if we are able to recruit numerous resellers who have existing relationships with prospective customers.
Develop our internal sales staff. During 2005, we continued the development of our internal direct sales force to better sell our more complex products, such as Enhanced File Transfer, Secure FTP Server and PublishXML. We intend to continue to develop our sales staff through further training and certification.
Continue to develop online marketing capabilities. We believe we have significant expertise in driving online sales via online marketing activities, including product placement on third party sites such as search engines and referral sites, and electronic mail campaigns. This type of sales activity is particularly well suited to certain of our lower priced products because of the lower cost of sale. We intend to continue to
leverage our established Web presence to drive online sales as well as supporting our direct and reseller sales efforts.
Sales and Marketing
We sell our software primarily via download from our Web site, www.globalscape.com. Prospective buyers may use our software products free for a thirty-day evaluation period. The programs are automatically disabled if a license is not purchased by the end of the trial period. Our current products range in price from $19.95 to $25,000 per license. Historically, the majority of our software sales have been made online using a credit card. Our software is also available for download from a variety of independent internet software sites such as CNet’s Download.com, as well as sites in Western Europe, Canada, Australia, and Asia. We distribute a limited number of copies on CD in Fry’s and Micro Center stores in the United States and through numerous international resellers. We provide free customer support via a searchable knowledge base on our Web site and sell “live” support and maintenance packages.
Since 2003, we have increased our emphasis on developing our internal sales staff and reseller channels to capture those sales that require personal attention, such as sales of our more complex products and sales to larger enterprises. We require training, testing and professional development of our sales people to insure that they are capable of meeting the needs of our customers.
Seasonality
We believe our internet sales are subject to seasonal variations and we experience significantly less sales volume during national holidays and weekends when compared to normal business days. In the fourth quarter of 2004, our sales revenues increased approximately 11% over the same period in 2003, as a result of new product releases and our sales force development although sales declined from November 2004 to December 2004. Our fourth quarter revenues in 2005 increased approximately 56% over the same quarter in 2004. The seasonality we have experienced seems to be lessening as we rely more on sales by our direct sales force, rather than our internet sales. We expect that in future periods we may see weakness in the fourth quarter on internet sales when compared to the third quarter, due to the holiday season.
Network and Equipment
We have contracted with various network providers for internet access. Our arrangements provide for redundancy in the event of a failure, and also for rapid expansion of available bandwidth in the event that there is a dramatic increase in demand. To protect critical customer data, GlobalSCAPE’s secure server utilizes Secure Sockets Layer encryption. We have dedicated servers on and off site and expansion plans in place to allow rapid and cost effective scalability.
Research and Development
Our internal software engineers are responsible for software design, managing the development process, testing and quality assurance. We utilize offshore developers for a large portion of the coding phase of software development. All phases of development, including scope approval, functional and implementation design, object modeling and programming, are subject to internal quality assurance testing. Our use of external developers allows us to tap into a highly skilled labor pool, maintain a 24-hour development schedule, decrease time to market, and minimize programming costs.
For the years 2003, 2004 and 2005, GlobalSCAPE spent approximately $945,000, $728,000 and $870,000 respectively, on research and development, all of which were expensed.
Competition
The file management, content management and Web development software market sectors are intensely competitive, subject to rapid change and are significantly affected by new product introductions and other activities of market participants. Our primary competitors vary by product and are listed below.
CuteFTP. CuteFTP exists in a highly competitive environment with several hundred FTP software utilities available on the internet. We believe our primary competitors are WS_FTP from Ipswitch, Inc. and FTP Voyager by Rhino Software, Inc. CuteFTP was the second Windows-based FTP client to market and is consistently the most frequently downloaded FTP client on popular download sites. CuteFTP Mac, our FTP client for the Macintosh platform, competes with Fetch, by Fetch Softworks, Interachry, by Stairways Software Pty Ltd., and Transmit FTP, by Panic Inc.
CuteFTP Pro. CuteFTP Professional competes in the higher end of the same market as CuteFTP, targeting the security-minded IT professional. CuteFTP Professional is positioned as one of the only secure FTP client programs that support a wide range of security standards related to the FTP protocol. Competitors in the general FTP market offer products that support a smaller subset of these security standards and address a narrower segment of the secure FTP market. Competitors include Van Dyke, Inc., Ipswitch, Inc., and Rhino Software, Inc.
Secure FTP Server. Secure FTP Server competes against a limited number of secure Windows-based FTP servers. We believe our primary competitors are WS_FTP Server and Serve-U. Secure FTP Server has the advantage of leveraging the success of CuteFTP Pro through product integration, offering proprietary extensions to the FTP protocol, and cross-marketing efforts to an existing customer base.
Enhanced File Transfer Server. Enhanced File Transfer Server competes in the managed file transfer server market. We believe our primary competitors are Tumbleweed, Sterling, Proginet, and SSH’s Tectia. Enhanced File Transfer Server has the advantage of being very cost effective in its market while leveraging and extending the security and file management features of our other FTP products.
CuteSITE Builder. CuteSITE Builder competes against approximately one hundred WYSIWYG editors, including MS FrontPage, Macromedia’s Dreamweaver, HotMetal and HotDog. CuteSITE Builder offers most of the features available in FrontPage, however, the product was developed to further simplify the Web site creation process and is arguably easier to use, better serving the novice. In addition, the product is priced well below FrontPage.
PublishXML. The “content management” market is diverse and encompasses the areas of knowledge management, document management, digital asset management and Web content management. PublishXML is designed for Web content management. The market for Web content management solutions for Fortune 500 companies and other large organizations is dominated by companies such as Vignette, Interwoven, Documentum, Stellant and Microsoft, each of which offers solutions that can cost hundreds of thousands of dollars. We do not intend to compete in this market but are focused on small to medium-sized businesses with a simpler, affordably priced solution. We believe that we have a competitive advantage in that we are better known than some of our competitors among technology professionals who are already familiar with our file management programs, CuteFTP and CuteFTP Pro.
We offer PublishXML as a packaged solution. A “packaged solution” means that we license a copy of the software to the customer for a one-time fee to install and use on their own servers. Our competitors include providers of online solutions, such as Atomz, Crown Peak, and iUpload, and providers of packaged solutions, including Macromedia’s Contribute, Userland, Infosquare and Ektron. PublishXML also competes against software that incorporate subsets of Web content management functions in Web authoring programs, such as Microsoft’s FrontPage, and Macromedia’s Dreamweaver and Contribute.
Web Survey. Competitive products include both applications and services including Zoomerang, WebSurveyor, EZSurvey and SurveyMonkey. We believe Web Survey has an advantage of a lower total cost of ownership than the competition.
CuteHTML. CuteHTML exists in a highly competitive environment with approximately one hundred text-based HTML editors. CuteHTML’s competition includes HomeSite from Allaire, Inc. CuteHTML’s advantage is that it doesn’t add extraneous code to Web pages, an attribute preferred by many professional Web masters.
CuteHTML Pro. CuteHTML Pro faces heavy competition from visual or “WYSIWYG” editors such as Front Page, by Microsoft, Dreamweaver, by Macromedia Inc, and competition from other direct editors, such as Homesite, also by Macromedia Inc. CuteHTML Pro’s advantage is its appeal to professional Webmasters who typically shun visual editors in favor of the extra features and added control provided by direct editors such as CuteHTML Pro.
CuteMAP. CuteMAP competes against approximately 65 image-mapping utilities, which exist in a niche market. Primary competitors include CoffeeCup Image Mapper, Ulead Smart Saver and MapEdit. CuteMAP has the advantage of being able to leverage the success of CuteHTML through product integration and cross-marketing efforts to an existing customer base.
CuteZIP. CuteZIP exists in the highly competitive file compression utility market, competing against several hundred file compression utilities. Its main competitors include WinZIP, the current market leader, and NetZIP. CuteZIP’s main advantage is that it is one of the only compression utilities offering 128-bit encryption to secure compressed files. In addition, users can create self-extracting encrypted archives that recipients may open even if they don’t have a zip utility installed.
We have limited information regarding our products’ market shares in their respective categories. Many of our competitors have substantially greater financial, technical, sales, marketing, personnel, and other resources, as well as greater name recognition and a larger customer base than we do. Significant competition characterizes the markets for our products and we anticipate that we will face increasing pricing pressures from competitors in the future. Moreover, given that there are low barriers to entry into the software market, and the market is rapidly evolving and subject to rapid technological change, we believe that competition will persist and intensify in the future. We have experienced price declines over the last several years. A reduction in the price of our products would negatively affect gross margins as a percentage of net revenues, and would require us to increase software unit sales, in order to maintain net revenues at existing levels. For more discussion on the risks associated with our competition, you should read the information under “Risk Factors - Risks Related to Operations - We face significant competition and competition in our market is likely to increase” and “- GlobalSCAPE may not be able to compete effectively with larger, better positioned companies, resulting in lower margins and loss of market share.”
Intellectual Property
Our trademarks, copyrights and technology are central to our business. We protect our intellectual property rights through a combination of licenses, trademarks, service marks, copyrights, trade secret laws and restrictions on disclosure.
We currently have registered trademarks for GlobalSCAPE, CuteFTP, CuteFTP Pro, PureCMS, CuteHTML, CuteZIP, CuteMAP and CuteSITE Builder. We have obtained United States copyright registrations for all but the most recently developed versions of our software applications, and have applied for registration for the most recently developed versions.
We seek to protect our software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult, and while we are unable to
determine the extent to which piracy of our software products exists, software piracy can be expected to be a persistent problem. In selling our products, we rely primarily on click-wrap licenses that are not signed by licensees, and may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. In addition, the number of patents applied for and granted for software inventions is increasing. Consequently, there is a growing risk of third parties asserting patent claims against us. We have received, and may receive in the future, communications from third parties asserting that our products infringe, or may infringe, the proprietary rights of third parties, seeking indemnification against such infringement or indicating that we may be required to obtain a license or royalty from such third parties. For more discussion on the risks associated with our intellectual property, you should read the information under “Risk Factors,” especially “Risks Related to Legal Uncertainty.”
Employees
As of March 1, 2006, we had 41 full-time and part-time employees organized within seven functional areas. The employee distribution according to function is as follows:
None of our employees are covered by collective bargaining agreements and we believe our employee relations are good.
Item 1A.
Item 1A. Risk Factors
We have described below risks that we are aware of that could have a material adverse effect on your stock ownership and our business.
Risks Related to Operations
GlobalSCAPE depends on two products for a substantial portion of its revenues.
GlobalSCAPE depends on two products, CuteFTP and CuteFTP Pro, for approximately 50% of its revenues. In addition, GlobalSCAPE’s ability to produce revenues related to other products and new products depends substantially on exploiting the traffic to GlobalSCAPE’s Web site generated by the demand for CuteFTP and CuteFTP Pro. If GlobalSCAPE is not able to maintain its competitive position with these products, its revenues could decline dramatically and GlobalSCAPE’s plans to expand its business could be substantially impaired. From 1996 to 2000, sales of licenses for CuteFTP increased significantly year to year. From 2002 through 2004, combined revenues recognized from CuteFTP and CuteFTP Pro declined year to year. CuteFTP revenue declined approximately 22%, whereas CuteFTP Pro increased approximately 18% from 2004 to 2005. Although the percentage of combined revenue for CuteFTP and CuteFTP Pro has declined as compared to total revenues, actual revenues from these two products increased approximately 1% from 2004 to 2005. 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, these products may have reached such a point in their lifecycles. If we are not successful in shifting a higher percentage of our revenues to our other products and if sales of CuteFTP and Cute FTP Pro continue to remain flat or decline, our revenues, cash flow from operations and net income will decrease.
GlobalSCAPE’s new product introductions may fail to generate sufficient revenue.
While we have had success in introducing our EFT products through 2005, we will need to continue to market and enhance these products with new features and modules to maintain our place in the market. If we fail to meet the needs of customers, or delay the introduction of demanded features, we may lose sales to the competition. If revenues from CuteFTP and CuteFTP Pro decline and our new products fail to generate sufficient revenue to replace the declining revenues, our revenues, cash flow from operations and net income will decline.
GlobalSCAPE may fail to develop or license the intellectual property needed to launch new products.
Our strategy for future growth depends significantly on the addition of new products. If we fail to timely license, and/or develop new programs, or if our new programs are not functionally competitive with other programs in our markets, our revenue growth could be substantially impaired.
GlobalSCAPE may not be able to develop its sales force as needed to successfully market its new products.
GlobalSCAPE has relied heavily on internet sales in the past. However, our newer enterprise programs, Secure FTP Server, PublishXML and Enhanced File Transfer (EFT), require a more complex distribution model, including reliance on value-added resellers such as Web development and system consultants. In addition, our internal sales force must be skilled at managing a complex and multi-stage sales process appropriate for these products. We have experienced some turnover among our internal sales personnel during 2005, resulting in training new personnel to take their place. Training new employees takes time and can result in a loss of sales due to the technical skills that need to be gained in order to sell our enterprise type software. Future turnover could have an immediate and direct effect on our revenues. Continued turnover, especially of key personnel, could cause revenues to decline dramatically.
If GlobalSCAPE loses key personnel it may not be able to execute its business plan.
GlobalSCAPE’s future success depends on the continued services of key members of its management team. GlobalSCAPE did not experience turnover in its management team during 2005, which has been a key to moving our products and revenues forward. These individuals are difficult to replace because of the intense competition for similarly skilled people. In addition, new members of the management team may not be productive for weeks or months as they learn about GlobalSCAPE’s products and the administration within the Company.
We face significant competition and competition in our market is likely to increase.
The markets for our products are intensely competitive and characterized by rapid technological change. GlobalSCAPE’s competitors are constantly releasing improved versions of their products. The needs and expectations of GlobalSCAPE’s customers are also evolving. Therefore, GlobalSCAPE must continually enhance its products and develop new products to remain competitive. When a new product is brought to market with functionality better suited to a particular use, the demand for currently available products may decrease. All of GlobalSCAPE’s products are subject to the threat of reduced market share resulting from the introduction of competitive products. GlobalSCAPE may fail to develop new products and functionalities as quickly as is necessary in the future to avoid losing its position in the internet software market.
In addition, software development generally requires substantial lead-time, so GlobalSCAPE must accurately predict what changes will be needed. GlobalSCAPE may fail to predict these changes far enough in advance, or it may not have sufficient technical personnel to make such changes. If GlobalSCAPE cannot keep pace, its products will lose their position in the market.
GlobalSCAPE utilizes “open source” software in some of its products.
The open source software community develops software technology for free use by anyone. We have relied on open source technology for the encryption features in our CuteFTP Pro and GlobalSCAPE Secure FTP Server products. Our reliance on open source code software may impose limitations on our ability to commercialize our solution and may subject us to possible intellectual property litigation.
We incorporate a limited amount of open source code software into our solution, and we may use more open source code software in the future. Open source code may impose limitations on our ability to commercialize our solution because, among other reasons, open source license terms may be ambiguous and may result in unanticipated obligations regarding our solution, and open source software cannot be protected under trade secret law. In addition, it may be difficult for us to accurately determine the developers of the open source code and whether the acquired software infringes third-party intellectual property rights. As a result, we could be subject to suits by parties claiming ownership of what we believe to be open source software. Claims of infringement or misappropriation against us could be costly for us to defend and could require us to seek to obtain licenses from third parties in order to continue offering our solution, to re-engineer our solution or to discontinue the sale of our solution in the event re-engineering could not be accomplished on a timely basis. If this occurs, our business and operating results could be harmed.
In addition, from time to time there have been claims challenging the ownership of open source software against companies that incorporate open source software into their products. We use a limited amount of open source software in our solution and may use more open source software in the future. As a result, we could be subject to suits by parties claiming ownership of what we believe to be open source software. Any of this litigation could be costly for us to defend, hurt our results of operations and financial condition or require us to devote additional research and development resources to change our solution.
Future government regulation may increase our cost of doing business and reduce demand for our products.
New laws may be adopted to address areas such as taxation, privacy, copyrights, and quality of services, and existing laws may be applied to the internet in unexpected ways. New laws and unexpected application of existing laws related to the internet could create uncertainty in the internet market place, which could increase our cost of doing business, reduce demand for our products, and have a material adverse effect on our business, financial condition and operations.
If an effective internet sales tax scheme is implemented, demand for our products could decrease.
GlobalSCAPE is not currently required to collect sales tax on its online sales except to customers in certain states. In general, state laws require that if the seller does not collect sales tax, residents who purchase goods online should remit sales tax to the appropriate taxing agency in the state where they live. However, state agencies rarely enforce this rule and we believe that less than 1% of our customers actually remit sales tax to their state taxing agencies. For practical purposes, most of our customers who do not pay sales tax to us purchase their license on a tax-free basis. If an effective internet sales tax scheme is implemented it would effectively increase the cost of our software in the eyes of our customers and therefore likely have a tendency to decrease demand for our software.
Taxes imposed by foreign governments may decrease demand for our products in those markets.
On 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 member nations and rates vary by country. Western European countries account for a substantial portion of our international sales. These taxes, which vary in rate from 15% to 25%, may decrease demand for our products in these markets. Expansion in the number of the EU member nations may also decrease demand for our products as these taxes are imposed on more of our customers.
GlobalSCAPE may not be able to compete effectively with larger, better-positioned companies, resulting in lower margins and loss of market share.
GlobalSCAPE competes with a variety of companies who have significantly greater revenues and financial resources than GlobalSCAPE as well as greater personnel and technical resources. For example, CuteFTP and CuteFTP Pro compete with products offered by Ipswitch, Inc. and Microsoft Corporation, PureCMS competes with Macromedia Inc.’s software, and CuteSITE Builder competes with Microsoft and Macromedia software. Large companies may be able to develop new technologies more quickly than GlobalSCAPE, to offer a broader array of products, and to respond more quickly to new opportunities, industry standards or customer requirements. For example, Macromedia’s Dreamweaver is one of the most popular Web authoring programs for consumers and small businesses, providing them with a huge established customer base to which they are able to directly market their content management product, Contribute. Some competitors may also be able to adopt more aggressive pricing strategies. For example, Ipswitch gives an older version of its file transfer protocol program away for free for non-commercial use, and Microsoft includes file transfer protocol functionality in its internet browser, which it distributes for free. Increased competition may result in lower operating margins and loss of market share. Additional competitors may enter the market and may have significantly greater capabilities and resources than GlobalSCAPE. You should read the information under “Business-Competition” for more information on our competitors.
It may be difficult for GlobalSCAPE to recruit software developers and other technical and management personnel because GlobalSCAPE is a relatively small company.
GlobalSCAPE competes intensely with other internet software development and distribution companies internationally to recruit and hire from a limited pool of qualified personnel. Some qualified candidates prefer to work for larger, better known companies. Failure to attract and maintain qualified personnel would impede our development and maintenance of new and existing products.
GlobalSCAPE’s ability to develop its software will be seriously impaired if it is not able to use its foreign subcontractors.
GlobalSCAPE relies on foreign subcontractors to help it develop its software. If these programmers decided to stop working for GlobalSCAPE, or if GlobalSCAPE were unable to continue using them because of political or economic instability, GlobalSCAPE would have difficulty finding comparably skilled developers. In addition, GlobalSCAPE would likely have to pay considerably more for the same work, especially if it used U.S. personnel. If GlobalSCAPE could not replace the programmers, it would take it significantly longer to develop its products.
GlobalSCAPE may incur losses as it attempts to expand its business.
GlobalSCAPE intends to expand its business and therefore expects to expend significant additional resources on developing its sales force, developing a more robust reseller program, research and development, marketing and product development. As a result, GlobalSCAPE may need to expend significant resources to accomplish these goals. If GlobalSCAPE fails to successfully develop and market new products or improve its direct and channel sales results, it may not be able to achieve the necessary revenue growth and may not be profitable.
GlobalSCAPE’s operations are vulnerable to security breaches that could harm the quality of its products and services or disrupt its ability to deliver its products and services.
Third parties may breach GlobalSCAPE’s system security and damage its products and services or misappropriate confidential customer information. This might cause GlobalSCAPE to lose customers, or even cause customers to make claims on GlobalSCAPE for damages to them. In addition, GlobalSCAPE may be required to expend significant resources to protect against security breaches and/or to address problems caused by such breaches.
GlobalSCAPE’s products may expose customers to invasion of privacy, causing customer dissatisfaction.
GlobalSCAPE’s Secure FTP Server and Enhanced File Transfer are intended to provide outsiders access to a customer’s computer, making the customer vulnerable to security breaches, which could result in the loss of their privacy or property. If customers suffer invasions of privacy or other harm, this may result in customer dissatisfaction and possible claims against us for any resulting damages.
GlobalSCAPE’s products may contain defects that may be costly to correct, delay market acceptance of its products and damage its reputation.
Errors may be found in GlobalSCAPE’s products after distribution. If errors are discovered, GlobalSCAPE may have to make significant expenditures of capital to eliminate them and may not be able to correct them in a timely manner or at all. Errors and failures in GlobalSCAPE’s products could result in a loss of, or delay in, market acceptance of its products and could damage its reputation.
GlobalSCAPE’s products rely on the prevalence of Windows-based operating systems and if that technology fails to maintain or improve market share, GlobalSCAPE’s products would not be as marketable.
Almost all of GlobalSCAPE’s current software products can only be used on a Windows-based operating system and are not compatible with other operating systems. Anything that affects Windows market share negatively could have a material adverse effect on the demand for GlobalSCAPE’s products.
GlobalSCAPE’s internal controls are limited, increasing the risk of employee mismanagement or error.
All of our finance, accounting and SEC disclosure work is managed by a single officer, Thomas F. Farar, Chief Financial Officer, Secretary and Treasurer. Mr. Farar has an accounting staff of two persons. Without an increase in staffing, it may still be difficult for us to implement the types of internal controls that are common to larger corporations, and we therefore face a greater risk of mismanagement or error in these areas.
Risks Related to Stock Ownership
Our stock is a penny stock, which makes it more difficult to sell.
A “penny stock” is any stock which is not traded on a national exchange or quoted on NASDAQ and which falls below a selling price of $5.00 per share in the public market. Our common stock is quoted on the NASD’s OTC Bulletin Board and not on an exchange or the NASDAQ, and it has traded from $0.10 to $4.90 since it began active trading in February 2002. The SEC’s penny stock rules require brokers and dealers to take certain steps before trading in a penny stock, making it more difficult to sell a penny stock than other stock. A sale of penny stock does not usually take place as quickly as a sale of other stock. You may decide to sell your stock when the market price is desirable to you, but by the time the sale is complete, the price of the stock may have fallen to the point that the sale is no longer desirable. The price of penny stocks is typically more volatile than other stocks, exacerbating this problem. Also, some brokers are unwilling to trade in shares of penny stocks.
Our stock price is/may be volatile.
The trading price of our common stock has been and could continue to be subject to wide fluctuations in response to certain factors, including:
• Quarter-to-quarter variations in results of operations;
• Our announcements of new products;
• Our competitors’ announcements of new products;
• Our product development or release schedule;
• General conditions in the software industry; and
• Investor perceptions and expectations regarding our products, plans and strategic position and those of our competitors and customers.
In addition, the public stock markets experience extreme price and trading volume volatility, particularly in high-technology sectors of the market. This volatility has significantly affected the market prices of securities of many technology companies for reasons often unrelated to the operating performance of the specific companies. The broad market fluctuations may adversely affect the market price of our common stock.
We do not pay dividends on our common stock.
We have not paid a dividend on our common stock and have no plan to do so in the near future.
Our principal shareholders may control our management decisions.
Thomas Brown and David Mann, own approximately 70% of our outstanding common stock. Therefore, Messers Brown and Mann are able to exercise significant influence over all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may delay or prevent a change of control of GlobalSCAPE or discourage a potential acquirer from attempting to obtain control of GlobalSCAPE, either of which could have an adverse effect on the value of our common stock.
Anti-takeover provisions in GlobalSCAPE’s charter and Delaware law could inhibit others from acquiring GlobalSCAPE.
Some of the provisions of GlobalSCAPE’s certificate of incorporation and bylaws and in Delaware law could, together or separately:
• discourage potential acquisition proposals;
• delay or prevent a change in control; and
• limit the price that investors may be willing to pay in the future for shares of GlobalSCAPE’s common stock.
In particular, GlobalSCAPE’s certificate of incorporation and bylaws provide for, among other things, limitations on the individuals that may call meetings of the stockholders and do not allow for cumulative voting. GlobalSCAPE is also subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any interested stockholder, as defined in the statute, for a period of three years following the date on which the stockholder became an interested stockholder.
Stockholders’ ownership of GlobalSCAPE stock may be significantly diluted, affecting the value of the stock.
There are options for 2,058,600 shares currently outstanding under GlobalSCAPE’s employee stock option plans as of the date of this report. Of the 2,058,600 options, 1,047,451 were vested as of March 1, 2006. We have filed a registration statement under the Securities Act of 1933, as amended (the “Securities Act”), covering stock issued upon the exercise of options by non-affiliates, and we may file a registration statement covering options held by affiliates as well. If we do not file a registration statement covering affiliates, affiliates who exercise their options may choose to sell the stock under an exemption from registration, such as Rule 144 under the Securities Act. The exercise of these options and sale of the resulting stock could depress the value of our stock.
Risks Related to Legal Uncertainty
GlobalSCAPE is vulnerable to claims that GlobalSCAPE’s products infringe third-party intellectual property rights particularly because GlobalSCAPE’s products are partially developed by independent parties.
GlobalSCAPE may be exposed to future litigation based on claims that GlobalSCAPE’s products infringe the intellectual property rights of others. This risk is exacerbated by the fact that some of the code in GlobalSCAPE’s products is developed by independent parties or licensed from third parties over whom GlobalSCAPE has less control than it exercises over internal developers. In addition, we expect that infringement claims against software developers will become more prevalent as the number of products and developers grows and the functionality of software programs in the market increasingly overlaps. Claims of infringement could require GlobalSCAPE to re-engineer its products or seek to obtain licenses from third parties in order to continue offering its products. In addition, an adverse legal decision affecting GlobalSCAPE’s intellectual property, or the use of significant resources to defend against this type of claim could place a significant strain on GlobalSCAPE’s financial resources and harm its reputation.
GlobalSCAPE may not be able to protect its intellectual property rights.
GlobalSCAPE’s software code, and trade and service marks are some of GlobalSCAPE’s most valuable assets. Given the global nature of the internet and GlobalSCAPE’s business, GlobalSCAPE is vulnerable to the misappropriation of this intellectual property, particularly in foreign markets, such as China and Eastern Europe, where laws or law enforcement practices are less developed. The global nature of the internet makes it difficult to control the ultimate destination or security of GlobalSCAPE’s software making it more likely that unauthorized third parties will copy certain portions of GlobalSCAPE’s proprietary information or reverse engineer the proprietary information used in its programs. If GlobalSCAPE’s proprietary rights were infringed by a third-party, and GlobalSCAPE did not have adequate legal recourse, GlobalSCAPE’s ability to earn profits, which are highly dependent on those rights, would be severely diminished.
Other companies may own, obtain or claim trademarks that could prevent, limit or interfere with GlobalSCAPE’s use of its trademarks.
GlobalSCAPE’s various trademarks are important to its business. If GlobalSCAPE were to lose the use of any its trademarks, its business would be harmed and GlobalSCAPE would have to devote substantial resources towards developing an independent brand identity. Defending or enforcing GlobalSCAPE’s trademark rights at a local and international level could result in the expenditure of significant financial and managerial resources.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Our corporate office is located in a technical park in northwest San Antonio called University Park Tech Center II. Our lease for the 14,700 square foot facility expires in September 2008. Our annual rent is approximately $191,000. We believe these facilities will be suitable for our current business needs and that suitable additional space will be available on acceptable terms when needed.
Item 3.
Item 3. Legal Proceedings
We are not currently involved in any material pending legal proceedings, but may become subject to legal proceedings in the ordinary course of our business. Such claims may result in the expenditure of significant financial and managerial resources.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 4A. Executive Officers of the Company
Charles R. Poole. Mr. Poole has served as GlobalSCAPE’s President since February 2004. From September 2003 until February 2004, he served as the company’s Vice President of Sales and Marketing. Mr. Poole has over twenty years of experience in senior management and sales with telecommunications companies, most recently as the President of GlobalSCAPE’s former parent company, ATSI Communications, Inc., from 1998 - 2001. Mr. Poole has served as a Senior Vice President for A+ Communications, responsible for paging, cellular and telemessaging sales from 1995 - 1997, as General Manager of American Paging, Texas from 1994 - 1995, as a Division Manager of Data Documents, Inc. of Omaha, Nebraska from 1992 - 1994, as President of GeoCom Partners, a satellite-based telecommunications company from 1989 - 1992, as Senior Vice President of MobileComm (a BellSouth Company) from 1984-1989, and as Regional Vice President of Burroughs Corp (now Unisys) from 1966-1984.
Thomas F. Farar. Mr. Farar serves as GlobalSCAPE’s Treasurer, Secretary, and Chief Financial Officer. He is responsible for all finance and accounting functions. Mr. Farar joined GlobalSCAPE in June 2004. Prior to joining GlobalSCAPE, Mr. Farar served as Senior Accounting Manager (1999-2003) and Controller (2003-2004) for UDP, Ltd., a telecommunications service bureau. Mr. Farar also served as Disbursements Supervisor for PG&E Gas Transmission - Texas in 1999. Mr. Farar was Controller and Treasurer of CDH Feeders, Inc., an agricultural operation of cattle feedlots, and affiliated companies from 1991-1998. Mr. Farar holds a B.B.A. in Accounting from The University of Texas at San Antonio.
Jeffrey Gehring. Mr. Gehring serves as GlobalSCAPE’s Vice President of Sales and has been with GlobalSCAPE since November 2004 in that capacity. Mr. Gehring is responsible for the company’s inbound sales, corporate sales and the reseller program. Mr. Gehring was employed by Nextel Partners as Director of Sales in 2004, where he coordinated sales across the country. From 2003 to 2004, Mr. Gehring was Sales Manager for GlobalSCAPE, performing the duties he presently holds. From 2002 to 2003, Mr. Gehring was a principal in a start up business, ConnectOne Telecom, where got the business off the ground from the organizational stage to operations. Prior to 2002, Mr. Gehring was Director of Sales and Marketing at UDP, a telecommunications billing, order management and customer service software company. In addition to his UDP experience, he has more than 20 years of operational and sales management experience in large and medium-sized businesses, including Unisys, Bell South and Metrocall. His experience includes strategic planning and implementation for companies that require rapid growth, as well as establishing processes and policies that foster world-class sales organizations.
Gregory Hoffer. Mr. Hoffer serves as Vice President and Chief Technology Officer and has been employed by GlobalSCAPE since May 2000. Mr. Hoffer is responsible for overseeing all software development and Web development at GlobalSCAPE. Before joining GlobalSCAPE, Mr. Hoffer held software development positions at the consulting firm of Marotz, Inc. Prior to that, Mr. Hoffer managed the IT department and was head of the computer science department at Saint Mary’s Hall, a private school in San Antonio, Texas. Mr. Hoffer received a bachelor’s degree in computer science from Trinity University and is pursuing his master’s degree in computer science.
Stefan Lagmark. Mr. Lagmark serves as Vice President of Marketing. Mr. Lagmark has been with GlobalSCAPE since August 2004 and is responsible for the overall marketing strategy of GlobalSCAPE. From 2002 to 2004, Lagmark was a principal in Lagmark Business Brokers, where he marketed the company’s services of brokering businesses in San Antonio, Texas and the surrounding area. Prior to 2002, he held the position of National Sales Manager of Gallagher Power Fence, and has held several senior management positions with multinational corporations, including that of Director of Marketing and Sales of T-Systems International, a large agricultural irrigation company and General Manager of Glo-Vet Supply, a distribution company of animal and veterinarian supplies, and a subsidiary
of De Laval. In these leadership positions, he successfully achieved growth in sales and profitability through innovative marketing programs, product and brand management, new distribution development and new market development. Stefan earned his Master’s degree in Economics and Business Administration from Stockholm School of Economics, Sweden.
K. Earl Posey. Mr. Posey serves as GlobalSCAPE’s Vice President of Strategic Development. Mr. Posey is responsible for locating technologies, partners and/or companies that fit within GlobalSCAPE’s strategies and developing relationships that will grow GlobalSCAPE’s business. Prior to joining GlobalSCAPE in January of 2006, he was Vice-president of Administration for ATSI, Inc. an international telecommunications company located in San Antonio, from 2000-2003. During 2004 and 2005, he was the Senior Principal and founder for Gossyppia Partners, a management consulting firm specializing in development of strategic management plans for corporations. Mr. Posey did his graduate and post graduate work at Vanderbilt University.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity
Our common stock is listed on the NASD’s OTC Bulletin Board under the symbol GSCP. As of February 22, 2006, there were approximately 2,550 holders of record of our common stock representing approximately 9,000 beneficial owners. GlobalSCAPE stock began trading on February 15, 2002. The table below sets forth the quarterly high and low bid prices for our common stock for the last two fiscal years.
Common Stock Price
The closing bid price on March 6, 2006 was $2.72. Over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission and may not necessarily represent actual transactions.
We have never paid a cash dividend, and do not expect to do so in the foreseeable future. We expect to reinvest all of our earnings in the further growth of the business.
Item 6.
Item 6. Selected Financial Data
The selected financial data presented below for the years ended December 31, 2001, 2002, 2003, 2004 and 2005 are derived from our audited financial statements.
Statement of Operations Data:
Balance Sheet Data:
Item 7.
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, 2003, 2004 and 2005 and related notes included elsewhere in this document.
Overview
GlobalSCAPE develops and distributes secure file management software that enables users to safely send data over the internet. Our products guarantee the privacy of critical information such as financial data, medical records, customer files and other similar documents. In addition, our products ensure compliance with government regulations relating to the protection of information while allowing users to reduce IT costs, increase efficiency, track and audit transaction and automate processes. We also develop and distribute Web content management and Web development tools.
Since 2000, we have focused on enhancing our portfolio of products to meet the increasing demand for data security, and for solutions that permit non-technical personnel to contribute content to their organizations’ Web sites. 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 the security features of our current product line. We believe that the next phase of our growth will come through the continued development of our secure FTP Server and Enhanced File Transfer products involving secure file transfer to meet the growing demand for file security when transferring information across the internet due to changes in regulations in various industries and the demand of users for secure solutions. We are encouraged with the interest we have seen in our enhanced file transfer offerings so far, with sales exceeding our expectations. We intend to release new versions of CuteFTP, CuteFTP Pro and Secure FTP Server early in 2006 and we believe we can slow the decline in sales of CuteFTP and improve sales of CuteFTP Pro and Secure FTP Server. We plan on releasing additional versions of EFT and modules for it throughout 2006.
Substantially all software products ultimately reach a point in their lifecycle in which sales can be expected to plateau or decline. Management believes that the market for stand-alone FTP client programs for home consumers may be declining. While it cannot be determined with certainty, CuteFTP and CuteFTP Pro may have reached such a point in their lifecycles. In order to respond to this decline, we have begun concentrating on product offerings for business users. We have not seen the same decline in the market for secure FTP client programs and servers such as CuteFTP Pro and Secure FTP Server which we believe better target the needs of businesses.
Our shift to emphasizing product offerings for business users will have important consequences for our business. GlobalSCAPE will require more technical sales and support persons to handle the complex configurations of customer systems as the customer base grows. More difficult and different situations will arise as customer needs grow. We will need to have the ability to understand and solve technical issues in a timely manner. With increased sales to business we should realize additional revenues from maintenance and support agreements to support the additional personnel.
Liquidity and Capital Resources
Our capital requirements are driven principally by our need to enhance our existing products and to develop new products. The amount of our capital expenditures has a direct impact on our ability to offer enhanced and new products to our customers. Our principal source of capital is cash flow from operations which, in turn, is highly dependent on our sales revenue. Historically, we have relied heavily on sales of CuteFTP Home and CuteFTP Professional, which accounted for 69% and 50% of our revenues in the years ended December 31, 2004 and 2005, respectively. Newer products in 2005, namely Enhanced File Transfer and Secure FTP Server, have increased our total revenue while reducing the percentage of total revenue previously held by the two CuteFTP products.
Our principal sources of capital are cash on hand and cash flow from operations. To the extent that sales decline, our cash flow from operations will also decline. If sales decline or our liquidity otherwise requires, management may substantially reduce personnel and personnel-related costs, reduce or substantially eliminate capital expenditures and/or reduce or substantially eliminate research and development expenditures.
Net cash provided (used) by operating activities was ($105,548), $384,314 and $1,549,636 in 2003, 2004 and 2005, respectively. Net cash used in operating activities in 2003 was primarily the result of the net loss for the period offset somewhat by depreciation and amortization charges for the period. In 2004, net cash provided resulted from an increase in net income primarily as a result of increased revenues, adjustments related to depreciation and amortization as well as decreased accounts receivable. Net cash provided by operating activities in 2005 was primarily due to an increase in net income primarily as a result of increased revenues, offset by an increase in accounts receivable, accrued liabilities and deferred revenue and a decrease in accounts payable.
Net cash used in investing activities for 2003, 2004 and 2005 was $73,207, $42,250, and $102,062 respectively. In 2003, 2004 and 2005, we capitalized the purchase of $73,027, $42,250 and $103,304 in equipment and software, respectively.
Net cash provided (used) in financing activities during 2003, 2004 and 2005 was $ 40,399, ($111,538) and $8,940, respectively. In 2003, we made principal payments of $61,317 on capital lease obligations and borrowed $100,000 under our line of credit and received $1,716 for the exercise of stock options. In 2004, we made principal payments on notes payable of $100,000 and made principal payments of $15,294 on capital lease obligations and received $3,756 for the exercise of stock options. In 2005, we received $8,940 for the exercise of stock options. We did not enter into any new capital leases in 2004 or 2005.
As of December 31, 2005, we had $2,029,473 in cash and cash equivalents, current assets of $2,685,505 and current liabilities of $849,673, resulting in working capital of $1,835,832. This represented a working capital improvement of $1,494,083 over December 31, 2004. Our principal commitments at December 31, 2005, consisted of obligations outstanding under operating leases as well as royalty agreements with third parties. The commitments related to royalty agreements are contingent on sales volumes. We plan 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, but will manage the business based on the immediately foreseeable operating cash flows. The facility that we currently occupy is expected to be sufficient for the next twelve months. Consequently, we do not anticipate significant expenditures for leasehold improvements or furniture for 2006.
We do not currently have any commitments for outside sources of capital. At December 31, 2005, we had a $250,000 revolving credit agreement which expires on March 31, 2006. We believe that, if necessary, we could enter into a similar arrangement in the future, although we cannot assure you that we will be able to do so. We may also sell equity securities in order to finance future acquisitions or licensing activities.
The following table summarizes our contractual obligations at December 31, 2005, consisting of future minimum capital lease payments and future minimum payments under operating leases:
Critical Accounting Policies
Use of Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon the Company’s financial statements, which have been prepared in accordance with accounting principles generally accepted in the Unites 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 and contingencies. 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. In periods where we had revenue from advertising, we recognized the net proceeds received from advertisers as revenue. 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. The majority of our sales are delivered electronically via email.
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. We sometimes sell installation and training services with our PureCMS and EFT products. Revenue for installation and training is recognized when performed.
The Company began selling technical support and maintenance services for some of its software products in 2001. Deferred revenue grew to a balance of approximately $142,000 at December 31, 2002 and remained relatively flat, ending 2003 with a balance of approximately $140,000. Sales of these agreements grew in 2004 and 2005 with higher priced support and maintenance for our enterprise class software products and our efforts to renew agreements upon their expiration. Growth in the sales of maintenance and support agreements may result in the deferred recognition of a significant amount of revenue in future periods.
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 net revenues in 2003 or 2004. In 2005, we had one customer that accounted for approximately 2.6% of net revenues.
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 2003, 2004 or 2005.
Stock-Based Compensation
The Company measures compensation expense for its stock-based employee compensation plans, which are described in Note 8. 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. On December 31, 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 continued to account for its stock-based compensation according to the provisions of APB Opinion No. 25. The pro forma disclosure requirements prescribed by SFAS 123, as amended by SFAS 148 are included in Note 1 to the Financial Statements.
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 first quarter of 2006, 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.
See note 1 to the financial statements on page 44 under the heading Stock Options. The Company will adopt the fair value method of accounting for stock options during the first quarter of 2006.
Research and Development
Research and development expenses include all direct costs, primarily salaries for personnel and expenditures with external development sources, related to the development of new products and significant enhancements to existing products and are expensed as incurred until such time as technological
feasibility is achieved. For the years 2003, 2004 and 2005, we spent approximately $945,000, $728,000 and $870,000 respectively, on research and development. No research and development expenses were capitalized in 2003, 2004 or 2005 and all previously capitalized research and development expenses were fully amortized at December 31, 2002.
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 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 are carried on the balance sheet with the presumption that they will be realizable in future periods when pre-tax income is generated. Predicting the ability to realize these assets in future periods requires a great deal of judgment by management. Although we have generated pre-tax income in previous years, unusual or infrequently occurring transactions resulted in pre-tax losses in 2001 and 2002 (compensation charges in 2001 and the settlement with ATSI and termination of CEO in 2002). 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. After consideration of all of the evidence, both positive and negative, management determined that a $540,350 valuation allowance at December 31, 2003 and $484,853 valuation allowance at December 31, 2004, was necessary to reduce the deferred tax assets to the amount that will more likely than not be realized. No allowance was considered necessary at December 31, 2005. The change in the valuation allowance for the current year is a net decrease of $484,853.
Comparison of Year Ended December 31, 2005 to Year Ended December 31, 2004
Revenue. We derive our revenues primarily from software sales. Revenue is comprised of the gross selling price of software, including shipping charges and the earned portion of support and maintenance agreements. Revenues increased approximately 39% from 2004 to 2005, from $4,930,660 in 2004 to $6,833,048 in 2005. Unit volume decreased with approximately 170,000 licenses sold in 2004 versus 124,000 sold in 2005. The decrease in unit volumes was offset by an increase in the average selling price of our products from $39.66 in 2004 to $58.87 in 2005 as a result of increased sales of our enhanced file transfer offerings. The increase in revenues was up quarter over quarter in 2005 compared to the same quarters in 2004. We believe the economic uncertainty in the first three quarters of 2004 contributed to those periods’ poor performance along with the turnover in our sales force. Our fourth quarter revenues in 2004 increased approximately 11% over the same quarter in 2003 and approximately 56% in the fourth quarter 2005 over 2004.
In 2004 and 2005, approximately 69% and 50%, respectively, of our revenues were generated from sales of CuteFTP and CuteFTP Pro. Combined sales of these products increased approximately 1% in revenue year over year. Sales of CuteFTP declined approximately 22% while sales of CuteFTP Pro increased approximately 18%. Those changes were the result of the continuing maturity of CuteFTP and the increasing demand by business users of CuteFTP Pro. CuteFTP Pro has more features and is designed for business use, whereas CuteFTP is for home use only. Users are moving to CuteFTP Pro for the advanced features and security levels. Our reliance on these products may negatively impact future results from operations if we are unable to maintain revenues from these products or successfully introduce new product offerings. The relatively flat sales performance of CuteFTP and CuteFTP Pro was offset by an increase in sales of our Secure Server and Enhanced File Transfer products. Sales of these products grew from 14% of our revenues in 2004 to 43% in 2005. This increase was the result of the needs of businesses to transfer files in a secure fashion using business or enterprise level software. In addition, because of the more complex nature of these products, purchasers require increased maintenance and support. As a result, our maintenance and support revenues increased by 239% from 2004 to 2005 from $217,469 in 2004 to $737,003, net of deferred revenue. Our maintenance and support revenues are generally recognized over the life of the agreement, which is discussed further under the Deferred Revenue section of Item 7.
Cost of Revenues. Cost of revenues consists primarily of royalties, a portion of our bandwidth costs as well as production, packaging and shipping costs for boxed copies of software products. Cost of revenues decreased by approximately 25% between periods from $371,242 in 2004 to $279,964 in 2005 due to a decrease in royalty expenses related to our software distribution agreements with third parties. Royalties that we pay on software products licensed from third parties, which we resell, are expensed as a cost of sales when the software product is sold or earlier if the recoverability of any prepaid royalties is in doubt. We expect the cost of revenues to remain consistent both as a percentage of sales and in gross terms in 2006 when compared to 2005.
Selling, General and Administrative. Selling, general and administrative expenses consist primarily of personnel and related expenses, marketing, customer support, professional fees, rent, bad debt and credit card transaction fees. Selling, general and administrative expenses increased by approximately 15% from $3,456,598 in 2004 to $3,989,372 in 2005. The number of persons employed by GlobalSCAPE was reduced from 45 to 36 in February 2004. As of March 1, 2006 the number of employees was 41.
Research and Development. Research and development expenses increased by approximately 19% from $727,000 in 2004 to $870,000 in 2005. Included in the research and development expenses, external development costs increased approximately 48% from 2004 to 2005. External development was increased in order to maintain the scheduled releases of CuteFTP, CuteFTP Pro, Secure FTP Server, and EFT.
Depreciation and Amortization. Depreciation and amortization expense consists of depreciation expense related to our fixed assets and the amortization of the trademark associated with our purchase of CuteFTP in 1998. Depreciation and amortization expense declined by $73,763 or approximately 43% year over year. This decrease was due primarily to a reduction in amortization expense. The purchase of CuteFTP was fully amortized as of September 20, 2003. In addition, depreciation expense has declined due to a slowdown in additions to fixed assets in current periods relative to prior periods.
Other Income (Expense), Net. In 2004, we had interest expense of $1,651 related primarily to an advance on our line of credit and financing of insurance premiums. In 2005, we had interest expense of $620 related primarily to the financing of insurance premiums. During 2005, we had interest income of $10,685 as a result of interest earned on excess cash balances. During 2005, we had a gain of $1,242 on the sale of fully depreciated fixed assets.
Income Taxes. The provision for state income taxes in 2004 was $1,489 and there was no provision for federal income taxes in 2004. GlobalSCAPE’s effective income tax rate was 0.7% and differs from the federal rate primarily because of a change in the valuation allowance for deferred tax assets. The provision for state income taxes in 2005 was $1,065 and the provision for federal income taxes was $65,546 in 2005. GlobalSCAPE’s effective income tax rate is 4.1% and differs from the federal rate primarily because of a change in the valuation allowance for deferred tax assets. The Company utilized net operating loss carryforwards in 2004 to eliminate its Federal income tax expense and utilized the remaining net operating loss carryforwards in 2005 to substantially reduce its Federal income tax expense.
Net Income. In 2004, net income was primarily the result of a slight increase in revenue, a decrease in the cost of revenues, SG&A, research and development and depreciation costs. Significant effort was put in to controlling expenses in 2004, including the layoff of 9 employees. In 2005, net income was primarily the result of the introduction of our Enhanced File Transfer product and the features added to our Secure FTP Server product, resulting in an increase in revenue, while we continued to control expenses.
Comparison of Year Ended December 31, 2004 to Year Ended December 31, 2003
Revenue. We derive our revenues primarily from software sales. Revenue is comprised of the gross selling price of software, including shipping charges and the earned portion of support and maintenance agreements. Revenues increased approximately 2% from 2003 to 2004, from $4,847,119 in 2003 to $4,930,660 in 2004. Unit volume was relatively flat with approximately 175,000 sold in 2003
versus 170,000 in 2004. The increase in revenues was pronounced in the fourth quarter when compared to the same period in 2003. We believe the economic uncertainty in the first three quarters of 2004 contributed to those periods’ poor performance along with the turnover in our sales force. Our fourth quarter revenues increased approximately 11% over the same quarter in 2003.
In 2003 and 2004, approximately 75% and 69%, respectively, of our revenues were generated from sales of CuteFTP and CuteFTP Pro. Combined sales of these products declined approximately 7% year over year as a result of the changing needs of individuals and business to transfer files on the internet. Sales of CuteFTP declined approximately 36% while sales of CuteFTP Pro increased approximately 41%. The shift in revenue from CuteFTP to CuteFTP Pro was due to additional features in CuteFTP Pro that businesses and individuals required to securely transfer files across the internet. Our reliance on these products may negatively impact future results from operations if we are unable to maintain revenues from these products or successfully introduce new product offerings. In November 2004, GlobalSCAPE introduced its Enhanced File Transfer product to meet the growing needs of businesses to comply with requirements of businesses to transfer sensitive information securely.
Cost of Revenues. Cost of revenues consists primarily of royalties, a portion of our bandwidth costs as well as production, packaging and shipping costs for boxed copies of software products. Cost of revenues decreased approximately 30% between periods from $532,910 in 2003 to $371,242 in 2004 due to a decrease in royalty expenses related to our software distribution agreements with third parties. Royalties that the Company pays on software products licensed from third parties, which it resells, are expensed as a cost of sales when the software product is sold or earlier if the recoverability of any prepaid royalties is in doubt. GlobalSCAPE no longer distributes the Protect IIS product and expensed prepaid royalties of approximately $15,000 in December 2003. GlobalSCAPE’s agreement with Hannon Hill Corp. required a minimum royalty of $16,667 per month, as prepayment of royalties, for 12 months beginning in December 2002. These payments were expensed as paid because the lower than expected sales of PureCMS raised doubt as to the realization of benefit from these prepayments. The total amount expensed in 2003 relating to these prepayments was $183,337.
Selling, General and Administrative. Selling, general and administrative expenses consist primarily of personnel and related expenses, marketing, customer support, professional fees, rent, bad debt and credit card transaction fees. Selling, general and administrative expenses decreased approximately 4% a year from $3,613,759 in 2003 to $3,456,598 in 2004 as a result of a decrease in the number of employees in 2004. The number of persons employed by GlobalSCAPE was reduced from 45 to 36 in February 2004.
For comparative purposes, selling, general and administrative expenses for 2003 includes approximately $540,000 in advertising expenses, relating primarily to the launch of the PureCMS product, as compared to $205,000 in 2004. Selling, general and administrative expenses also include approximately $134,900 in amortization of the CuteFTP trademark in 2003, when it was fully amortized.
Research and Development. Research and development expenses decreased approximately 23% from $945,395 in 2003 to $727,423 due to a reduction in the number of employees in 2004 and related salaries, payroll taxes and benefits costs. External development costs increased approximately 11% from 2003 to 2004. External development was increased to offset the loss of internal labor due to the layoff in order to maintain the scheduled releases of CuteFTP, CuteFTP Pro, Secure FTP Server, PureCMS and EFT.
Depreciation and Amortization. Depreciation and amortization expense consists of depreciation expense related to our fixed assets and the amortization of the trademark associated with our purchase of CuteFTP in 1998. Depreciation and amortization expense declined $218,320 or approximately 56% year over year. This decrease was due primarily to a reduction in amortization expense. The purchase of CuteFTP was fully amortized as of September 2003. In addition, depreciation expense has declined due to a slowdown in additions to fixed assets in current periods relative to prior periods.
Interest Expense, Net. In 2003, we had interest expense of $5,016 related primarily to capital leases. In 2004, we had interest expense of $1,651 related primarily to an advance on our line of credit and financing of insurance premiums.
Income Taxes. The provision for state income taxes in 2003 was $1,400 and there was no provision for federal income taxes in 2003. GlobalSCAPE’s effective income tax rate was negative 0.2% and differs from the federal rate primarily because of a change in the valuation allowance for deferred tax assets. The provision for state income taxes in 2004 was $1,489 and there was no provision for federal income taxes in 2004. GlobalSCAPE’s effective income tax rate is 0.7% and differs from the federal rate primarily because of a change in the valuation allowance for deferred tax assets. The Company utilized its net operating loss carryforwards in 2004 to reduce its Federal income tax expense.
Net Income. In 2003, the net loss was primarily the result of disappointing revenue performance in the first and fourth quarters exacerbated by the product launch expenses related to PureCMS. In 2004, the net income was primarily the result of a slight increase in revenue, a decrease in the cost of revenues, SG&A, research and development and depreciation costs. Significant effort was put in to controlling expenses in 2004, including the layoff of 9 employees.
Item 7A.
Item 7A. 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 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 any currency translation involved in the remittance of VAT taxes will not be material to our business.
Item 8.
Item 8. Financial Statements and Supplementary Data
GlobalSCAPE, Inc.
Index to Consolidated Financial Statements
Years ending December 31, 2003, 2004 and 2005
Contents
Report of Independent Registered Public Accounting Firm - Helin, Donovan,
Trubee & Wilkinson, LLP
Report of Independent Registered Public Accounting Firm - Ernst & Young, LLP
Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
GlobalSCAPE, Inc.:
We have audited the accompanying consolidated balance sheets of GlobalSCAPE, Inc. (the Company) as of December 31, 2004 and 2005, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of GlobalSCAPE, Inc. as of December 31, 2004 and 2005, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles in the United States of America.
Helin, Donovan, Trubee & Wilkinson, LLP
February 17,
Austin, Texas
Report of Independent Registered Public Accounting Firm
To the Board of Directors
GlobalSCAPE, Inc.
We have audited the accompanying consolidated statements of operations, stockholders’ equity and cash flows of GlobalSCAPE, Inc. for the year ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provided a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of GlobalSCAPE, Inc. for the year ended December 31, 2003 in conformity with accounting principles generally accepted in the United States.
Ernst & Young LLP
San Antonio, Texas
February 27, 2004
GlobalSCAPE, Inc.
Consolidated Balance Sheets
GlobalSCAPE, Inc.
Consolidated Balance Sheets
See accompanying notes.
GlobalSCAPE, Inc.
Consolidated Statements of Operations
See accompanying notes.
GlobalSCAPE, Inc.
Consolidated Statements of Stockholders’ Equity
See accompanying notes.
GlobalSCAPE, Inc.
Consolidated Statements of Cash Flows
See accompanying notes.
See accompanying notes.
GlobalSCAPE, Inc. Notes to Consolidated Financial Statements December 31, 2004 and 2005
1. Overview of the Business and Significant Accounting Policies
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. was approximately 70% owned by the Brown and Mann-GlobalSCAPE Joint Venture, with the remainder held publicly. In October 2004, the Brown and Mann-GlobalSCAPE Joint Venture began distribution of its GlobalSCAPE stock to its two partners in their respective percentages. Prior to December 31, 2005, the partnership had completed its distribution. GlobalSCAPE, Inc. is a holding company and conducts no operations. 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.
Nature of Business
GlobalSCAPE, founded in April 1996, develops and distributes Internet related software. The Company is best known for its popular file transfer program, CuteFTP. Sales of CuteFTP and CuteFTP Pro accounted for 69% and 50% of total revenues in 2004 and 2005, respectively. Secure FTP Server accounted for approximately 14% of total revenues in 2004 and 22% in 2005, increasing from 7% of total revenues in 2003. The Company derives its revenues primarily from sales of licenses to use its software products. The Company is organized and operates as one operating segment, the provision of Internet-based software, which it markets over the Internet and through its direct internal sales force.
Basis of Presentation
The preparation of financial statements in conformity with accounting principles generally accepted in the Unites States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include all subsidiaries. All inter-company transactions and balances have been eliminated.
Liquidity
The Company incurred significant operating losses during 2001, 2002 and 2003 and continued, in January, February and March of 2004, to incur significant operating losses. In February 2004 GlobalSCAPE reduced its workforce by 20%, laying off 9 of the 45 people then employed by the Company.
The Company is highly dependent on the sale of two software products, CuteFTP and CuteFTP Pro, which are subject to technological and competitive obsolescence. Sales from these two products, which represented 50% of the Company’s revenues in 2005, increased 1% in revenue from the previous year. This increase was primarily in sales of CuteFTP Pro, which increased 18%. Sales of CuteFTP decreased 22% year over year and sales of Secure FTP Server, the companion product to CuteFTP Pro, increased 119%. Secure FTP Server accounted for approximately 14% and 22% in 2004 and 2005 respectively of total revenues. 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 may have reached such a point in its lifecycle. 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 Pro and Secure Server which we believe better target the needs of businesses.
The Company’s liquidity could be reduced in 2006 if sales of CuteFTP continue to decline and the Company is unable to successfully introduce new products or increase sales of existing products.
If sales decline or the Company’s liquidity otherwise requires, management has the intent and ability to reduce personnel and personnel-related costs, reduce or substantially eliminate capital expenditures and/or reduce or substantially eliminate research and development expenditures.
Revenue Recognition
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.
The Company also sells 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 in 2001. In 2004 and 2005, sales of enterprise class products resulted in higher maintenance and support agreements sold to customers and as a result deferred revenue at December 31, 2005 was $406,145.
The outbound shipping charges charged to the customer are included in software product revenues and amounted to approximately $58,000, $38,000 and $18,000 in 2003, 2004 and 2005, respectively. The costs associated with these shipping charges are included in the software products cost of revenue.
Royalty Costs
Royalties that the Company pays on software products licensed from third parties, which it resells, are expensed as a cost of sales 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 Glueck and Kanja. The GlobalSCAPE software products associated with each of the companies are PublishXML, CuteSITE Builder, Web Survey, Mac FTP, CuteHTML Pro and Enhanced File Transfer (EFT), respectively. GlobalSCAPE’s agreement with Hannon Hill Corp. required a minimum royalty of $16,667 per month, as prepayment of royalties, for 12 months beginning in December 2002. These payments were expensed as paid because the lower than expected sales of PureCMS raised doubt as to the realization of benefit from these prepayments. The total amount expensed in 2003 relating to these prepayments was $183,337. The Company accrued approximately $36,000, $11,000, and $10,000 in royalty expense in 2003, 2004 and 2005, respectively.
Concentrations of Credit Risk and Significant Customers
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, and accounts receivable. Cash is deposited in demand accounts in federally insured domestic institutions to minimize risk. The Company provides credit, in the normal course of business, to a number of companies and performs ongoing evaluations of its credit risk. The Company requires no collateral from its customers. Management estimates the allowance for uncollectible accounts based on their historical experience and credit evaluation. No single customer accounted for more than 2% of revenues in 2003 or 2004. One customer accounted for approximately 2.6% of revenues in 2005.
Cash and cash equivalents, accounts receivable, employee advances, accounts payable, accrued expenses and notes payable, related party are reflected in the accompanying financial statements at cost, which approximates fair value because of the short term maturity of these instruments.
Other Concentrations
Sales in Foreign Markets. In 2003, 2004 and 2005, approximately 35%, 36% and 33%, respectively, of the Company’s revenues were generated from sales to customers who provided addresses in foreign countries. However, all revenues are received in U.S. dollars so there is no exchange rate risk with respect to the sale of our products. These sales were concentrated mostly in Western Europe, Canada, and Australia. In 2003, 2004 and 2005, the UK accounted for approximately 11.1%, 10.9% and 9.25%, respectively, of total revenues.
Labor. GlobalSCAPE utilizes offshore developers for a large portion of the coding phase of software development. If GlobalSCAPE were unable to continue using these developers because of political or economic instability, GlobalSCAPE may have difficulty finding comparably skilled developers or may have to pay considerably more for the same work, which would have a material adverse impact on results of operations.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expenses charged to operations for the years ended December 31, 2003, 2004 and 2005 were approximately $542,000, $205,000 and $300,000, respectively, and are included in selling, general and administrative expenses. The advertising expenses in 2003 relate primarily to the PureCMS product launch. In 2004 and 2005, the Company incurred advertising cost principally for the purchase of keywords for internet searches, a direct mail campaign for EFT, trade show participation and advertising in various publications.
Income Taxes
The Company 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 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 are carried on the balance sheet with the presumption that they will be realizable in future periods when pre-tax income is generated. GlobalSCAPE recorded a deferred tax asset of $51,983 at December 31, 2005 as a result of its taxable income for the year. 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. After consideration of all of the evidence, both positive and negative, management determined that a valuation allowance was necessary at December 31, 2004. No valuation was considered necessary at December 31, 2005. During 2005 a decrease in the valuation allowance of $484,853 at was necessary to
decrease the valuation allowance for the benefit of the net operating loss carryforward benefit utilized in the current year.
Research and Development
Research and development expenses include all direct costs, primarily salaries for personnel and expenditures with external development sources, related to the development of new products and significant enhancements to existing products and are expensed as incurred until such time as technological feasibility is achieved. For the years 2003, 2004 and 2005, we spent approximately $945,000, $728,000 and $870,000, respectively, on research and development. Typically technological feasibility is achieved very late in the development cycle and as such no research and development expenses were capitalized in 2003, 2004 or 2005 and all previously capitalized research and development expenses were fully amortized at December 31, 2002.
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. On December 31, 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 has continued to account for its stock-based compensation using the intrinsic value method 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 at the grant date is amortized to expense over the options’ estimated vesting period. The Company’s pro forma information for 2003, 2004 and 2005 follows:
The weighted average fair value of the individual stock options granted during 2003, 2004, and 2005 is estimated at $0.20, $0.11 and $0.31, respectively, on the date of grant. The fair values were determined using a minimum value options-pricing model with the following assumptions:
Cash and cash equivalents
Cash includes all cash and highly liquid investments with original maturities of three months or less.
Property and Equipment
Property and equipment is comprised of furniture and fixtures, software, computer equipment and leasehold improvements which are recorded at cost and depreciated using the straight-line method over their estimated useful lives. Expenditures for maintenance and repairs are charged to operations as incurred. Property and equipment acquired under capital leases are depreciated over their useful lives or the respective lease term, if shorter. Depreciation periods used for property and equipment range from three to five years.
Leasehold improvements are depreciated over the shorter of the lease term or the estimated useful life of the asset.
Sale / Disposal of Assets
During 2005, the Company disposed of equipment and software with an original purchase price of $29,949 and accumulated depreciation of $29,949. GlobalSCAPE recognized a gain of $1,242 related to the disposal of these assets. During 2004 the Company disposed of equipment and software with an original purchase price of $31,494 and accumulated depreciation of $31,494. GlobalSCAPE recognized no gain or loss related to the disposal of these assets. During 2003 the Company disposed of equipment and software with an original purchase price of $69,738 and accumulated depreciation of $68,252. GlobalSCAPE recognized a loss of $1,486 related to the disposal of these assets.
Capitalized Software Development Costs
Capitalization of software development costs begins upon the establishment of technological feasibility and ceases when the product is available for general release. The establishment of technological feasibility and the ongoing assessment of recoverability of capitalized software development costs require considerable judgment by management concerning certain external factors including, but not limited to, technological feasibility, anticipated future gross revenue, estimated economic life and changes in software and hardware technologies. These software development costs were amortized using the straight-line method over a three-year period and are only those costs incurred in the development of products that are sold to external customers and not used for internal purposes. No research and development expenses were capitalized in 2003, 2004 or 2005 and all previously capitalized research and development expenses were fully amortized at December 31, 2002. These software development costs are not related to those costs
incurred for the acquisition of software products or titles. For the years 2003, 2004 and 2005, we spent approximately $945,000, $728,000 and $870,000, respectively, on research and development.
Other Long-Term Assets
Costs incurred for the acquisition of CuteFTP were capitalized and amortized over the estimated useful life of five years using the straight-line method. The Core Software Technology on the balance sheet represents the purchase of the source code and related trademark for CuteFTP and the related amortization of these costs. GlobalSCAPE recognized amortization expense related to CuteFTP of approximately $135,000 in 2003. The asset was fully amortized at December 31, 2003.
Other assets include deposits for facilities, which are anticipated to be refunded to the Company upon termination of the lease.
Deferred Compensation
The deferred compensation liability is related to an employment agreement with the President. The deferred compensation is subject to certain terms and conditions related to his planned retirement in December 2008.
Other Long-Term Liabilities
Other long-term liabilities relate to deferred payments of rent expense. The total amount of base lease payments is being charged to expense on the straight-line method over the term of the lease.
Earnings Per 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 following years:
(1) For the year ended December 31, 2003, 1,856,171 options have not been included in dilutive shares as the effect would be anti-dilutive.
(2) For the year ended December 31, 2004, 882,000 options have not been included in dilutive shares as the effect would be anti-dilutive.
(3) For the year ended December 31, 2005, all options have been included in dilutive shares.
Recent Accounting Pronouncements
Effective July 1, 2005, the Company adopted SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of Accounting Principles Board (“APB”) Opinion No. 29 (“SFAS 153”). SFAS 153 amended prior guidance to eliminate the exception for nonmonetary exchanges of similar productive assets and replaced it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of SFAS 153 were required to be applied prospectively. SFAS 153 did not have a material impact on the Company’s unaudited interim condensed consolidated financial statements.
In June 2005, the EITF reached consensus on Issue No. 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights (“EITF 04-5”). EITF 04-5 provides a framework for determining whether a general partner controls and should consolidate a limited partnership or a similar entity in light of certain rights held by the limited partners. The consensus also provides additional guidance on substantive rights. EITF 04-5 was effective after June 29, 2005 for all newly formed partnerships and for any pre-existing limited partnerships that modified their partnership agreements after that date. The adoption of this provision of EITF 04-5 did not have a material impact on the Company’s unaudited interim condensed consolidated financial statements. EITF 04-5 must be adopted by January 1, 2006 for all other limited partnerships through a cumulative effect of a change in accounting principle recorded in opening equity or it may be applied retrospectively by adjusting prior period financial statements. The adoption of this provision of EITF 04-5 is not expected to have a material impact on the Company’s unaudited interim condensed consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3 (“SFAS 154”). The statement requires retrospective application to prior periods’ financial statements for a voluntary change in accounting principle unless it is deemed impracticable. It also requires that a change in the method of depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate rather than a change in accounting principle. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. SFAS 154 is not expected to have a material impact on the Company’s unaudited interim condensed consolidated financial statements.
In December 2004, the FASB issued SFAS 123 (revised 2004) Share-Based Payment (“SFAS 123(r)”), which revised SFAS No. 123, Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123(r) provides additional guidance on
determining whether certain financial instruments awarded in share-based payment transactions are liabilities. SFAS 123(r) also requires that the cost of all share-based transactions be measured at fair value and recognized over the period during which an employee is required to provide service in exchange for an award. The SEC issued a final ruling in April 2005 allowing a public company that is not a small business issuer to implement SFAS 123(r) at the beginning of the next fiscal year after June 15, 2005. Thus, the revised pronouncement must be adopted by the Company by January 1, 2006. As permitted under SFAS 148, Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123, the Company elected to use the prospective method of accounting for stock options granted subsequent to December 31, 2002. Options granted prior to January 1, 2003 will continue to be accounted for under the intrinsic value method until the adoption of SFAS 123(r). In addition, the pro forma impact of accounting for these options at fair value will continue to be accounted for under the intrinsic value method until the last of those options vest in 2005. The adoption of SFAS 123(r)® is expected to increase compensation expense during period that employees vest in their stock options.
2. Accounts Receivable
Accounts receivable, which are primarily from sales of software licenses, are presented net of an allowance for doubtful accounts. The activity of the Company’s allowance for doubtful accounts for the years ended December 31, 2003, 2004 and 2005 is presented in the following table:
(1) Represents amounts written off as uncollectible accounts receivable.
3. Debt
The Company has obtained a $250,000 revolving line of credit agreement with a commercial bank. The line of credit expired in December 2004, when it was renewed and extended through March 2006. The line is due on demand, but if no demand then in March 2006. The interest rate is subject to change and is indexed to the bank’s prime rate. The rate at December 31, 2005 was 9.25%. 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 property and equipment. The Company borrowed $100,000 on September 11, 2003 under this agreement. This amount remained outstanding at December 31, 2003 and was repaid in February 2004. The Company does not intend to renew this line of credit.
4. Commitments and Contingencies
Capital Leases
The Company had financed the acquisition of certain fixed assets through capital lease obligations. These obligations were paid in full in 2004. As of December 31, 2005 GlobalSCAPE had no capital lease obligations.
Property and equipment at December 31, 2003 and 2004 includes $227,000 for assets held under capital leases, less associated accumulated depreciation of $203,000 and $227,000, respectively. Depreciation for assets held under capital leases is included in depreciation and amortization expense.
Operating Leases
Minimum future lease payments on non-cancelable operating leases for office facilities are as follows for the years ending December 31:
This lease provides the Company with two successive 5-year renewal options. Operating lease expense amounted to approximately $180,000 in each of 2003, 2004 and 2005.
Contingencies
The Company from time to time may be involved in litigation relating to claims arising out of its ordinary course of business. There are no pending claims against the Company that would have a material adverse effect on the financial statements of the Company.
5. Related Party Transactions
On June 11, 2002, ATSI sold its majority interest in GlobalSCAPE, Inc. to Brown and Mann-GlobalSCAPE Joint Venture, a Texas general partnership owned by San Antonio-based investors Thomas W. Brown and David L. Mann. Contemporaneously with this transaction, GlobalSCAPE agreed to compromise and settle a $612,304 inter-company balance owed to it by ATSI, which resulted in charges to GlobalSCAPE of $392,905. The balance was settled for (i) $200,000 in cash from ATSI; (ii) NTFC Capital Corporation’s release of GlobalSCAPE as a co-borrower on a capital lease executed by ATSI in 1999, and (iii) ATSI’s agreement to provide $50,000 worth of transition support services to GlobalSCAPE over the nine months ending March 11, 2003.
On March 30, 2004, the Company obtained a $200,000 line of credit with the Brown and Mann-GlobalSCAPE Joint Venture. The line of credit was available after June 21, 2004 if the Company failed to extend a line of credit with a bank and matured on December 31, 2004. The line of credit with the partnership was not renewed. The interest rate was subject to change and was indexed to the prime rate published in the Wall Street Journal. In connection with the line of credit, GlobalSCAPE entered into a Commercial Security Agreement with the Brown and Mann-GlobalSCAPE Joint Venture whereby GlobalSCAPE granted a security interest in all its accounts receivable and property and equipment. The Brown and Mann-GlobalSCAPE Joint Venture is 70% owned by Thomas W. Brown and 30% owned by David L. Mann, both of whom are members of GlobalSCAPE’s Board of Directors. In October 2004 the Brown and Mann-GlobalSCAPE Joint Venture distributed all shares held by the partnership to its two partners with the exception of 17,856 shares, which were distributed in 2005.
6. Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities are related to the following:
A reconciliation of income tax expense and the amount computed by applying the statutory federal income tax rate (34%) to income before income taxes is as follows:
At December 31, 2005 the Company has utilized its available net operating loss carryforwards for both financial reporting and Federal income tax reporting purposes.
7. Employee Benefit Plan
The Company has a 401(k) plan that covers substantially all employees with at least six months of service. Under the plan, employees may elect to contribute a percentage of their annual salary subject to the Internal Revenue Code maximum limitations. The plan provides for employer matching and discretionary contributions, the amounts of which are to be determined annually by the Board of Directors. The Company made contributions to the plan of $7,533, $6,910 and $11,120 for the years ended December 31, 2003, 2004 and 2005, respectively.
8. Stock Options and Stock Based Compensation
In January 1998, the Company approved the 1998 Stock Option Plan (the “1998 Plan”) for officers, other employees, directors, and consultants of the Company. Under the terms of the 1998 Plan, up to 728,571 shares of the Company’s common stock may be granted in the form of incentive stock options or non-qualified stock options, awarded, or sold to officers, other employees, directors and consultants. As of July 31, 2001, no additional grants could be issued under the 1998 Plan.
In May 2000, the Board of Directors approved the 2000 stock option plan (the “2000 Plan”) for key employees, non-employee directors, and advisors of the Company. Under the terms of the 2000 Plan, up to 3,660,000 shares of the Company’s common stock may be granted in the form of incentive stock options or non-qualified stock options. The maximum aggregate number of shares of common stock that may be granted to any optionee during the term of the 2000 Plan may not exceed 2,000,000. The 2000 Plan provides that the purchase price per share for incentive stock options and non-qualified stock options shall not be less than the fair market value of the common stock on the date of grant. The maximum term for an option granted is ten years from the date of grant.
The Company has adopted Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation” (SFAS No. 123), 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. No options were issued below fair value for the years ended December 31, 2004 and 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 first quarter of 2006, 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.
During the second quarter of 2005, 469,000 options were granted to various employees at an average exercise price of $0.3172 per share.
Supplemental Disclosures for Stock Options
The following table shows the number of options granted, cancelled and exercised for all option plans for the three years ending December 31, 2005.
The following table shows information about outstanding stock options at December 31, 2005.
There were 535,571 shares exercised in January 2006 at a weighted average exercise price of $0.0132 per share.
9. Quarterly Financial Information (unaudited)
GlobalSCAPE released its Enhanced File Transfer product in November 2004, comparisons of GlobalSCAPE’s quarterly results from operations should take this item into consideration.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
As of the end of the period covered by this Annual Report, our President and Chief Financial Officer carried out an evaluation of the effectiveness of GlobalSCAPE’s disclosure controls and procedures (as defined SEC Rules 13a-15(e) and 15d-15(e) 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.
There has been no change in our internal controls over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information called for by Item 10 of Form 10-K as to Directors is incorporated herein by reference to such information included in our Proxy Statement for the 2006 Annual Meeting of Stockholders to be held on June 1, 2006 under the caption “Election of Directors.” Also see Item 4A of Part I of this Form 10-K. The information called for by Item 10 of Form 10-K as to compliance with Section 16(a) of the Exchange Act is incorporated herein by reference to such information included in our Proxy Statement for the 2006 Annual Meeting of Stockholders to be held on June 1, 2006 under the caption “Executive Officers.”
GlobalSCAPE has adopted a Code of Ethics that applies to all its employees, including its President (its chief executive officer) and its Vice President of Finance and Operations (its chief financial officer). GlobalSCAPE will provide a copy of its Code of Ethics to any person without charge upon written request to:
Thomas F. Farar
Chief Financial Officer
GlobalSCAPE, Inc.
6000 Northwest Parkway, Suite 100
San Antonio, Texas 78249
Item 11.
Item 11. Executive Compensation
The information called for by Item 11 of Form 10-K is incorporated herein by reference to such information included in our Proxy Statement for the 2006 Annual Meeting of Stockholders to be held on June 1, 2006, under the caption “Executive Compensation” except for those parts under the captions “Board Report on Executive Compensation”.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information called for by Item 12 of Form 10-K is incorporated herein by reference to such information included in our Proxy Statement for the 2006 Annual Meeting of Stockholders to be held on June 1, 2006, under the caption “Security Ownership of Certain Beneficial Owners and Management.”
Item 13.
Item 13. Certain Relationships and Related Transactions
The information called for by Item 13 of Form 10-K is incorporated herein by reference to such information included in our Proxy Statement for the 2006 Annual Meeting of Stockholders to be held on June 1, 2006, under the caption “Certain Relationships and Related Transactions.”
Item 14.
Item 14. Principal Accountant Fees and Services.
The information called for by Item 14 of Form 10-K is incorporated herein by reference to such information included in our Proxy Statement for the 2006 Annual Meeting of Stockholders to be held on June 1, 2006 under the caption “Principal Accountant Fees and Services.”
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a)(1) Financial Statements and Schedules
The following financial statements of GlobalSCAPE, Inc. are included in Item 8:
• Consolidated balance sheets - December 31, 2004 and 2005
• Consolidated statements of operations - Years ended December 31, 2003, 2004 and 2005
• Consolidated statements of stockholders’ equity - Years ended December 31, 2003, 2004 and 2005
• Consolidated statements of cash flows - Years ended December 31, 2003, 2004 and 2005
• Notes to consolidated financial statements - December 31, 2005
(2) Schedules not listed above have been omitted because they are not applicable or required, or the information required to be set forth therein is included in the Financial Statements or Notes thereto.
(3) Exhibits
Exhibit
Number
Description
3.1
Certificate of Incorporation of the Company dated April 17, 1996 (Filed as Exhibit 3.1 to Form 10 filed May 12, 2000).
3.2
Certificate of Renewal and Revival of Certificate of Incorporation for the Company dated February 16, 1999 (Filed as Exhibit 3.2 to Form 10 filed May 12, 2000).
3.3
Certificate of Amendment of Certificate of Incorporation dated May 11, 2000 (Filed as Exhibit 3.3 to Form 10 filed May 12, 2000).
3.4
Certificate of Amendment to Certificate of Incorporation dated September 5, 2000 (Filed as Exhibit 3.5 to Form 10, Amendment No. 2, filed September 12, 2000)
3.5
Bylaws of the Company (Filed as Exhibit 3.4 to Form 10 filed May 12, 2000).
3.6
Amended and Restated Bylaws of the Company effective as of September 1, 2000 (Filed as Exhibit 3.6 to Form 10, Amendment No. 2, filed September 12 2000).
3.7
Amended and Restated Bylaws of GlobalSCAPE effective as of October 10, 2000 (Filed as Exhibit 10.1 to Form 8-K filed October 10, 2000).
3.8
Amended and Restated Bylaws of GlobalSCAPE effective as of January 30, 2003 (Filed as Exhibit 3.8 to Annual Report on Form 10-K filed March 31, 2003).
4.1
Specimen of Stock Certificate (Filed as Exhibit 4.1 to Annual Report on Form 10-K filed April 2, 2001).
*10.1
1998 Stock Option Plan as amended May 13, 1999 (Filed as Exhibit 4.2 to Form 10 filed May 12, 2000).
*10.2
2000 Stock Option Plan dated May 8, 2000 (Filed as Exhibit 4.3 to Form 10 filed May 12, 2000).
*10.3
Form of 1998 Stock Option Plan Rights Termination Letter Agreement of Directors to Agree Not to Claim Any Right of Adjustment dated February 4, 2000 (Filed as Exhibit 4.6 to Form 10 filed May 12, 2000).
*10.4
Form of 1998 Stock Option Plan Rights Termination Letter Agreement for Employees and Consultants to Cancel Options dated February 8, 2000 (Filed as Exhibit 4.7 to Form 10, filed May 12, 2000).
Exhibit
Number
Description
*10.5
Form of 1998 Stock Option Plan Rights Termination Letter of Officer to Agree Not to Claim Any Right of Adjustment dated February 8, 2000 (Filed as Exhibit 4.8 to Form 10 filed May 12, 2000).
*10.6
Form of 1998 Stock Option Plan Rights Termination Letter Agreement of Officer to Agree Not to Exercise Options dated February 8, 2000 (Filed as Exhibit 4.9 to Form 10 filed May 12, 2000).
*10.7
Form of 1998 Stock Option Plan Reinstatement and Adjustment Letter for Employees dated December 19, 2000 (Filed as Exhibit 10.17 to Annual Report on Form 10-K filed April 2, 2001).
*10.8
Form of Release and Indemnity Agreement between GlobalSCAPE, Inc. and Employees dated December 19, 2000 (Filed as Exhibit 10.18 to Annual Report on Form 10-K filed April 2, 2001).
10.9
Commercial Lease Agreement between ACLP University Park S.A. II, L.P. and the Company dated April 13, 1999 (Filed as Exhibit 10.1 to Form 10 filed May 12, 2000).
*10.10
Release and Indemnity Agreement between GlobalSCAPE, Inc. and Sandra Poole-Christal dated April 2, 2001 (Filed as Exhibit 10.17 to Annual Report on Form 10-K filed April 1, 2002).
*10.11
Granting letter for 808,571 options to Sandra Poole-Christal under GlobalSCAPE, Inc. 1998 Stock Option Plan dated April 20, 2001 (Filed as Exhibit 10.18 to Annual Report on Form 10-K filed April 1, 2002).
*10.12
Bonus letter for Sandra Poole-Christal in connection with grant of 808,571 options under 1998 Stock Option Plan (Filed as Exhibit 10.19 to Annual Report on Form 10-K filed April 1, 2002).
*10.13
Incentive Stock Option Agreement between GlobalSCAPE, Inc. and Sandra Poole Christal dated April 20, 2001 (Filed as Exhibit 10.20 to Annual Report on Form 10-K filed April 1, 2002).
*10.14
Form of Incentive Stock Option Agreement under GlobalSCAPE, Inc. 2000 Stock Option Plan (Filed as Exhibit 10.21 to Annual Report on Form 10-K filed April 1, 2002).
*10.15
Employment Agreement between GlobalSCAPE, Inc. and Charles R. Poole dated effective July 1, 2005 (Filed as exhibit 10.1 on Form 8-K filed June 20, 2005).
*10.16
Incentive Stock Option Agreement between GlobalSCAPE, Inc. and Charles R. Poole dated June 15, 2005 (Filed as Exhibit 10.2 on Form 8-K filed June 20, 2005).
Subsidiaries (Filed as Exhibit 21 on Form 10-K filed March 24, 2005).
23.1
Consent of Helin, Donovan, Trubee & Wilkinson, LLP (filed herewith).
23.2
Consent of Ernst & Young LLP (filed herewith)
31.1
Rule 13a-14(a)/15d - 14(a) Certification of Charles R. Poole, President and Chief Operating Officer of GlobalSCAPE, Inc. (filed herewith).
31.2
Rule 13a-14(a)/15d - 14(a) Certification of Thomas F. Farar, Chief Financial Officer (filed herewith).
32.1
Certificate pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (filed herewith).
* Management Compensatory Plan or Agreement
Signatures
Pursuant to the requirements of Section 13 or 15(d) 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, in San Antonio, Texas on March 9, 2006.
Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated on March 9, 2006.