GLOBALSCAPE, INC. The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements for the years endedDecember 31, 2019 and 2018, and related notes included elsewhere in this Annual Report. Overview We develop and sell computer software that provides secure information exchange, data transfer and sharing capabilities for enterprises and consumers. We have been in business for more than twenty years and serve over 100 companies in the Fortune 500. Our primary business is selling and supporting MFT software for enterprises. MFT software facilitates the transfer of data from one location to another across a computer network within a single enterprise or between multiple computer networks in multiple enterprises. Our MFT products are based upon our EFT platform. This on-premise and cloud-based delivery platform emphasizes secure and efficient data exchange for virtually any organization. It enables business partners, clients and employees to share critical information safely and securely. The EFT platform provides enterprise-level security while automating the integration of back-end systems which are features often missing from traditional file transfer software. The EFT platform features built-in regulatory compliance, governance, and visibility controls to maintain data safety and security. It can replace legacy systems, homegrown servers, expensive leased lines and virtual area networks. The EFT platform promotes ease of administration while providing the detailed capabilities necessary for complete control of a file transfer system. We continue to explore strategic alternatives to improve the market position and profitability of our product offerings in the marketplace, generate additional liquidity and enhance our valuation. We may pursue our goals through organic growth or other alternatives.
For a more comprehensive discussion of the products we sell and the services we offer, see "Software Products and Services" above.
Key Business Metrics
Key Business Metrics
We review a number of key business metrics on an ongoing basis to help us monitor our performance and to identify material trends which may affect our business. The significant metrics we review are described below.
Revenue Growth We believe annual revenue growth is a key metric for monitoring our continued success in developing our business in future periods. Given our diverse solution portfolio, we regularly review our revenue mix and changes in revenue across all solutions to identify emerging trends. See "Comparison of the Consolidated Statement of Operations for the Years EndedDecember 31, 2019 and 2018" for a discussion of trends in our revenue growth that we monitor using this metric. 36
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Adjusted EBITDA (Non-GAAP Measurement)
We utilize Adjusted EBITDA (Earnings Before Interest, Taxes, Total Other Income/Expense, Depreciation, Amortization and Share-Based Compensation Expense) to provide us a view of income and expenses that is supplemental and secondary to our primary assessment of net income as presented in our consolidated statement of operations and comprehensive income. We use Adjusted EBITDA to provide another perspective for measuring profitability that does not include the effects of the following items:
? Expenses that typically do not require us to pay them in cash in the current
period (such as depreciation, amortization and share-based compensation);
? The cost of financing our business; and
? The effects of income taxes.
We monitor Adjusted EBITDA to assess our performance relative to our intended
strategies, expected patterns of action, and budgets. We use the results of that
assessment to adjust our future activities to the extent we deem necessary.
Adjusted EBITDA is not a measure of financial performance under generally
accepted accounting principles ("GAAP"). It should not be considered as a
substitute for net income presented on our consolidated statement of operations
and comprehensive income. Adjusted EBITDA has limitations as an analytical tool
and when assessing our operating performance. Adjusted EBITDA should not be
considered in isolation or without a simultaneous reading and consideration of
our consolidated financial statements prepared in accordance with GAAP.
We compute Adjusted EBITDA as follows ($ in thousands):
Year Ended
December 31,
2019 2018
Net Income $ 13,267 $ 3,654 Add (subtract) items to determine Adjusted EBITDA: Income tax expense
1,965 1,227
Interest (income) expense, net 265 (86 )
Depreciation and amortization:
Total depreciation and amortization 1,746 2,173
Share-based compensation expense 2,415 1,269
Adjusted EBITDA $ 19,658 $ 8,237
See "Comparison of the Consolidated Statement of Operations for the Years Ended
December 31, 2019 and 2018" for discussion of the variances between periods in
the components comprising Adjusted EBITDA.
Liquidity and Capital Resources
Our cash and working capital positions were as follows ($ in thousands):
December 31, 2019 December 31, 2018
Cash and cash equivalents $ 4,702 $ 9,173
Current assets $ 15,066 $ 17,351
Current liabilities (22,602 ) (15,483 )
Working capital $ (7,536 ) $ 1,868
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Our capital requirements principally relate to our need to fund our ongoing
operating expenditures, which are primarily related to employee salaries and
benefits. We make these expenditures to enhance our existing products, develop
new products, sell those products in the marketplace and support our clients
after the sale.
We rely on cash and cash equivalents on hand and cash flows from operations to
fund our operating activities and believe those items will be our principal
sources of capital for the foreseeable future. If our revenue declines and/or
our expenses increase, our cash flow from operations and cash on hand could
decline.
Cash provided or used by our various activities consisted of the following ($ in
thousands):
Cash Provided (Used) During the Years Ended
December 31,
2019 2018
Operating activities $ 17,339 $ 4,896
Investing activities $ (1,138 ) $ 14,356
Financing activities $ (20,672 ) $ (21,662 )
Our cash provided by operating activities increased during 2019 compared to 2018
primarily due to the following factors set forth on our Consolidated Statements
of Cash Flows:
? Net income after considering items not involving cash at the time they are
recorded in the statement of operations and comprehensive income, as set forth
on our Consolidated Statement of Cash Flows, increasing
as compared to increasing
Statement of Operations for the Year Ended
discussion of the changes in the components of these amounts.
? Deferred revenue increasing
$813,000 in 2018 due primarily to increasing the resources dedicated to securing M&S renewals. ? Accrued expenses increasing$384,000 in 2019 as compared to decreasing
2019.
? Prepaid expenses and other decreasing $155,000 in 2019 as compared to
increasing
from our D&O insurance in 2019.
? Accounts payable decreasing $74,000 in 2019 as compared to decreasing
vendors.
Offset by:
? Federal income tax receivable increasing
federal income tax payable increasing
increased estimated tax payments related to the increase in taxable income.
The amount of cash we used for investing activities during 2019 decreased as compared to 2018 due primarily to:
? The redemption of our certificates of deposit in 2018 for which no comparable
event occurred in 2019.
Offset by:
? A decrease in capitalized software development costs due to fewer employed
software engineers and technical personnel.
Financing activities used less cash during 2019 than during 2018 primarily due
to the funding of our credit facility, a reduction in the purchase of treasury
stock related to the Dutch tender offer in 2018 that was not repeated in 2019
and an increase in the proceeds received from the exercise of stock options,
offset by the funding of our special dividends and payment of debt issuance
costs.
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Table of Contents Loan Agreement InNovember 2019 , we entered into a credit facility withJ.P. Morgan Chase Bank , N.A, asAdministrative Agent andEast West Bank as Syndication Agent consisting of a$50.0 million term loan and a$5 million revolving agreement (the "Loan Agreement"). Funds from the term loan were substantially used to fund a special dividend of$3.35 to our common shareholders which was paid onDecember 5, 2019 . The revolving loan may be accessed to fund working capital needs. The loans bear a variable interest rate of LIBOR plus a Term Loan Spread between 3.75% and 2.25%. The amount of the Term Loan Spread is a function of the Company's Leverage Ratio. EffectiveJanuary 3, 2020 , the Company entered into an Amendment and Waiver No. 1 to the Credit Agreement to increase the amount of the special dividend permitted to be paid to stockholders onDecember 5, 2019 to accommodate last minute option exercises and to exclude theMay 28, 2019 special dividend from the fixed charges calculation.
At
The aggregate maturities of our notes payable, as ofDecember 31, 2019 , are as follows:$5.0 million in 2020,$7.5 million in 2021,$7.5 million in 2022,$10.0 million in 2023, and$19.4 million in 2024.
Interest payments under the credit facility are due monthly. Principal payments are due quarterly. The loans may be prepaid at any time without penalty.
The Loan Agreement contains the following financial covenants:
? We must not exceed a Total Leverage Ratio of 3.25%. This ratio decreases to 3.0% atSeptember 30, 2020 , 2.75% atMarch 31, 2021 and 2.25% atMarch 31, 2022 . This ratio is defined in the Loan Agreement as the ratio of (a) consolidated total funded indebtedness to consolidated EBITDA minus capitalized software expenditures for the period of the four most recent consecutive fiscal quarters. As ofDecember 31, 2019 , this debt service coverage ratio was 2.58. ? We must maintain a Fixed Coverage Charge Ratio of 1.25%. This ratio is defined in the Loan Agreement as the ratio of (a) consolidated EBITDA minus unfinanced capital expenditures to cash interest expense plus scheduled principal payments made plus taxes paid in cash plus restricted payments made in cash. As ofDecember 31, 2019 , this debt to tangible net worth ratio was 4.01. The Loan Agreement contains customary covenants relating to maintaining legal existence and good standing, complying with applicable laws, delivery of financial statements, payment of taxes and maintaining insurance. The Loan Agreement also contains customary events of default including the failure to make payments of principal and interest, the breach of any covenants, the occurrence of a material adverse change, and certain bankruptcy and insolvency events.
Contractual Obligations and Commitments
At
? Obligations outstanding under the loan agreement described above. An
obligation to deliver services in the future to satisfy our right to earn our
deferred revenue of
our obligations under M&S contracts. We will recognize this deferred revenue
as revenue over the remaining life of those contracts which generally ranges
from one to three years. Deferred revenue, unlike the other liability
components of our working capital, is an obligation we will satisfy through
providing services in the future to our clients as part of our ongoing
operating activities from which we have historically generated cash flow. Our
deferred revenue does not involve a disbursement of cash as a direct payment
of that liability.
? Trade accounts payable and accrued liabilities which include our contractual
obligations to pay software royalties to third parties that vary in amount
based on our sales volume of products upon which royalties are payable.
? Operating lease for our office space.
? Federal and state taxes.
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Recent Accounting Pronouncements
See Note 2 "Significant Accounting Policies" of our consolidated financial statements included in this Annual Report which includes a discussion of recent accounting pronouncements and the impact they may have on our consolidated financial statements.
Critical Accounting Policies
We follow accounting standards set by theFinancial Accounting Standards Board . This board sets GAAP, which we follow in preparing financial statements that report our financial position, results of operations, and sources and uses of cash. We also follow the reporting regulations of theSEC . The preparation of financial statements in accordance with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published, and the reported amounts of revenues and expenses during the reporting period. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of our consolidated financial statements. It is possible the actual results could differ from these estimates and assumptions and could have a material effect on the reported amounts of our financial position and results of operations.
For a description of our critical accounting policies, please refer to Note 2 "Significant Accounting Policies" of our consolidated financial statements included in this Annual Report.
Results of Operations
Comparison of the Consolidated Statements of Operations for the Years Ended
2019 2018 $ Change
($ in thousands)
Total revenues $ 40,343 $ 34,416 $ 5,927
Cost of revenues 6,130 6,236 (106 )
Gross profit 34,213 28,180 6,033
Operating expenses
Sales and marketing 8,331 10,009 (1,678 )
General and administrative 7,495 6,382 1,113
Legal & Professional 1,520 4,623 (3,103 )
Severance 15 488 (473 )Research and development 1,355 1,883 (528 ) Total operating expenses 18,716 23,385 (4,669 ) Income from operations 15,497 4,795 10,702 Other income (expense), net (265 ) 86 (351 ) Provision for income taxes 1,965 1,227
738
Net Income $ 13,267 $ 3,654 $ 9,613
In the discussions below, we refer to the year ended December 31, 2019 as "2019"
and the year ended December 31, 2018 as "2018". The percentage changes cited in
our discussions below are the change between 2019 and 2018.
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The components of our revenues were as follows ($ in thousands):
Revenue for the Year Ended December 31,
2019 2018
Percent of Percent of
Amount Total Amount Total
Revenue By Type
License $ 11,243 27 % $ 10,512 30 %
M&S 26,318 65 % 21,587 63 %
Professional Services (all EFT
Platform) 2,782 7 % 2,317 7 %
Total Revenue $ 40,343 100 % $ 34,416 100 %
Revenue by Product Line
License
EFT Platform $ 11,036 98 % $ 10,208 97 %
Other 207 2 % 304 3 %
Total License Revenue 11,243 100 % 10,512 100 %
M&S
EFT Platform 25,548 97 % 20,707 96 %
Other 770 3 % 880 4 %
26,318 100 % 21,587 100 %
Professional Services (all EFT
Platform) 2,782 100 % 2,317 100 %
Total Revenue
EFT Platform 39,366 98 % 33,232 97 %
Other 977 2 % 1,184 3 %
$ 40,343 100 % $ 34,416 100 %
Our total revenue increased 17%. Revenue from our EFT platform products and services increased 18%. Revenue from our other products that consist of Mail Express, WAFS, and CuteFTP, decreased to less than 3% of our total revenue, which is a trend that is in line with our de-emphasis of those products.
We continue to offer product support for Mail Express and WAFS, which we
discontinued as products for sale as of
EFT Platform Products
License revenue from our EFT platform products increased 8%. This increase was
anticipated as a result of a number of changing variables in sales strategy
starting in
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M&S revenue from our EFT platform products increased 23% primarily due to:
? The addition of sales resources that are focused on (i) increasing the number
of clients who renew M&S and (ii) increasing annual contract prices to better
reflect the value provided by our support teams.
? Ongoing license sales since a majority of license sales are accompanied by an
M&S contract. The change in M&S revenue typically lags behind the related
change in license revenue because license sales are recognized as revenue in
full in the period the license is delivered while the related M&S revenue is
recognized in future periods as those services are delivered.
? Sustaining high renewal rates of M&S contracts by clients who initiallypurchased these services in earlier periods. We believe these renewals are the
result of clients recognizing the value provided by our Maintenance and
Support team.
Our professional services revenue increased 20% in 2019 as compared to 2018.
This increase was primarily due to an increase in software license sales and an
expansion of our library of service offerings as well as a focus on selling
complete solutions.
Cost of Revenues. These expenses are associated with the production, delivery
and support of our products and services. We believe it is most meaningful to
view cost of revenues as a percent of the revenues to which those costs relate
since many of those costs are variable relative to revenue.
Cost of license revenue consists primarily of:
? Amortization of capitalized software development costs we incur when producing
our software products. This amortization begins when a product is ready for
general release to the public and generally is an expense that is not directly
variable relative to revenue.
? Royalties we pay to use software developed by others for certain features of
our products that is generally an expense that is variable relative to
revenue.
? Fees we pay to third parties who provide services supporting our SaaSsubscription solutions for our EFT platform that generally have components
that are both variable and not variable relative to revenue.
Cost of M&S revenue and cost of professional services revenue consist primarily of salaries and related costs of our employees and third parties we use to deliver these services.
Cost of software license revenue decreased 10% and as a percent of software license revenue was 24% in 2019 compared to 28% in 2018. These decreases were primarily due to a decrease in amortization of capitalized software development costs. Cost of M&S revenue as a percent of M&S revenue was 9% in 2019 as compared to 10% in 2018. Cost of revenue for M&S in absolute dollars increased by 10%. The increase in absolute dollars was due primarily to an increase in personnel related expenses. Cost of professional services revenue as a percent of that revenue was 42% in 2019 as compared to 50% in 2018. The cost in absolute dollars was relatively flat. The variation in percent of revenue resulted from the varying scope and mix of the professional services we deliver that can change from period-to-period in response to the circumstances of the client environments in which we are working. Sales and Marketing. We believe it meaningful to view cost of sales and marketing as a percent of revenues since many of those costs, particularly sales commissions, are variable relative to revenue. These expenses were 21% of total revenue for 2019 compared to 29% of total revenue for 2018. In absolute dollars these expenses decreased 17%, due primarily to decreased marketing expenses related to a decrease in our spending for content syndication and reduced personnel expenses. General and Administrative. These expenses increased 17% primarily due to a special bonus paid to employees inDecember 2019 , an increase in share based compensation expense related to the accelerated vesting of options granted to our former Chief Executive Officer who passed away unexpectedly inMarch 2019 and the accelerated vesting of restricted stock granted to a former member of our Board of Directors. The vesting acceleration of the stock options was pursuant to the terms of the applicable option agreements and the vesting acceleration of the restricted stock grant was approved by the Compensation Committee of the Board of Directors. 42
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Legal and Professional. These expenses decreased 67% primarily due to decreases in professional fees and related expenses associated with the previously disclosed internal investigation, the restatement of certain of our financial statements and related litigation.
Severance. These expenses decreased
Research and Development. The overall profile of our research and development activities was as follows ($ in thousands):
Year Ending December 31,
2019 2018
R&D expense $ 1,355 $ 1,883
Capitalized software development costs 1,074 1,276
Total resources expensed for R&D
Our total R&D expenditures decreased 23% in 2019 as compared to 2018 primarily due to fewer employed software engineers and technical personnel.
Total resources expended for R&D serves to illustrate our total corporate efforts to improve our existing products and to develop new products regardless of whether or not our expenditures for those efforts were expensed or capitalized. Total resources expended for R&D is not a measure of financial performance under GAAP and should not be considered a substitute for R&D expense and capitalized software development costs individually. While we believe the non-GAAP total resources expended for R&D amount provides useful supplemental information regarding our overall corporate product improvement and new product creation activities, there are limitations associated with the use of this non-GAAP measurement. Total resources expended for R&D is a non-GAAP measure not prepared in accordance with GAAP and may not be comparable to similarly titled measures of other companies since there is no standard for preparing this non-GAAP measure. As a result, this non-GAAP measure of total resources expended for R&D has limitations and should not be considered in isolation from, or as a substitute for, R&D expense and capitalized software development costs individually. Other Income (Expense). Other income (expense) consists primarily of interest expense related to our credit facility more fully described in Note 8 of our financial statements.
Income Taxes. Our effective tax rate was 13% for 2019 and 25% for 2018.
In 2019 our effective rate was lower than the federal statutory rate of 21% primarily due to a tax benefit realized upon the exercise of certain share based awards and the deduction for foreign derived intangible income offset by certain expenses in our consolidated financial statements that are not deductible for federal income tax purposes and state income tax included in income tax expense in our consolidated financial statements. In 2018 our effective rate was higher than the federal statutory rate primarily due to certain expenses in our consolidated financial statements that are not deductible for federal income tax purposes and state income tax included in income tax expense in our consolidated financial statements offset by the research and development tax credit and the deduction for foreign derived intangible income.
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