UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period ended September 30, 2013

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from    to  .

Commission File No. 001-33601

GlobalSCAPE, Inc.

(Exact name of registrant as specified in its charter)

Delaware	74-2785449
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
4500 Lockhill-Selma, Suite 150 San Antonio, Texas	78249
(Address of Principal Executive Office)	(Zip Code)

(210) 308-8267

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes     ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨  (Do not check if a smaller reporting company)	Smaller reporting company	x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    ¨  Yes    x  No

As of November 1, 2013, there were 18,780,616 shares of common stock outstanding.
 

GlobalSCAPE Inc.

Quarterly Report on Form 10-Q

For the Quarter ended September 30, 2013

Table of Contents

		Page
Part I.	Financial Information
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets	2
	Condensed Consolidated Statements of Operations and Comprehensive Income	3
	Condensed Consolidated Statement of Stockholders’ Equity	4
	Condensed Consolidated Statements of Cash Flows	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	39
Item 4.	Controls and Procedures	39
Part II.	Other Information	40
Item 1.	Legal Proceedings	40
Item1A	Risk Factors	40
Item 6.	Exhibits	40
Signatures		41

GlobalSCAPE®, CuteFTP®, CuteFTP Pro®, CuteBackup®, DMZ Gateway®, CuteSendIt®, Mail Express are registered trademarks of GlobalSCAPE, Inc. Secure FTP ServerTM, Wide Area File ServicesTM, WAFSTM, CDPTM, Advanced Workflow EngineTM, AWETM, Enhanced File TransferTM, Managed Information XchangeTM, MIXTM, Hosted Enhanced File Transfer ServerTM, EFT ServerTM, CuteFTP LiteTM, CuteFTP HomeTM, Secure Ad Hoc TransferTM, Total Path SecurityTM, Enhanced File Transfer ServerTM, EFT Server EnterpriseTM, Enhanced File Transfer Server Enterprise TM, Total Recall TM, GlobalSCAPE Securely ConnectedTM, and appShieldTM are trademarks of GlobalSCAPE, Inc. TappIn® and TappIn and design are registered trademarks of our wholly-owned subsidiary, TappIn, Inc.-Now Playing TM, TappIn Secure Share TM, Social Share TM, and Enhanced A La Carte Playlist TM, are trademarks of our wholly-owned subsidiary TappIn, Inc. Other trademarks and trade names in this Quarterly Report are the property of their respective owners.

1

GlobalSCAPE, Inc.

Condensed Consolidated Balance Sheets

(in thousands except per share amounts)

(Unaudited)

	September 30, 2013			December 31, 2012
Assets
Current assets:
Cash and cash equivalents	$	9,757		$	8,079
Accounts receivable (net of allowance for doubtful accounts      of $155 and $171 as of September 30, 2013 and      December 31, 2012, respectively)		3,572			3,350
Current deferred tax assets		123			177
Prepaid expenses		418			426
Total current assets		13,870			12,032
Fixed assets, net		739			900
Investment in certificate of deposit		3,107			3,060
Intangible assets, net		867			4,308
Goodwill		12,712			12,712
Deferred tax asset		1,619			535
Other assets		103			41
Total assets	$	33,017		$	33,588
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	426		$	432
Accrued expenses		1,204			1,353
Income tax payable		22			46
TappIn earn out, current portion		-			500
Long term debt, current portion		1,381			1,335
Deferred revenue		9,134			8,293
Total current liabilities		12,167			11,959
Deferred revenue, non-current portion		1,587			1,480
Other long term liabilities		60			62
TappIn earn out, non-current portion		-			3,694
Long term debt, non-current portion		3,344			4,389
Commitments and contingencies
Stockholders’ equity:
Preferred stock, par value $0.001 per share, 10,000,000     authorized, no shares issued or outstanding		-			-
Common stock, par value $0.001 per share, 40,000,000     authorized, 19,184,197 and 18,846,547 issued September 30, 2013     and December 31, 2012, respectively		19			19
Additional paid-in capital		15,105			14,435
Treasury stock, 403,581 shares, at cost, at September 30, 2013     and December 31, 2012.		(1,452	)		(1,452	)
Retained earnings		2,187			(998	)
Total stockholders’ equity		15,859			12,004
Total liabilities and stockholders’ equity	$	33,017		$	33,588

The accompanying notes are an integral part of these condensed and consolidated financial statements.

2

GlobalSCAPE, Inc.

Condensed Consolidated Statements of Operations and Comprehensive Income

(In thousands, except per share amounts)

(Unaudited)

	Three months ended September 30,						Nine months ended September 30,
	2013			2012			2013			2012
Operating Revenues:
Software licenses	$	2,103		$	2,528		$	5,966		$	7,424
Maintenance and support		3,478			3,054			10,128			8,294
Professional services		412			274			1,237			1,013
Other		344			222			811			442
Total Revenues		6,337			6,078			18,142			17,173
Operating Expenses:
Cost of revenues		250			331			782			962
Selling, general and administrative expenses		3,492			4,136			11,137			12,532
Research and development expenses		923			822			2,653			2,660
TappIn intangible asset impairment and earnout liability elimination		(128	)		-			(128	)		-
Affiliated entity asset impairment		-			3,264			-			3,264
Depreciation and amortization		265			314			787			951
Total operating expenses		4,802			8,867			15,231			20,369
Income (loss) from operations		1,535			(2,789	)		2,911			(3,196	)
Other income (expense), net		(39	)		(11	)		(130	)		(138	)
Income (loss) before income taxes		1,496			(2,800	)		2,781			(3,334	)
Provision (benefit) for income taxes		(791	)		(86	)		(404	)		(227	)
Net income (loss)	$	2,287		$	(2,714	)	$	3,185		$	(3,107	)
Comprehensive income (loss)	$	2,287		$	(2,714	)	$	3,185		$	(3,107	)
Net income (loss) per common share -
Basic	$	0.12		$	(0.15	)	$	0.17		$	(0.17	)
Diluted	$	0.12		$	(0.15	)	$	0.17		$	(0.17	)
Weighted average shares outstanding:
Basic		18,761			18,398			18,570			18,336
Diluted		19,158			18,398			19,001			18,336

The accompanying notes are an integral part of these condensed and consolidated financial statements.

3

GlobalSCAPE, Inc.

Condensed Consolidated Statement of Stockholders' Equity

(In thousands, except share amounts)

(Unaudited)

					Additional
	Common Stock				Paid-in			Treasury			Retained
	Shares		Amount		Capital			Stock			Earnings			Total
Balances at December 31, 2012		18,846,547	$	19	$	14,435		$	(1,452	)	$	(998	)	$	12,004
Shares issued upon exercise of stock options		177,650		-		231			-			-			231
Stock-based compensation expense:
Stock options		-		-		416			-			-			416
Restricted stock		160,000		-		106									106
									-			-
Net decrease in excess tax benefit from stock-based compensation		-		-		(83	)		-			-			(83	)
Net income		-		-		-			-			3,185			3,185
Balances at September 30, 2013		19,184,197	$	19	$	15,105		$	(1,452	)	$	2,187		$	15,859

The accompanying notes are an integral part of these condensed and consolidated financial statements.

4

GlobalSCAPE, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

	For the nine months ended September 30,
	2013			2012
Operating Activities:
Net income (loss)	$	3,185		$	(3,107	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		787			951
Stock-based compensation		522			711
Deferred taxes		(1,030	)		(341	)
Bad debt expense (recoveries)		29			(55	)
Net tax effect of stock option and restricted stock activity		83			2
TappIn intangible asset impairment and earnout liability elimination		(128	)		-
Affiliated entity asset impairment		-			3,264
Other		-			40
Subtotal before changes in operating assets and liabilities		3,448			1,465
Changes in operating assets and liabilities:
Accounts receivable		(251	)		314
CoreTrace receivable		-			(150	)
Prepaid expenses		8			(65	)
Income tax receivable and payable		(107	)		(178	)
Other assets		(62	)		(11	)
Accounts payable		(6	)		(239	)
Accrued expenses		(149	)		(202	)
Deferred revenues		948			1,926
Other long-term liabilities		(2	)		6
Net cash provided by (used for) operating activities		3,827			2,866
Investing Activities:
Purchase of property and equipment		(65	)		(210	)
Software development costs		(686	)		(313	)
Tappin, Inc. earnout liability paid		(500	)		-
Interest reinvested in certificate of deposit		(47	)		(45	)
Net cash provided by (used for) investing activities		(1,298	)		(568	)
Financing Activities:
Proceeds from exercise of stock options		231			48
Net tax effect of stock option and restricted stock activity		(83	)		(2	)
Notes payable principle payments		(999	)		(952	)
Net cash provided by (used for) financing activities		(851	)		(906	)
Net increase (decrease) in cash		1,678			1,392
Cash at beginning of period		8,079			8,861
Cash at end of period	$	9,757		$	10,253
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest on notes payable	$	182		$	248
Income taxes	$	731		$	271

The accompanying notes are an integral part of these condensed and consolidated financial statements.

5

GlobalSCAPE,  Inc.

Notes to Condensed Consolidated Financial Statements

Nine Months Ended September 30, 2013

(Unaudited)

1. Nature of Business

GlobalSCAPE, Inc. and its wholly-owned subsidiary TappIn, Inc.(together referred to as “we,” “us,” “our,” “GlobalSCAPE,” or the “Company”) operate primarily in the managed file transfer industry by providing secure information exchange capabilities for enterprises and consumers through the development and sale of software, delivery of managed and hosted solutions, and provisioning of associated services. Our solutions portfolio facilitates transmission of critical information such as financial data, medical records, customer files, vendor files, personnel files and other similar information between diverse and geographically separated network infrastructures while supporting a range of information protection approaches to meet privacy and other security requirements. Our solutions provide the ability to monitor these activities, as well as access the underlying data, securely and flexibly, through a wide range of network-enabled, mobile devices, including tablets and smartphones.

Throughout these notes unless otherwise noted, our references to the 2013 period and the 2012 period refer to the nine months ended September 30, 2013 and September 30, 2012, respectively.

2. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Rule 10-01 of Regulation S-X, “Interim Financial Statements”, as prescribed by the Securities and Exchange Commission, or SEC. Accordingly, they do not include all information and footnotes required under generally accepted accounting principles in the United States (“GAAP”) for complete financial statements. In the opinion of management, all accounting entries necessary for a fair presentation of our financial position and results of operations have been made. The results of operations for any interim period are not necessarily indicative of the results to be expected for the full year. The information included in this Form 10-Q should be read in conjunction with the financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, which we refer to as the 2012 Form 10-K, as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations also included in our 2012 Form 10-K and in this report.

We follow accounting standards set by the Financial Accounting Standards Board. This board sets GAAP that 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 the SEC.

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

3. Significant Accounting Policies

There have been no changes in our significant accounting policies during the 2013 period from those described in our 2012 Form 10-K. Listed below is a condensed version of our significant accounting policies.

Principles of Consolidation

The accompanying consolidated financial statements of GlobalSCAPE are prepared in conformity with GAAP. All intercompany accounts and transactions have been eliminated.

Revenue Recognition and Deferred Revenue

We develop, market and sell software products and deliver associated services. We recognize revenue from a sales transaction when the following conditions are met:

• Persuasive evidence of an arrangement exists.

• Delivery has occurred or services have been rendered.

• The amount is fixed or determinable.

• Collection is reasonably assured.

6

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

We earn the majority of our software license revenue from software products sold under perpetual software license agreements. At the time our customers purchase these products, they typically also purchase a product maintenance and support, or M&S, agreement. These transactions are multiple element software sales for which we assess the presence of vendor specific objective evidence (“VSOE”) of the fair value of the undelivered elements to determine the portion of these sales to recognize as revenue upon delivery of the software product and the portion of these sales to record as deferred revenue at the time the product is delivered. We amortize the deferred revenue component to revenue in future periods as we deliver the related future services to the customer. For transactions, if any, for which we cannot establish VSOE of fair value of the undelivered elements, we initially record the entire transaction as deferred revenue and amortize that amount to revenue in future periods as we deliver the related future services to the customer.

Our deferred revenue consists primarily of revenue to be earned in the future as we deliver services under M&S agreements. Certain of our customers will accept, and sometimes pay, our invoices for M&S services prior to the commencement of the M&S period. In such cases, we record accounts receivable and deferred revenue in the same amount at the time we submit an invoice to the customer and commence recognition of the deferred revenue as revenue only after the M&S period begins.

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

We provide professional services to our customers consisting primarily of software installation support, operations support and training. We recognize revenue from these services as they are completed and accepted by our customers.

We collect sales tax on many of our sales. We do not include sales tax collected in our revenue. We record it as a liability payable to taxing authorities.

Goodwill

Goodwill is not amortized. On at least an annual basis, we test goodwill for impairment at the reporting unit level. We operate as a single reporting unit.

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

•   Macroeconomic conditions.

•   Industry and market considerations.

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

•   Our overall financial performance and outlook for the future.

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

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

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

7

As of December 31, 2012, after assessing the totality of the relevant qualitative events and circumstances, we determined it not more likely than not that the fair value of our reporting unit was less than its carrying amount. Accordingly, we concluded there was no impairment of goodwill as of that date and, in accordance with GAAP, performed no further testing. There have been no material events or changes in circumstances since that time indicating that the carrying amount of these assets may exceed their fair market value and that interim testing needed to be performed.

Intangible Assets – Capitalized Software Development Costs

When we complete research and development for a software product and have completed a detail program design or a working model of that software product, we capitalize production costs incurred for that software product from that point forward until it is ready for general release to the public. Thereafter, we amortize capitalized software production costs to expense using the straight-line method over the estimated useful life of that product, which is generally three years.

Research and Development

We expense research and development costs as incurred.

Share-Based Compensation

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

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

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

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

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

The assumptions used to determine compensation cost for our stock options are as follows:

	Nine Months Ended September 30,
	2013			2012
Expected volatility		55	%		68	%
Expected annual dividend yield		0			0
Risk free rate of return		1.42	%		1.27	%
Expected option term (years)		6.00			6.00

Income Taxes

We recognize taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our financial statements or tax returns.

Reclassifications

Capitalized software development costs are included in intangible assets at September 30, 2013, and December 31, 2012 in the accompanying financial statements. That balance as of December 31, 2012, of $303,000 was previously included in fixed assets in our consolidated financial statements included in our 2012 Form 10-K.

8

4. Capitalized Software Development Costs

Our capitalized software development costs profile is as follows: ($’s in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Amount capitalized during the period	$	327	$	136	$	686	$	313
Amortization expense	$	47	$	-	$	124	$	-

	September 30, 2013			December 31, 2012
Gross capitalized balance	$	1,016		$	330
Accumulated amortization		(152	)		(27	)
Net balance	$	864		$	303

Estimated Future Amortization Expense:
Three months ending December 31, 2013	$	56
Year ending December 31,
2014		265
2015		311
2016		159
2017		73
Total	$	864

See Note 7 for discussion of our intangible assets related to TappIn, Inc.

5. Notes Payable

In December 2011, we borrowed $7 million under loan agreements with The Bank of San Antonio to fund a portion of the purchase price of TappIn, Inc. (“TappIn”). These loan agreements provide for the following notes payable:

• A note payable with an original principal balance of $4 million bearing interest at 4.75% per annum and secured by substantially all of our assets.

• A note payable with an original principal balance of $3 million bearing interest at 4.25% per annum and secured by a certificate of deposit with The Bank of San Antonio of $3.0 million bearing interest at 2.0% per annum. This certificate of deposit is included in long-term investments on our balance sheet.

At September 30, 2013, the total principal balance outstanding under these notes payable was $4.7 million.

Interest and principal are payable under both notes payable in 60 equal monthly installments aggregating $131,000 each that will fully amortize the notes as of their December 2, 2016 maturity date. The loans may be prepaid at any time without premium or penalty.

Scheduled future principal payments under the loan agreements as of September 30, 2013, are as follows ($ in thousands):

Three months ending December 31, 2013	$	336
Year Ending December 31,
2014		1,397
2015		1,462
2016		1,530
Total	$	4,725

9

The Loan Agreements contain the following financial covenants:

• We must maintain a debt service coverage ratio of at least 1.25. This ratio is defined in the loan agreements as (1) net income plus depreciation, interest and non-cash charges divided by (2) the sum of the current portion of long-term debt plus interest expense. As of September 30, 2013, this debt service coverage ratio was 7.24.

• We must maintain a maximum debt to tangible net worth ratio of 4.00:1. This ratio is defined in the loan agreements as (1) total liabilities less deferred revenues divided by (2) total assets, excluding intangible assets, minus total liabilities, excluding deferred revenues. As of September 30, 2013, this debt to tangible net worth ratio was 0.50:1.

• We must maintain liquid assets (cash and marketable securities) of at least $3.2 million in 2013 and $2.2 million in 2014. As of September 30, 2013, cash and marketable securities were $9.8 million.

The loan agreements contain 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.

6. Stock Options, Restricted Stock and Share-Based Compensation

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

Three Months Ended September 30,				Nine Months Ended September 30,
2013		2012		2013		2012
$	225	$	283	$	522	$	711

Stock Options

The GlobalSCAPE, Inc. 2010 Employee Long-Term Equity Incentive Plan (“2010 EIP”) is our current stock-based incentive plan for our employees. It authorizes the issuance of up to three million shares of common stock for stock-based incentives including stock options and restricted stock awards. The exercise price, term and other conditions applicable to each stock option or stock award granted under the 2010 EIP are determined by the Compensation Committee of the Board of Directors. The exercise price of stock options is set on the grant date and may not be less than the fair market value per share of our stock at market close on that date. Stock options expire ten years from the date of grant. During a portion of 2010 and in earlier years, we issued stock options under the GlobalSCAPE, Inc. 2000 Stock Option Plan, which is a plan under which we no longer issue stock options.

Stock option activity for the nine months ended September 30, 2013 was as follows:

	Number of Shares			Average Exercise Price		Remaining Contractual Term		Intrinsic Value (in thousands)
Outstanding at December 31, 2012		3,650,095		$	1.91		6.14	$	300
Granted		350,740			1.56
Exercised		(177,650	)		1.30
Forfeited		(263,790	)		2.25
Outstanding at September 30, 2013		3,559,395		$	1.88		4.87	$	453
Exercisable at September 30, 2013		2,714,920		$	1.90		3.64	$	435

10

Additional information about our stock options was as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Weighted average fair value per share of options granted	$	0.80	$	1.11	$	0.82	$	1.09
Intrinsic value of options exercised  (in thousands)	$	27	$	35	$	62	$	50
Cash received from stock option exercises	$	74,000	$	28,000	$	231,000	$	48,000
Unrecognized compensation expense related to non-vested options at the end of the period	$	658,000	$	1,400,000	$	658,000	$	1,400,000
Weighted average years over which non-vested options will be recognized		1.83		2.03		1.83		2.03

Restricted Stock Awards

The 2006 Non-Employee Directors Long Term Incentive Plan provides for the issuance of either stock options or restricted stock awards. The fair value of stock awards is based upon the market price of the underlying common stock as of the date of grant. Stock awards are amortized over their applicable vesting period of one year using the straight-line method. Stock awards activity for the nine months ended September 30, 2013 was as follows:

	Number of Shares			Grant Date Fair Value Per Share		Total Value of Shares That Vested
Restricted shares outstanding at December 31, 2012		80,000		$	1.97
Shares granted with restrictions		80,000			1.65
Shares vested and restrictions eliminated		(80,000	)		1.97	$	133,600
Restricted shares outstanding at September 30, 2013		80,000		$	1.65

At September 30, 2013, we had $91,000 of unrecognized compensation cost related to non-vested, restricted stock awards which is expected to be recognized as expense over a weighted-average period of 8 months.

7. TappIn Intangible Assets and Earnout Liability

In December 2011, we acquired all of the issued and outstanding shares of TappIn.  At the time of this acquisition, we allocated the total purchase price of this acquisition to assets and liabilities based on their estimated fair values at the acquisition date.  That allocation resulted in our recording of intangible assets as follows:

			Accumulated
			Amortization			Net Book Value
	Gross Carrying		Through			as of
	Amount		September 30, 2013			September 30, 2013
Customer relationship	$	1,863	$	(342	)	$	1,521
Developed technology		2,771		(726	)		2,045
Total	$	4,634	$	(1,068	)	$	3,566

The acquisition provides for the possible payment of $4.5 million of contingent consideration to the former shareholders of TappIn. if our TappIn product line achieves certain revenue milestones by no later than December 31, 2014. Based on our past estimates of the probability and likelihood of this earn out ultimately being paid, our balance sheet has previously included a liability of $3.7 million for these possible payments.

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We evaluated input from our customers and the marketplace as a whole relative to the TappIn product line and concluded that our future emphasis will be on merging the TappIn technology and functionality with our EFT Standard Edition and EFT Enterprise Edition products to create a TappIn Enterprise solution.  We believe offering the TappIn technology through this integration will maximize the return on our investment in this product line. While we will continue to offer TappIn as a standalone product in its Standard and Professional Editions, we have concluded that revenue earned from the TappIn product line sold in those configurations will not be significant to our results of operations and financial position in the future.

For accounting and financial statement presentation purposes, the value assigned to the developed technology intangible asset as of the date we acquired TappIn. and subsequent thereto relates only to the TappIn Standard Edition developed technology that existed on the date we acquired TappIn.  Under GAAP, none of the value of this intangible asset can be derived from the TappIn Professional Edition or from other uses of the TappIn technology.  Specifically, none of the TappIn core technology, enabling technology or the migration of that technology, including the application of that technology to our EFT Standard Edition and EFT Enterprise Edition product lines as mentioned above, can be relied upon to ascribe value to the developed technology intangible asset. Since we believe revenue earned from the TappIn Standard Edition will not be significant to our results of operations and financial position in the future, we have concluded it to be more-likely-than-not that the intangible asset arising from this developed technology is of nominal future value. Accordingly, we have reduced its value to zero on our balance sheet as of September 30, 2013, and have recorded a corresponding expense for the three months ended September 30, 2013.

For accounting and financial statement purposes, the value assigned to the customer relationship intangible asset relates to one contract with a third-party as it stood and was in place on the date we acquired TappIn.  Under GAAP, none of the value of this intangible can be derived from future modifications of this contract or from other, subsequent customer relationships.  The value of the contract that gave rise to this customer relationship intangible is dependent upon both (1) continued shipments of that customer’s products as they existed at the time we acquired TappIn. and (2) the purchasers of that customer’s products subscribing to TappIn Professional Edition.  We believe revenue earned from the activities upon which the value of the customer relationship intangible asset was derived will not be significant to our results of operations and financial position in the future. Our relationship with that customer remains in place relative to products it is currently selling that did not exist at the time we acquired TappIn. and that were not part of determining the intangible value of this customer relationship at that time.  We have concluded it to be more-likely-than-not that the intangible asset arising from this customer relationship and the products it covered as they existed at the time we acquired TappIn. is of nominal future value.  Accordingly, we have reduced its value to zero on our balance sheet as of September 30, 2013, and have recorded a corresponding expense for the three months ended September 30, 2013.

We evaluated the likelihood of the TappIn product lines achieving the revenue milestones by December 31, 2014, necessary for the earn out to be paid.  We concluded it remote and to be  more-likely-than-not that those revenue milestones will not be achieved and that the contingent consideration will not have to be paid.  Accordingly, we have reduced the TappIn earn out liability on our balance sheet to zero as of September 30, 2013 and have recorded a corresponding credit to income for the three months ended September 30, 2013.

When we acquired TappIn, Inc. in December 2011, we recorded a deferred tax liability resulting from our recording of the intangible assets described above as of the acquisition date for which there was no corresponding change in the tax basis of the TappIn common stock that we purchased.  The balance of this deferred tax liability was $1.2 million as of September 30, 2013.  Our reduction of the TappIn intangible assets to zero eliminated this deferred tax liability with a corresponding credit to federal income tax expense during the three months ended September 30, 2013.

The effects of the above items are summarized below (amounts in $000’s):

Reduction of intangible assets:
Customer relationship	$	(1,521	)
Developed technology		(2,045	)
Elimination of earn out liability		3,694
Net TappIn asset impairment and earnout liability elimination before taxes		128
Federal income taxes		1,213
Net TappIn asset impairment and earnout liability elimination after taxes	$	1,341

Our amortization expense related to these intangibles was approximately $437,000 for each of the nine months ended September 30, 2013 and 2012.

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8. Income Taxes

For the 2013 period, our effective income tax rate of 52.9% differed from a federal statutory rate of 34% primarily due to:

• Research and development tax credits that will be claimed on our federal income tax return.

• The domestic production activities deduction taken on our federal income tax return that is not an expense for financial statement purposes.

• The elimination of the deferred tax liability related to the TappIn intangible assets as discussed in Note 7.

Offset by:

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

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

For the 2012 period, our effective tax rate of 6.8% differed from the statutory rate of 34% primarily due to:

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

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

• The effect of the affiliated entity asset impairment expense that is not deductible for federal income tax purposes.

As of September 30, 2013, we had federal income tax net operating loss carry forwards of $1.1 million available to offset future federal taxable income, if any, that expire in 2030 and 2031. These carry forwards arose from TappIn operations before we purchased TappIn. Since our acquisition of TappIn. resulted in a change in control of that entity as defined by Section 382 of the Internal Revenue Code, we are limited to applying the following maximum amounts of this carry forwards against our taxable income in the indicated year:

2013	$	342,000
2014		175,000
2015		175,000
2016		175,000
2017		175,000
2018		93,000

We claimed research and experimentation tax credits (“R&D tax credit”) on certain of our tax returns and have included the effect of those credits in our provision for income taxes with a related resulting effect on our income taxes payable amounts. Certain of those returns, and in particular the R&D tax credit claimed on those returns, have been examined by the Internal Revenue Service, or IRS. The IRS has informed us of their intent not to allow a portion of those R&D tax credits we claimed. Certain components of this determination by the IRS involve estimates and judgments that we believe we applied in accordance with the Internal Revenue Code. Accordingly, we are in the processing of appealing this IRS position. However, since the IRS could prevail in their interpretation of these estimates and judgments despite our appeal, we are taking a position in preparing our financial statements that there is a more-likely-than-not chance that this examination could result in $125,000 of such credits not being allowed. Accordingly, income taxes payable includes $125,000 due to the uncertainty of this item.

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9. Earnings per Common Share

Earnings per share for the periods indicated was as follows (in thousands except per share amounts):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2013		2012			2013		2012
Net income (loss)	$	2,287	$	(2,714	)	$	3,185	$	(3,107	)
Weighted average shares outstanding - basic		18,761		18,398			18,570		18,336
Stock options and restricted shares (1)		397		-			431		-
Weighted average shares outstanding - diluted		19,158		18,398			19,001		18,336
Net (loss) income per common share - basic	$	0.12	$	(0.15	)	$	0.17	$	(0.17	)
Net (loss) income per common share - diluted	$	0.12	$	(0.15	)	$	0.17	$	(0.17	)

(1) For the three and nine months ended September 30, 2012, stock options and restricted shares are not included in the earnings per share computation as their effect would be anti-dilutive.

10. Contingencies

We were named as one of a number of defendants in a patent infringement suit filed by Achates Reference Publishing, Inc. in the United States District Court for the Eastern District of Texas Marshall Division. During the three months ended June 30, 2013, we settled this matter in a manner that was immaterial to our financial position and results of operations.

We were named as one of a number of defendants in a patent infringement suit filed by Uniloc Luxembourg S.A. in the United States District Court for the Eastern District of Texas Marshall Division. During the three months ended September 30, 2013, the court dismissed the plaintiff’s claims with prejudice.

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

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. “Forward looking statements” are those statements that describe management’s beliefs and expectations about the future. We have identified forward-looking statements by using words such as “anticipate,” “believe,” “could,” “estimate,” “may,” “expect,” and “intend.” Although we believe these expectations are reasonable, our operations involve a number of risks and uncertainties, including those described in the “Risk Factors” section of our 2012 Form 10-K and other documents filed with the Securities and Exchange Commission. GlobalSCAPE’s actual results could differ materially from those discussed in any forward-looking statements included in this Quarterly Report.

Overview

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

We operate primarily in the Managed File Transfer, or MFT, industry. Our solution portfolio addresses data and information management, movement, security and accessibility across a broad range of environments encompassing data and information in motion (for example, with traditional MFT solutions delivered as on-premises software or as a cloud service) and at rest (for example, through securely deleting or purging files or securely accessing stored data from mobile tablet or smartphone devices using our TappIn solution).

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

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

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

We offer managed e-mail attachment solutions for information sharing. We believe our managed e-mail attachment solution addresses the needs of customers who are constrained by the typical limits on e-mail attachment size or who require additional security, auditing, and reporting for file attachments shared through e-mail.

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We also offer software-as-a-service, or SaaS, and cloud-based subscription solutions for information sharing. Our SaaS and cloud-based subscription solutions allow customers to reduce their upfront and total cost of ownership and achieve other recognized benefits of cloud-based solutions, including service elasticity and strong service level agreements for IT infrastructure reliability and performance.  We believe our managed, cloud-based subscription solutions may become a notable part of our future revenue because these solutions provide recurring revenue which potentially builds over time, as compared to sales of on-premises software licenses which must be reconstituted every period. While we remain in the early stages of growing our subscription services, we have the capability to deliver these services in the United States as well as in additional geographies, such as the United Kingdom and Canada, where country-specific compliance requirements may necessitate in-country service delivery.

We serve the secure content mobility market with our TappIn solutions. Secure content mobility provides users with the ability to easily and securely access and share data and information using a web-browser, tablet or other mobile device such as a smartphone. Secure content mobility integrates aspects of ad hoc file transfer, broader MFT capabilities, cloud services, and remote accessibility to address growing market demand for secure, ‘anytime and anywhere’, device-independent access to distributed content. We believe that the inclusion of secure content mobility capability in our portfolio potentially could have profound implications on the future growth of our business due to the continuing growth of tablet computers and smartphone sales and their increasing adoption by business users.

As a corporation, we have won multiple awards for performance and reputation, including:

•   In 2013, we were named in Software Magazine’s Software 500 revenue-based ranking of the world’s largest software and service providers for the third year in a row.

•   In 2013, we were listed in the highest ranking category of “Champion” in Info-Tech Research Group’s Vendor Landscape Report for managed file transfer for the second year in a row.

•   In 2013, Texas Monthly named GlobalSCAPE one of the best companies to work for in Texas for the fourth year in a row, ranking us #13 in the medium size category.

•   In 2013, the San Antonio Business Journal recognized us for fast growth in revenue for the second consecutive year.

•   In 2012, we were named one of the top 50 companies in the San Antonio Express-News Top Workplaces for the third year in a row.

•   In 2012, we were named one of the “Best Places to Work” by the San Antonio Business Journal for the third year in a row.

•   In 2011, Computerworld named GlobalSCAPE on its list of “100 Best Places to Work in IT” for the second year in a row.

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 provide products and solutions to small, medium and large, multinational corporations as well as to individual consumers. We have a broad product line that has allowed us to grow revenue through software products installed at a customer’s location as well as through cloud-based and software-as-a-service solution delivery. In addition, we have grown our professional services capabilities to enhance our customers’ implementation, training and overall user experience. Our enterprise products, solutions, and services comprised more than 85% of our revenue during the three and nine months ended September 30, 2013. We continue to serve consumers and small businesses with our CuteFTP software and other consumer products. Our consumer products, while less than 15% of total revenue for the three and nine months ended September 30, 2013, are recognized brands in the marketplace that have a positive effect on our overall product offerings and corporate franchise.

Although we often have grown revenue sequentially quarter over quarter in recent years, we view annual revenue growth as the more important metric, especially considering the ongoing evolution of our solution portfolio. We believe annual “core” revenue growth, excluding larger, exceptional transactions, is a key metric for monitoring our continued success in developing our business in future periods. Given our diverse solution portfolio and the addition of subscription services, we review our revenue mix and changes in revenue, across all solutions, on a regular basis to identify key trends and adjust resource allocations.

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

The impact of cloud-based managed solutions on our revenue growth trends depends on several key factors, including the number of customers who may shift from software licenses to subscription services, the rate at which they may do so, the subscription term and fees, and the comparative value of the opportunity had it materialized as a software license sale instead of as a subscription service. The long-term impact also depends on whether availability of the managed solutions ultimately provides us with an expanded market footprint enabled by this additional means of delivering our solution capabilities.

Similarly, we believe market adoption of secure content mobility solutions, such as those provided by our TappIn solutions, will increase in future periods as use of personal computing devices, such as smart phones and tablets, continues to grow exponentially and as businesses increasingly embrace the rapidly increasing use of mobile devices, including “Bring Your Own Device”, or BYOD, operating models. In order to capitalize on this trend, our future emphasis will be on merging the TappIn technology and functionality with our EFT Standard Edition and EFT Enterprise Edition products to create a TappIn Enterprise solution.  We believe offering the TappIn technology through this integration will maximize the return on our investment in this product line.

We discuss our revenue growth and trends in the sections below titled Comparison of the Statement of Operations for the Three Months Ended September 30, 2013 and 2012 and Comparison of the Statement of Operations for the Nine Months Ended September 30, 2013 and 2012 .

Recurring Revenue Growth

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

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

We discuss our recurring revenue trends in the section below titled Comparison of the Statement of Operations for the Three Months Ended September 30, 2013 and 2012 and Comparison of the Statement of Operations for the Nine Months Ended September 30, 2013 and 2012.

Aggregate Contract Value Growth (Non-GAAP Measurement)

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

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

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

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

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

	September 30
	2013		2012
	(thousands)
Amounts we have billed and/or been paid in advance (presented as deferred revenue in our financial statements)	$	10,721	$	9,557
Amounts we will bill and be paid in the future (will appear in our financial statements when we are paid and/or when we provide the products and services)		392		752
Total ACV	$	11,113	$	10,309

The deferred revenue amounts in the table above appear on our balance sheet as follows:

	September 30,
	2013		2012
Deferred revenue, current portion	$	9,134	$	7,966
Deferred revenue, non-current portion		1,587		1,591
Total deferred revenue	$	10,721	$	9,557

Measurement of Income and Expense Excluding Infrequent Events (Non-GAAP Measurement)

We use supplemental measurements of income and expense excluding infrequent items to monitor the financial performance of our core operating activities prior to consideration of significant events that occur infrequently. These measurements of income and expense excluding infrequent items include:

• Operating expenses excluding infrequent items.

• Operating income excluding infrequent items.

• Net income excluding infrequent items.

• Earnings per share excluding infrequent items.

We exclude infrequent items from these income and expense measurements because we do not consider them part of our core operating results when assessing our ongoing operational performance, allocating resources to our business activities and preparing operating budgets. We believe that by comparing such income and expense measurements across historical periods, our operating results can be evaluated exclusive of the effects of certain infrequent items that may not be indicative of our core operations.

Income and expense excluding infrequent items are not measures of financial performance under GAAP and should not be considered a substitute for the similar items that include infrequent items. While we believe these non-GAAP income and expense measures provide useful supplemental information, there are limitations associated with the use of these non-GAAP income and expense measures. These non-GAAP income and expense measures are not prepared in accordance with GAAP and may not be comparable to similarly titled measures of other companies since there is no standard for preparing these non-GAAP income and expense measures. Items excluded in preparing these non-GAAP income and expense measures individually and collectively can have a material impact on operating expenses, operating income, net income and earnings per share. As a result, these non-GAAP income and expense measures have limitations and should not be considered in isolation from, or as a substitute for, financial statements prepared in accordance with GAAP.

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Income and expense excluding infrequent items is as follows:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2013			2012			2013			2012
Non-GAAP Operating Expenses
GAAP total operating expenses	$	4,802		$	8,867		$	15,231		$	20,369
Add: TappIn intangible asset impairment and earnout liability elimination	$	128			-		$	128			-
Less: Affiliated entity asset impairment		-			(3,264	)		-			(3,264	)
Operating expenses excluding infrequent items	$	4,930		$	5,603		$	15,359		$	17,105
Non-GAAP (Loss) Income From Operations
GAAP income (loss) from operations	$	1,535		$	(2,789	)	$	2,911		$	(3,196	)
Less: TappIn intangible asset impairment and earnout liability elimination	$	(128	)		-		$	(128	)		-
Add: Affiliated entity asset impairment		-			3,264			-			3,264
Operating income excluding infrequent items	$	1,407		$	475		$	2,783		$	68
Non-GAAP Net Income (Loss)
GAAP net income (loss)	$	2,287		$	(2,714	)	$	3,185		$	(3,107	)
Less: TappIn intangible asset impairment and earnout liability elimination	$	(1,341	)		-		$	(1,341	)		-
Add: Affiliated entity asset impairment		-			2,929			-			2,929
Net income (loss) excluding infrequent items	$	946		$	215		$	1,844		$	(178	)
Non-GAAP Earnings Per Share
Net income excluding infrequent items	$	946		$	215		$	1,844		$	(178	)
Weighted average share outstanding:
Basic		18,761			18,398			18,570			18,336
Diluted		19,158			19,125			19,001			18,336
Net income per common share excluding infrequent items:
Basic	$	0.05		$	0.01		$	0.10		$	(0.01	)
Diluted	$	0.05		$	0.01		$	0.10		$	(0.01	)

The TappIn intangible asset impairment and earnout liability elimination effect on non-GAAP net income (loss) of $(1.3) million is the gross TappIn intangible asset impairment and earnout liability elimination of $128,000 plus $1.2 million of related federal income tax effects. The affiliated entity asset impairment effect on non-GAAP net income (loss) of $2.9 million is the gross affiliated entity asset impairment of $3.3 million net of related federal income tax effects.

See our comparison of results for the three and nine months ended September 30, 2013 and 2012 below for our discussion of variations in the underlying elements comprising the amounts above.

Adjusted EBITDA Excluding Infrequent Items (Non-GAAP Measurement)

We utilize Adjusted EBITDA (Earnings Before Interest, Taxes, Total Other Income/Expense, Depreciation, Amortization and Share-Based Compensation Expense) Excluding Infrequent Items to measure profitability and cash flow from our core operating activities. We monitor and review cost of revenues, selling, general, and administrative, or SG&A, expenses and research and development, or R&D, expenses to assess conformance with established budget expectations and to identify specific variances. Identifying and, if necessary, addressing variances above budget is important for the purpose of staying within budget ceilings. However, even variances below budget may indicate imbalances in resource allocations or deviation of operating activities from established expectations. We exclude infrequent items because they typically do not directly impact profitability and cash flow resulting from our core activities.

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

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

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2013			2012			2013			2012
Net income (loss)	$	2,287		$	(2,714	)	$	3,185		$	(3,107	)
Add (subtract) items to determine adjusted EBITDA:
Income tax expense		(791	)		(86	)		(404	)		(227	)
Other expense		39			11			130			138
Depreciation and amortization		265			314			787			951
Stock-based compensation expense		225			283			522			711
Infrequent items:
TappIn intangible asset impairment and earnout liability elimination		(128	)		-			(128	)		-
Affliated entity asset impairment		-			3,264			-			3,264
Adjusted EBITDA	$	1,897		$	1,072		$	4,092		$	1,730

See the section below comparing our results of operations for the three and nine months ended September 30, 2013 and 2012, for a discussion of the variances between periods in the components comprising Adjusted EBITDA.

Our Product and Service Solutions and Trends

The following is a summary description of our products and solutions.

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

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

EFT Standard and Enterprise Editions

We earn most of our software license revenue from sales of our EFT Standard Edition and EFT Enterprise Edition solutions. These “server side” solutions provide a common, scalable MFT platform that accommodates a broad family of add-on modules to provide small and medium-sized businesses, or SMB’s, as well as larger enterprise customers, with increased security, automation, and performance when compared to traditional FTP-based and e-mail delivery systems. The add-on modules allow customers to select the solution configuration most applicable to their requirements for auditing and reporting, encryption, ad hoc and web-based file transfers, operability in or through a DMZ network, and integration with back-end business processes, including workflow automation capabilities. In 2013, we released Version 6.5 of our EFT platform which we branded as EFT 2013. Enhancements and added capabilities in this latest version include, among others:

• Enhanced integration with our Mail Express managed email attachment solution.

• Comprehensive support for Unicode UTF-8 encoding allowing greater international use.

• Enhanced administrative controls and improved visibility of the status and progress of file transfer activities.

• Full support for Microsoft Windows Server 2012 and Microsoft SQL Server 2012.

We continue to develop these products and solutions by, for example, improving their speed and responsiveness of performance, providing additional administration flexibility supporting cross-platform implementation with our DMZ Gateway solution, implementing business activity monitoring, and providing additional language support. We have sustained the year-to-year increase in our revenue from these products and solutions as a result of our ongoing development of this product line that has continued to enhance its appeal in the marketplace.

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CuteFTP

CuteFTP is a ‘“client side” software product, installed on a user’s local computer that enables file transfers from or to a file transfer server. The target market for the CuteFTP product includes corporate IT professionals who use it to transfer data between locations via the Internet and individual Web site operators who use it to upload their Web pages to their Web hosting provider, among others.

While CuteFTP still has significant brand recognition in the market, the revenue we earn from this product line and its percent of our total revenue have declined in recent years. We believe market availability of free FTP utilities and the emergence of social media with embedded capabilities for sharing non-sensitive data such as photos and videos are examples of the primary causes of the decline in CuteFTP revenue. Notable features introduced in our current CuteFTP Version 9 in include, among others:

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

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

• Integration with TappIn, enabled by the WebDAV support.

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

Cloud-Based MFT

Since 2010, we have had a partner agreement with Rackspace Hosting, Inc., a world leader in the hosting and cloud computing industry. We have a similar, more recent agreement with PEER 1 Hosting. Through these relationships, we deliver cloud-based, managed file transfer solutions (MIX, Hosted Mail Express, and Hosted EFT) for the secure exchange of business-to-business data, including large files and sensitive data. Our cloud-based solutions allow customers to outsource all or part of their complex and demanding information exchange needs to reduce costs, improve operational efficiencies, track and audit transactions, and provide a greater level of security. We offer our cloud services capability in the United States, Canada and in Europe. We meet country-specific compliance requirements in the UK and Canada which can necessitate in-country delivery of the services.

The cloud-based solutions established an additional delivery method for our MFT products and solutions and potentially for other solution capabilities. Through our cloud services, we can offer new and existing customers “pay as you go”, flexible pricing under one, two, and three-year contracts that help them eliminate upfront capital expenditures. This subscription revenue provides us with a growing revenue stream visible into future periods. The revenue we earn from this product line is included in other revenue in the table below. While our cloud-based MFT revenue has grown from year-to-year, it does not yet constitute a material portion of our overall revenue.

Wide Area File Services and Continuous Data Protection Solution

Our WAFS software provides a file sharing, collaboration, and replication solution over multiple sites. WAFS technology can have our CDP product added to provide enterprises with a file access and data protection combination that centralizes data storage and IT administration facilities without compromising data sharing and protection. A key feature and benefit of WAFS is its byte-level differencing architecture that continually transmits only changed bytes (versus an entire file) thereby allowing rapid update of large files accessed by widely dispersed, multiple users. Other key features of WAFS include native file locking, replication to multiple locations simultaneously and adherence to access control list file permissions, and full UTF-8 support.

Our WAFS revenue for the nine months ended September 30, 2013, was lower than for the comparable period in 2012 due to our need to restrict the environments into which it is sold and installed to those that can be configured to operate within the data transmission volume and stored file size operating specifications of the software. We have an ongoing product development program to expand these operating specifications so we can introduce WAFS to a broader spectrum of the marketplace and increase our revenue from this product. We believe WAFS will be competitive in the marketplace for the foreseeable future as a product serving the need for wide area file access and data protection.

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Managed E-mail Attachment Solution

Our managed e-mail attachment solution, Mail Express, is a client-server application that allows users to send and receive e-mail attachments of unlimited size easily and transparently without resorting to unapproved and potentially insecure methods such as USB drives or social media sites.  The ability of Mail Express to transmit multi-terabyte and larger attachments, which is well beyond the operation range of typical competing approaches to sending email attachments, means the user is limited only by their available bandwidth when sending files as an email attachment.  Mail Express provides increased benefits for the information technology organizations by offering greater visibility into email-based file movement across the enterprise, including robust tracking and auditing. The Mail Express application provides flexible, customer-defined administration privileges to allow e-mail administrators and end users to configure specific parameters for handling e-mail attachments in accordance with corporate policy. In 2013, we introduced Mail Express Version 3.3 that includes a number of enhancements including, among others:

• Integration with EFT 2013.

• More flexible language support to enhance international appeal.

• A new dashboard allowing additional administrator visibility into all connected clients.

We believe Mail Express will be competitive in the marketplace for the foreseeable future as a product for securely sharing and managing large e-mail attachments.

Secure Content Mobility Solution

Our TappIn product line provides the ability to easily and securely access and share documents, pictures, videos and music anytime, anywhere while eliminating or minimizing the storage of data in the cloud and the associated security and privacy concerns. From the office, at home, or on the road, customers can “Tapp In” to their files, stored in multiple locations, using any web browser and most Internet-enabled mobile devices (including Apple iPhone and iPad, Google Android,Windows Phone and Kindle Fire). With TappIn, users can avoid uploading and/or syncing to a cloud storage location and eliminate the need to pay for additional cloud storage. Instead, the TappIn service securely leverages the user’s existing in-house storage devices (such as a desktop computer, in-house network servers or network-attached storage devices), allows sharing of large files and provides encryption to safeguard content.

The TappIn solutions incorporate elements of on-premises software, cloud and SaaS delivery models. Unlike other remote access products that can consume significant amounts of storage capacity on a smartphone or tablet, TappIn makes content available through a secure pathway that gives users access to files on their existing in-house storage devices without having to download those files to their mobile device. This delivery method not only saves storage space on the mobile device but also ensures content remains secure and private on the user’s existing in-house storage devices.

We believe secure content mobility is a rapidly emerging, central feature of the markets we serve, including our primary MFT market. We believe exponential growth in smartphone and tablet sales and adoption, combined with rapid growth in retained content and BYOD expectations, potentially will drive strong revenue growth in this market segment particularly in the enterprise space. In order to capitalize on these trends, our future emphasis will be on merging the TappIn technology and functionality with our EFT Standard Edition and EFT Enterprise Edition products to create a TappIn Enterprise solution.  We believe offering the TappIn technology through this integration will maximize the return on our investment in this product line.

Professional Services

We offer a range of professional services to complement our software and cloud-based solutions. These professional services include product customization and system integration, solution “quickstart” implementations, business process and workflow, policy development, education and training, and solution health checks. In addition, we may provide longer-term engineering services, including supporting multi-year contracts, if necessary to support certain solution implementations and integrations.

Our professional services revenue is directly correlated to certain components of our cost of revenues because the services necessarily are labor intensive. For this reason, professional services typically have significantly lower margins than product sales or subscription services. However, we believe professional services allow us to better establish and maintain our solution implementations, while also providing our customers with the training and education services that help them make more complete use of our solution capabilities. In addition, for large contracts like the engineering services we provide to the U.S. Army, such professional services provide significant past performance that facilitates additional business. Over time, we believe the return on investment from increased professional services outweighs the potential near-term impacts on operating margins.

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Overall Revenue Trends and Mix Between Products, Services, and Maintenance and Support

See our discussion below under Comparison of the Statement of Operations for the Three and Nine Months Ended September 30, 2013 and 2012 for a review of our overall revenue trends and mix between products, services, and maintenance and support.

Strategy and Outlook

We intend to build upon our leadership position in the MFT market to provide businesses, other organizations, and individual users with the solutions necessary to meet their growing need for secure information exchange. From our perspective, fully addressing this need for secure information exchange requires consideration of capabilities beyond traditional MFT, including managed e-mail attachment, cloud-based, and remote access security solutions. We believe we must consider ongoing, fundamental changes in customer technologies and processes, such as the rapidly increasing use of mobile devices and BYOD aspirations, in the workplace.

Our strategic focus continues to center on:

• Entering and establishing leadership in broader information exchange markets while maintaining leadership in the MFT industry.

• Growing recurring revenue.

• Developing and enhancing our software solutions.

• Extending our presence in the secure content mobility market.

• Increasing international sales through third-party distributor channels.

• Growing enterprise and government sales.

• Developing our corporate brand and market recognition.

Entering and Establishing Leadership in Broader Markets

Gartner Inc., a notable industry analyst, and International Data Corporation have stated that the annual MFT market is in excess of $700 million. We are a leader in MFT products and services. In both 2013 and 2012, we achieved one of the highest ratings in the latest Managed File Transfer Vendor Landscape Report from Info-Tech Research Group. In both years, the report designated GlobalSCAPE a “Champion” in its Vendor Landscape matrix. Info-Tech Research Group evaluated criteria such as strategy, viability, sales and support reach, and channel partner programs. Their evaluation of our strategy garnered one of the highest possible scores due in part to our TappIn product line and our approach to mobile file access. Also playing a role in our rating was the assessment of our EFT Enterprise Edition, one of our primary MFT solutions. EFT Enterprise Edition was commended for its ability to meet advanced security requirements, its flexible deployment options and our responsive customer support. We also received the highest marks for our available features and flexible system architecture.

We also were positioned in the leader’s quadrant of the Gartner Magic Quadrant for Managed File Transfer in the latest years for which Gartner published this magic quadrant. With MFT capabilities increasingly being integrated into business-to-business, or B2B, gateway, data integration, service oriented architecture, and other technical solutions, we believe the market will continue shifting toward consideration of MFT as more of a “feature” than a solution. This shift may take many years, but we believe early recognition of the trend and appropriate strategic planning increase our potential for evolving our solutions in front of the ongoing market changes. We have begun to address this shift in a number of ways.

We offer services to the much larger, and adjacent, cloud services market with our MIX and Hosted Enhanced File Transfer solutions. Gartner estimated the cloud computing market would grow to approximately $210 billion by 2016. This market includes categories such as infrastructure-as-a-service, management and security, and SaaS. Our partner agreements with hosting providers such as Rackspace and Peer 1, and the proven, modular capabilities of our EFT solution suite, provide us a straightforward path for delivering our products and technology to specific segments of this market

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We have added adjacent-market capabilities, such as business automation and business activity monitoring, to the EFT software also through our modular solution architecture. These capabilities are helping to underpin the consistent growth in revenue from the EFT solution suite. In addition, our Mail Express solution was recognized by Info Security Products Guide as a “Global Excellence Award” winner in the Email Management and Security category in 2012 and by Network Products Guide as a Best Products and Services winner in the Email, Security and Management Category in 2013. We believe strengthening our ad hoc file transfer solutions remains a key strategy element and we intend to pursue solution enhancements in this area in future periods. Our secure content mobility competencies provide another potentially compelling complement to traditional MFT capabilities, including ad hoc file transfer solutions. We have developed a secure mobile access module for our EFT solution as an initial point of integration with our TappIn technology. We regard secure content mobility potentially as a unifying concept for our solution portfolio given the central position and importance of content (i.e., data and information) in the market drivers for our solutions. We intend to further integrate our solution capabilities, for example as demonstrated by the February 2013 integration of Mail Express functionality as a module within the EFT solution suite, to take advantage of potential synergies and strengths across our solution portfolio, while also possibly simplifying our marketing and sales processes.

We believe that building on our MFT capabilities provides a clear opportunity to increase our average transaction size and repeat business through greater scalability, business integration, and application of professional services to support implementation planning and execution. Our enterprise solutions, such as EFT Enterprise, have increased considerably in capability over the years. The add-on modules available for EFT Enterprise and increased technical performance for other offerings in our portfolio provide a strong platform for greater business adoption and integration of our solutions. We believe continued focus on capabilities necessary for even broader B2B applicability, including appropriate treatment of evolving secure content mobility requirements, is a key strategic opportunity for our future business operations.

With MFT capabilities increasingly being integrated into B2B gateway, data integration, service oriented architecture, and other technical solutions, the need to keep evolving our solutions and entering adjacent markets also is clear. We continue to believe the market will shift toward consideration of traditional MFT as more of a “feature” than a solution. This shift may take many years, but we believe early recognition of the trend and appropriate strategic planning increase our potential for evolving our solutions in front of the ongoing market changes.

Growing Recurring Revenue

Recurring revenue includes M&S contracts and subscriptions for our cloud-based managed and hosted solutions. In the broadest sense, delivery of labor hours on long-duration professional services contracts also fits within this growth strategy because such “contracted sales” provide a book of sold business that will be recognized as revenue in future periods with some revenue from these contracts potentially visible even two or three years in the future. This future revenue is included in deferred revenue on our balance sheet and in Aggregate Contract Value (ACV) as previously described in the Key Business Metrics section. We believe increasing recurring revenue provides greater predictability of revenue in future periods and a stronger hedge against future business or broader economic downturns.

We believe execution of this strategy element potentially could provide greater predictability of revenue in future periods and a stronger hedge against future business (or broader economic) downturns. Currently, the largest component of our recurring revenue is from M&S contracts. We intend to focus on delivering continued growth in M&S contracts and the future revenue they yield, while assessing market traction for the full range of our solutions on an ongoing basis. From this perspective, M&S revenue may continue to grow in absolute terms, and as a percentage of total revenue, for some period of time, depending on the relative future growth rates of all of our solutions.

Subscription sales of our MIX and Hosted EFT managed solutions and TappIn products may change the trajectory of our future revenue growth. We believe that due to its compounding effects, subscription revenue for these software-as-a-service offerings potentially can grow more quickly and significantly than software license revenue and create increased operating margins.

Developing and Enhancing Our Solutions

We have allocated significant resources to enhancing and developing our solutions in recent years. This strategic focus has delivered additional features and functionality in our Enhanced File Transfer, WAFS and Mail Express solutions, our MIX and Hosted EFT cloud-based offerings, our TappIn secure content mobility products and our professional services. We intend to maintain our focus on developing our solution portfolio and, as appropriate, enhancing our existing solutions.

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Our solution portfolio may evolve over time, for example, through development of new offerings in adjacent markets or through acquisitions. We maintain an active research and development program and work closely with partners and others in the industry to identify new solution opportunities. Examples of this activity over the years include:

• In 2008, we began our first original equipment manufacturer, or OEM, partnership with Network Automation, embedding Network Automation’s AutoMate product as the Advanced Workflow Engine, or AWE, module to our Enhanced File Transfer Server platform.

• In 2010, we expanded our partner agreement to become a worldwide reseller of Network Automation’s software solutions, AutoMate and AutoMate Business Process Automation Server.

• Over the past three years, we have partnered with hosting providers (including Rackspace Hosting) to deliver the MIX and Hosted EFT solutions.

• In December 2011, we acquired the TappIn secure content mobility technology.

• In 2012, we established additional OEM and co-marketing relationships for our TappIn solutions.

Recently, we have decided to emphasize merging the TappIn technology and functionality with our EFT Standard Edition and EFT Enterprise Edition products to create a TappIn Enterprise solution.  We believe offering the TappIn technology through this integration will maximize the return on our investment in this product line.

As we evolve our solution portfolio, we intend to maintain an appropriate balance between legacy and new solutions, including making choices about transitioning, sustaining, or retiring solutions as necessary to best operate under prevailing business conditions. Transitioning or sustaining solutions may involve consolidating capabilities within our solution portfolio, releasing upgrades in response to market or customer needs, or making bug fixes in accordance with our communicated End of Life, or EOL, Policy. We also may phase out solutions periodically in accordance with the EOL Policy.

Entering and Extending our Presence in the Secure Content Mobility Market

In December 2011, we entered the secure content mobility market with the acquisition and introduction of our TappIn product line. Secure content mobility provides users with the ability to easily and securely access and share data and information using a web-browser, tablet or other mobile device such as a smartphone. Secure content mobility integrates aspects of ad hoc file transfer, broader MFT capabilities, cloud services, and remote accessibility to address growing market demand for secure, ‘anytime and anywhere’, device-independent access to distributed content.

We believe the addition of secure content mobility capability to our portfolio potentially has profound implications due to the continuing growth of tablet computers and smartphone sales and their increasing adoption by business users. While storing and accessing data in a cloud environment is viable in many circumstances, we believe there also is a significant demand in the marketplace for the ability to access data in a manner similar to that offered by cloud computing but with the data being accessed and stored within the security of computers, servers or data centers owned by or dedicated solely to a particular individual or enterprise, rather than in the cloud. Many of our customers already using our EFT solution and other products have expressed a desire to have the flexibility to access their data from anywhere using a tablet computer or smartphone with security protocols at least equivalent to that offered by our EFT software and other products within our portfolio. Our TappIn technology potentially can provide or contribute to that functionality. Therefore, we intend to expand and enhance the TappIn capabilities and appeal for enterprise customers including merging the TappIn technology and functionality with our EFT Standard Edition and EFT Enterprise Edition products to create a TappIn Enterprise solution.

TappIn currently supports the consumer user’s needs by providing the capability to access data stored on the user’s personal computer, network attached storage or similar device from a remote location using a tablet, smartphone or other network-enabled device. There is demand in the marketplace for this capability in light of concerns about the security of personal data when it is stored in the cloud. We are accessing this market through direct sales of the TappIn application to consumers through our website and by partnering with major storage device manufacturers who will ship their products pre-configured with TappIn capabilities.

Increasing International Sales Through Third-Party Distributor Channels

We have added several channel partners in recent years and also organized our sales force and associated sales processes, to more effectively support our partner network worldwide. Channel partners resell, distribute, or integrate our solutions. These channel partners provide us with additional opportunities to penetrate deeper into existing markets and enter new sales territories.

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Channel sales can help us establish a lower-touch delivery model through which we train and provision the partners to sell and distribute our solutions. We leverage this approach to reduce our overall cost of marketing and selling our solutions in geographic areas where it would be costly to establish a presence with our own employees. To facilitate this approach, we host channel partner conferences to provide a forum for exchanging ideas and delivering partner-specific sales education and training. We currently derive approximately 86.8 percent of our sales from the United States, United Kingdom, Canada, and Australia. Achieving an additional presence in regions we historically have not served to any notable degree could increase our sales in future years. For example, we have placed increased emphasis on sales to Latin America and Asia in recent periods.

Growing Enterprise and Government Sales

GlobalSCAPE conducts business with thousands of businesses around the world. We provide solutions to some of the world’s largest banks, insurance companies, healthcare providers, automakers, film companies and technology providers. We intend to continue penetrating large enterprise firms with our expanding solutions and services.

Government sales, particularly large contracts from the U.S. Army, have had a significant positive impact on our growth and market image in recent years. However, these large contracts also have caused significant swings in our financial results. We are focused on more deliberate growth in government sales, including software and associated services, potentially augmented by occasional large product orders.

We have an M&S contract with the U.S. Army to support the Standard Army Maintenance System-Enhanced (SAMS-E) logistics program. This is the fourth large U.S. Army contract for GlobalSCAPE since 2005. Under this agreement, we provide M&S for previously purchased software licenses, including the EFT solution and CuteFTP Pro managed file transfer application. GlobalSCAPE solutions enable the SAMS-E program to maintain compliance with federal and U.S. Army and information security regulations as a result of our product certifications that include Federal Information Processing Standards (FIPS 140-2) and the U.S. Army Certificate of Networthiness. In June 2013, the U.S. Army exercised year one of a two-year option to continue Globalscape’s support to this program, extending this contract to July 2014. We will receive $1.45 million for our M&S services during this period which will yield in excess of $360,000 of revenue per quarter. If the second option year is exercised, it could result in a total value of $4.4 million over three years, making it potentially the largest single contract win in company history.

Developing our Corporate Brand

GlobalSCAPE traditionally has been better known for CuteFTP than as a corporate brand. We have an ongoing initiative to elevate our corporate profile under the GlobalSCAPE brand. We use internal resources as well as outside marketing, communications and investor relations professionals to support this work.

We have participated in numerous analyst briefings and investor conferences that have increased our recognition within the investor and analyst communities. We have revised our website, logos, and other areas to more prominently emphasize our corporate brand. Through these activities, we have established a more consistent, recognizable brand that may better support future growth and market visibility.

We believe we have continued to enhance our brand through additional national and regional attention resulting from the numerous corporate awards we have received including:

•   In 2013, we were named in Software Magazine’s Software 500 revenue-based ranking of the world’s largest software and service providers for the third year in a row.

•   In 2013, we were listed in the highest ranking category of  “Champion” in Info-Tech Research Group’s Vendor Landscape Report for managed file transfer for the second year in a row.

•   In 2013, Texas Monthly named GlobalSCAPE one of the best companies to work for in Texas for the fourth year in a row, ranking us #13 in the medium size category.

•   In 2013, the San Antonio Business Journal recognized us for fast growth in revenue for the second consecutive year..

•   In 2012, we also were named one of the top 50 companies in the San Antonio Express-News Top Workplaces for the third year in a row.

•   In 2012, we were named one of the “Best Places to Work” by the San Antonio Business Journal for the third year in a row.

•   In 2011, Computerworld named GlobalSCAPE on its list of “100 Best Places to Work in IT” for the second year in a row.

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We believe the corporate, financial, and technical awards we have received over the years in aggregate increase our market visibility and provide a stronger basis for continued development of the GlobalSCAPE brand.

Liquidity and Capital Resources

Our cash and working capital positions were as follows (in thousands):

	September 30, 2013		December 31, 2012
Cash and cash equivalents	$	9,757	$	8,079
Working capital		1,703		73
Working capital plus deferred revenue (non-GAAP presentation)		12,424		9,846

Deferred revenue, unlike the other liability components of our working capital, is an obligation we will satisfy through 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. Working capital plus deferred revenue is not a measure of financial position under GAAP, has limitations as an analytical tool and when assessing our financial position, and should not be considered a substitute for working capital computed in accordance with GAAP.

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

	Cash Provided (Used) During the Nine Months Ended September 30,
	2013			2012
Operating activities	$	3,827		$	2,866
Investing activities		(1,298	)		(568	)
Financing activities		(851	)		(906	)

Our cash provided by operating activities increased during the nine months ended September 30, 2013 (“the 2013 period”) compared to the nine months ended September 30, 2012 (“the 2012 period”), primarily due to:

•   Net income, after adjustments to reconcile net income to net cash provided by operating activities as illustrated on our Condensed Consolidated Statements of Cash Flow, of $3.4 million for the 2013 period compared to $1.5 million for the 2012 period which yielded approximately $1.9 million of additional cash flow for the 2013 period compared to the 2012 period. See the comparison of statement of operations for the 2013 period and the 2012 period below for a discussion of the changes in the components of these amounts.

•   Accounts payable decreasing $6,000 during the 2013 period compared to decreasing $239,000 during the 2012 period with the lower decrease due to enhanced cash management policies related to vendor payments and normal variations in the timing of our payments to vendors.

Offset by

•   Deferred revenue increasing $948,000 during the 2013 period compared to increasing $1.9 million during the 2012 period.  During the 2012 period, we received an M&S order from the U.S. Army that was notably higher than the expiring M&S order it replaced which contributed to the deferred revenue increase in 2012.  The similar U.S. Army M&S renewal in 2013 was for an amount similar to the 2012 amount thereby not creating a similar increase in deferred revenue in 2013.

•   Accounts receivable increasing $251,000 during the 2013 period compared to decreasing $314,000 during the 2012 period with this change due to non-recurring circumstances causing certain of our customers to take longer to pay in 2013 compared to 2012 but which did not result in an increase in uncollectable accounts receivable.

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The increased use of cash for investing activities during the 2013 period compared to the 2012 period was primarily due to:

•   A $500,000 disbursement in the 2013 period to satisfy the payment of part of the TappIn earn-out liability, which is an event that did not occur in the 2012 period.

•   An increase in capitalized software development costs in the 2013 period compared to the 2012 period due to a greater number of our software development projects having progressed to having a detailed program design or working prototype.

Offset by:

•   Lower purchases of property and equipment during the 2013 period compared to the 2012 period primarily due to the timing of when such items had been purchased such that our property and equipment in place at the beginning of the 2013 period was substantially adequate to meet our operating needs during that period.

The amount of cash used for financing activities during the 2013 period was less than the amount used during the 2012 period primarily due to proceeds received from the exercise of stock options held by one of our former officers.

The reduction of the TappIn intangible assets and earnout liability to zero as discussed below did not provide or use cash.

Our primary obligations at September 30, 2013 were:

• Deferred revenue of $10.7 million of which $9.1 million is the primary component of our current liabilities. Our deferred revenue arises primarily from our obligation to provide services in the future under maintenance and support contracts for which we have received advance payment. We will recognize this deferred revenue as revenue over the remaining life of those contracts which generally ranges from one to three years.

• Notes payable to a bank of $4.7 million (see discussion below under Loan Agreements).

• Trade accounts payable, accrued liabilities, obligations under operating leases and amounts due third parties under royalty agreements all incurred in the normal course of business.

We rely on cash on hand and cash flows from operations to fund our operations and believe these items will be our principal sources of operating capital during the foreseeable future. Our capital requirements principally relate to our need to fund our ongoing operating expenditures, which are primarily related to employee salaries and benefits. We make these expenditures to enhance our existing products, develop new products, sell those products in the marketplace and support our customers after the sale.

We plan to expend significant resources in the future on internal product development programs, such as merging TappIn and our EFT Standard Edition and EFT Enterprise Edition to create a TappIn Enterprise Solution, and may also use our cash possibly to license or acquire technology, products, or businesses. Because our principal source of cash is cash flow from operations, if our sales were to decline or our expenses to increase, our available cash could also decline. If sales decline or expenses increase significantly, or if our liquidity is otherwise under duress, 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. We may also sell equity securities or enter into credit arrangements in order to finance future acquisitions or licensing activities, to the extent available.

Loan Agreements

In December 2011, we borrowed $7 million under loan agreements with The Bank of San Antonio to fund a portion of the purchase price of TappIn. These loan agreements provide for the following notes payable:

• A note payable with an original principal balance of $4.0 million bearing interest at 4.75% per annum and secured by substantially all of our consolidated assets.

• A note payable with an original principal balance of $3.0 million bearing interest at 4.25% per annum and secured by a certificate of deposit with The Bank of San Antonio of $3.0 million bearing interest at 2.0% per annum. This certificate of deposit is included in long-term investments on our balance sheet.

At September 30, 2013, the total principal balance outstanding under these notes payable was $4.7 million.

Interest and principal are payable under both notes in 60 equal monthly installments that will fully amortize the notes as of their December 2, 2016 maturity date. The loans may be prepaid at any time without premium or penalty.

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The Loan Agreements contain the following financial covenants:

• We must maintain a debt service coverage ratio of at least 1.25. This ratio is defined in the loan agreements as (1) net income plus depreciation, interest and non-cash charges divided by (2) the sum of the current portion of long-term debt plus interest expense. As of September 30, 2013, this debt service coverage ratio was 7.25.

• We must maintain a maximum debt to tangible net worth ratio of 4.00:1. This ratio is defined in the loan agreements as (1) total liabilities less deferred revenues divided by (2) total assets, excluding intangible assets, minus total liabilities, excluding deferred revenues. As of September 30, 2013, this debt to tangible net worth ratio was 0.50:1.

• We must maintain liquid assets (cash and marketable securities) of at least $3.2 million in 2013 and $2.2 million in 2014. As of September 30, 2013, cash and marketable securities were $9.8 million.

The loan agreements contain customary covenants relating to maintaining legal existence and good standing, complying with applicable laws, delivery of financial statements, payment of taxes and maintaining insurance. We are prohibited, without obtaining advance approval from the bank, from selling any of our assets other than in the ordinary course of business, acquiring any other entities, changing the types of business we are engaged in, incurring indebtedness other than that permitted by the loan agreements, incurring any liens on our assets other than those permitted by the loan agreements, making certain investments or acquiring any shares of our capital stock. The loan agreements also contain 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

At September 30, 2013, our principal commitments consisted of obligations outstanding under the loan agreements described above, operating leases for our office space, royalty agreements with third parties, federal income tax payable, trade accounts payable and accrued liabilities. The commitments related to royalty agreements are contingent on sales volumes. We plan to continue to expend significant resources on product development in future periods which may require that we enter into additional contractual arrangements and use our cash to acquire or license technology, intellectual property, products or businesses related to our current business strategy.

Our contractual obligations at September 30, 2013, other than (1) the TappIn earnout liability described above and (2) trade accounts payable, accrued liabilities, royalties and federal income taxes we incur in the normal course of business consisted of the following:

	Amounts Due for the Period (000's)
	Three Months Ending December 31,		Fiscal Years
	2013		2014 - 2016		2017 - 2019		Thereafter		Total
Long term debt	$	336	$	4,389	$	-	$	-	$	4,725
Operating leases		118		1,177		810		-		2,105
	$	454	$	5,566	$	810	$	-	$	6,830

TappIn Intangible Assets and Earnout Liability

In December 2011, we acquired all of the issued and outstanding shares of TappIn.  At the time of this acquisition, we allocated the total purchase price of this acquisition to assets and liabilities based on their estimated fair values at the acquisition date.  That allocation resulting in us recording intangible assets consisting of the following:

			Accumulated
			Amortization			Net Book Value
	Gross Carrying		Through			as of
	Amount		September 30, 2013			September 30, 2013
Customer relationship	$	1,863	$	(342	)	$	1,521
Developed technology		2,771		(726	)		2,045
Total	$	4,634	$	(1,068	)	$	3,566

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The acquisition of all of the issued and outstanding shares of TappIn provided for the possible payment of $4.5 million of contingent consideration to the former shareholders of TappIn. if our TappIn product line achieves certain revenue milestones by no later than December 31, 2014. Based on our past estimates of the probability and likelihood of this earn out ultimately being paid, our balance sheet has previously included a liability of $3.694 million for these possible payments.

We evaluated input from our customers and the marketplace as a whole relative to the TappIn product line and concluded that our future emphasis will be on merging the TappIn technology and functionality with our EFT Standard Edition and EFT Enterprise Edition products to create a TappIn Enterprise solution.  We believe offering the TappIn technology through this integration will maximize the return on our investment in this product line. While we will continue to offer TappIn as a standalone product in its Standard and Professional Editions, we have concluded that revenue earned from the TappIn product line sold in those configurations will not be significant to our results of operations and financial position in the future.

For accounting and financial statement presentation purposes, the value assigned to the developed technology intangible asset as of the date we acquired TappIn. and subsequent thereto relates only to the TappIn Standard Edition developed technology that existed on the date we acquired TappIn.  Under GAAP, none of the value of this intangible asset can be derived from the TappIn Professional Edition or from other uses of the TappIn technology.  Specifically, none of the TappIn core technology, enabling technology or the migration of that technology, including the application of that technology to our EFT Standard Edition and EFT Enterprise Edition product lines as mentioned above, can be relied upon to ascribe value to the developed technology intangible asset. Since we believe revenue earned from the TappIn Standard Edition will not be significant to our results of operations and financial position in the future, we have concluded it to be more-likely-than-not that the intangible asset arising from this developed technology is of nominal future value. Accordingly, we have reduced its value to zero on our balance sheet as of September 30, 2013, and have recorded a corresponding expense for the three months ended September 30, 2013.

For accounting and financial statement purposes, the value assigned to the customer relationship intangible asset relates to one contract with a third-party as it stood and was in place on the date we acquired TappIn.  Under GAAP, none of the value of this intangible can be derived from future modifications of this contract or from other, subsequent customer relationships.  The value of the contract that gave rise to this customer relationship intangible is dependent upon both (1) continued shipments of that customer’s products as they existed at the time we acquired TappIn. and (2) the purchasers of that customer’s products subscribing to TappIn Professional Edition.  We believe revenue earned from the activities upon which the value of the customer relationship intangible asset was derived will not be significant to our results of operations and financial position in the future. Our relationship with that customer remains in place relative to products they are currently selling that did not exist at the time we acquired TappIn. and that were not part of determining the intangible value of this customer relationship at that time.  We have concluded it to be more-likely-than-not that the intangible asset arising from this customer relationship and the products it covered as they existed at the time we acquired TappIn. is of nominal future value.  Accordingly, we have reduced its value to zero on our balance sheet as of September 30, 2013, and have recorded a corresponding expense for the three months ended September 30, 2013.

When we acquired TappIn, Inc. in December 2011, we recorded a deferred tax liability resulting our recording of the intangible assets described above as of the acquisition date for which there was no corresponding change in the tax basis of the TappIn common stock that we purchased.  The balance of this deferred tax liability was $1.2 million as of September 30, 2013.  Our reduction of the TappIn intangible assets to zero eliminated this deferred tax liability with a corresponding credit to federal income tax expense during the three months ended September 30, 2013.

We evaluated the likelihood of the TappIn product lines achieving the revenue milestones by December 31, 2014, necessary for the contingent consideration described above to be paid.  We concluded it remote and more-likely-than-not that those revenue milestones will not be achieved and that the contingent consideration will not have to be paid.  Accordingly, we have reduced the TappIn earn out liability on our balance sheet to zero as of September 30, 2013 and have recorded a corresponding credit to income for the three months ended September 30, 2013.

The effects of the above items are summarized as follows (amounts in $000’s):

Reduction of intangible assets:
Customer relationship	$	(1,521	)
Developed technology		(2,045	)
Elimination of earn out liability		3,694
Net TappIn asset impairment and earnout liability elimination before taxes		128
Federal income taxes		1,213
Net TappIn asset impairment and earnout liability elimination after taxes	$	1,341

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Comparison of the Statement of Operations for the Three Months Ended September 30, 2013 and 2012

In our discussion below, we refer to the three months ended September 30, 2013 as the “2013 quarter” and the three months ended September 30, 2012 as the “2012 quarter”. Our references to increases or decreases relate to the 2013 quarter compared to the 2012 quarter as presented in the following table ($’s in thousands):

	Three Months Ended September 30,
	2013			2012			$ Change
Total revenues	$	6,337		$	6,078		$	259
Cost of revenues		250			331			(81	)
Selling, general and administrative  expenses		3,492			4,136			(644	)
Research and development expenses		923			822			101
TappIn intangible asset impairment and earnout liability elimination		(128	)		-			(128	)
Affiliated entity asset impairment		-			3,264			(3,264	)
Depreciation and amortization		265			314			(49	)
Total operating expenses		4,802			8,867			(4,065	)
(Loss) income from operations		1,535			(2,789	)		4,324
Other income (expense)		(39	)		(11	)		(28	)
Net (loss) income before income taxes		1,496			(2,800	)		4,296
Income tax expense (benefit)		(791	)		(86	)		(705	)
Net (loss) income	$	2,287			(2,714	)	$	5,001

Revenue. We derive our revenue primarily from the following activities:

• Software license revenue, which results primarily from sales of our EFT Enterprise, EFT Standard, CuteFTP and WAFS products and solutions, which we typically recognize at the time of product shipment.

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

• Professional services revenue, which includes a variety of customization, implementation, and integration services, as well as delivery of education and training associated with our solutions, all of which are recognized as the services are performed.

• Subscription revenue under a SaaS model from sales of our Managed Solutions, which include Managed Information Exchange, or MIX, Hosted Enhanced File Transfer Server, or Hosted EFT Server and TappIn, which is typically recognized on a monthly basis as the services are billed over the contract period which typically ranges from one to three years.

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

	Revenue for the Three Months Ended September 30,
	2013					2012
			% of Total					% of Total
	Amount		Revenue			Amount		Revenue
Revenue by Product
EFT Enterprise	$	3,984		62.9	%	$	4,089		67.3	%
EFT Standard		1,020		16.1	%		845		13.9	%
Total EFT Products and Solutions	$	5,004		79.0	%	$	4,934		81.2	%
Wide Area File Services/CDP		291		4.6	%		310		5.1	%
Professional Services		412		6.5	%		274		4.5	%
CuteFTP		286		4.5	%		254		4.2	%
Other		344		5.4	%		306		5.0	%
Total Revenue	$	6,337		100.0	%	$	6,078		100.0	%
Maintenance and Suppport Included in Total Revenue	$	3,478		54.9	%	$	3,054		50.2	%

Our total revenue increased 4.3% in the 2013 quarter compared to the 2012 quarter. This increase consisted of a 13.9% increase in our revenue from M&S sales offset by a 5.4% decrease in revenue from all other sources combined. Specific components of these changes consisted of the following:

• EFT Enterprise Edition and Standard Edition revenue in total increased 1.4% which consisted of a 17.02% increase in M&S revenue offset by a 17.0% decrease in software license revenue. The M&S revenue increase reflects our continued emphasis on customer satisfaction resulting in continued growth in M&S contract renewals. The software license revenue decrease was primarily a result of decreased effectiveness of lead generation from our marketing activities, including a search engine optimization effort during the second half of 2012 and into 2013 that had the unintended effect of temporarily, negatively impacting the generation of new customer leads from online marketing activities. During 2013, we have made significant changes in personnel leading our sales and marketing groups. Our new management team has implemented new sales and marketing campaigns, engaged third party search engine optimization experts to redirect our efforts in that area and is increasing our resource allocation to support a return to a growth trend in software license revenue from our EFT products and solutions. For example, we have begun to focus our efforts on merging the TappIn technology and functionality with our EFT Standard Edition and EFT Enterprise Edition products to create a TappIn Enterprise solution. We believe this product will allow us to capitalize on the emerging BYOD trend in the workplace. By renewing the growth in our EFT software license sales, we believe we will concurrently contribute to continued growth of M&S revenue because substantially all purchasers of our EFT software licenses also purchase an M&S contract which in turn also makes them candidates for M&S renewals in future years.

• Wide Area File Services/CDP revenue decreased 6.1% which consisted of a 4.8% increase in M&S revenue offset by a 27.1% decrease in software license revenue. The M&S revenue increase reflects our continued emphasis on customer satisfaction resulting in continued growth in M&S contract renewals. The license revenue decrease was primarily due to the continuation of our plan, implemented in prior periods, to more selectively sell this product in environments that can be configured to operate within the data transmission volume and stored file size operating specifications of the software which we have found allow customers to effectively use the WAFS product without encountering legacy WAFS issues. We are continuing development of this product so that it functions effectively and efficiently in additional environments which would allow us to broaden its market opportunities. We believe that initiative, combined with our ongoing commitment to customer satisfaction and support, could yield increased WAFS/CDP revenue in the future.

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• Professional services revenue increased 50.4% primarily due to additional emphasis during our product sales efforts on promoting delivery of complementary professional services that enhance our new customers’ implementation and training experience. Similarly, we have implemented programs, focused on existing customers, where we promote supplemental, post-sale services that have produced incremental and larger professional services engagements within our customer base. This emphasis on professional services sales and delivery has allowed us to significantly increase our revenue in this area, even as revenue derived from our participation under the MAT contract with the U.S. Army supporting Army logistics has declined compared to prior years. We have historically earned a notable portion of our professional services revenue under our contract supporting Army logistics. Globalscape successfully completed the terms of the final option year of the MAT contract in September 2013.  As there is now a new primary contractor, we do not anticipate future revenue from these activities.   We believe we can offset the effects of this event by continuing to increase deliveries of our higher margin, commercial (non-government) professional services as we increasingly bundle those services with new sales of our enterprise solutions and as we deliver additional services to existing customers.

• CuteFTP revenue increased 12.6% primarily as a result of our release in November 2012 of CuteFTP Version 9 with an improved feature set to better address the user’s higher performance and security demands. CuteFTP is one of few secure FTP client programs that support a wide range of security standards related to the FTP protocol.

While we believe our software solutions remain competitive in their served markets, the overall license revenue trend has been flat or even negative in recent periods. This trend is reflected in our EFT platform revenue, as discussed above. If this decline were to continue over a long period of time, it could begin to have a negative impact on our future M&S revenue, even if our customers continue to renew M&S contracts at historical rates. This situation, in turn, could negatively impact our business and could harm our financial results. In order to increase license sales, we have increased our focus on lead generation, improved sales pipeline management, and commenced other activities intended to increase software license revenue in future periods. For example, we have retained a search engine optimization firm, increased our outbound marketing activities, and established new sales leadership and processes since the beginning of the second quarter. Additional resources are also being assigned to increasing our engineering focus on the development and evolution of our core EFT platform. For example, we have begun to focus our efforts on merging the TappIn technology and functionality with our EFT Standard Edition and EFT Enterprise Edition products to create a TappIn Enterprise solution. We believe this product will allow us to capitalize on the emerging BYOD trend in the workplace.

During the 2013 quarter, M&S revenue continued its trend over recent years of becoming an increasing percentage of our total revenue. Our M&S revenue growth and its increasing percentage of our total revenue are primarily due to:

• Our recent emphasis on maximizing revenue from M&S contract renewals as discussed above,

• The growing installed base of our software products in the marketplace, and

• Declining software license revenue in recent periods.

The installed base growth creates a compounding effect for M&S renewals because the cumulative number of licensed software installations sold over multiple years that create M&S renewals in any single year predictably (and in line with our expectations) exceeds the number of new software licenses we sell in a single year. We expect this compounding effect to continue to grow, even as we potentially increase software license revenue in future periods. We view this M&S revenue increase as a positive indicator of our customers’ ongoing satisfaction with our products purchased in past years.

Cost of Revenues. Cost of revenues consists primarily of royalties, a portion of our bandwidth costs, hosted service expenses for our Managed Solutions, expenses directly associated with professional services delivery and amortization of capitalized software development costs. Cost of revenues decreased 24.5% primarily due to decreased labor costs of $60,000 associated with professional services under the MAT contract as a result of the reduction in our level of participation in the MAT contract as described in our revenue discussion above.

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 Selling, General and Administrative. Selling, general, and administrative expenses decreased 15.6% primarily due to decreases in:

•   Salaries and wages of $273,000 resulting primarily from the consolidation of our chief executive officer and president/chief operating officer positions and an overall reduction in headcount through natural attrition. Instead of hiring to fill all vacated positions, we have addressed those responsibilities through enhanced and more efficient operating practices and procedures.

•   Stock-based compensation expense of $61,000 resulting from forfeitures of vested stock options held by certain former employees.

•   Public relations expense of $41,000 due to increased use of in-house resources in 2013 as compared to using more expensive outside firms in 2012 and more focused and optimized spending in the areas of international and trade show outreach costs.

•   Legal fee expense of $131,000 due to a reduction in ongoing litigation.

•   Sales commission expense of $135,000 due primarily to a higher percentage of our sales being for M&S for which the commission rate is lower.

Research and Development. Research and development expenses increased 12.3% primarily due to increases in:

•   External research and development of $175,000 for work to further develop our WAFS product.

•   Salaries of $145,000 due to the hiring of additional software engineers.

•   Recruiting expense of $24,000 paid to third parties for assistance in finding experienced software engineers.

Offset by:

•   An increase in capitalized software development costs of $327,000 resulting from development of enhanced versions of our EFT Standard and Enterprise Editions. Capitalized software development costs are excluded from expenses at the time of capitalization but are included in operating expenses in subsequent periods through amortization when the products to which the capitalized costs relate are completed and ready for sale.

TappIn Intangible Asset Impairment and Earnout Liability Elimination.  This expense in the 2013 quarter relates to the reduction of the TappIn intangible assets and earnout liability to zero as discussed under Liquidity and Capital Resources above in the section titled TappIn Intangible Assets and Earnout Liability.  There was no similar event in the 2012 quarter.

Affliliated Entity Asset Impairment.  This expense in the 2012 quarter relates to the elimination of the value of our investments in and notes receivable from CoreTrace Corporation due to that company selling a substantial portion of its assets, other than our appShield product, to an unrelated third party.  There was no similar event in the 2013 quarter.

Depreciation and Amortization. Depreciation and amortization decreased 15.6% due to the 2012 quarter including amortization of the software and customer list intangible assets arising from the Availl acquisition while the 2013 quarter did not include any such amortization as a result of those intangible assets becoming fully amortized subsequent to the 2012 quarter.

Other Income and Expense. Other expense was higher during the 2013 quarter than during the 2012 quarter due to the amount for the 2012 quarter including interest income from Coretrace notes receivable that did not exist in 2013.  Other expense was further affected in the 2013 quarter compared to the 2012 quarter by the decrease in interest expense as a result of the outstanding principle balance on our notes payable declining throughout the year as we made the scheduled payments of principle and interest.

Income Taxes. For the 2013 quarter, our effective income tax rate of 52.9% differed from a federal statutory rate of 34% primarily due to:

• Research and development tax credits that will be claimed on our federal income tax return.

• The domestic production activities deduction taken on our federal income tax return that is not an expense for financial statement purposes.

• The elimination of the deferred tax liability related to the TappIn intangible assets that were reduced to zero as described under TappIn Intangible Asset Impairment and Earnout Liability Elimination above.

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Offset by:

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

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

For the 2012 quarter, our effective tax rate of 3.1% differed from the statutory rate of 34% primarily due to the same reasons described above regarding the 2013 quarter, plus the effect of the affiliated entity asset impairment expense that is not deductible for federal income tax purposes.

Comparison of the Statement of Operations for the Nine Months Ended September 30, 2013 and 2012

In our discussion below, we refer to the nine months ended September 30, 2013 as the “2013 period” and the nine months ended September 30, 2012 as the “2012 period”. Our references to increases or decreases relate to the 2013 period compared to the 2012 period as presented in the following table ($’s in thousands):

	Nine Months Ended September 30,
	2013			2012			$ Change
Total revenues	$	18,142		$	17,173		$	969
Cost of revenues		782			962			(180	)
Selling, general and administrative  expenses		11,137			12,532			(1,395	)
Research and development expenses		2,653			2,660			(7	)
TappIn intangible asset impairment and earnout liability elimination		(128	)		-			(128	)
Affiliated entity asset impairment		-			3,264			(3,264	)
Depreciation and amortization		787			951			(164	)
Total operating expenses		15,231			20,369			(5,138	)
(Loss) income from operations		2,911			(3,196	)		6,107
Other income (expense)		(130	)		(138	)		8
Net (loss) income before income taxes		2,781			(3,334	)		6,115
Income tax expense (benefit)		(404	)		(227	)		(177	)
Net (loss) income	$	3,185		$	(3,107	)	$	6,292

Revenue. We derive our revenue primarily from the following activities:

• Software license revenue, which results primarily from sales of our EFT Enterprise, EFT Standard, CuteFTP and WAFS products and solutions, which we typically recognize at the time of product shipment.

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

• Professional services revenue, which includes a variety of customization, implementation, and integration services, as well as delivery of education and training associated with our solutions, all of which are recognized as the services are performed.

• Subscription revenues under a SaaS model from sales of our Managed Solutions, which include Managed Information Exchange, or MIX, Hosted Enhanced File Transfer Server, or Hosted EFT Server and TappIn, which is typically recognized on a monthly basis as the services are billed over the contract period, which typically ranges from one to three years.

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The components of our revenues are as follows ($’s in thousands):

	Revenue for the Nine Months Ended September 30,
	2013					2012
			% of Total					% of Total
	Amount		Revenue			Amount		Revenue
Revenue by Product
EFT Enterprise	$	11,276		62.2	%	$	11,073		64.5	%
EFT Standard		2,923		16.1	%		2,507		14.6	%
Total EFT Products and Solutions	$	14,199		78.3	%	$	13,580		79.1	%
Wide Area File Services/CDP		959		5.3	%		1,042		6.1	%
Professional Services		1,237		6.8	%		1,013		5.9	%
CuteFTP		936		5.2	%		784		4.6	%
Other		811		4.4	%		754		4.3	%
Total Revenue	$	18,142		100.0	%	$	17,173		100.0	%
Maintenance and Support Included in Total Revenue	$	10,128		55.8	%	$	8,294		48.3	%

Our total revenue increased 5.6% in the 2013 period compared to the 2012 period. This increase consisted of a 23.7% increase in our revenue from M&S sales offset by a 10.8% decrease in revenue from all other sources combined. Specific components of these changes consisted of the following:

• EFT Enterprise Edition and Standard Edition revenue in total increased 4.6% which consisted of a 26.0% increase in M&S revenue offset by a 19.6% decrease in software license revenue. The M&S revenue increase reflects our continued emphasis on customer satisfaction resulting in continued growth in M&S contract renewals. The software license revenue decrease was primarily a result of decreased effectiveness of lead generation from our marketing activities, including a search engine optimization effort during the second half of 2012 and into 2013 that had the unintended effect of temporarily, negatively impacting the generation of new customer leads from online marketing activities. During the 2013 period, we have made significant changes in personnel leading our sales and marketing groups. Our new management team has implemented new sales and marketing campaigns, engaged third party search engine optimization experts to redirect our efforts in that area and is increasing our resource allocation, to support a return to a growth trend in software license revenue from our EFT products and solutions. For example, we have begun to focus our efforts on merging the TappIn technology and functionality with our EFT Standard Edition and EFT Enterprise Edition products to create a TappIn Enterprise solution. We believe this product will allow us to capitalize on the emerging BYOD trend in the workplace. By renewing the growth in our EFT software license sales, we believe we will concurrently contribute to continued growth of M&S revenue because substantially all purchasers of our EFT software licenses also purchase an M&S contract which in turn also makes them candidates for M&S renewals in future years.

• Wide Area File Services/CDP revenue decreased 8.0% which consisted of a 6.4% increase in M&S revenue offset by a 3.4% decrease in software license revenue. The M&S revenue increase reflects our continued emphasis on customer satisfaction resulting in continued growth in M&S contract renewals. The license revenue decrease was primarily due to the continuation of our plan, implemented in prior periods, to more selectively sell this product in environments that can be configured to operate within the data transmission volume and stored file size operating specifications of the software which we have found allow customers to effectively use the WAFS product without encountering legacy WAFS issues. We are continuing development of this product so that it functions effectively and efficiently in additional environments which would allow us to broaden its market opportunities. We believe that initiative, combined with our ongoing commitment to customer satisfaction and support, could yield increased WAFS/CDP revenue in the future.

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• Professional services revenue increased 22.1% primarily due to additional emphasis during our product sales efforts on promoting delivery of complementary professional services that enhance our new customers’ implementation and training experience. Similarly, we have implemented programs, focused on existing customers, where we promote supplemental, post-sale services that have produced incremental and larger professional services engagements within our customer base. This emphasis on professional services sales and delivery has allowed us to significantly increase our revenue in this area, even as revenue derived from our participation under the MAT contract with the U.S. Army supporting Army logistics has declined compared to prior years. We have historically earned a notable portion of our professional services revenue under our contract supporting Army logistics. Globalscape successfully completed the terms of the final option year of the MAT contract in September 2013.  As there is now a new primary contractor, we do not anticipate future revenue from these activities.  We believe we can offset the effects of this event by continuing to increase deliveries of our higher margin, commercial (non-government) professional services as we increasingly bundle those services with new sales of our enterprise solutions and as we deliver additional services to existing customers.

• CuteFTP revenue increased 19.4% primarily as a result of our release in November 2012 of CuteFTP Version 9 with an improved feature set to better address the user’s higher performance and security demands. CuteFTP is one of few secure FTP client programs that supports a wide range of security standards related to the FTP protocol.

While we believe our software solutions remain competitive in their served markets, the overall license revenue trend has been flat or even negative in recent periods. This trend is reflected in our EFT platform revenue, as discussed above. If this decline were to continue over a long period of time, it could begin to have a negative impact on our future M&S revenue, even if our customers continue to renew M&S contracts at historical rates. This situation, in turn, could negatively impact our business and could harm our financial results. In order to increase license sales, Therefore, we have increased our focus on lead generation, improved sales pipeline management, and commenced other activities intended to increase software license revenue in future periods. For example, we have retained a search engine optimization firm, increased our outbound marketing activities, and established new sales leadership and processes since the beginning of the second quarter. Additional resources are also being assigned to increasing our engineering focus on the development and evolution of our core EFT platform. For example, we have begun to focus our efforts on merging the TappIn technology and functionality with our EFT Standard Edition and EFT Enterprise Edition products to create a TappIn Enterprise solution. We believe this product will allow us to capitalize on the emerging BYOD trend in the workplace.

During the 2013 period, M&S revenue continued its trend over recent years of becoming an increasing percentage of our total revenue. Our M&S revenue growth and its increasing percentage of our total revenue are primarily due to:

• Our recent emphasis on maximizing revenue from M&S contract renewals as discussed above,

• The growing installed base of our software products in the marketplace, and

• Declining software license revenue in recent periods.

The installed base growth creates a compounding effect for M&S renewals because the cumulative number of licensed software installations sold over multiple years that create M&S renewals in any single year predictably (and in line with our expectations) exceeds the number of new software licenses we sell in a single year. We expect this compounding effect to continue to grow, even as we potentially increase software license revenue in future periods. We view this M&S revenue increase as a positive indicator of our customers’ ongoing satisfaction with our products purchased in past years.

Cost of Revenues. Cost of revenues consists primarily of royalties, a portion of our bandwidth costs, hosted service expenses for our Managed Solutions, expenses directly associated with professional services delivery and amortization of capitalized software development costs. Cost of revenues decreased 18.7% primarily due to:

• Decreased labor costs of $154,000 associated with professional services under the MAT contract as a result of the reduction in our level of participation in the MAT contract as described in our revenue discussion above.

• Decreased royalties of $19,000 on certain product sales due to a favorable renegotiation of the terms of certain royalty agreements.

Offset by:

• Increased hosted server expenses of $20,000 to support our MIX and Hosted EFT Server solutions in international markets.

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Selling, General and Administrative. Selling, general, and administrative expenses decreased 11.1% primarily due to decreases in:

·   Salaries and wages of $603,000 resulting primarily from the consolidation of our chief executive officer and president/chief operating officer positions and an overall reduction in headcount through natural attrition. Instead of hiring to fill those vacated positions, we have addressed certain of those responsibilities through enhanced and more efficient operating practices and procedures.

·   Stock-based compensation expense of $151,000 resulting from forfeitures of vested stock options held by certain former employees.

·   Travel and entertainment expense of $149,000 due to increasing maturity of international sales relationships (therefore requiring less travel) and enhanced general cost control policies.

·   Public relations expense of $140,000 due an increased use of inside resources in 2013 as compared to the use of more expensive outside firms in 2012 and  more focused and optimized spending in the areas of international and trade show outreach costs.

·   Sales commission expense of $100,000 due primarily to a higher percentage of our sales being for M&S for which the commission rate is lower.

·   Seminars and training expense of $77,000 due to enhanced general cost control policies.

Research and Development.  Research and development expense decreased by less than 1.0% due to:

·   An increase in capitalized software development costs of $686,000 resulting from development of enhanced versions of our EFT Standard and Enterprise Editions.  Capitalized software development costs are excluded from expenses at the time of capitalization but are included in expenses in subsequent periods through amortization when the products to which the capitalized costs relate are completed and ready for sale.

Offset by increases in:

·   External research and development of $285,000 for work to upgrade the performance our WAFS product.

·   Salaries of $286,158 due to the hiring of additional software engineers.

·   Recruiting expense of $51,000 paid for assistance in finding experienced software engineers.

TappIn Intangible Asset Impairment and Earnout Liability Elimination.  This expense in the 2013 period relates to the elimination of the TappIn intangible assets and earnout liability as discussed under Liquidity and Capital Resources above in the section titled TappIn Intangible Assets and Earnout Liability.  There was no similar event in the 2012 period.

Affliliated Entity Asset Impairment.  This expense in the 2012 period relates to the elimination of the value of our investments in and notes receivable from CoreTrace Corporation due to that company selling a substantial portion of its assets, other than our appShield product, to an unrelated third party.  There was no similar event in the 2013 period.

Depreciation and Amortization. Depreciation and amortization decreased 17.3% due to the 2012 period including amortization of the software and customer list intangible assets arising from the Availl acquisition while the 2013 period did not include any such amortization as a result of those intangible assets becoming fully amortized subsequent to the 2012 period.

Other Income and Expense.  Other expense was higher during the 2013 period than during the 2012 period due to the amount for the 2012 period including interest income from Coretrace notes receivable that did not exist in 2013.  Other expense was further affected in the 2013 period compared to the 2012 period by the decrease in interest expense as a result of the outstanding principle balance on our notes payable declining throughout the year as we made the scheduled payments of principle and interest.

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Income Taxes. For the 2013 period, our effective income tax rate of 14.5% differed from a federal statutory rate of 34% primarily due to:

• Research and development tax credits that will be claimed on our federal income tax return.

• The domestic production activities deduction taken on our federal income tax return that is not an expense for financial statement purposes.

The elimination of the deferred tax liability related to the TappIn intangible assets that were reduced to zero as described under TappIn Intangible Asset Impairment and Earnout Liability Elimination above. Offset by:

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

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

For the 2012 period, our effective tax rate of 6.8% differed from the statutory rate of 34% primarily due to the same reasons described above regarding the 2013 period plus the effect of the affiliated entity asset impairment expense that is not deductible for federal income tax purposes.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

During the nine months ended September 30, 2013, approximately 26% of our sales came from customers outside the United States. We receive all revenue in U.S. dollars, so we have no material exchange rate risk with regard to the sales. We charge Value Added Taxes to our non-business customers in the European Union. We remit these taxes periodically in pound sterling. The impact of this currency translation has not been material to our business.

Item 4. Controls and Procedures

As of the end of the period covered by this report, our President and Chief Executive Officer and our Chief Financial Officer carried out an evaluation of the effectiveness of GlobalSCAPE’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) and concluded that the disclosure controls and procedures were effective.

There were no changes in our internal controls over financial reporting during the nine months ended September 30, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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Part II. Other Information

Item 1. Legal Proceedings

GlobalSCAPE was named as one of a number of defendants in a patent infringement suit filed by Achates Reference Publishing, Inc. in the United States District Court for the Eastern District of Texas Marshall Division. During the three months ended June 30, 2013, we settled this matter in a manner that was immaterial to our financial position and results of operations.

GlobalSCAPE was named as one of a number of defendants in a patent infringement suit filed by Uniloc Luxembourg S.A. in the United States District Court for the Eastern District of Texas Tyler Division. During the three months ended September 30, 2013, the court dismissed the plaintiff’s claims with prejudice.

Item 1A. Risk Factors.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our 2012 Form 10-K filed with the Securities and Exchange Commission on March 28, 2013. These risk factors could materially affect our business, financial condition or future results, but they are not the only risks facing GlobalSCAPE. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, and/or operating results.

Item 6.  Exhibits

(a) Exhibits

31.1	Certification by Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification by Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32	Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	Interactive Data File.

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Signatures

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

		GLOBALSCAPE, INC.
November 12, 2013	By:	/s/ James W. Albrecht, Jr.
Date		James W. Albrecht, Jr.
		Chief Financial Officer

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