| Small & micro cap project

Globalscape : Signs of moat, well-written CEO letter & significant percentage in Fondren Management’s portfolio

by | Oct 13, 2019

M.Cap: $201 million

The company’s primary business is selling and supporting managed file transfer software (MFT) for enterprises. So, what is MFT? It is software or a service that manages the secure transfer of data from one computer to another through a network.

The company’s flagship MFT product platform, Enhanced File Transfer (EFT), is its strategic focus and responsible for 97% of the 2018 revenue. EFT is highly reliable, easy to install, and is delivered as on-premise software, through the cloud, or as a hybrid deployment.

One of the largest broker-dealers in the United States depends on us to securely transmit millions of time-sensitive financial transactions. Few industries are as demanding or regulated as financial services and our solution satisfies a host of stringent regulatory and business requirements. Another example of how customers rely on our solution can be found in the cruise ship industry. We serve an operator that last year had a passenger market share of over 20%. They trust Globalscape to securely transmit point-of-sale data and other transactions generated while at sea.

Fondren Management

  • The top five stocks account for 31% of the total portfolio.
  • GlobalSCAPE accounts for 6% of the total portfolio – Rank #2

Sign of moat

Huge recurring revenue: The maintenance and support segment accounted for 63% of the 2018 revenue.  Maintenance and support (M&S) are recurring in nature. Almost all customers who purchase a perpetual license to use the EFT platform also purchase an M&S contract, for which they pay a recurring fee that is typically 20% to 30% of the perpetual license fee per year.

While our growth depends on new software license revenue, we are keenly focused on our maintenance and support (M&S) business which represents the recurring revenue in our business model. When customers purchase our on-premise software, they almost always purchase the first year of M&S. At year two, customers are not required to purchase M&S, but the vast majority renew their subscription. One impressive driver for M&S renewals is our proven, documented ability to deliver customer satisfaction. In 2018 we had a customer satisfaction rating of 94%, almost two percentage points better than 2017.

 

Additional notes

(1) 22% repurchase

In the FY 2018, the company repurchased a whopping 22% of its o/s shares.

(2) The letter to the shareholder is a “must read”. This is a well-written piece. Link

March 29, 2019

Dear Shareholder,

Globalscape embarked on a mission in 2018 to enhance the Company’s performance by improving cash flow per share. To achieve this objective, we focused on three things: revenue, operating expenses, and capital allocation. We are pleased to report that results of this three-part effort are evident in the Company’s superior fourth quarter financial performance. We believe shareholders and customers will be further rewarded as we continue to execute our revised business plan and capital
allocation strategy.

Globalscape develops and sells managed file transfer (MFT) software that provides secure information exchange, data transfer, and file sharing capabilities. Our flagship MFT product platform, Enhanced File Transfer (EFT), is our strategic focus and responsible for 97% of 2018 revenue. EFT is highly reliable, easy to install, and is delivered as on-premise software or through cloud and hybrid deployments. Our enterprise customers include market leaders in financial services, health care, media and entertainment, and retail. One of the largest broker-dealers in the United States depends on us to securely transmit millions of time-sensitive financial transactions. Few industries are as demanding or regulated as financial services and our solution satisfies a host of stringent regulatory and business requirements. Another example of how customers rely on our solution can be found in the cruise ship industry. We serve an operator that last year had a passenger market share of over 20%. They trust Globalscape to securely transmit point-of-sale data and other transactions generated while at sea.

Many customers realize that homegrown or non-enterprise solutions lack scalability, flexibility, and the security architecture necessary to comply with arduous and ever-changing state, federal, and international regulatory mandates. Our well-rounded product offering is the result of serving thousands of customers over two decades. Buyers are motivated by our feature-rich software, but are also drawn to our world-class customer support and professional services portfolio.

Globalscape generates revenue from three sources: software licenses, maintenance and support (M&S), and professional services. In 2018, software license revenue was $10.5 million and accounted for 30% of total revenue, M&S revenue was $21.6 million and represented 63% of total revenue while professional services revenue was $2.3 million, or 7% of total revenue. We primarily go to market using a direct salesforce; however, we do support a robust partner network. While our growth depends on new software license revenue, we are keenly focused on our maintenance and support (M&S) business which represents the recurring revenue in our business model. When customers purchase our on-premise software, they almost always purchase the first year of M&S. At year two, customers are not required to purchase M&S, but the vast majority renew their subscription. One impressive driver for M&S renewals is our proven, documented ability to deliver customer satisfaction. In 2018 we had a customer satisfaction rating of 94%, almost two percentage points better than 2017. Another metric that measures our service acumen is what is known as a Net Promoter System score, or NPS score. In 2018, our NPS score was 75, an 11% increase over 2017. NPS scores of 50 or more are considered great; a score over 70 is reserved for companies delivering service considered ‘world class.’ These exceptional customer satisfaction scores reflect the high quality of our service delivery and strengthen Globalscape’s recurring revenue model. Because customers often renew M&S over a span of years, we have excellent visibility into the largest portion of our revenue stream. We have earned our customers’ loyalty and continue to offer what we believe to be the industry’s best customer experience. It also speaks to something we often hear from customers: “your software works.” To keep pace with customer requirements, we periodically release product updates. Access to product updates and upgrades is an important driver for M&S renewals. We continue to seek ways to add value to our EFT product platform and remain optimistic about our competitive position in the marketplace. Customer loyalty is a testimony to our strategic focus. It is also a reflection of our highly skilled and dedicated support team who solve mission-critical customer problems twenty-four hours a day.

Another competitive advantage we leverage is our professional services team. Our experts provide training, platform assessment, business automation development, and implementation assistance for on-premise or cloud deployments. These limited scope engagements utilize our vast experience and allow us to tailor solutions to almost any customer environment. Sometimes we help customers migrate from their old internal solution to our EFT platform, or we provide advice on how best
to architect a desired solution. We believe maintaining a highly-skilled professional services team is an important component to attracting new enterprise customers.
The positive momentum in our business is the result of decisive action taken by the management team in the middle of 2018. After careful analysis, it was clear our operating expenses needed to be reduced. On August 3, 2018, we performed the difficult task of right-sizing the business by reducing our workforce by 30%. We accomplished this primarily by refocusing selling efforts to our core EFT platform and reducing marketing spending that had failed to yield increased revenue. We also
targeted product development efforts to more closely align with specific customer requirements. One of the concerns we had when implementing the reduction in force was whether or not key employees would leave for greener pastures. Fortunately, employee retention has remained high and morale has never been better. As part of the transition to a smaller workforce, management sharpened internal communication to ensure employees understood why the Company was making changes and
what were the desired outcomes. We asked teams to direct their tactical efforts to activities that generate new revenue or enhance service delivery to existing customers. We also began developing a program to train and equip our middle managers. These collective efforts have yielded a culture that we believe is healthier and more vibrant. A recent employee survey confirms that our transparent communication and clearly articulated strategy have fostered a healthy workplace. It has also helped that front-line employees see the fruits of the new strategy in the improved financial performance. We will continue to invest in our people and company culture in 2019.

Throughout 2018, the Company’s board of directors and management team also successfully dealt with challenging legal and regulatory matters. Most notably, on June 15, 2018 we regained compliance with NYSE American continued listing standards and on August 20, 2018 we announced the settlement of a class action lawsuit for $1.4 million related to our 2016 and 2017 financial restatements. While there continue to be legal matters that present risks, we are pleased to be past the
matters that were resolved. During 2018 we were also concerned about how revenue would be impacted as a result of a smaller workforce. We are pleased to report that our combined 2018 third and fourth quarter revenue was up 13% when compared to the first two quarters of 2018 and 7.4% over the third and fourth quarter of 2017. Increased revenue is attributable to our renewed focus on providing EFT platform products that our customers value and avoiding activities that divert from this strategy.

While sales in the second half of 2018 improved, operating expenses declined markedly over the same period (see chart 1). Operating expenses declined in aggregate by 25% when comparing the first half of the year ($13.4 million) to the second half of 2018 ($10 million). The savings are flowing through to the bottom line. First half generally accepted accounting principles (“GAAP”) net loss was ($342,000) compared to GAAP net income of $4.0 million in the second half of 2018. Adjusted
EBITDA1 went from $1.6 million in the first half of 2018 to $6.6 million in the second half of the year, and $4.6 million in the fourth quarter of 2018 alone

In fact, the strength of our business is clear when comparing the fourth quarter of 2018 to the fourth quarter of 2017 (see chart 2). Most impressive is the 6% increase in revenue we achieved despite undergoing a 30% reduction in force just two months prior to the start of the fourth quarter. Operating expenses declined by 43%, aided in part by a $1 million decline in legal expense as activity subsided. The positive revenue trends and lower operating expenses yielded a dramatic turnaround in fourth quarter adjusted EBITDA and earnings per share. In fourth quarter 2018, we generated $4.6 million of adjusted EBITDA compared to $1.5 million in the fourth quarter of 2017, a 218% increase. Earnings per share expanded to $.17 compared to a loss of a penny in the fourth quarter of 2017.

Comparisons to full year 2017 financial results are also favorable. Chart 3 illustrates the year-over-year improvement in financial performance. We are pleased with the improved results and will continue to focus on executing a business strategy that emphasizes operational efficiency and profitability.

The other important issue the management team addressed in 2018 was to embark on an optimal capital allocation strategy. Globalscape ended the second quarter of 2018 with almost $28 million in cash and a decision needed to be made on how best to invest those assets. The board determined that repurchasing Globalscape stock presented the best potential return on investment when compared to other alternatives. On August 20, 2018, the Company announced the launch of a modified
Dutch auction tender offer. The final results reduced the outstanding shares by 4,011,013 shares. The shares repurchased represented approximately 18.2% of the Company’s common stock issued and outstanding as of September 24, 2018. The tender offer and related fees utilized approximately $16.8 million of our cash. As a follow-on to the tender offer, the board of directors approved a stock repurchase program pursuant to which the Company was authorized to purchase up to $5 million
of its outstanding common stock. In the fourth quarter of 2018 we repurchased an additional 896,348 shares. The common shares outstanding at December 31, 2018 was 17,130,918: 22% less than at the end of 2017. Despite directing over $20 million toward stock repurchases (including the tender offer), the balance sheet remains strong. At the end of 2018 we had no debt and $9.2 million in cash and cash equivalents. We will continue to monitor the market for opportunities as we pursue a
capital allocation strategy designed to increase shareholder value.

As we enter the 2019 fiscal year, our management team and board of directors remain committed to increasing shareholder value. We consider Globalscape an undervalued asset and remain optimistic about our future. As of December 31, 2018, the board of directors and insiders beneficially own approximately 36% of the Company’s outstanding common stock. Clearly, we are aligned with the long-term interests of all shareholders. In closing, we want to express our appreciation to our
dedicated and talented workforce for their singular focus on customer success. Most of all, we thank our shareholders for their support as we work to drive cash earnings per share.

Sincerely,
Robert H. Alpert                                                                                                         Matthew C. Goulet
Chairman of the Board                                                                                             Chief Executive Officer

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