**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-Q**

**x****                              ****QUARTERTLY****REPORT PURSUANT TOSECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For the Quarterly Periodended June 30, 2006**

**OR**

o                                   **TRANSITION REPORT PURSUANT TO SECTION13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For the transition periodfrom           to         .**

**Commission File No.000-30617**

**GlobalSCAPE, Inc.**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                           | **74-2785449**      |
|----------------------------------------|---------------------|
| (State or other  jurisdiction of       | (I.R.S. Employer    |
| incorporation or  organization)        | Identification No.) |
|                                   |                |
| **6000  Northwest Parkway, Suite 100** | ** **          |
| **San  Antonio, Texas**                | **78249**           |
| (Address of Principal                  | (Zip Code)          |
| Executive Office)                      |                |

 

**(210) 308-8267**

(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

**None**

Securities registered pursuant to Section 12(g) of theAct:

**Common Stock, par value $0.001 pershare**

(Title of Class)

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has been subjectto such filing requirements for the past 90 days.

**x** Yes     o No

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

Large Accelerated filer o     Acceleratedfiler o     Non-Acceleratedfiler **x**

Indicate by check mark if the registrant is a shellcompany (as defined in Rule 12b-2 of the Act).

o Yes     **x **No

The aggregate market value of the registrant’s outstanding common stockheld by non-affiliates was approximately $36,053,250 as of the last businessday of the registrant’s most recently completed second fiscal quarter, basedupon the closing sales price of $2.50  pershare on such date on the NASD’s OTC Bulletin Board.

As of August 11, 2006, there were 14,421,300 shares of common stockoutstanding.

 

 

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## **GlobalSCAPE Inc.**

## **Quarterly Report on Form 10-Q**

## **For the Quarter ended June 30, 2006**

 

## **Index**

|                               | ** ** | ** **                                                                                        | ** ** | ** ** |
|-------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|------------|
| **Part  I.**                  | ** ** | **Financial  Information**                                                                        |       |       |
| Item 1.                       |       | Interim Consolidated Financial  Statements (Unaudited)                                            |       |       |
|                          |       | Consolidated  Balance Sheets as of December 31, 2005 and June 30, 2006                            |       |       |
|                          |       | Consolidated  Statements of Operations for the three and six months ended June 30, 2005 and  2006 |       |       |
|                          |       | Consolidated  Statements of Cash Flows for the six months ended June 30, 2005 and 2006            |       |       |
|                          |       | Notes  to Consolidated Financial Statements                                                       |       |       |
| Item 2.                       |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations       |       |       |
| Item 3.                       |       | Quantitative  and Qualitative Disclosures About Market Risk                                       |       |       |
| Item 4.                       |       | Controls and  Procedures                                                                          |       |       |
| **Part II.**                  | ** ** | **Other Information**                                                                             | ** ** | ** ** |
| Item 1.                       |       | Legal Proceedings                                                                                 |       |       |
| Item 1A                       |       | Risk Factors                                                                                      |       |       |
| Item 2.                       |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                      |       |       |
| Item 3.                       |       | Defaults  Upon Senior Securities                                                                  |       |       |
| Item 4.                       |       | Submission  of Matters to a Vote of Security Holders                                              |       |       |
| Item 5.                       |       | Other Information                                                                                 |       |       |
| Item 6.                       |       | Exhibits                                                                                          |       |       |
| Signatures and Certifications |       |                                                                                              |
|                               |            |                                                                                                   |            |            |  |

 

 

GlobalSCAPE®,CuteFTP®, CuteSITE Builder®, PureCMS®, CuteZIP®, CuteHTML® and CuteMAP® and areregistered trademarks of GlobalSCAPE Texas, LP. GlobalSCAPE SecureFTP Server, GlobalSCAPE Enhanced File Transfer,PublishXML and SnapEdit are trademarks of GlobalSCAPE Texas, LP.  Other trademarks and tradenames in thisquarterly report are the property of their respective owners.

 

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**PartI.     Financial Information**

**Item1. Financial Statements**

**GlobalSCAPE,Inc.**

**ConsolidatedBalance Sheets**
| ** **                                                                                                                                | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                | ** ** | **2005**              | ** ** | **2006**          | ** ** |
| ** **                                                                                                                                | ** ** | ** **            | ** ** | **(unaudited)**   | ** ** |
| Assets                                                                                                                                    |       |                  |       |              |       |
| Current assets:                                                                                                                           |       |                  |       |              |       |
| Cash and cash equivalents                                                                                                                 |       | $                     | 2,029,473  |              | $          | 3,435,532 |   |
| Accounts receivable (net of allowance for doubtful  accounts of $12,273 and $7,983 at December 31, 2005 and June 30, 2006,  respectively) |       | 590,715               |       | 814,557           |       |
| Prepaid expenses                                                                                                                          |       | 65,317                |       | 101,933           |       |
| Total current  assets                                                                                                                     |       | 2,685,505             |       | 4,352,022         |       |
|                                                                                                                                      |       |                  |       |              |       |
| Property and equipment:                                                                                                                   |       |                  |       |              |       |
| Furniture and fixtures                                                                                                                    |       | 334,603               |       | 341,017           |       |
| Software                                                                                                                                  |       | 284,621               |       | 310,009           |       |
| Equipment                                                                                                                                 |       | 604,517               |       | 611,216           |       |
| Leasehold improvements                                                                                                                    |       | 167,762               |       | 187,827           |       |
|                                                                                                                                      |       | 1,390,963             |       | 1,450,069         |       |
| Accumulated  depreciation and amortization                                                                                                |       | 1,238,392             |       | 1,267,709         |       |
| Net property and  equipment                                                                                                               |       | 152,571               |       | 182,360           |       |
|                                                                                                                                      |       |                  |       |              |       |
| Other assets:                                                                                                                             |       |                  |       |              |       |
| Deferred tax asset                                                                                                                        |       | 51,983                |       | 51,159            |       |
| Other                                                                                                                                     |       | 11,612                |       | 11,612            |       |
| Total other  assets                                                                                                                       |       | 63,595                |       | 62,771            |       |
|                                                                                                                                      |       |                  |       |              |       |
| Total assets                                                                                                                              |       | $                     | 2,901,671  |              | $          | 4,597,153 |   |

 

1

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**GlobalSCAPE,Inc.**

**ConsolidatedBalance Sheets**
| ** **                                                                                                                                                                             | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                             | ** ** | **2005**              | ** ** | **2006**          | ** ** |
| ** **                                                                                                                                                                             | ** ** | ** **            | ** ** | **(unaudited)**   | ** ** |
| Liabilities and  Stockholders’ Equity                                                                                                                                             |       |                  |       |              |       |
| Current liabilities:                                                                                                                                                                   |       |                  |       |              |       |
| Accounts payable                                                                                                                                                                       |       | $                     | 91,763     |              | $          | 65,017 |   |
| Accrued expenses                                                                                                                                                                       |       | 230,911               |       | 307,545           |       |
| Federal income tax payable                                                                                                                                                             |       | 60,899                |       | 214,391           |       |
| Deferred revenue                                                                                                                                                                       |       | 560,578               |       | 846,789           |       |
| Total current  liabilities                                                                                                                                                             |       | 944,151               |       | 1,439,742         |       |
|                                                                                                                                                                                   |       |                  |       |              |       |
|                                                                                                                                                                                   |       |                  |       |              |       |
| Long-term liabilities:                                                                                                                                                                 |       |                  |       |              |       |
| Deferred compensation                                                                                                                                                                  |       | 12,121                |       | 25,127            |       |
| Other long-term liabilities                                                                                                                                                            |       | 16,824                |       | 11,215            |       |
| Total long-term  liabilities                                                                                                                                                           |       | 28,945                |       | 36,342            |       |
|                                                                                                                                                                                   |       |                  |       |              |       |
| Total  Liabilities                                                                                                                                                                     |       | 973,096               |       | 1,470,084         |       |
|                                                                                                                                                                                   |       |                  |       |              |       |
| 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  shares authorized, 13,798,119 and 14,421,300 shares issued and outstanding at  December 31, 2005 and June 30, 2006, respectively |       | 13,797                |       | 14,421            |       |
| Additional paid-in capital                                                                                                                                                             |       | 684,281               |       | 833,163           |       |
| Retained earnings                                                                                                                                                                      |       | 1,230,497             |       | 2,279,485         |       |
| Total  stockholders’ equity                                                                                                                                                       |       | 1,928,575             |       | 3,127,069         |       |
| Total liabilities and  stockholders’ equity                                                                                                                                       |       | $                     | 2,901,671  |              | $          | 4,597,153 |   |

See accompanying notes.

2

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**GlobalSCAPE,Inc.**

**ConsolidatedStatements of Operations**

**(Unaudited)**
| ** **                                                                            | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2005**                                            | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **2006** | ** ** |
| Operating revenues:                                                                   |       |                                                |       |                                              |       |   |   |   |   |
| Software product revenues                                                             |       | $                                                   | 1,612,687  |                                              | $          | 2,133,525 |   | $ | 2,921,553 |   | $ | 4,327,840 |   |
| Maintenance and support (net of deferred revenues)                                    |       | 206,689                                             |       | 311,802                                           |       | 320,204 |   | 532,409 |   |
| Total revenues                                                                        |       | 1,819,376                                           |       | 2,445,327                                         |       | 3,241,757 |   | 4,860,249 |   |
|                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Operating expenses:                                                                   |       |                                                |       |                                              |       |   |   |   |   |
| Cost of revenues (exclusive of depreciation and  amortization shown separately below) |       | 77,819                                              |       | 85,507                                            |       | 159,377 |   | 226,918 |   |
| Selling, general and administrative Expenses                                          |       | 986,379                                             |       | 1,346,972                                         |       | 1,960,439 |   | 2,560,509 |   |
| Research and development expenses                                                     |       | 205,043                                             |       | 267,474                                           |       | 383,809 |   | 496,804 |   |
| Depreciation and amortization                                                         |       | 24,315                                              |       | 23,442                                            |       | 53,415 |   | 44,679 |   |
| Total operating expense                                                               |       | 1,293,556                                           |       | 1,723,395                                         |       | 2,557,040 |   | 3,328,910 |   |
| Income from  operations                                                               |       | 525,820                                             |       | 721,932                                           |       | 684,717 |   | 1,531,339 |   |
|                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Other income (expense):                                                               |       |                                                |       |                                              |       |   |   |   |   |
| Interest expense                                                                      |       | (397                                                | )          | —                                            |       | (725 | ) | — |   |
| Interest income                                                                       |       | —                                              |       | 23,005                                            |       | — |   | 36,930 |   |
| Gain on sale of assets                                                                |       | 191                                                 |       | 191                                               |       | 191 |   | 619 |   |
| Other expense                                                                         |       | —                                              |       | (294                                              | )          | — |   | (294 | ) |
| Total other income (expense)                                                          |       | (206                                                | )          | 22,902                                            |       | (534 | ) | 37,255 |   |
| Income before  income taxes                                                           |       | 525,614                                             |       | 744,834                                           |       | 685,248 |   | 1,568,594 |   |
|                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Income tax expense  (benefit):                                                        |       |                                                |       |                                              |       |   |   |   |   |
| Current:                                                                              |       |                                                |       |                                              |       |   |   |   |   |
| Federal                                                                               |       | —                                              |       | 251,365                                           |       | — |   | 526,193 |   |
| State                                                                                 |       | —                                              |       | —                                            |       | — |   | — |   |
| Deferred:                                                                             |       |                                                |       |                                              |       |   |   |   |   |
| Federal                                                                               |       | —                                              |       | (6,587                                            | )          | — |   | (6,587 | ) |
| State                                                                                 |       | —                                              |       | —                                            |       | — |   | — |   |
| Total income tax  provision                                                           |       | —                                              |       | 244,778                                           |       | — |   | 519,606 |   |
|                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Net income                                                                            |       | $                                                   | 525,614    |                                              | $          | 500,056 |   | $ | 684,183 |   | $ | 1,048,988 |   |
|                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Net income per common  share- basic                                                   |       | $                                                   | 0.04       |                                              | $          | 0.03 |   | $ | 0.05 |   | $ | 0.07 |   |
| Net income per  common share- assuming dilution                                       |       | $                                                   | 0.04       |                                              | $          | 0.03 |   | $ | 0.05 |   | $ | 0.07 |   |
|                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Average shares  outstanding:                                                          |       |                                                |       |                                              |       |   |   |   |   |
|                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Basic                                                                                 |       | 13,773,219                                          |       | 14,379,061                                        |       | 13,773,219 |   | 14,379,061 |   |
| Diluted                                                                               |       | 14,584,284                                          |       | 15,081,666                                        |       | 14,515,873 |   | 15,065,152 |   |

 

 See accompanying notes.

3

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** **

**GlobalSCAPE,Inc.**

**ConsolidatedStatements of Cash Flows**

**(Unaudited)**
| ** **                                                                         | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                                          | ** ** | **2006** | ** ** |
| Operating Activities:                                                              |       |                                              |       |   |   |
| Net Income                                                                         |       | $                                                 | 684,183    |   | $ | 1,048,988 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                              |       |   |   |
| Bad debt expense (recovery)                                                        |       | 9,717                                             |       | (4,290 | ) |
| Depreciation and amortization                                                      |       | 53,415                                            |       | 44,679 |   |
| (Gain) loss on disposition of assets                                               |       | (191                                              | )          | (619 | ) |
| Stock-based compensation                                                           |       | —                                            |       | 120,538 |   |
| Deferred taxes                                                                     |       | —                                            |       | 824 |   |
| Changes in  operating assets and liabilities:                                      |       |                                              |       |   |   |
| Accounts receivable                                                                |       | (435,911                                          | )          | (219,551 | ) |
| Prepaid expenses                                                                   |       | 46,710                                            |       | (36,616 | ) |
| Accounts payable                                                                   |       | (61,018                                           | )          | (26,746 | ) |
| Accrued expenses                                                                   |       | 107,027                                           |       | 76,633 |   |
| Federal income tax payable                                                         |       | —                                            |       | 153,492 |   |
| Deferred revenues                                                                  |       | 77,541                                            |       | 286,211 |   |
| Deferred Compensation                                                              |       | —                                            |       | 13,006 |   |
| Other long-term liabilities                                                        |       | (5,607                                            | )          | (5,609 | ) |
| Net cash  provided by operating activities                                         |       | 475,866                                           |       | 1,450,940 |   |
| Investing Activities:                                                              |       |                                              |       |   |   |
| Proceeds from sale of property and equipment                                       |       | 191                                               |       | 619 |   |
| Purchase of property and equipment                                                 |       | (63,753                                           | )          | (73,849 | ) |
| Net cash used in  investing activities                                             |       | (63,562                                           | )          | (73,230 | ) |
| Financing Activities:                                                              |       |                                              |       |   |   |
| Exercise of stock options                                                          |       | —                                            |       | 28,968 |   |
| Net cash  provided by financing activities                                         |       | —                                            |       | 28,969 |   |
| Net increase in  cash                                                              |       | 412,304                                           |       | 1,406,059 |   |
| Cash at  beginning of period                                                       |       | 572,959                                           |       | 2,029,473 |   |
| Cash at end of  period                                                             |       | $                                                 | 985,263    |   | $ | 3,435,532 |   |

See accompanying notes.

 

Supplemental disclosures:

 
| Interest paid     |   | $ | 725    |   | $ | —  |   |
|-------------------|--------|---|--------|--------|---|---------|--------|
| Income taxes paid |   | $ | — |   | $ | 421,920 |   |

 

4

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**GlobalSCAPE,Inc.**

**Notesto Consolidated Financial Statements**

**1.             Overview of the Business andSignificant Accounting Policies**

# **Nature of Business**

GlobalSCAPE, Inc., founded in April 1996, develops and distributessecure file management software that enables users to safely send data over theinternet. Our products guarantee the privacy of critical information such asfinancial data, medical records, customer files and other similar documents. Inaddition, our products ensure compliance with government regulations relatingto the protection of information while allowing users to reduce IT costs,increase efficiency, track and audit transactions and automate processes.

We started in 1996 with thedistribution of CuteFTP, a file transfer protocol client program, and haveachieved significant success and popularity with this product. We built on thissuccess by steadily adding complementary products and believe we now have a reputationas a provider of easy-to use, affordable software for both individual andenterprise users. Since 2000, we have focused on enhancing our portfolio ofproducts to meet the increasing demand for data security, and for solutionsthat permit non-technical personnel to contribute content to theirorganizations’ Web sites. Our software is used worldwide across a wide range ofindustries. Through the end of 2005, we had sold approximately 1,300,000software licenses and our customer base includes individual consumers, small tomedium-sized businesses, as well as some of the largest corporations in theworld.

During the six months endedJune 30, 2006, approximately 66% of our revenues were generated from customerswithin the United States, with the remaining 34% concentrated mostly in WesternEurope, Canada and Australia. Virtually all of our 2006 revenues were derivedfrom sales of software licenses and support agreements. The combined sales ofCuteFTP Home and CuteFTP Pro accounted for 69% and 50% of our revenues in 2004and 2005, respectively, and 32% of our revenues for the six months ended June30, 2006. The combined sales of our Secure Server and Enhanced File Transferproducts grew from 14% of our revenues in 2004 to 43% in 2005, and 58% for thesix months ended June 30, 2006.

***Corporate Structure***

All of the Company’s operations are conducted by GlobalSCAPE Texas, LP,a Texas limited partnership.  Thepartners of GlobalSCAPE Texas, LP are two Nevada limited liability companies,which are both wholly-owned subsidiaries of GlobalSCAPE, Inc., a Delawarecorporation.  GlobalSCAPE Inc. isapproximately 70% owned by Thomas Brown and David Mann, individually, with theremainder held publicly.  GlobalSCAPE,Inc. is a holding company and conducts no operations; however, the stock ofGlobalSCAPE, Inc. is quoted on the OTC Bulletin Board.  References to “GlobalSCAPE” or the “Company”refer collectively to all of these entities unless otherwise indicated.

# **Basis ofPresentation**

The accompanying unaudited financial statements have been prepared inaccordance with Rule 10-01 of Regulation S-X, “Interim Financial Statements.”  Accordingly, they do not include allinformation and footnotes required under generally accepted accountingprinciples for complete financial statements. In the opinion of management, all adjustments (consisting of normallyrecurring accruals) considered necessary for a fair presentation have beenmade.  The results of operations for anyinterim period are not necessarily indicative of the results to be expected forthe full year.

The Balance Sheet at December 31, 2005 has been derived from theaudited financial statements at that date but does not include all theinformation and footnotes required by generally accepted accounting principlesfor complete financial statements.  Forfurther information, refer to the financial statements and 

5

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footnotes included in GlobalSCAPE’s Annual Report onForm 10-K/A Number 1 for the year ended December 31, 2005.

# **Principles ofConsolidation**

The consolidated financial statements include all subsidiaries.  All inter-company transactions and balanceshave been eliminated.

# **Liquidity**

Our capital requirements aredriven principally by our need to enhance our existing products and to developnew products.  The amount of our capitalexpenditures has a direct impact on our ability to offer enhanced and newproducts to our customers.  Our principalsource of capital is cash flow from operations which, in turn, is highlydependent on our sales revenue. Historically, we have relied heavily on sales of CuteFTP Home andCuteFTP Professional, which accounted for approximately 49%****and32% of total revenues in the quarters ended June 30, 2005 and 2006,respectively.  Our newer products in2005, namely Enhanced File Transfer and SecureFTP Server, increased our totalrevenue in 2005 while reducing the percentage of total revenue previously heldby the two CuteFTP products. The newer enterprise products have continued toincrease revenue through the two quarters ended June 30, 2006.

Our principal sources ofcapital are cash on hand and cash flow from operations.  To the extent that sales decline, our cashflow from operations will also decline. If sales decline or our liquidity otherwise requires, management maysubstantially reduce personnel and personnel-related costs, reduce orsubstantially eliminate capital expenditures and/or reduce or substantiallyeliminate research and development expenditures.

The Company’s liquidity couldbe reduced in 2006 if sales of CuteFTP continue to decline and the Company isunable to successfully introduce new products or increase sales of existingproducts.

***Reclassifications***

***Certain prior period amounts havebeen reclassified to conform to the current year presentation. Thesereclassifications had no impact on operating income as previously reported.***

***Sale / Disposal of Assets***

***During***the first six months of 2006, the Companydisposed of equipment with an original purchase price of $15,362 andaccumulated depreciation of $15,362. GlobalSCAPE recognized a gain of $619related to the disposal of these assets.

# **Stock-BasedCompensation**

Stock-Based Compensation Plans

          GlobalSCAPEhas stock-based compensation plans available to grant incentive stock optionsto employees. Under the GlobalSCAPE, Inc. 2000 Stock Option Plan (the Plan),which was approved by the Board of Directors and became effective on May 17,2001, a maximum of 3,660,000 shares of GlobalSCAPE common stock may be awarded.GlobalSCAPE expects that common stock awarded on an annual basis will bebetween zero and two percent of total common stock outstanding.

          Theexercise price, term and other conditions applicable to each stock optiongranted under the Plan are generally determined by the Board of Directors. Theexercise price of stock options is set on the grant date and may not be lessthan the fair market value per share of our stock on that date. The optionsgenerally become exercisable over a three-year period and expire after tenyears.

6

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          EffectiveJanuary 1, 2006, we adopted the provisions of Statement of Financial AccountingStandards No. 123 (revised 2004), “Share-Based Payment” (SFAS No.123R)requiring that compensation cost relating to share-based payment transactionsbe recognized in the financial statements. The cost is measured at the grantdate, based on the calculated fair value of the award, and is recognized as anexpense over the employee’s requisite service period (generally the vestingperiod of the equity award). Prior to January 1, 2006, we accounted forshare-based compensation to employees in accordance with Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees” (APB No. 25),and related interpretations. We also followed the disclosure requirements ofStatement of Financial Accounting Standards No. 123, “Accounting forStock-Based Compensation”, as amended by Statement of Financial AccountingStandards No. 148, “Accounting for Stock-Based Compensation-Transition andDisclosure”. We adopted SFAS No. 123R using the modified prospective methodand, accordingly, financial statement amounts for prior periods presented inthis Form 10-Q have not been restated to reflect the fair value method ofrecognizing compensation cost relating to stock options.

          Therewas $120,538 of compensation cost related to incentive stock options recognizedin operating results in the six months ended June 30, 2006.

          Thefair value of each option award is estimated on the date of grant using theBlack-Scholes option-pricing model. Expected volatility is based on historicalvolatility of GlobalSCAPE stock. We used the simplified method to derive anexpected term. The expected term represents an estimate of the time options areexpected to remain outstanding. The risk-free rate for periods within thecontractual life of the option is based on the U.S. treasury yield curve ineffect at the time of grant. The following table sets forth the assumptionsused to determine compensation cost for our stock options consistent with therequirements of SFAS No. 123R.

|                                 | ** ** | **Three Months Ended  June 30, 2006** | ** ** |
|---------------------------------|------------|-----------------------------------------------------------|------------|
|                            |       |                                                      |       |
| Expected  volatility            |       | 109.91                                                    | %          |
| Expected annual  dividend yield |       | 0.0                                                       | %          |
| Risk free rate  of return       |       | 4.81                                                      | %          |
| Expected option term  (years)   |       | 6.0                                                       |       |

          UnderAPB No. 25 there was no compensation cost recognized for our stock optionsawarded in the three or six months ended June 30, 2005 as these stock optionshad an exercise price equal to the market value of the underlying stock at thegrant date. The following table sets forth pro forma information as ifcompensation cost had been determined consistent with the requirements of SFASNo. 123.

 

|                                                                                                                                                    | ** ** | **Three Months Ended  June 30, 2005** | ** ** | **Six Months Ended  June 30, 2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|
|                                                                                                                                               |       |                                                      |       |                                                    |       |
| Net income, as  adjusted                                                                                                                           |       | $                                                         | 525,614    |                                                    | $          | 684,183 |   |
| Deduct: Total  stock-based employee compensation cost determined under fair value method for  fixed stock option plans, net of related tax effects |       | (4,438                                                    | )          | (8,485                                                  | )          |
|                                                                                                                                               |       |                                                      |       |                                                    |       |
| Pro forma net  income                                                                                                                              |       | 521,176                                                   |       | 675,698                                                 |       |
|                                                                                                                                               |       |                                                      |       |                                                    |       |
|                                                                                                                                               |       |                                                      |       |                                                    |       |
| Earnings per share of  common stock:                                                                                                               |       |                                                      |       |                                                    |       |
| Basic — as adjusted                                                                                                                           |       | $                                                         | 0.04       |                                                    | $          | 0.05 |   |
|                                                                                                                                               |       |                                                      |       |                                                    |       |
| Basic — pro forma                                                                                                                             |       | $                                                         | 0.04       |                                                    | $          | 0.05 |   |
|                                                                                                                                               |       |                                                      |       |                                                    |       |
|                                                                                                                                               |       |                                                      |       |                                                    |       |
| Earnings per share of  common stock:                                                                                                               |       |                                                      |       |                                                    |       |
| Assuming  dilution - as adjusted                                                                                                                   |       | $                                                         | 0.04       |                                                    | $          | 0.05 |   |
|                                                                                                                                               |       |                                                      |       |                                                    |       |
| Assuming  dilution - pro forma                                                                                                                     |       | $                                                         | 0.04       |                                                    | $          | 0.05 |   |

 

7

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          Thefollowing table summarizes information about stock option activity for the sixmonths ended June 30, 2006: 

|                                   | ** ** | **Number  of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (years)** | ** ** | **Aggregate  Intrinsic  Value ($M)** | ** ** |
|-----------------------------------|------------|-------------------------|------------|----------------------------------------|------------|------------------------------------------------------------------|------------|-------------------------------------------|------------|
|                              |       |                    |       |                                   |       |                                                             |       |                                      |       |
| Outstanding at  December 31, 2005 |       | 2,373,211               |       | $                                      | .25        |                                                             | 6.5        |                                      |       |   |
| Granted                           |       | 325,000                 |       | 2.31                                   |       |                                                             |       |                                      |       |
| Exercised                         |       | (597,321                | )          | .03                                    |       |                                                             |       |                                      |       |
| Lapsed or canceled                |       | (13,000                 | )          | .21                                    |       |                                                             |       |                                      |       |
|                              |       |                    |       |                                   |       |                                                             |       |                                      |       |
| Outstanding at  June 30, 2006     |       | 2,087,890               |       | $                                      | .64        |                                                             | 7.18       |                                      | $          | 3.89 |   |
|                              |       |                    |       |                                   |       |                                                             |       |                                      |       |
| Exercisable at June 30,  2006     |       | 1,208,183               |       | $                                      | .38        |                                                             | 5.84       |                                      | $          | 2.56 |   |

 

        Theweighted average fair value of options granted during the three months endedJune 30, 2006 was $3.03. The total intrinsic value of options (which is theamount by which the stock price exceeded the exercise price of the options onthe date of exercise) exercised during the three months ended June 30, 2006 was$0.16. During the six months ended June 30, 2006, the amount of cash receivedfrom the exercise of stock options was $28,968 with no associated taxbenefit. The following table summarizes information about nonvested stockoption awards as of June 30, 2006 and changes for the six months ended June 30,2006.

|                                  | ** ** | **Number  Of  Options** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|----------------------------------|------------|-------------------------|------------|-------------------------------------------------------------|------------|
| Non-vested at  December 31, 2005 |       | 772,457                 |       | $                                                           | .2462      |   |
| Granted                          |       | 325,000                 |       | 2.31                                                        |       |
| Vested                           |       | (214,995                | )          | .27                                                         |       |
| Forfeited                        |       | (2,754                  | )          | .20                                                         |       |
|                             |       |                    |       |                                                        |       |
| Non-vested at June 30,  2006     |       | 879,708                 |       | $                                                           | 1.01       |   |

          AtJune 30, 2006, there was $721,584 of total unrecognized compensation costrelated to non-vested stock option awards which is expected to be recognizedover a weighted-average period of 3 years. There were 214,995 options that becamevested during the three months ended June 30, 2006.

8

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# **2.             Earnings per Common Share**

Basic and diluted net income per common share is presented inconformity with Statement of Financial Accounting Standards No. 128, “EarningsPer Share” (SFAS 128) for all periods presented. Basic earnings per share isbased on the weighted effect of all common shares issued and outstanding, andis calculated by dividing net income (loss) available to common stockholders bythe weighted average shares outstanding during the period. Diluted earnings pershare is calculated by dividing net income (loss) available to commonstockholders by the weighted average number of common shares used in the basicearnings per share calculation plus the number of common shares that would beissued assuming conversion of all potentially dilutive common sharesoutstanding.  Below is a reconciliationof the numerators and denominators of basic and diluted earnings per share foreach of the periods presented:
| ** **                                              | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                              | ** ** | **2005**                                            | ** ** | **2006**                                          | ** ** | **2005** | ** ** | **2006** | ** ** |
| **Numerators**                                          |       |                                                |       |                                              | * *   | * * | * * | * * | * * |
| Numerators for basic  and diluted earnings per share:   |       |                                                |       |                                              | * *   | * * | * * | * * | * * |
| Net income                                              |       | $                                                   | 525,614    |                                              | $          | 500,056 |   | $ | 684,183 |   | $ | 1,048,988 |   |
|                                                    |       |                                                |       |                                              |       |   | * * | * * | * * |
| **Denominators**                                        |       |                                                |       |                                              | * *   | * * | * * | * * | * * |
| Denominators for basic  and diluted earnings per share: |       |                                                |       |                                              | * *   | * * | * * | * * | * * |
| Weighted average  shares outstanding — basic       |       | 13,773,219                                          |       | 14,379,061                                        |       | 13,773,219 |   | 14,379,061 |   |
|                                                    |       |                                                |       |                                              |       |   | * * | * * | * * |
| **Dilutive potential common  shares**                   |       |                                                |       |                                              | * *   | * * | * * | * * | * * |
| Stock options  (1)                                      |       | 811,065                                             |       | 1,529,316                                         |       | 742,564 |   | 1,482,834 | * * |
| Denominator for  dilutive earnings per share            |       | 14,584,284                                          |       | 15,908,377                                        |       | 14,515,873 |   | 15,861,895 | * * |
| Net income per  common share                            |       | $                                                   | 0.04       |                                              | $          | 0.03 |   | $ | 0.05 |   | $ | 0.07 | * * |
| Net income per common  share — assuming dilution   |       | $                                                   | 0.04       |                                              | $          | 0.03 |   | $ | 0.05 |   | $ | 0.07 | * * |

----

(1)             Forthe three and six months ended June 30, 2005, 1,686,417 and 1,618,006 optionshave not been included in dilutive shares, as the effect would beanti-dilutive.  For the three and sixmonths ended June 30, 2006, 225,000 options have not been included in dilutiveshares, as the effect would be anti-dilutive.

 

9

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# **Item 2.  Management’s Discussion and Analysis ofFinancial 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 thosestatements that describe management’s beliefs and expectations about thefuture.  We have identifiedforward-looking statements by using words such as “anticipate,” “believe,” “could,”“estimate,” “may,” “expect,” and “intend.” Although we believe these expectations are reasonable, our operationsinvolve a number of risks and uncertainties, including those described in the “RiskFactors” section of our Annual Report on Form 10-K/A Number 1 and otherdocuments filed with the Securities and Exchange Commission.  GlobalSCAPE’s actual results could differmaterially from those discussed in any forward-looking statements included inthis Quarterly Report.

**Overview**

GlobalSCAPE develops and distributes secure file management softwarefor individuals and business users to safely send data over the internet.  Our products guarantee the privacy ofcritical information such as financial data, medical records, customer filesand other similar documents.  Inaddition, our products ensure compliance with government regulations relatingto the protection of information while allowing users to reduce IT costs,increase efficiency, track and audit transaction and automate processes.  We also develop and distribute Web contentmanagement and Web development tools.

The following is a brief description of our products:

·                  **File Management Products** — Our FileManagement products are best known for the “CuteFTP” product line. They primarilyconsist of products that help users securely move and copy files on theinternet. A substantial portion of our revenues are derived from licensing ourFile Management products. Some of our products encrypt the transfers forsecurity using technology similar to a Web browser. The products consist ofthree product categories; client, server and compression transfer. Our FileManagement product line includes CuteFTP Home, Cute FTP Professional, SecureFTPServer, Enhanced File Transfer and CuteZIP.

·                  **Content Management Products**—****Our Content Management product helpsnon-technical business users update and manage Web site content withoutexcessive training. Our content management software is Cascade Server, a newrelease of our former product, PublishXML.

·                  **Web Development Products** — Our WebDevelopment Products help Web developers create Web sites. They provide a widerange of capabilities such as creating Web sites from a template, directediting of Web based computer code and creating Web surveys. Our WebDevelopment product line includes CuteSITE Builder, CuteHTML, CuteHTML Pro,CuteMAP and Web Survey.

We started in 1996 with the distribution of CuteFTP, a file transferprotocol client program, and have achieved significant success and popularitywith this product. We built on this success by steadily adding complementaryproducts and believe we now have a reputation as a provider of easy-to use,affordable software for both individual and enterprise users.  Since 2000, we have focused on enhancing ourportfolio of products to meet the increasing demand for data security, and forsolutions that permit non-technical personnel to contribute content to theirorganizations’ Web sites.  Our strategyis to continue enhancing our file transfer products across the board to meetthe demands of both individual and enterprise users, while improving thesecurity features of our current product line. We believe that our continued growth will come through the furtherdevelopment of our SecureFTP Server and Enhanced File Transfer productsinvolving secure file transfer to meet the growing demand for file securitywhen transferring 

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information across the internet due to changes inregulations in various industries and the demand of users for secure solutions.

Substantially all software products ultimately reach a point in theirlifecycle in which sales can be expected to plateau or decline.  Management believes that the market forstand-alone FTP client programs for home consumers may be declining.  While it cannot be determined with certainty,CuteFTP and CuteFTP Pro may have reached such a point in their lifecycles.  In order to respond to this decline, we havebegun concentrating on product offerings for business users.  We have not seen the same decline in themarket for SecureFTP client programs and servers such as CuteFTP Pro andSecureFTP Server which we believe better target the needs of businesses.

We intend to release new versions of CuteFTP, CuteFTP Pro and SecureFTPServer in 2006 and we believe we can slow the decline in sales of CuteFTP andimprove sales of CuteFTP Pro and SecureFTP Server and EFT.  We plan on releasing additional versions ofEFT and modules for it throughout 2006.

Our shift to emphasizing product offerings for business users will haveimportant consequences for our business. GlobalSCAPE will require moretechnical sales and support persons to handle the complex configurations ofcustomer systems as the customer base grows. More difficult and differentsituations will arise as customer needs grow. We will need to have the abilityto understand and solve technical issues in a timely manner. With increasedsales to business we should realize additional revenues from maintenance andsupport agreements to support the additional personnel.

CuteFTP and CuteFTP Pro accounted for approximately 49%****and 32% of total revenues in the quarters ended June 30,2005 and 2006, respectively, and 55% and 32% for the six months ended June 30,2005 and 2006, respectively.** **Sales of these products declinedapproximately 17% as a percentage of revenue when comparing the second quarterof 2005 to the second quarter of 2006.****The percentageof revenue decline was 23% for the six months ended June 30, 2005 compared tothe same period of 2006. ** **The decline as a percentage ofrevenue was due to an increase in sales of other products such as SecureFTPServer and Enhanced File Transfer. GlobalSCAPE’s goal is to continue to enhanceour SecureFTP Server and Enhanced File Transfer products to meet the needs ofour customers and the enterprise market.****Total revenuesincreased 34% from the second quarter of 2005 to the second quarter of 2006 andincreased 50% from the six months ended June 30, 2005 to the same period of2006 due to stronger sales of SecureFTP Server, PublishXML and Enhanced FileTransfer.

Our strategy is to continue enhancing our file transfer products acrossthe board to meet the demands of both individual and enterprise users, whileimproving our current product line. Our success in 2006 is, to a great extent,dependent on our ability to market and sell our Enhanced File Transfer toenterprise users and continue to enhance our current products. We arecontinuing to address security issues for our customers for future releases. Weplan on releasing additional versions of our Enhanced File Transfer productthis year along with additional add on modules. In general, our success dependson our ability to introduce new products and the market’s acceptance of theseproducts.  We released new versions ofCuteFTP, CuteFTP Pro, Secure Server and Enhanced File Transfer in 2005 and weplan the same for 2006. We believe we can slow the decline in sales of CuteFTPand improve sales of CuteFTP Pro, Secure Server and Enhanced File Transfer aswe continue to reach out to the business market and offer new releases.

##### **Liquidity andCapital Resources**

Our capital requirements are driven principally by our need to enhanceour existing products and to develop new products.  The amount of our capital expenditures has adirect impact on our ability to offer enhanced and new products to ourcustomers.  We rely heavily on cash flowsfrom operations and these cash flows are directly linked to sales of CuteFTPHome and CuteFTP Professional, which accounted for 55%****and32% of our revenues in the six months ended June 30, 2005 and 2006,respectively.  Much of the decline inpercentage of revenues from the sale of these two products was offset by salesof other products in the first six months of 2006, namely, SecureFTP Server,Enhanced File Transfer and PublishXML which account for 33% and 62% of revenuesin the six months ended June 30, 2005 and 2006 respectively.  Total 

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revenues increased 34% when comparing the secondquarter of 2006 to the same period in 2005 and 50% when comparing the firsthalf of 2006 with the same period of 2005.

Our principal sources of capital are cash on hand and cash flow fromoperations.  To the extent that salesdecline, our cash flow from operations will also decline.  If sales decline or our liquidity otherwiserequires, management may substantially reduce personnel and personnel-relatedcosts, reduce or substantially eliminate capital expenditures and/or reduce orsubstantially eliminate research and development expenditures.

Net cash provided by operating activities was $475,866 in the sixmonths ended June 30, 2005 as compared to $1,450,940 for the six months endedJune 30, 2006.  Cash provided byoperations for the six months ended June 30, 2006, was primarily the result ofnet income, adjustments related to depreciation and amortization, stock-basedcompensation, with an increase in accounts receivable and federal income taxreceivable and to a lesser extent increases in, accrued expenses, and deferredrevenue offset by a decrease in accounts payable and an increase in federalincome tax payable.

Net cash used in investing activities for the six months ended June 30,2005 and 2006 was $63,562 and $73,230, respectively.  In both periods, the cash used in investingactivity was primarily for the purchase of computer equipment, software, andlease hold improvements.

Net cash provided by financing activities during the six months endedJune 30, 2005 and 2006 were $0 and $28,968 respectively.  The increase in cash provided from financingactivities was from issuance of stock from exercised options.

As of June 30, 2006, we had $3,435,532 in cash and cash equivalents,total current assets of $4,352,022 and current liabilities of $1,439,742,resulting in working capital of $2,912,280. Our principal commitments consisted of obligations outstanding underoperating leases, sales bonuses, royalty agreements with third parties, federalincome tax and trade accounts payable. We plan to continue to expend significant resources on productdevelopment in future periods and may also use our cash to acquire or licensetechnology, products or businesses related to our current business. Thefacility that we currently occupy is expected to be sufficient for our growthover the next twelve months. Consequently, we do not anticipate significant expenditures forleasehold improvements or furniture for 2006.

We do not currently have any commitments for outside sources ofcapital.  We previously had a $250,000revolving credit agreement which expired on March 31, 2006.  We believe that, if necessary, we could enterinto a similar arrangement in the future, although we cannot assure you that wewill be able to do so.  We may also sellequity securities in order to finance future acquisitions or licensingactivities.

**Contractual Obligations**

The following table sets forth the futureminimum payments required under contractual commitments at June 30, 2006**: **
| ** **                       | ** ** | **Payments Due by Fiscal Year** | ** ** |
|----------------------------------|------------|-----------------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **2006 (1)**                                   | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| Operating Lease                  |       | $                                                   | 95,330     |   | $ | 190,659 |   | $ | 95,329 |   | — |   | — |   | $ | 381,318 |   |
| Equipment Leases                 |       | 3,129                                               |       | 4,350 |   | 1,743 |   | — |   | — |   | 9,222 |   |
| Total Cash Obligations           |       | $                                                   | 98,459     |   | $ | 195,009 |   | $ | 97,072 |   | — |   | — |   | $ | 390,540 |   |

----

(1)             Amounts for 2006reflect the future minimum payments for the remaining six months of the fiscalyear.

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##### **Critical Accounting Policies**

# ***Use ofEstimates***

Management’sDiscussion and Analysis of Financial Condition and Results of Operations arebased upon the Company’s financial statements, which have been prepared inaccordance with accounting principles generally accepted in the UnitedStates.  The preparation of thesefinancial statements requires management to make estimates and assumptions thataffect the reported amount of assets and liabilities.  On an ongoing basis, management evaluates itsestimates and judgments, including those related to revenue recognition,allowance for doubtful accounts, accounts receivable, long-lived and intangibleassets, income taxes and contingencies. Management bases its estimates on historical experience, observabletrends, and various other assumptions that are believed to be reasonable underthe circumstances.  Management uses thisinformation to make judgments about the carrying values of assets andliabilities that are not readily apparent form other sources.  Actual results may differ from the estimatesunder different assumptions or conditions.

Managementbelieves the following critical accounting policies affect its more significantjudgments and estimates used in the preparation of its financial statements.

***Revenue Recognition***

Our revenue is generatedprimarily by licensing our software products and providing support for thoseproducts.  Revenues are comprisedof the gross selling price of the software, including shipping charges and theearned portion of support and maintenance agreements.  The Company recognizes revenue in accordancewith the American Institute of Certified Public Accountants Statement ofPosition (“SOP”) 97-2, *Software RevenueRecognition*, as modified by SOP 98-9, *Modification of SOP 97-2, Software Revenue Recognition, With Respect toCertain Transactions*.

Revenues fromthe sale of software products are recognized and completely earned uponshipment or electronic delivery of the product provided that persuasiveevidence of an arrangement exists, collection is probable, payment terms arefixed and determinable and no significant obligations remain.

We also selltechnical support and maintenance agreements (post contract customer support “PCS”),which are sometimes bundled with the software. When vendor specific objective evidence (“VSOE”) of fair valueexists for all elements in a multiple element arrangement, revenue is allocatedto each element based on the relative fair value of each of the elements. VSOEof fair value is established by the price charged when the same element is soldseparately.  In a multiple elementarrangement whereby VSOE of fair value of all undelivered elements exists butVSOE of fair value does not exist for one or more delivered elements, revenueis recognized using the residual method. Under the residual method, the fairvalue of the undelivered elements is deferred and the remaining portion of thearrangement fee is recognized as revenue, assuming collection is probable.  Revenue allocated to PCS is recognized ratablyover the contractual term, typically one year

The Companybegan selling technical support and maintenance services for some of itssoftware products in 2001 and had deferred recognition of approximately $11,000in revenue at the end of that year.  Deferredrevenue grew to a balance of approximately $178,000 and $560,578 at December31, 2004 and 2005, respectively. Sales of these agreements continued to growinto the first six months of 2006 with more deferrals that are due largely tothe enterprise type software they are supporting. For the six months ended June30, 2005 and 2006, the deferred revenue balance was $255,658 and $846,789,respectively. If the level of sales of technical support and maintenanceagreements remains the same or declines, the balance of deferred revenues willstabilize or decline. However if sales grow, the balance will increase,resulting in the deferred recognition of a significant amount of revenue infuture periods.

***Allowance for DoubtfulAccounts***

We providecredit, in the normal course of business, to a number of companies and performongoing evaluations of our credit risk. We require no collateral from our customers and we estimate theallowance for uncollectible accounts based on our historical experience andcurrent credit evaluations.  No 

13

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single customer accounted for more than 2% of netrevenues in the first six months of 2005. In the first six months of 2006, wehad one customer that accounted for more than 2% of net revenues individually.In total this one customer accounted for approximately 0% and 2.6% of netrevenues for the three and six months ended June 30, 2006, respectively.

***Valuation of Long-Lived and Intangible Assets***

The Companyassesses the impairment of long-lived and intangible assets whenever events orchanges in circumstances indicate that the carrying value may not berecoverable.  Factors consideredimportant which could trigger an impairment review included the following:  significant underperformance relative tohistorical or projected future cash flows; significant changes in the manner ofuse of the assets or the strategy for the overall business; and significantnegative industry trends.  Whenmanagement determines that the carrying value of long-lived and intangibleassets may not be recoverable, impairment is measured based on the excess ofthe assets’ carrying value over the estimated fair value.  No impairment was recognized in 2005 or thefirst six months of 2006.

***Stock-Based Compensation***

          EffectiveJanuary 1, 2006, we adopted the provisions of Statement of Financial AccountingStandards No. 123 (revised 2004), “Share-Based Payment” (SFAS No.123R)requiring that compensation cost relating to share-based payment transactionsbe recognized in the financial statements. The cost is measured at the grantdate, based on the calculated fair value of the award, and is recognized as anexpense over the employee’s requisite service period (generally the vestingperiod of the equity award). Prior to January 1, 2006, we accounted forshare-based compensation to employees in accordance with Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees” (APB No. 25),and related interpretations. We also followed the disclosure requirements ofStatement of Financial Accounting Standards No. 123, “Accounting forStock-Based Compensation”, as amended by Statement of Financial AccountingStandards No. 148, “Accounting for Stock-Based Compensation-Transition andDisclosure”. We adopted SFAS No. 123R using the modified prospective methodand, accordingly, financial statement amounts for prior periods presented inthis Form 10-Q have not been restated to reflect the fair value method ofrecognizing compensation cost relating to stock options.

In the secondquarter of 2006, 125,000 options were granted, 61,750 options were exercised,1,500 were forfeited and none expired.

***Research and Development***

Research anddevelopment expenses include all direct costs, primarily salaries for personneland expenditures with external development sources, related to the developmentof new products and significant enhancements to existing products and areexpensed as incurred until such time as technological feasibility is achieved.For the three months ended June 30, 2005 and 2006, we spent $205,043 and$267,474, respectively, on research and development.  For the six months ended June 30, 2005 and2006, we spent $383,809 and $496,804, respectively, on research anddevelopment.  No research and developmentexpenses were capitalized in either period and all previously capitalizedresearch and development expenses were fully amortized at December 31, 2002.

# ***IncomeTaxes***

GlobalSCAPEaccounts for income taxes using the liability method in accordance withStatement of Financial Accounting Standards No. 109, *Accounting for Income Taxes*. The liability method providesthat the deferred tax assets and liabilities are recorded based on thedifference between the book and tax basis of assets and liabilities and theircarrying amount for financial reporting purposes, as measured by the enactedtax rates and laws that will be in effect when the differences are expected toreverse.  Deferred tax assets are carriedon the balance sheet with the presumption that they will be realizable infuture periods 

14

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when pre-tax income is generated. GlobalSCAPE recordeda deferred tax asset at June 30, 2006 of $51,159 based on its taxable incomefor the quarter.

Statement ofFinancial Accounting Standards (SFAS) No. 109 requires a valuation allowance toreduce the deferred tax assets reported if, based on the weight of theevidence, it is more likely than not that some portion or all of the deferredtax assets will not be realized. After consideration of all the evidence, bothpositive and negative, management determined that no valuation allowance wasnecessary at June 30, 2006. During the quarter the deferred tax asset wasincreased by $1,763. During the six months ended June 30, 2006 the deferred taxasset was reduced by $824.

# **Comparisonof the Three Months ended June 30, 2005 and 2006**

| ** **                                    | ** ** | **2005**  | ** ** | **2006**  | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|-----------------------------------------------|------------|-----------|------------|-----------|------------|-------------------|------------|-------------------|------------|
| Software product  revenues                    |       | $         | 1,819,376  |      | $          | 2,445,327         |       | $                 | 625,951    |   | 34 | % |
| Cost of revenues                              |       | 77,819    |       | 85,507    |       | 7,688             |       | 10                | %          |
| Selling, general  and administrative Expenses |       | 986,379   |       | 1,346,972 |       | 360,593           |       | 37                | %          |
| Research and  development expenses            |       | 205,043   |       | 267,474   |       | 62,431            |       | 30                | %          |
| Depreciation and  amortization                |       | 24,315    |       | 23,442    |       | (873              | )          | (4                | )%         |
| Total operating  expense                      |       | 1,293,556 |       | 1,723,395 |       | 429,839           |       | 33                | %          |
| Income (loss)  from operations                |       | 525,820   |       | 721,932   |       | 196,112           |       | 37                | %          |
| Other Income (expense)                        |       | (206      | )          | 22,902    |       | 23,108            |       | 11,217            | %          |
| Income tax  expense                           |       | —    |       | 244,778   |       | 244,778           |       | 100               | %          |
| Net income (loss)                             |       | $         | 525,614    |      | $          | 500,056           |       | $                 | (25,558    | ) | (5 | )% |

 

***Revenue.***  For the three months ended June 30, 2005 and2006, total revenues increased $625,951 or approximately 34% from $1,819,376 to$2,445,327 largely due to the increase in revenues from SecureFTP Server andEnhanced File Transfer which continues to gain acceptance in the market,especially with large companies. Revenues from CuteFTP Home and CuteFTP Professionaldeclined by 12% as compared to the quarter ended June 30, 2005 due to the trendof including FTP capabilities in other applications thus reducing the need forstandalone FTP software. CuteFTP Home and CuteFTP Professional accounted forapproximately 49% and 32% of total revenues for the three months ended June 30,2005 and 2006 respectively.  SecureFTPServer and Enhanced File Transfer accounted for approximately 39% and 60% oftotal revenues for the three months ended June 30, 2005 and 2006 respectively.

The following table reflects revenue byproduct including the related maintenance and support for each product:
| ** **                                                                                               | ** ** | **Revenue for**                       | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                               | ** ** | **Quarter ending June 30,** | ** ** |
| **Product**                                                                                              | ** ** | **2005**                                   | ** ** | **2006** | ** ** |
| Enhanced File  Transfer                                                                                  |       | $                                          | 390,701    |   | 21.47 | % | $ | 944,072 |   | 38.61 | % |
| CuteFTP  Professional                                                                                    |       | 635,062                                    |       | 34.91 | % | 565,694 |   | 23.13 | % |
| CuteFTP Home                                                                                             |       | 290,215                                    |       | 15.95 | % | 246,169 |   | 10.07 | % |
| SecureFTP Server                                                                                         |       | 334,721                                    |       | 18.40 | % | 592,235 |   | 24.22 | % |
| All Others                                                                                               |       | 333,293                                    |       | 18.32 | % | 588,529 |   | 24.06 | % |
| Deferred Revenue  adjustment                                                                             |       | (164,616                                   | )          | -9.05 | % | (491,372 | ) | -20.09 | % |
| Total Operating Revenues                                                                                 |       | $                                          | 1,819,376  |   | 100.00 | % | $ | 2,445,327 |   | 100.00 | % |
| Gross maintenance and  support included above before recognition of the net adjustment to defer  revenue |       | $                                          | 108,411    |   | 5.96 | % | $ | 362,925 |   | 14.84 | % |

 

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Maintenance and support revenue continues toincrease as revenues from sales of our enterprise products, SecureFTP Serverand Enhanced File Transfer, continue to grow. Maintenance and support pricingis reflective of the license cost of the products and the additional support ittakes to maintain and support the products and customers. With highermaintenance and support revenues, there will be additional deferred revenue tobe recognized as we earn the revenue over the life of the maintenance andsupport agreement.

***Cost of Revenues.***  Cost of revenues consists primarily ofproduction, packaging and shipping costs for boxed copies of software productsas well as a portion of our bandwidth costs, certain licensing expenses androyalties.  Cost of revenues increased$7,688 or 10% between periods from $77,819 for the three months ended June 30,2005 to $85,507 for the three months ended June 30, 2006.  Royalties that the Company pays on softwareproducts licensed from third parties, which it resells, are expensed as a costof sale when the software product is sold or earlier if the recoverability ofany prepaid royalties is in doubt.  TheCompany has distribution agreements with Hannon Hill Corp., Trellix Corp.,Perseus Development Corp., Beehive Software, Inc., Visicom Media, Inc., andXnet Communications GmbH.  TheGlobalSCAPE software products associated with each of the companies are PublishXML, CuteSITE Builder, Web Survey, Mac FTP, CuteHTML Pro, and Mac FTP Pro,respectively.  GlobalSCAPE’s agreementwith Hannon Hill Corp. accounted for a large portion of the increase in royaltyexpense during the quarter ended June 30, 2006 due to the increase in sales ofproduct and maintenance and support during the quarter for PublishXML. Weexpect the cost of revenues to increase as sales of Hannon Hill productsincrease and decline when or if the sales decrease.

***Selling, General andAdministrative.*** Selling, general and administrative expenses consist primarily ofpersonnel and related expenses, marketing, customer support, rents, bad debtand professional fees.  For the threemonths ended June 30, 2005 and 2006, selling, general and administrativeexpenses were $986,379 and $1,346,972, respectively, an increase ofapproximately 37%. Salaries increased slightly as we have hired new employeesand commissions and bonuses more than doubled, based on the increase inrevenues. As required by FAS123R, we expensed $72,721 for stock basedcompensation related to the granting of stock options to employees.

***Research and Development.***  Research and development expenses increased$62,431 or 30% between periods, from $205,043 to $267,474.  The increase was due largely to additionalexpenditures for external development resources and hiring of additionalpersonnel to meet the release deadlines for our software products.

***Depreciation andAmortization.*** Depreciation and amortization expense consists of depreciation expenserelated to our fixed assets, amortization of the trademark associated with ourpurchase of CuteFTP and in prior periods, amortization of capitalizeddevelopment costs. Depreciation and amortization expense decreased from $24,315to $23,442, a decline of approximately 4%. This decrease was due primarily to a reduction in depreciation expenseas fixed assets come to the end of their depreciable life as well as a slowdownin additions to fixed assets in current periods relative to prior periods.

***Other Income,Expense.*** For the three months ended June 30, 2005 and 2006, interest expensedecreased from $397 to $0, respectively. The majority of interest expense incurred during 2005 was related tofinancing of insurance premiums. We earned $23,005 in interest during thesecond quarter of 2006 from investing our excess cash.

***Income Taxes.***  The provision for federal income taxes forthe quarter ended June 30, 2006 was $244,778. We recognized no benefit relatedto the net income in the three months ended June 30, 2005 because we could notbe certain of the future period recoverability of tax assets generated fromavailable net operating losses at that time.

***Net Income.***  GlobalSCAPE recorded net income of $525,614and $500,056 for the three months ended June 30, 2005 and 2006, respectively.This was a decrease of $25,558 quarter to quarter in net income. The decreasein net income was largely a result of an increase in federal taxes.

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# **Comparisonof the Six Months ended June 30, 2005 and 2006**

| ** **                                    | ** ** | **2005**  | ** ** | **2006**  | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|-----------------------------------------------|------------|-----------|------------|-----------|------------|-------------------|------------|-------------------|------------|
| Software product  revenues                    |       | $         | 3,241,757  |      | $          | 4,860,249         |       | $                 | 1,618,492  |   | 50 | % |
| Cost of revenues                              |       | 159,377   |       | 226,918   |       | 67,541            |       | 42                | %          |
| Selling, general  and administrative Expenses |       | 1,960,439 |       | 2,560,509 |       | 600,070           |       | 31                | %          |
| Research and  development expenses            |       | 383,809   |       | 496,804   |       | 112,995           |       | 29                | %          |
| Depreciation and  amortization                |       | 53,415    |       | 44,679    |       | (8,736            | )          | (16               | )%         |
| Total operating  expense                      |       | 2,557,040 |       | 3,328,910 |       | 771,870           |       | 30                | %          |
| Income (loss)  from operations                |       | 684,717   |       | 1,531,339 |       | 846,622           |       | 124               | %          |
| Other Income  (expense)                       |       | (534      | )          | 37,255    |       | 37,789            |       | 7,077             | %          |
| Income tax  expense                           |       | 0         |       | 519,606   |       | 519,606           |       | 100               | %          |
| Net income (loss)                             |       | $         | 684,183    |      | $          | 1,048,988         |       | $                 | 364,805    |   | 53 | % |

 

***Revenue.***  For the six months ended June 30, 2005 and2006, total revenues increased $1,618,492 or approximately 50% from $3,241,757to $4,860,249 largely due to the increase in revenues from SecureFTP Server andEnhanced File Transfer which continues to gain acceptance in the market,especially with large companies. Revenues from CuteFTP Home and CuteFTPProfessional declined by 23% as compared to the six months ended June 30, 2005due to the trend of including FTP capabilities in other applications thus reducingthe need for standalone FTP software. CuteFTP Home and CuteFTP Professionalaccounted for approximately 55% and 32% of total revenues for the six monthsended June 30, 2005 and 2006 respectively. SecureFTP Server and Enhanced FileTransfer accounted for approximately 31% and 58% of total revenues for the sixmonths ended June 30, 2005 and 2006 respectively.

The following table reflects revenue byproduct including the related maintenance and support for each product
| ** **                                                                                               | ** ** | **Revenue for**                               | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **Six months ending June 30,** | ** ** |
| **Product**                                                                                              | ** ** | **2005**                                           | ** ** | **2006** | ** ** |
| Enhanced File  Transfer                                                                                  |       | $                                                  | 473,526    |   | 14.61 | % | $ | 1,838,176 |   | 37.82 | % |
| CuteFTP  Professional                                                                                    |       | 1,249,916                                          |       | 38.56 | % | 1,156,375 |   | 23.79 | % |
| CuteFTP Home                                                                                             |       | 572,717                                            |       | 17.67 | % | 511,891 |   | 10.53 | % |
| SecureFTP Server                                                                                         |       | 544,111                                            |       | 16.78 | % | 1,161,776 |   | 23.90 | % |
| All Others                                                                                               |       | 679,187                                            |       | 20.95 | % | 1,130,047 |   | 23.26 | % |
| Deferred Revenue  adjustment                                                                             |       | (277,700                                           | )          | -8.57 | % | (938,016 | ) | -19.30 | % |
| Total Operating Revenues                                                                                 |       | $                                                  | 3,241,757  |   | 100.00 | % | $ | 4,860,249 |   | 100.00 | % |
| Gross maintenance and  support included above before recognition of the net adjustment to defer  revenue |       | $                                                  | 200,170    |   | 6.17 | % | $ | 651,922 |   | 26.66 | % |

 

Maintenance and support revenue continues toincrease as revenues from sales of our enterprise products, SecureFTP Serverand Enhanced File Transfer, continue to grow. Maintenance and support pricingis reflective of the license cost of the products and the additional support ittakes to maintain and support the products and customers. With highermaintenance and support revenues, there will be additional deferred revenue tobe recognized as we earn the revenue over the life of the maintenance andsupport agreement.

***Cost of Revenues.***  Cost of revenues consists primarily ofproduction, packaging and shipping costs for boxed copies of software productsas well as a portion of our bandwidth costs, certain licensing expenses androyalties.  Cost of revenues increased$67,541 or 42% between periods from $159,377 for the six months ended June 30,2005 to $226,918 for the six months ended June 30, 2006.  Royalties that the 

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Company pays on software products licensed from thirdparties, which it resells, are expensed as a cost of sale when the softwareproduct is sold or earlier if the recoverability of any prepaid royalties is indoubt.  The Company has distributionagreements with Hannon Hill Corp., Trellix Corp., Perseus Development Corp.,Beehive Software, Inc., Visicom Media, Inc., and Xnet Communications GmbH.  The GlobalSCAPE software products associatedwith each of the companies are Publish XML, CuteSITE Builder, Web Survey, MacFTP, CuteHTML Pro, and Mac FTP Pro, respectively.  GlobalSCAPE’s agreement with Hannon HillCorp. accounted for a large portion of the increase in royalty expense duringthe six months ended June 30, 2006 due to the increase in sales of product andmaintenance and support during the six months for PublishXML. We expect thecost of revenues to increase as sales of Hannon Hill products increase anddecline when or if the sales decrease.

***Selling, General andAdministrative.*** Selling, general and administrative expenses consist primarily ofpersonnel and related expenses, marketing, customer support, rents, bad debtand professional fees.  For the sixmonths ended June 30, 2005 and 2006, selling, general and administrativeexpenses were $1,960,439 and $2,560,509, respectively, an increase ofapproximately 31%. Salaries increased slightly as we have hired new employeesand commissions and bonuses more than doubled, based on the increase inrevenues. As required by FAS123R, we expensed $120,537 for stock basedcompensation related to the granting of stock options to employees.

***Research andDevelopment.*** Research and development expenses increased $112,995 or 29% betweenperiods, from $383,809 to $496,804.  Theincrease was due largely to additional expenditures for external developmentresources and hiring of additional personnel to meet the release deadlines forproducts.

***Depreciation andAmortization.*** Depreciation and amortization expense consists of depreciation expenserelated to our fixed assets, amortization of the trademark associated with ourpurchase of CuteFTP and in prior periods, amortization of capitalizeddevelopment costs. Depreciation and amortization expense decreased from $53,415to $44,679, a decline of approximately 16%. This decrease was due primarily to a reduction in depreciation expenseas fixed assets come to the end of their depreciable life as well as a slowdownin additions to fixed assets in current periods relative to prior periods.

***Other Income,Expense.*** For the six months ended June 30, 2005 and 2006, interest expensedecreased from $725 to $0, respectively. The majority of interest expense incurred during 2005 was related tofinancing of insurance premiums. We earned $36,930 in interest during the sixmonths ended June 30, 2006 from investing our excess cash.

***Income Taxes.***  The provision for federal income taxes forthe six months ended June 30, 2006 was $519,606. We recognized no federalbenefit related to the net income in the six months ended June 30, 2005 becausewe could not be certain of the future period recoverability of tax assetsgenerated from available net operating losses at that time.

***Net Income.***  GlobalSCAPE recorded net income of $684,183and $1,048,988 for the six months ended June 30, 2005 and 2006, respectively.This was an increase of $364,805 period to period in net income. The net incomewas largely a result of the acceptance of our SecureFTP Server and EnhancedFile Transfer products over the last year, resulting in higher revenues, whilecontrolling expenses.

##### ** Inflation**

Increases in inflation generally result in higher interest rates andoperating costs.  Our greatest exposureis to the cost of salaries and general and administrative expenses. To date webelieve that inflation has not had a significant impact on our operations.

##### **Seasonality**

We believe our internet salesare subject to seasonal variations and we experience significantly less salesvolume during national holidays and weekends when compared to normal businessdays. The seasonality we have experienced seems to be lessening as we rely moreon sales by our direct sales force, rather than our internet sales. Our fourthquarter revenues in 2005 increased approximately 56% over the same quarter in2004. We expect that in future periods we may see weakness in the fourthquarter on internet sales when compared to the third quarter, due to theholiday season.

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# **Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

To date, we have not utilized derivative financial instruments orderivative commodity instruments.  We donot expect to employ these or other strategies to hedge market risk in theforeseeable future.  We may invest ourcash in money market funds, which are subject to minimal credit and marketrisk.  We believe that the interest raterisk and other relevant market risks associated with these financialinstruments are immaterial.

In the six months ended June 30, 2006, approximately 34% of ourrevenues came from customers outside the United States.  All revenues are received in U.S. dollars sowe have no exchange rate risk with regard to the sale.  However, in July 2003, the European Union(EU) enacted Value Added Taxes (VAT) on electronic purchases.  These taxes are charged to our non-businesscustomers in the EU and, in our case, are remitted quarterly in poundsterling.   We expect that the impact ofthis currency translation will not be material to our business.

# **Item 4.  Controls and Procedures**

Asof the end of the period covered by this report, our Chief Executive Officerand Chief Financial Officer carried out an evaluation of the effectiveness ofGlobalSCAPE’s “disclosure controls and procedures” (as defined in theSecurities Exchange Act of 1934 Rules 13a-15(e)and 15d-15(e)) and concludedthat the disclosure controls and procedures were effective and designed toensure that material information relating to GlobalSCAPE and our consolidatedsubsidiaries which is required to be included in our periodic Securities andExchange Commission filings would be made known to them by others within thoseentities.  There were no changes in ourinternal controls over financial reporting during the period covered by thisreport that could materially affect, or are reasonably likely to materiallyaffect, our financial reporting.

 There were no significant changes in ourinternal control over financial reporting during the last fiscal year and/or upto and including the date of this filing that we believe materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting, except for improvements in the internal controls tostrengthen the process of capturing and reporting of deferred revenue.

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## **Part II.  Other Information**

# **Item 1.    Legal Proceedings**

We are notcurrently involved in any material legal proceedings.

**Item 1A.     RiskFactors.**

In addition to theother information set forth in this report, you should carefully consider thefactors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report onForm 10-K for the year ended December 31, 2005, which could materially affectour business, financial condition or future results.  The risks described in our Annual Report onForm 10-K are not the only risks facing GlobalSCAPE.  Additional risks and uncertainties notcurrently known to us or that we currently deem to be immaterial also maymaterially adversely affect our business, financial condition and/or operatingresults.

# **Item 2.    Unregistered Sales of Equity Securities andUse of Proceeds**

None.

# **Item 3.    Defaults Upon Senior Securities**

Not applicable.

# **Item 4.    Submission of Matters to a Vote of SecurityHolders**

The annual meeting of stockholders was held on June 1, 2006.  The following proposals were adopted by themargins indicated:

1.  Election of three nomineesfor membership on the Company’s Board of Directors, each to serve until thenext Annual Meeting of Stockholders, and until their successors are dulyelected and qualified.

| Name:            | ** ** | **Votes for:** | ** ** | **Votes Withheld:** | ** ** |
|------------------|------------|---------------------|------------|--------------------------|------------|
| Thomas W. Brown  |       | 10,982,642          |       | 5,465                    |       |
| David L. Mann    |       | 10,982,642          |       | 5,465                    |       |
| Charles R. Poole |       | 10,982,642          |       | 5,465                    |       |

 

2.  Approval of the appointmentof Helin, Donovan, Trubee & Wilkinson, LLP, as the Company’s independentcertified public accountants to audit the Company’s consolidated financialstatements for the year ending December 31, 2006.  This proposal received the following votes:

| **For:**     |   | 10,984,353 |   |
|--------------|--------|------------|--------|
| **Against:** |   | 2,401      |   |
| **Abstain:** |   | 1,353      |   |

 

# **Item 5.    Other Information**

On June 13, 2006, we announced that Bernard N. Schneider had been namedas our Chief Financial Officer.  Prior tojoining GlobalSCAPE, Mr. Schneider was Chief Financial Officer of Friedrich AirConditioning Company, a manufacturer of specialty air treatment products basedin San Antonio, Texas.

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# **Item 6.    Exhibits**

**(a)**           Exhibits

31.1 Certificate pursuant to Section 302 ofthe Sarbanes-Oxley Act of 2002.

31.2 Certificate pursuant to Section 302 ofthe Sarbanes-Oxley Act of 2002.

32.1 Certificate pursuant to Section 906 ofthe Sarbanes-Oxley Act of 2002.

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**Signatures**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                 |   | GLOBALSCAPE,  INC. |
|-----------------|--------|--------------------|
|            |   |               |   |   |
|            |   |               |   |   |
| August 11, 2006 |   | By:                |   | /s/ Charles R. Poole |
| Date            |   |               |   | Charles R. Poole |
|            |   |               |   | President and Chief Executive Officer |
|            |   |               |   |   |
| August 11, 2006 |   | By:                |   | /s/ Bernard N. Schneider |
| Date            |   |               |   | Bernard N. Schneider |
|            |   |               |   | Chief Financial Officer |

 

 

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