**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **ý** | ** ** | **QUARTERTLY****REPORT PURSUANT TO SECTION 13  OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                            |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                  |
|       |       | **For the Quarterly Period ended March 31,  2006**                                                                                                                                               |
|       |       |                                                                                                                                                                                                  |
|       |       | **OR**                                                                                                                                                                                                |
|       |       |                                                                                                                                                                                                  |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF  THE SECURITIES EXCHANGE ACT OF 1934**                                                                                               |
|       |       |                                                                                                                                                                                                  |
|       |       | **For the transition period from                to       .       ** |

 

**Commission File No. 000-30617**

 

**GlobalSCAPE, Inc.**

(Exact name of registrant as specified in itscharter)

 

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

 

**(210)308-8267**

(Registrant’s Telephone Number, Including AreaCode)

 

Securities registered pursuant to Section 12(b) ofthe Act:

**None**

 

Securities registered pursuant to Section 12(g) ofthe Act:

 

**CommonStock, par value $0.001 per share**

(Title of Class)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

 

ý 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-2of the Exchange Act (check one):

 

Large Accelerated filer o    Accelerated filer o    Non-Accelerated filer ý

 

Indicateby check mark if the registrant is a shell company (as defined in Rule 12b-2of the Act).

 

o Yes             ý No

 

The aggregate market value ofthe registrant’s outstanding common stock held by non-affiliates wasapproximately $1,285,850 as of the last business day of the registrant’s mostrecently completed second fiscal quarter, based upon the closing sales price of$0.37 per share on such date on the NASD’s OTC Bulletin Board.

 

As of May 12, 2006 therewere 14,359,550 shares of common stock outstanding.

 

 

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## **GlobalSCAPE Inc.**

## ** **

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

## **For the Quarter ended March 31, 2006**

## ** **

## **Index**

## ** **

| ** **                     | ** **                                                                                     | ** ** |
|--------------------------------|------------------------------------------------------------------------------------------------|------------|
| **Part I.**               | **Financial Information**                                                                      |       |
|                           |                                                                                           |       |
| Item 1.                        | Interim Consolidated Financial Statements (Unaudited)                                          |       |
|                           | Consolidated Balance Sheets as of December 31, 2005 and March 31,  2006              |       |
|                           | Consolidated Statements of Operations for the three months ended March 31,  2005 and 2006 |       |
|                           | Consolidated Statements of Cash Flows for the three months ended March 31,  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 2.                        | Changes in 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 and Reports on Form 8-K                                                          |       |
|                           |                                                                                           |       |
| Signatures  and Certifications |                                                                                           |

 

GlobalSCAPE®,CuteFTP®, CuteSITE Builder®, PureCMS®, CuteZIP®, CuteHTML® and CuteMAP® and areregistered trademarks of GlobalSCAPE Texas, LP. GlobalSCAPE Secure FTP Server,GlobalSCAPE  Transfer Engine, PublishXMLand SnapEdit are trademarks of GlobalSCAPE Texas, LP. Other trademarks andtradenames in this quarterly report are the property of their respectiveowners.

 

----

 

**Part I.** FinancialInformation

** **

**Item1. Financial Statements**

** **

**GlobalSCAPE, Inc.**

** **

**ConsolidatedBalance Sheets**

** **
| ** **                                                                                                                                            | ** ** | **December 31,   2005** | ** ** | **March 31,   2006** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                                            | ** ** | ** **                        | ** ** | **(unaudited)**                | ** ** |
| Assets                                                                                                                                                |       |                              |       |                           |       |
| Current assets:                                                                                                                                       |       |                              |       |                           |       |
| Cash and  cash equivalents                                                                                                                            |       | $                                 | 2,029,473  |                           | $          | 2,629,150 |   |
| Accounts  receivable (net of allowance for doubtful accounts of $12,273 and $13,460 at December 31,  2005 and March 31, 2006, respectively) |       | 590,715                           |       | 917,840                        |       |
| Prepaid  expenses                                                                                                                                     |       | 65,317                            |       | 68,238                         |       |
| Total current assets                                                                                                                                  |       | 2,685,505                         |       | 3,615,228                      |       |
|                                                                                                                                                  |       |                              |       |                           |       |
| Property and equipment:                                                                                                                               |       |                              |       |                           |       |
| Furniture  and fixtures                                                                                                                               |       | 334,603                           |       | 334,063                        |       |
| Software                                                                                                                                              |       | 284,621                           |       | 306,366                        |       |
| Equipment                                                                                                                                             |       | 604,517                           |       | 601,451                        |       |
| Leasehold  improvements                                                                                                                               |       | 167,762                           |       | 167,762                        |       |
|                                                                                                                                                  |       | 1,390,963                         |       | 1,409,642                      |       |
| Accumulated depreciation and amortization                                                                                                             |       | 1,238,392                         |       | 1,244,267                      |       |
| Net property and equipment                                                                                                                            |       | 152,571                           |       | 165,375                        |       |
|                                                                                                                                                  |       |                              |       |                           |       |
| Other assets:                                                                                                                                         |       |                              |       |                           |       |
| Deferred tax  asset                                                                                                                                   |       | 51,983                            |       | 49,396                         |       |
| Other                                                                                                                                                 |       | 11,612                            |       | 11,612                         |       |
| Total other assets                                                                                                                                    |       | 63,595                            |       | 61,008                         |       |
|                                                                                                                                                  |       |                              |       |                           |       |
| Total assets                                                                                                                                          |       | $                                 | 2,901,671  |                           | $          | 3,841,611 |   |
|                                                                                                                                                       |            |                                   |            |                                |            |  |  |  |  |

 

1

----

 
| ** **                                                                                                                                                                                         | ** ** | **December 31,   2005** | ** ** | **March 31,   2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                                                                                         | ** ** | ** **                        | ** ** | **(unaudited)**                | ** ** |
| Liabilities and Stockholders’ Equity                                                                                                                                                          |       |                              |       |                           |       |
| Current liabilities:                                                                                                                                                                               |       |                              |       |                           |       |
| Accounts  payable                                                                                                                                                                                  |       | $                                 | 91,763     |                           | $          | 73,107 |   |
| Accrued  expenses                                                                                                                                                                                  |       | 230,911                           |       | 257,350                        |       |
| Federal  income tax payable                                                                                                                                                                        |       | 60,899                            |       | 215,609                        |       |
| Deferred  revenue                                                                                                                                                                                  |       | 560,578                           |       | 718,278                        |       |
| Total current liabilities                                                                                                                                                                          |       | 944,151                           |       | 1,264,344                      |       |
|                                                                                                                                                                                               |       |                              |       |                           |       |
| Long-term liabilities:                                                                                                                                                                             |       |                              |       |                           |       |
| Deferred  compensation                                                                                                                                                                             |       | 12,121                            |       | 18,855                         |       |
| Other  long-term liabilities                                                                                                                                                                       |       | 16,824                            |       | 14,019                         |       |
| Total long-term liabilities                                                                                                                                                                        |       | 28,945                            |       | 32,874                         |       |
|                                                                                                                                                                                               |       |                              |       |                           |       |
| Total Liabilities                                                                                                                                                                                  |       | 973,096                           |       | 1,297,218                      |       |
|                                                                                                                                                                                               |       |                              |       |                           |       |
| 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 14,359,550 shares issued and outstanding at December 31, 2005 and March 31,  2006, respectively |       | 13,797                            |       | 14,359                         |       |
| Additional  paid-in capital                                                                                                                                                                        |       | 684,281                           |       | 750,605                        |       |
| Retained  earnings                                                                                                                                                                                 |       | 1,230,497                         |       | 1,779,429                      |       |
| Total stockholders’ equity                                                                                                                                                                    |       | 1,928,575                         |       | 2,544,393                      |       |
| Total liabilities and stockholders’ equity                                                                                                                                                    |       | $                                 | 2,901,671  |                           | $          | 3,841,611 |   |
|                                                                                                                                                                                                    |            |                                   |            |                                |            |  |  |  |

 

See accompanying notes.

 

2

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**GlobalSCAPE, Inc.**

** **

**ConsolidatedStatements of Operations**

** **

**(Unaudited)**

** **
| ** **                                                                            | ** ** | **Three months ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                            | ** ** | **2005**                              | ** ** | **2006** | ** ** |
| Operating  revenues:                                                                  |       |                                  |       |   |   |
| Software  product revenues                                                            |       | $                                     | 1,298,674  |   | $ | 2,194,316 |   |
| Maintenance  and support (net of deferred revenues)                                   |       | 123,707                               |       | 220,607 |   |
| Total  revenues                                                                       |       | 1,422,381                             |       | 2,414,923 |   |
|                                                                                  |       |                                  |       |   |   |
| Operating  expenses:                                                                  |       |                                  |       |   |   |
| Cost of  revenues (exclusive of depreciation and amortization shown separately below) |       | 81,558                                |       | 141,411 |   |
| Selling,  general and administrative Expenses                                         |       | 972,995                               |       | 1,210,737 |   |
| Research and  development expenses                                                    |       | 178,765                               |       | 229,330 |   |
| Depreciation  and amortization                                                        |       | 29,100                                |       | 21,237 |   |
| Total  operating expense                                                              |       | 1,262,418                             |       | 1,602,715 |   |
| Income from  operations                                                               |       | 159,963                               |       | 812,208 |   |
|                                                                                  |       |                                  |       |   |   |
| Other income  (expense):                                                              |       |                                  |       |   |   |
| Interest  expense                                                                     |       | (328                                  | )          | — |   |
| Interest  income                                                                      |       | —                                |       | 13,925 |   |
| Gain on sale  of assets                                                               |       | —                                |       | 427 |   |
| Total other  income (expense)                                                         |       | (328                                  | )          | 14,352 |   |
| Income  before income taxes                                                           |       | 159,635                               |       | 826,560 |   |
|                                                                                  |       |                                  |       |   |   |
| Income tax  expense (benefit):                                                        |       |                                  |       |   |   |
| Current:                                                                              |       |                                  |       |   |   |
| Federal                                                                               |       | —                                |       | 272,241 |   |
| State                                                                                 |       | 1,065                                 |       | 2,800 |   |
| Deferred:                                                                             |       |                                  |       |   |   |
| Federal                                                                               |       | —                                |       | 2,587 |   |
| State                                                                                 |       | —                                |       | — |   |
| Total income  tax provision (benefit)                                                 |       | 1,065                                 |       | 277,628 |   |
|                                                                                  |       |                                  |       |   |   |
| Net income                                                                            |       | $                                     | 158,570    |   | $ | 548,932 |   |
|                                                                                  |       |                                  |       |   |   |
| Net income  per common share- basic                                                   |       | $                                     | 0.01       |   | $ | 0.04 |   |
| Net income  per common share- assuming dilution                                       |       | $                                     | 0.01       |   | $ | 0.03 |   |
|                                                                                  |       |                                  |       |   |   |
| Average  shares outstanding:                                                          |       |                                  |       |   |   |
|                                                                                  |       |                                  |       |   |   |
| Basic                                                                                 |       | 13,773,619                            |       | 14,284,348 |   |
| Diluted                                                                               |       | 14,366,506                            |       | 15,971,013 |   |
|                                                                                       |            |                                       |            |  |  |  |  |  |

 

See accompanying notes.

 

3

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**GlobalSCAPE, Inc.**

** **

**ConsolidatedStatements of Cash Flows**

** **

**(Unaudited)**

** **
| ** **                                                                         | ** ** | **Three months ended   March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                                | ** ** | **2006** | ** ** |
| Operating Activities:                                                              |       |                                    |       |   |   |
| Net Income                                                                         |       | $                                       | 158,570    |   | $ | 548,932 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                    |       |   |   |
| Bad debt  expense                                                                  |       | (299                                    | )          | 1,797 |   |
| Depreciation  and amortization                                                     |       | 29,100                                  |       | 21,237 |   |
| (Gain) loss  on disposition of assets                                              |       | —                                  |       | (427 | ) |
| Stock-based  compensation                                                          |       | —                                  |       | 47,816 |   |
| Deferred  taxes                                                                    |       | —                                  |       | 2,587 |   |
| Changes in  operating assets and liabilities:                                      |       |                                    |       |   |   |
| Accounts  receivable                                                               |       | (147,794                                | )          | (328,922 | ) |
| Prepaid  expenses                                                                  |       | 43,112                                  |       | (2,921 | ) |
| Accounts  payable                                                                  |       | (5,923                                  | )          | (18,656 | ) |
| Accrued  expenses                                                                  |       | 83,642                                  |       | 26,439 |   |
| Federal  income tax payable                                                        |       | —                                  |       | 154,710 |   |
| Deferred  revenues                                                                 |       | 21,328                                  |       | 157,700 |   |
| Deferred  Compensation                                                             |       | —                                  |       | 6,734 |   |
| Other  long-term liabilities                                                       |       | (2,804                                  | )          | (2,805 | ) |
| Net cash provided by operating activities                                          |       | 178,932                                 |       | 614,221 |   |
| Investing Activities:                                                              |       |                                    |       |   |   |
| Proceeds  from sale of property and equipment                                      |       |                                    |       | 427 |   |
| Purchase of  property and equipment                                                |       | (34,908                                 | )          | (34,039 | ) |
| Net cash used in investing activities                                              |       | (34,908                                 | )          | (33,612 | ) |
| Financing Activities:                                                              |       |                                    |       |   |   |
| Issuance of  common stock                                                          |       | —                                  |       | 19,068 |   |
| Net cash provided by financing activities                                          |       | —                                  |       | 19,068 |   |
| Net increase in cash                                                               |       | 144,024                                 |       | 599,677 |   |
| Cash at beginning of period                                                        |       | 572,959                                 |       | 2,029,473 |   |
| Cash at end of period                                                              |       | $                                       | 716,983    |   | $ | 2,629,150 |   |
| Supplemental disclosures:                                                          |       |                                    |       |   |   |
|                                                                               |       |                                    |       |   |   |
| Interest  paid                                                                     |       | $                                       | 328        |   | — |   |
| Income taxes  paid                                                                 |       | $                                       | 1,065      |   | $ | 120,330 |   |

 

See accompanying notes.

 

4

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**GlobalSCAPE, Inc.**

** **

**Notesto Consolidated Financial Statements**

** **

# **Nature of Business**

# ** **

GlobalSCAPE, Inc.,founded in April 1996, develops and distributes secure file managementsoftware that enables users to safely send data over the internet. Our productsguarantee the privacy of critical information such as financial data, medicalrecords, customer files and other similar documents. In addition, our productsensure compliance with government regulations relating to the protection ofinformation while allowing users to reduce IT costs, increase efficiency, trackand audit transactions and automate processes.

 

We started in1996 with the distribution of CuteFTP, a file transfer protocol client program,and have achieved significant success and popularity with this product. Webuilt on this success by steadily adding complementary products and believe wenow have a reputation as a provider of easy-to use, affordable software forboth individual and enterprise users. Since 2000, we have focused on enhancingour portfolio of products to meet the increasing demand for data security, andfor solutions that permit non-technical personnel to contribute content totheir organizations’ Web sites. Our software is used worldwide across a widerange of industries. Through the end of 2005, we had sold approximately1,300,000 software licenses and our customer base includes individualconsumers, small to medium-sized businesses, as well as some of the largestcorporations in the world.

 

During 2005,approximately 67% of our revenues were generated from customers within theUnited States, with the remaining 33% concentrated mostly in Western Europe,Canada and Australia. Virtually all of our 2005 revenues were derived from salesof software licenses and support agreements. The combined sales of CuteFTP Homeand CuteFTP Pro accounted for 69% and 50% of our revenues in 2004 and 2005,respectively. Our combined sales of our Secure Server and Enhanced FileTransfer products grew from 14% of our revenues in 2004 to 43% in 2005.

 

***CorporateStructure***

*** ***

All of theCompany’s operations are conducted by GlobalSCAPE Texas, LP, a Texas limitedpartnership. The partners of GlobalSCAPE Texas, LP are two Nevada limitedliability companies, which are both wholly-owned subsidiaries of GlobalSCAPE, Inc.,a Delaware corporation. GlobalSCAPE Inc. is approximately 70% owned by ThomasBrown and David Mann, individually, with the remainder 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 otherwiseindicated.

 

# **Basis of Presentation**

# ** **

Theaccompanying unaudited financial statements have been prepared in accordancewith 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, alladjustments (consisting of normally recurring accruals) considered necessaryfor a fair presentation have been made. The results of operations for anyinterim period are not necessarily indicative of the results to be expected forthe full year.

 

The BalanceSheet at December 31, 2005 has been derived from the audited financialstatements at that date but does not include all the information and footnotesrequired by generally accepted accounting principles for complete financialstatements. For further information, refer to the financial statements and 

 

5

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footnotes included in GlobalSCAPE’s Annual Report on Form 10-K/ANumber 1 for the year ended December 31, 2005.

 

# **Principles of Consolidation**

# ** **

Theconsolidated financial statements include all subsidiaries. All inter-companytransactions and balances have been eliminated.

 

# **Liquidity**

# ** **

Our capitalrequirements are driven principally by our need to enhance our existingproducts and to develop new products. The amount of our capital expenditureshas a direct impact on our ability to offer enhanced and new products to ourcustomers. Our principal source of capital is cash flow from operations which,in turn, is highly dependent on our sales revenue. Historically, we have reliedheavily on sales of CuteFTP Home and CuteFTP Professional, which accounted for50% and 35% of our revenues in the year ended December 31, 2005 andquarter ended March 31, 2006, respectively. Our newer products in 2005,namely Enhanced File Transfer and Secure FTP 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 quarter ended March 31, 2006.

 

Our principalsources of capital are cash on hand and cash flow from operations. To theextent that sales decline, our cash flow from operations will also decline. Ifsales decline or our liquidity otherwise requires, management may substantiallyreduce personnel and personnel-related costs, reduce or substantially eliminatecapital expenditures and/or reduce or substantially eliminate research anddevelopment expenditures.

 

The Company’sliquidity could be reduced in 2006 if sales of CuteFTP continue to decline andthe Company is unable to successfully introduce new products or increase salesof existing products.

 

***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 quarter of 2006,the Company disposed of equipment with an original purchase price of $15,362and accumulated depreciation of $15,362. GlobalSCAPE recognized a gain of $427related to the disposal of these assets.

*** ***

# **Stock-Based Compensation**

# ** **

Stock-BasedCompensation Plans

 

GlobalSCAPE has stock-based compensation plans available to grant incentivestock options to employees. Under the GlobalSCAPE, Inc. 2000 Stock OptionPlan (the Plan), which was approved by the Board of Directors and becameeffective on May 17, 2001, a maximum of 3,660,000 shares of GlobalSCAPEcommon stock may be awarded. GlobaSCAPE expects that common stock awardedon an annual basis will be between 0 and 2 percent of total common stockoutstanding. Following approval of the Plan on May 17, 0001, GlobaSCAPEwill not grant any new awards under any previously existing stock-basedcompensation plans.

 

The exercise price, term and other conditions applicable to each stockoption granted under the stock plans are generally determined by the the Boardof Directors. The exercise price of stock options is set on 

 

6

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the grant dateand may not be less than the fair market value per share of our stock onthat date. The options generally become exercisable over a three-year periodand expire after ten years.

 

Effective January 1, 2006, we adopted the provisions of Statementof Financial Accounting Standards No. 123 (revised 2004), “Share-BasedPayment” (SFAS No.123R) requiring that compensation cost relating toshare-based payment transactions be recognized in the financial statements. Thecost is measured at the grant date, based on the calculated fair value of theaward, and is recognized as an expense over the employee’s requisite serviceperiod (generally the vesting period of the equity award). Prior to January 1,2006, we accounted for share-based compensation to employees in accordance withAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” (APB No. 25), and related interpretations. We also followedthe disclosure requirements of Statement of Financial Accounting Standards No. 123,“Accounting for Stock-Based Compensation”, as amended by Statement of FinancialAccounting Standards No. 148, “Accounting for Stock-BasedCompensation-Transition and Disclosure”. We adopted SFAS No. 123R usingthe modified prospective method and, accordingly, financial statement amountsfor prior periods presented in this Form 10-Q have not been restated toreflect the fair value method of recognizing compensation cost relating tonon-qualified stock options.

 

There was $47,816 of compensation cost related to non-qualified stockoptions recognized in operating results in the three months ended March 31,2006. The associated future income tax benefit recognized was $19,120 in thethree months ended March 31, 2006.

 

The fair value of each option award is estimated on the date of grantusing the Black-Scholes option-pricing model. Expected volatility is based onhistorical volatility of GlobaSCAPE stock. We used the simplified method toderive an expected term. The expected term represents an estimate of the timeoptions are expected to remain outstanding. The risk-free rate for periodswithin the contractual life of the option is based on the U.S. treasury yieldcurve in effect at the time of grant. The following table sets forth theassumptions used to determine compensation cost for our non-qualified stockoptions consistent with the requirements of SFAS No. 123R.

 
| ** **                     | ** ** | **Three Months Ended  March 31, 2006** | ** ** |
|--------------------------------|------------|---------------------------------------------|------------|
| Expected volatility            |       | 111.56                                      | %          |
| Expected annual dividend yield |       | 0                                           | %          |
| Risk free rate of return       |       | 4.81                                        | %          |
| Expected option term (years)   |       | 6.0                                         |       |

 

Under APB No. 25 there was no compensation cost recognized for ournon-qualified stock options awarded in the three months ended March 31,2005 as these non-qualified stock options had an exercise price equal to themarket value of the underlying stock at the grant date. The following tablesets forth pro forma information as if compensation cost had been determinedconsistent with the requirements of SFAS No. 123.

 
| ** **                                                                                                                                         | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
|                                                                                                                                               |       |                                        |       |
| Net income, as adjusted                                                                                                                            |       | $                                           | 158,570    |   |
| Deduct:  Total stock-based employee compensation cost determined under fair value  method for fixed stock option plans, net of related tax effects |       | 4,047                                       |       |
| Pro forma net income                                                                                                                               |       | $                                           | 154,523    |   |
|                                                                                                                                               |       |                                        |       |
| Earnings per share of common stock:                                                                                                                |       |                                        |       |
| Basic - as  adjusted                                                                                                                               |       | $                                           | .01        |   |
| Basic – pro  forma                                                                                                                            |       | $                                           | .01        |   |
|                                                                                                                                               |       |                                        |       |
| Earnings per share of common stock:                                                                                                                |       |                                        |       |
| Assuming  dilution - as adjusted                                                                                                                   |       | $                                           | .01        |   |
| Assuming  dilution - pro forma                                                                                                                     |       | $                                           | .01        |   |

 

7

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The following sets forth fair value per share information, includingrelated assumptions, used to determine compensation cost consistent with therequirements of SFAS No. 123:

 
| ** **                      | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|---------------------------------|------------|---------------------------------------------|------------|
|                            |       |                                        |       |
| Assumptions:                    |       |                                        |       |
| Expected  annual dividend yield |       | 0.0                                         | %          |
| Expected  volatility            |       | 98.7                                        | %          |
| Risk-free  rate of return       |       | 3.64                                        | %          |
| Expected  option term (years)   |       | 5                                           |       |

 

The following table summarizes information about stock option activityfor the three months ended March 31, 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                               |       | 200,000                 |       | 1.86                                   |       |                                                        |       |                                 |       |
| Exercised                             |       | (535,571                | )          | .01                                    |       |                                                        |       |                                 |       |
| Lapsed or  canceled                   |       | (11,500                 | )          | .21                                    |       |                                                        |       |                                 |       |
|                                  |       |                    |       |                                   |       |                                                        |       |                                 |       |
| Outstanding at March 31, 2006    |       | 2,026,140               |       | $                                      | .48        |                                                        | 6.79       |                                 | $          | 4.1 |   |
|                                  |       |                    |       |                                   |       |                                                        |       |                                 |       |
| Exercisable at March 31, 2006    |       | 1,017,235               |       | $                                      | .40        |                                                        | 5.29       |                                 | $          | 2.5 |   |

 

The weighted average fair value of options granted during the threemonths ended March 31, 2006 was $1.86. The total intrinsic value ofoptions (which is the amount by which the stock price exceeded the exerciseprice of the options on the date of exercise) exercised during the three monthsended March 31, 2006 was $727,112. During the three months ended March 31,2006, the amount of cash received from the exercise of stock options was$18,507 with no associated tax benefit. The following table summarizesinformation about nonvested stock option awards as of March 31, 2006 andchanges for the three months ended March 31, 2006.

 

8

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| ** **                           | ** ** | **Number  Of  Options** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|--------------------------------------|------------|-------------------------|------------|----------------------------------------------|------------|
| Non-vested at December 31, 2005 |       | 811,149                 |       | $                                            | .2462      |   |
| Granted                              |       | 200,000                 |       | 1.8600                                       |       |
| Vested                               |       | —                  |       | —                                       |       |
| Forfeited                            |       | 6,600                   |       | .2000                                        |       |
|                                 |       |                    |       |                                         |       |
| Non-vested at March 31, 2006    |       | 1,004,549               |       | $                                            | .5676      |   |

 

At March 31, 2006, there was $480,890 of total unrecognizedcompensation cost related to non-vested non-qualified stock option awards whichis expected to be recognized over a weighted-average period of 3 years. Therewere no options that became vested during the three months ended March 31,2006.

 

# **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, and iscalculated 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 reconciliation of the numerators and denominators ofbasic and diluted earnings per share for each of the periods presented:

 
| ** **                                              | ** ** | **Three months ended March 31,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                              | ** ** | **2005**                              | ** ** | **2006** | ** ** |
| **Numerators**                                          | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Numerators for basic and diluted earnings  per share:   |       |                                  |       |   |   |
| Net income                                              |       | $                                     | 158,570    |   | $ | 548,932 |   |
|                                                    |       |                                  |       |   |   |
| **Denominators**                                        | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Denominators for basic and diluted earnings  per share: |       |                                  |       |   |   |
| Weighted  average shares outstanding – basic       |       | 13,773,619                            |       | 14,284,348 |   |
|                                                    |       |                                  |       |   |   |
| **Dilutive potential common shares**                    | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Stock options (1)                                       |       | 593,287                               |       | 1,686,665 |   |
| Denominator for dilutive earnings per share             |       | 14,366,506                            |       | 15,971,013 |   |
|                                                    |       |                                  |       |   |   |
| Net income per common share                             |       | $                                     | 0.01       |   | $ | 0.04 |   |
| Net income per common share - assuming  dilution        |       | $                                     | 0.01       |   | $ | 0.03 |   |
|                                                         |            |                                       |            |  |  |  |  |  |

 

----

(1)          For the three monthsended March 31, 2005, 1,366,784 options have not been included in dilutiveshares, as the effect would be anti-dilutive. For the three months ended March 31,2006, all options have been included in dilutive shares.

 

9

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# **Item 2. Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

# ** **

This QuarterlyReport on Form 10-Q contains “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities and Exchange Act of 1934, as amended. “Forward lookingstatements” are those statements that describe management’s beliefs andexpectations about the future. We have identified forward-looking statements byusing words such as “anticipate,” “believe,” “could,” “estimate,” “may,” “expect,”and “intend.”  Although we believe theseexpectations are reasonable, our operations involve a number of risks anduncertainties, including those described in the “Risk Factors” section ofour Annual Report on Form 10-K/A Number 1 and other documents filed withthe Securities and Exchange Commission. GlobalSCAPE’s actual results coulddiffer materially from those discussed in any forward-looking statementsincluded in this Quarterly Report.

 

**Overview**

 

GlobalSCAPEdevelops and distributes secure file management software for individuals andbusiness users to safely send data over the internet. Our products guaranteethe privacy of critical information such as financial data, medical records,customer files and other similar documents. In addition, our products ensurecompliance with government regulations relating to the protection ofinformation while allowing users to reduce IT costs, increase efficiency, trackand audit transaction and automate processes. We also develop and distributeWeb content management and Web development tools.

 

Since 2000, wehave focused on enhancing our portfolio of products to meet the increasingdemand for data security, and for solutions that permit non-technical personnelto contribute content to their organizations’ Web sites. Our strategy is tocontinue enhancing our file transfer products across the board to meet thedemands of both individual and enterprise users, while improving the securityfeatures of our current product line. We believe that our continued growth willcome through the further development of our secure FTP Server and Enhanced FileTransfer products involving secure file transfer to meet the growing demand forfile security when transferring information across the internet due to changesin regulations in various industries and the demand of users for securesolutions. We are encouraged with the interest we have seen in our enhancedfile transfer offerings so far, with sales exceeding our expectations. Weintend to release new versions of CuteFTP, CuteFTP Pro and Secure FTP Server inmid 2006 and we believe we can slow the decline in sales of CuteFTP and improvesales of CuteFTP Pro and Secure FTP Server and EFT. We plan on releasingadditional versions of EFT and modules for it throughout 2006.

 

Substantiallyall software products ultimately reach a point in their lifecycle in whichsales can be expected to plateau or decline. Management believes that themarket for stand-alone FTP client programs for home consumers may be declining.While it cannot be determined with certainty, CuteFTP and CuteFTP Pro may havereached such a point in their lifecycles. In order to respond to this decline,we have begun concentrating on product offerings for business users. We havenot seen the same decline in the market for secure FTP client programs andservers such as CuteFTP Pro and Secure FTP Server which we believe bettertarget the needs of businesses.

 

Our shift toemphasizing product offerings for business users will have important consequencesfor our business. GlobalSCAPE will require more technical sales and supportpersons to handle the complex configurations of customer systems as thecustomer base grows. More difficult and different situations will arise ascustomer needs grow. We will need to have the ability to understand and solvetechnical issues in a timely manner. With increased sales to business we shouldrealize additional revenues from maintenance and support agreements to supportthe additional personnel.

 

•                  **File Management Products** – Our FileManagement products are best known for the “CuteFTP” product line. Theyprimarily consist of products that help users securely move and copy files onthe Internet. A substantial portion of our revenues are derived from licensingour File Management products. Some of our products encrypt the transfers for 

 

10

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security usingtechnology similar to a Web browser. The products are made up in threecategories; client, server and compression transfer . Our File Managementproduct line includes CuteFTP Home, Cute FTP Professional, SecureFTP Server,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.

 

CuteFTP andCuteFTP Pro accounted for approximately 50%****and 35% oftotal revenues in 2005 and in the first quarter of 2006, respectively. Sales ofthese products declined approximately 28% as a percentage of revenue whencomparing the first quarter of 2005 to the first quarter of 2006, althoughrevenue for these products decreased approximately 5%. The decline as apercentage of revenue was due to an increase in sales of other products such asSecureFTP Server and Enhanced File Transfer. GlobalSCAPE’s  goal is to continue to enhance our SecureFTPServer and Enhanced File Transfer products to meet the needs of our customersand the enterprise market.****Total revenuesincreased over 69% from the first quarter of 2005 to the first quarter of 2006due to stronger sales of  SecureFTPServer, PublishXML and Enhanced File Transfer.

 

Substantiallyall software products ultimately reach a point in their lifecycle in whichsales can be expected to plateau or decline. While it cannot be determined withcertainty, CuteFTP may have reached such a point in its lifecycle. Managementbelieves that the market for stand-alone FTP clients for home consumers may bedeclining. However, we have not seen the same decline in the market for secureFTP clients and servers such as CuteFTP Pro, Secure Server and Enhanced FileTransfer, which we believe better target the needs of businesses.

 

Our strategyis to continue enhancing our file transfer products across the board to meetthe demands of both individual and enterprise users, while improving ourcurrent product line. Our success in 2006 is, to a great extent, dependent onour ability to market and sell our Enhanced File Transfer to enterprise usersand continue to enhance our current products. We are continuing to addresssecurity issues for our customers for future releases. We plan on releasingadditional versions of our Enhanced File Transfer product this year along withadditional add on modules. In general, our success depends on our ability tointroduce new products and the market’s acceptance of these products. Wereleased new versions of CuteFTP, CuteFTP Pro, Secure Server and Enhanced FileTransfer in 2005, we plan the same for 2006. We believe we can slow the declinein sales of CuteFTP and improve sales of CuteFTP Pro, Secure Server andEnhanced File Transfer as we continue to reach out to the business market andoffer new releases.

 

##### **Liquidity and CapitalResources**

##### ** **

The Companycontinues to improve its positive working capital position through acombination of revenue growth and net income.

 

We relyheavily on cash flows from operations and these cash flows are directly linkedto CuteFTP Home and CuteFTP Professional, which accounted for 63%****and 35% of our revenues in the three months ended March 31,2005 and 2006 respectively. Although there was a decline in the percentage ofrevenue for these two products, the revenue from them decreased approximately$40,953. Much of the decline in percentage of revenues from the sale of thesetwo products was offset by sales of other products 

 

11

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in the first quarter of 2006, namely, SecureFTP Server, Enhanced FileTransfer and PublishXML. Total revenues increased 69% when comparing the firstquarter of 2006 to the same period in 2005.

 

The Company’sliquidity could be reduced in 2006 if sales of CuteFTP continue to decline andthe Company is unable to successfully introduce new products or increase salesof existing products.

 

If salescontinue to decline or the Company’s liquidity position otherwise requires,management has the intent and ability to substantially reduce personnel andpersonnel-related costs, reduce or substantially eliminate capital expendituresand/or reduce or substantially eliminate research and development expenditures.

 

The Companychose not to renew its $250,000 line of credit with a bank that expired on March 31,2006. The company had not borrowed on the line of credit since September 11,2003 under the agreement.

 

Net cashprovided by operating activities was $614,221 for the three months ended March 31,2006 as compared to $178,932 in the three months ended March 31, 2005. Cashprovided in operations for the three months ended March 31, 2006, wasprimarily the result of net income, depreciation and amortization, stock-basedcompensation, with an increase in accounts receivable and federal income taxreceivable and to a lesser extent increases, accrued expenses, and deferredrevenue offset by a decrease in accounts payable and an increase in federalincome tax payable.

 

Net cash usedin investing activities for the three months ended March 31, 2005 and 2006was $34,908 and $33,612, respectively. In both periods, the cash used ininvesting activity was primarily for the purchase of computer equipment andsoftware.

 

Net cash providedin financing activities during the three months ended March 31, 2005 and2006 were $0 and $19,068 respectively. The increase in cash provided fromfinancing activities was from issuance of stock from exercised options.

 

As of March 31,2006, we had $2,629,150 in cash and cash equivalents, total current assets of$3,615,228 and current liabilities of $1,264,344, resulting in working capitalof $2,350,884. Our principal commitments consisted of obligations outstandingunder operating leases, sales bonuses, royalty agreements with third parties,federal income tax and trade accounts payable. We plan to continue to expendsignificant resources on product development in future periods and may alsouse our cash to acquire or license technology, products or businesses relatedto our current business. The facility that we currently occupy is expected tobe sufficient for our growth over the next twelve months. Consequently, we donot anticipate significant expenditures for leasehold improvements or furniturefor 2006.

 

The following table sets forth the future minimum payments requiredunder contractual commitments at March 31, 2006:

 
| ** **                       | ** ** | **Payments Due by Fiscal Year** | ** ** |
|----------------------------------|------------|---------------------------------|------------|
| **Contractual Obligations** | ** ** | **2006 (1)**               | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| Operating Lease                  |       | $                               | 142,994    |   | $ | 190,659 |   | $ | 95,330 |   | — |   | — |   | $ | 428,983 |   |
| Equipment Leases                 |       | 4,693                           |       | 3,105 |   | — |   | — |   | — |   | 7,798 |   |
| Total Cash Obligations           |       | $                               | 147,687    |   | $ | 193,764 |   | $ | 95,330 |   | — |   | — |   | $ | 436,781 |   |
|                                  |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)          Amounts for 2006 reflect the future minimum payments for the remaining nine months of the fiscal year.

 

12

 

##### **Critical AccountingPolicies**

##### ** **

# ***Useof Estimates***

# ** **

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 United States. Thepreparation of these financial statements requires management to make estimatesand assumptions that affect the reported amount of assets and liabilities. Onan ongoing basis, management evaluates its estimates and judgments, includingthose related to revenue recognition, allowance for doubtful accountsreceivable, long-lived and intangible assets, income taxes and contingencies. Managementbases its estimates on historical experience, observable trends, and variousother assumptions that are believed to be reasonable under the circumstances. Managementuses this information to make judgments about the carrying values of assets andliabilities that are not readily apparent form other sources. Actualresults may differ from the estimates under different assumptions orconditions.

 

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

 

***RevenueRecognition***

* *

Our revenue is generatedprimarily by licensing our software products and providing support for thoseproducts. Revenues are comprised of the gross selling price of thesoftware, including shipping charges and the earned portion of support andmaintenance agreements. The Company recognizes revenue in accordance with theAmerican Institute of Certified Public Accountants Statement of Position (“SOP”)97-2, *Software Revenue Recognition*,as modified by SOP 98-9, *Modification of SOP97-2, Software Revenue Recognition, With Respect to Certain 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 specificobjective evidence (“VSOE”) of fair value exists for all elements in a multipleelement arrangement, revenue is allocated to each element based on the relativefair value of each of the elements. VSOE of fair value is established by theprice charged when the same element is sold separately. 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. Revenueallocated to PCS is recognized ratably over the contractual term, typically oneyear

 

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. Deferred revenue grew to a balance ofapproximately $178,000 and $560,578 at December 31, 2004 and  2005, respectively. Sales of these agreementscontinued to grow into the first quarter of 2006 with more deferrals that aredue largely to the enterprise type software they are supporting. For the threemonths ended March 31, 2005 and 2006, the deferred revenue balance was$199,445 and $718,278, respectively. If the level of sales of technical supportand maintenance agreements remains the same or declines, the balance ofdeferred revenues will stabilize or decline. However if sales grow, the balancewill increase, resulting in the deferred recognition of a significant amount ofrevenue in future periods.

 

13

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***Allowance for Doubtful Accounts***

*** ***

We providecredit, in the normal course of business, to a number of companies and perform ongoingevaluations of our credit risk. We require no collateral from our customers andwe estimate the allowance for uncollectible accounts based on our historicalexperience and current credit evaluations. No single customer accounted formore than 2% of net revenues in the first three months of 2005. In the firstquarter of 2006, we had 3 customers that accounted for than 2% of net revenuesindividually. In total these three customers amounted for approximately 12% ofnet revenues for the quarter ended March 31, 2006.

 

***Valuationof 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 considered important which could trigger an impairmentreview included the following: significant underperformance relative to historical or projected futurecash flows; significant changes in the manner of use of the assets or thestrategy for the overall business; and significant negative industry trends. Whenmanagement determines that the carrying value of long-lived and intangibleassets may not be recoverable, impairment is measured based on the excessof the assets’ carrying value over the estimated fair value. No impairment wasrecognized in 2005 or the first three months of 2006.

 

***Stock-BasedCompensation***

* *

Effective January 1,2006, we adopted the provisions of Statement of Financial Accounting Standards No. 123(revised 2004), “Share-Based Payment” (SFAS No.123R) requiring thatcompensation cost relating to share-based payment transactions be recognized inthe financial statements. The cost is measured at the grant date, based on thecalculated fair value of the award, and is recognized as an expense over theemployee’s requisite service period (generally the vesting period of the equityaward). Prior to January 1, 2006, we accounted for share-basedcompensation to employees in accordance with Accounting Principles BoardOpinion 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 prospectivemethod and, accordingly, financial statement amounts for prior periodspresented in this Form 10-Q have not been restated to reflect the fairvalue method of recognizing compensation cost relating to non-qualified stockoptions.

 

In the firstquarter of 2006, 200,000 options were granted, 561,431 options were exercised,6,600 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 March 31, 2005 and 2006, we spent approximately$178,765 and $229,330, respectively, on research and development. No researchand development expenses were capitalized in either period and all previouslycapitalized research and development expenses were fully amortized at December 31,2002.

 

14

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# ***IncomeTaxes***

# ** **

GlobalSCAPEaccounts for income taxes using the liability method in accordance withStatement of Financial Accounting Standards No. 109, *Accounting for Income Taxes*. The liabilitymethod provides that the deferred tax assets and liabilities are recorded basedon the difference between the book and tax basis of assets and liabilities andtheir carrying amount for financial reporting purposes, as measured by theenacted tax rates and laws that will be in effect when the differences areexpected to reverse. Deferred tax assets are carried on the balance sheet withthe presumption that they will be realizable in future periods when pre-taxincome is generated. GlobalSCAPE recorded a deferred tax asset at March 31,2006 of $49,396 based on its taxable income for the quarter.

 

Statement ofFinancial Accounting Standards (SFAS) No. 109 requires a valuationallowance to reduce the deferred tax assets reported if, based on the weight ofthe evidence, it is more likely than not that some portion or all of thedeferred tax assets will not be realized. After consideration of all theevidence, both positive and negative, management determined that no valuationallowance was necessary at March 31, 2006. During the quarter the deferredtax asset was reduced by $2,587.

 

# **Comparison of the Three Months ended March 31,2005 and 2006**

# ** **

| ** **                                    | ** ** | **2005**  | ** ** | **2006**  | ** ** | **$**     | ** Change** | ** ** | **% Change** | ** ** |
|-----------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------------|------------|--------------|------------|
| Software product revenues                     |       | $         | 1,422,381  |      | $          | 2,414,923 |             | $          | 992,542      |       | 70 | % |
| Cost of revenues                              |       | 81,558    |       | 141,411   |       | 59,853    |             | 73         | %            |
| Selling, general and administrative  Expenses |       | 972,995   |       | 1,210,737 |       | 237,742   |             | 24         | %            |
| Research and development expenses             |       | 178,765   |       | 229,330   |       | 50,565    |             | 28         | %            |
| Depreciation and amortization                 |       | 29,100    |       | 21,237    |       | (7,863    | )                | (27        | )%           |
| Total operating expense                       |       | 1,262,418 |       | 1,602,715 |       | 340,297   |             | 27         | %            |
| Income (loss) from operations                 |       | 159,963   |       | 812,208   |       | 652,245   |             | 408        | %            |
| Other Income (expense)                        |       | (328      | )          | 14,352    |       | 14,680    |             | 4476       | %            |
| Income tax expense                            |       | 1,065     |       | 277,628   |       | 276,563   |             | 25968      | %            |
| Net income (loss)                             |       | $         | 158,570    |      | $          | 548,932   |             | $          | 390,362      |       | 246 | % |

 

***Revenue.***Forthe three months ended March 31, 2005 and 2006, total revenues increased$992,541 or approximately 70% from $1,422,381 to $2,414,923 largely due to theincrease in revenues from SecureFTP Server and Enhanced File Transfer. Revenuesfrom CuteFTP Home and CuteFTP Professional declined by 5% as compared to thequarter ended March 31, 2005. CuteFTP Home and CuteFTP Professionalaccounted for approximately 63% and 35% of total revenues for the three monthsended March 31, 2005 and 2006 respectively.

 

The following table reflects revenue by product including the relatedmaintenance and support for each product

 
| ** **                                                                                               | ** ** | **Revenue for   Quarter ending March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| **Product**                                                                                              | ** ** | **2005**                                        | ** ** | **2006** | ** ** |
| Enhanced File Transfer                                                                                   |       | $                                               | 82,825     |   | 5.82 | % | $ | 894,104 |   | 37.02 | % |
| CuteFTP Professional                                                                                     |       | 614,855                                         |       | 43.23 | % | 590,680 |   | 24.46 | % |
| CuteFTP Home                                                                                             |       | 282,502                                         |       | 19.86 | % | 265,723 |   | 11.00 | % |
| SecureFTP Server                                                                                         |       | 244,607                                         |       | 17.20 | % | 595,541 |   | 24.66 | % |
| All Others                                                                                               |       | 218,921                                         |       | 15.39 | % | 226,574 |   | 9.38 | % |
|                                                                                                     |       |                                            |       |   |   |   |   |   |   |
| Deferred Revenue adjustment                                                                              |       | (21,328                                         | )          | -1.50 | % | (157,699 | ) | -6.53 | % |
| Total  Operating Revenues                                                                                |       | $                                               | 1,422,381  |   | 100.00 | %  | $ | 2,414,923 |   | 100.00 | % |
| Gross  maintenance and support included above before recognition of the net  adjustment to defer revenue |       | $                                               | 145,035    |   | 10.05 | % | $ | 378,306 |   | 14.71 | % |
|                                                                                                          |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |

 

15

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Maintenance and support revenue continues to increase as revenues fromsales of our enterprise products, SecureFTP Server and Enhanced File Transfercontinues to grow. Maintenance and support pricing is reflective of the licensecost of the products and the additional support it takes to maintain andsupport the products and customers. With higher maintenance and supportrevenues, there will be additional deferred revenue will be recognized as weearn the revenue over the life of the maintenance and support agreement.

 

***Cost of Revenues.***Costof revenues consists primarily of production, packaging and shipping costs forboxed copies of software products as well as a portion of our bandwidth costs,certain licensing expenses and royalties. Cost of revenues increased $59,853 or73% between periods from $81,558 for the three months ended March 31, 2005to $141,411 for the three months ended March 31, 2006. Royalties that theCompany pays on software products licensed from third parties, which itresells, are expensed as a cost of sale when the software product is sold orearlier if the recoverability of any prepaid royalties is in doubt. The Companyhas distribution agreements with Hannon Hill Corp., Trellix Corp., PerseusDevelopment Corp., Beehive Software, Inc., Visicom Media, Inc., andXnet Communications GmbH. The GlobalSCAPE software products associated witheach of the companies are Publish XML, CuteSITE Builder, Web Survey, Mac FTP,CuteHTML Pro, and Mac FTP Pro, respectively. GlobalSCAPE’s agreement withHannon Hill Corp. accounted for a large portion of the increase in royaltyexpense during the quarter ended March 31, 2006 due to the increase insales of product and maintenance and support during the quarter for PublishXML.We expect 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 andadministrative expenses consist primarily of personnel and related expenses,marketing, customer support, rents, bad debt and professional fees. For thethree months ended March 31, 2005 and 2006, selling, general andadministrative expenses were $972,995 and $1,210,737, respectively, an increaseof  approximately 23%. Salaries increasedslightly as we have hired new employees and commissions and bonuses more thandoubled, based on the increase in revenues. As required by FAS123r, we expensed$47,816 for stock based compensation related to the granting of stock optionsto employees.

 

***Research andDevelopment.***Research and development expensesincreased $50,565 or 28% between periods, from $178,766 to $229,330. Theincrease was due largely to additional expenditures for external developmentresources and hiring of additional personnel to meet the release deadlines forproducts that are scheduled.

 

***Depreciation andAmortization.***Depreciation and amortizationexpense consists of depreciation expense related to our fixed assets,amortization of the trademark associated with our purchase of CuteFTP and inprior periods, amortization of capitalized development costs. Depreciation andamortization expense decreased from $29,100 to $21,237, a decline ofapproximately 27%. This decrease was due primarily to a reduction indepreciation expense as fixed assets come to the end of their depreciable lifeas well as a slowdown in additions to fixed assets in current periods relativeto prior periods.

 

***Other Income,Expense.***For the three months ended March 31,2005 and 2006, interest expense decreased from $382 to $0, respectively. Themajority of interest expense incurred during 2005 was related to financing ofinsurance premiums. We earned $13,925 in interest during the first quarter of2006 on investing our excess cash.

 

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***Income Taxes.***Theprovision for federal income taxes for the quarter ended March 31, 2006was $274,828. We recognized no benefit related to the net income in the firstthree months of 2005 because we could not be certain of the future periodrecoverability of tax assets generated from available net operating losses atthat time.

 

***Net Income.***GlobalSCAPEincurred net income of $158,570 and $548,932 for the three months ended March 31,2005 and 2006, respectively. This was an increase of $390,362 quarter overquarter in net income. The net income was largely a result of the acceptance ofour SecureFTP Server and Enhanced File Transfer products over the last year,resulting in higher revenues, while controlling expenses.

 

##### ** Inflation**

##### ** **

Increases ininflation generally result in higher interest rates and operating costs. Ourgreatest exposure is to the cost of salaries and general and administrativeexpenses. To date we believe that inflation has not had a significant impact onour 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. Our fourth quarter revenues in 2005 increased approximately 56% over thesame quarter in 2004. The seasonality we have experienced seems to be lesseningas we rely more on sales by our direct sales force, rather than our internetsales. 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.

 

# **Item 3. Quantitative and Qualitative Disclosures AboutMarket Risk**

# ** **

To date, wehave not utilized derivative financial instruments or derivative commodityinstruments. We do not expect to employ these or other strategies to hedgemarket risk in the foreseeable future. We may invest our cash in moneymarket funds, which are subject to minimal credit and market risk. We believethat the interest rate risk and other relevant market risks associated withthese financial instruments are immaterial.

 

In the threemonths ended March 31, 2006, approximately 36% of our revenues came fromcustomers outside the United States. All revenues are received in U.S. dollarsso we 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-business customers in the EU and, in ourcase, are remitted quarterly in pound sterling. We expect that the impact ofthis currency translation will not be material to our business.

 

# **Item 4. Controls and Procedures**

# ** **

(a) GlobalSCAPE  maintains disclosure controls and procedures(as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”)) that aredesigned to ensure that information required to be disclosed in its reportsfiled or submitted under the Exchange Act is processed, recorded, summarizedand reported within the time periods specified in the SEC’s rules andforms, and that such information is accumulated and communicated to GlobalSCAPE’s management, including its Chief Executive Officer and Chief FinancialOfficer, as appropriate, to allow for timely decisions regarding requireddisclosure. In designing and evaluating the disclosure controls and procedures,management recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives.

 

As required by SEC Rule 13a-15(b),GlobalSCAPE carried out an evaluation, under the supervision and with theparticipation of management, including its Chief Executive Officer and ChiefFinancial Officer, of the effectiveness of the design and operation ofGlobalSCAPE’s disclosure controls

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and procedures as of the end ofthe period covered by this Quarterly Report. Based on this evaluation,management concluded that GlobalSCAPE’s disclosure controls and procedures werenot effective as of December 31, 2005, at the reasonable assurance level,because of an error made in the reporting of revenue from maintenance andsupport (net of deferred revenues) for the year ended December 31, 2005. Notwithstandingthis error that existed as of December 31, 2005, management has concludedthat the restated consolidated financial statements included in their AnnualReport on Form 10-K/A present fairly, in all material respects, thefinancial position, results of operation and cash flows of GlobalSCAPE inconformity with accounting principles generally accepted in the United Statesof America.

 

The Company believes that the restatementwill be a one time occurrence and that moving forward its Controls andProcedures will once again be effective as the Company has taken steps toimplement changes to its process and system for accounting for deferredrevenue. Changes have been made to the controls in recognition of deferredrevenue, and Management has concluded the consolidated financial statementsincluded in this Quarterly Report on Form 10-Q present fairly, in all materialrespects, the financial position, results of operation and cash flows ofGlobalSCAPE in conformity with accounting principles generally accepted in theUnited States of America.

 

(b) Changes in internal control overfinancial reporting. There were no significant changes in our internal controlover financial reporting during the last fiscal year and/or up to and includingthe date of this filing that we believe materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting,except for the aforementioned issue relating to recognition of deferred revenueand the additional changes to the internal controls to address the capturingand 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 2.**           Changes in Securities and Use of Proceeds

# ** **

None in the firstquarter of 2006.

 

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

# ** **

Not applicable.

 

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

# ** **

None in thefirst quarter of 2006.

 

# **Item 5.**           Other Information

# ** **

None in thefirst quarter of 2006.

 

# **Item 6.**           Exhibits and Reports on Form 8-K

# ** **

**(a)**                                  Exhibits

 

31.1 Certificatepursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

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

 

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

 

**(b)**                                  Reports on Form 8-K

 

A Form 8-Kwas filed on January 18, 2006, under Item 7.01 Regulation FD, relating toa press release issued January 17, 2006 disclosing sales estimates for thefourth quarter of fiscal 2005 and disclosing that a Stock Purchase Agreementhad been entered into.

 

A Form 8-Kwas filed on April 4, 2006, under Item 5.02, relating to the change intitle of Charles R. Poole from President and Chief Operating Officer toPresident and Chief Executive Officer. In addition reported under Item 7.01Regulation FD, relating to a press release issued April 4, 2006 disclosingrevenue estimates for the first quarter of fiscal 2006.

 

A Form 8-Kwas filed on May 2, 2006, under Item 4.02(a), relating to the restatementof its financial statements for fiscal year 2005 and announcement it will filea 10-K/A.

 

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**Signatures**

** **

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|               |   | GLOBALSCAPE, INC.                |
|--------------------|--------|---------------------------------------|
|               |   |                                  |
|               |   |                                  |
| May 12, 2006  |   | By:                                   | /s/ Charles R. Poole |   |
| Date               |   |                                  | Charles R. Poole |
|               |   | President and Chief Executive Officer |
|               |   |                                  |
| May 12,  2006 |   | By:                                   | /s/ Thomas F. Farar |   |
| Date               |   |                                  | Thomas F. Farar |
|               |   | Chief Financial Officer               |
|                    |        |                                       |  |  |  |

 

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