**UNITED STATESSECURITIES AND 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 September 30, 2006** |
| ** **                                             |
| **OR**                                                 |
| ** **                                             |
| o                                                      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(D) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition periodfrom           to         .**

**Commission File No.000-30617**

**GlobalSCAPE, Inc.**

(Exact name of registrant asspecified in its charter)

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

 

**(210)308-8267**

(Registrant’s TelephoneNumber, Including Area Code)

Securities registered pursuant to Section12(b) of the Act:

**None**

Securities registeredpursuant to Section 12(g) of the Act:

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

(Title of Class)

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

x Yes    o No

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act (check one):

LargeAccelerated filer o    Accelerated filer o    Non-Accelerated filer x

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

o Yes    x No

The aggregate market value of the registrant’s outstanding common stockheld by non-affiliates was approximately $46,171,345 as of the last businessday of the registrant’s most recently completed third fiscal quarter, basedupon the closing sales price of $3.05 per share on such date on the NASD’s OTC Bulletin Board.

As of November 13, 2006, there were 15,138,146 shares of common stockoutstanding.

 

----

## **GlobalSCAPE Inc.**

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

## **For the Quarter endedSeptember 30, 2006**

## **Index**

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

 

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

----

**PartI.     Financial Information**

**Item1. Financial Statements**

**GlobalSCAPE,Inc.**

**ConsolidatedBalance Sheets**
| ** **                                                                                                                                      | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                                                                                      | ** ** | **2005**              | ** ** | **2006**               | ** ** |
| ** **                                                                                                                                      | ** ** | ** **            | ** ** | **(unaudited)**        | ** ** |
| Assets                                                                                                                                          |       |                  |       |                   |       |
| Current assets:                                                                                                                                 |       |                  |       |                   |       |
| Cash and cash  equivalents                                                                                                                      |       | $                     | 2,029,473  |                   | $          | 1,345,971 |   |
| Accounts  receivable (net of allowance for doubtful accounts of $12,273 and $14,833 at  December 31, 2005 and September 30, 2006, respectively) |       | 590,715               |       | 1,702,185              |       |
| Prepaid expenses                                                                                                                                |       | 65,317                |       | 166,220                |       |
| Total current assets                                                                                                                            |       | 2,685,505             |       | 3,214,376              |       |
|                                                                                                                                            |       |                  |       |                   |       |
| Property and equipment:                                                                                                                         |       |                  |       |                   |       |
| Furniture and  fixtures                                                                                                                         |       | 334,063               |       | 390,486                |       |
| Software                                                                                                                                        |       | 284,621               |       | 312,642                |       |
| Equipment                                                                                                                                       |       | 604,517               |       | 644,728                |       |
| Leasehold  improvements                                                                                                                         |       | 167,762               |       | 191,090                |       |
|                                                                                                                                            |       | 1,390,963             |       | 1,538,946              |       |
| Accumulated  depreciation and amortization                                                                                                      |       | 1,238,392             |       | 1,316,392              |       |
| Net property and  equipment                                                                                                                     |       | 152,571               |       | 222,554                |       |
|                                                                                                                                            |       |                  |       |                   |       |
| Other assets:                                                                                                                                   |       |                  |       |                   |       |
| Goodwill                                                                                                                                        |       | —                |       | 9,581,366              |       |
| Deferred loan  costs                                                                                                                            |       | —                |       | 38,484                 |       |
| Deferred tax  asset                                                                                                                             |       | 51,983                |       | 63,932                 |       |
| Other                                                                                                                                           |       | 11,612                |       | 29,228                 |       |
| Total other assets                                                                                                                              |       | 63,595                |       | 9,713,010              |       |
|                                                                                                                                            |       |                  |       |                   |       |
| Total assets                                                                                                                                    |       | $                     | 2,901,671  |                   | $          | 13,149,940 |   |

 

1

----

 
| ** **                                                                                                                                                                                  | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                  | ** ** | **2005**              | ** ** | **2006**               | ** ** |
| ** **                                                                                                                                                                                  | ** ** | ** **            | ** ** | **(unaudited)**        | ** ** |
| Liabilities and  Stockholders’ Equity                                                                                                                                                  |       |                  |       |                   |       |
| Current  liabilities:                                                                                                                                                                       |       |                  |       |                   |       |
| Accounts payable                                                                                                                                                                            |       | $                     | 91,763     |                   | $          | 293,231 |   |
| Accrued expenses                                                                                                                                                                            |       | 230,911               |       | 502,357                |       |
| Federal income tax payable                                                                                                                                                                  |       | 60,899                |       | 276,720                |       |
| Deferred revenue                                                                                                                                                                            |       | 560,578               |       | 1,302,336              |       |
| Term loan - current                                                                                                                                                                         |       | —                |       | 1,666,667              |       |
| Total current  liabilities                                                                                                                                                                  |       | 944,151               |       | 4,041,311              |       |
|                                                                                                                                                                                        |       |                  |       |                   |       |
| Long-term  liabilities:                                                                                                                                                                     |       |                  |       |                   |       |
| Term loan                                                                                                                                                                                   |       | —                |       | 3,333,333              |       |
| Deferred compensation                                                                                                                                                                       |       | 12,121                |       | 31,861                 |       |
| Other long-term liabilities                                                                                                                                                                 |       | 16,824                |       | 8,412                  |       |
| Total long-term  liabilities                                                                                                                                                                |       | 28,945                |       | 3,373,606              |       |
|                                                                                                                                                                                        |       |                  |       |                   |       |
| Total  Liabilities                                                                                                                                                                          |       | 973,096               |       | 7, 414,917             |       |
|                                                                                                                                                                                        |       |                  |       |                   |       |
| 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 15,138,146 shares issued and outstanding at  December 31, 2005 and September 30, 2006, respectively |       | 13,797                |       | 15,138                 |       |
| Additional paid-in capital                                                                                                                                                                  |       | 684,281               |       | 2,916,844              |       |
| Retained earnings                                                                                                                                                                           |       | 1,230,497             |       | 2,803,041              |       |
| Total  stockholders’ equity                                                                                                                                                            |       | 1,928,575             |       | 5,735,023              |       |
| Total  liabilities and stockholders’ equity                                                                                                                                            |       | $                     | 2,901,671  |                   | $          | 13,149,940 |   |

See accompanying notes.

2

----

**GlobalSCAPE,Inc.**

**ConsolidatedStatements of Operations**

**(Unaudited)**
| ** **                                                                            | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2005**                                                 | ** ** | **2006**                                                | ** ** | **2005** | ** ** | **2006** | ** ** |
| Operating  revenues:                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Software product revenues                                                             |       | $                                                        | 1,559,126  |                                                    | $          | 2,002,989 |   | $ | 4,480,679 |   | $ | 6,330,830 |   |
|                                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Maintenance and support (net of deferred revenues)                                    |       | 164,559                                                  |       | 600,247                                                 |       | 484,763 |   | 1,132,656 |   |
| Total revenues                                                                        |       | 1,723,685                                                |       | 2,603,236                                               |       | 4,965,442 |   | 7,463,486 |   |
|                                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Operating  expenses:                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Cost of revenues (exclusive of depreciation and  amortization shown separately below) |       | 66,709                                                   |       | 145,646                                                 |       | 226,086 |   | 372,565 |   |
| Selling, general and administrative Expenses                                          |       | 1,014,011                                                |       | 1,318,952                                               |       | 2,973,385 |   | 3,879,460 |   |
| Research and development expenses                                                     |       | 230,947                                                  |       | 302,363                                                 |       | 614,756 |   | 799,168 |   |
| Depreciation and amortization                                                         |       | 22,714                                                   |       | 25,046                                                  |       | 76,129 |   | 69,726 |   |
| Total operating expense                                                               |       | 1,334,381                                                |       | 1,792,007                                               |       | 3,890,356 |   | 5,120,919 |   |
| Income from  operations                                                               |       | 389,304                                                  |       | 811,229                                                 |       | 1,075,086 |   | 2,342,567 |   |
|                                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Other income  (expense):                                                              |       |                                                     |       |                                                    |       |   |   |   |   |
| Interest expense                                                                      |       | 105                                                      |       | —                                                  |       | (620 | ) | — |   |
| Interest income                                                                       |       | 3,552                                                    |       | 21,412                                                  |       | 3,552 |   | 58,342 |   |
| Gain on sale of assets                                                                |       | 767                                                      |       | —                                                  |       | 958 |   | 619 |   |
| Other expense                                                                         |       | —                                                   |       | —                                                  |       | — |   | (295 | ) |
| Total other income (expense)                                                          |       | 4,424                                                    |       | 21,412                                                  |       | 3,890 |   | 58,666 |   |
| Income before  income taxes                                                           |       | 393,728                                                  |       | 832,640                                                 |       | 1,078,976 |   | 2,401,233 |   |
|                                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Income tax  expense (benefit):                                                        |       |                                                     |       |                                                    |       |   |   |   |   |
| Current:                                                                              |       |                                                     |       |                                                    |       |   |   |   |   |
| Federal                                                                               |       | —                                                   |       | 307,329                                                 |       | 1,065 |   | 826,110 |   |
| State                                                                                 |       | —                                                   |       | —                                                  |       | — |   | — |   |
| Deferred:                                                                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Federal                                                                               |       | —                                                   |       | (12,773                                                 | )          | — |   | (11,949 | ) |
| State                                                                                 |       | —                                                   |       | —                                                  |       | — |   | — |   |
| Total income tax  provision                                                           |       | —                                                   |       | 294,556                                                 |       | 1,065 |   | 814,162 |   |
|                                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Net income                                                                            |       | $                                                        | 393,728    |                                                    | $          | 538,085 |   | $ | 1,077,911 |   | $ | 1,587,072 |   |
|                                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Net income per  common share- basic                                                   |       | $                                                        | 0.03       |                                                    | $          | 0.04 |   | $ | 0.08 |   | $ | 0.11 |   |
| Net income per  common share- assuming dilution                                       |       | $                                                        | 0.03       |                                                    | $          | 0.03 |   | $ | 0.07 |   | $ | 0.10 |   |
|                                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Average shares  outstanding:                                                          |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic                                                                                 |       | 13,776,969                                               |       | 14,484,319                                              |       | 13,774,483 |   | 14,152,932 |   |
| Diluted                                                                               |       | 15,582,248                                               |       | 15,891,298                                              |       | 14,937,374 |   | 15,549,377 |   |

 

See accompanying notes.

3

----

**GlobalSCAPE,Inc.**

**ConsolidatedStatements of Cash Flows**

**(Unaudited)**
| ** **                                                                         | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                                            | ** ** | **2006** | ** ** |
| Operating  Activities:                                                             |       |                                                |       |   |   |
| Net Income                                                                         |       | $                                                   | 1,077,911  |   | $ | 1,587,072 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                                |       |   |   |
| Bad debt expense (recovery)                                                        |       | 7,775                                               |       | 2,560 |   |
| Depreciation and amortization                                                      |       | 76,129                                              |       | 69,726 |   |
| (Gain) loss on disposition of assets                                               |       | —                                              |       | (619 | ) |
| Stock-based compensation                                                           |       | —                                              |       | 204,935 |   |
| Deferred taxes                                                                     |       | —                                              |       | (11,949 | ) |
| Changes in operating assets and liabilities:                                       |       |                                                |       |   |   |
| Accounts receivable                                                                |       | (440,462                                            | )          | (574,761 | ) |
| Prepaid expenses                                                                   |       | (3,465                                              | )          | (94,963 | ) |
| Accounts payable                                                                   |       | (28,420                                             | )          | 168,744 |   |
| Accrued expenses                                                                   |       | 38,076                                              |       | 77,453 |   |
| Federal income tax payable                                                         |       | —                                              |       | 215,821 |   |
| Deferred revenues                                                                  |       | 166,840                                             |       | 379,002 |   |
| Deferred Compensation                                                              |       | —                                              |       | 19,740 |   |
| Other long-term liabilities                                                        |       | (2,061                                              | )          | (46,153 | ) |
| Net cash  provided by operating activities                                         |       | 892,323                                             |       | 1,996,608 |   |
| Investing  Activities:                                                             |       |                                                |       |   |   |
| Proceeds from sale of property and equipment                                       |       | —                                              |       | 619 |   |
| Purchase of property and equipment                                                 |       | (88,035                                             | )          | (114,043 | ) |
| Purchase of Availl, Inc.                                                           |       | —                                              |       | (7,776,932 | ) |
| Cash acquired in purchase of Availl, Inc.                                          |       | —                                              |       | 181,277 |   |
| Net cash used in  investing activities                                             |       | (88,035                                             | )          | (7,709,079 | ) |
| Financing  Activities:                                                             |       |                                                |       |   |   |
| Exercise of stock options                                                          |       | 6,960                                               |       | 28,969 |   |
| Proceeds from term loan                                                            |       | —                                              |       | 5,000,000 |   |
| Net cash  provided by financing activities                                         |       | 6,960                                               |       | 5,028,969 |   |
| Net increase  (decrease) in cash                                                   |       | 811,248                                             |       | (683,502 | ) |
| Cash at  beginning of period                                                       |       | 572,959                                             |       | 2,029,473 |   |
| Cash at end of period                                                              |       | $                                                   | 1,384,207  |   | $ | 1,345,971 |   |

 

See accompanying notes.
| Supplemental disclosures: |   |   |   |   |   |
|---------------------------|--------|--------|--------|--------|--------|
|                      |   |   |   |   |   |
| Interest paid             |   | $      | 620    |   | — |   |
| Income taxes paid         |   | $      | 1,065  |   | $      | 666,920 |   |
|                           |        |        |        |        |        |  |  |

 

4

----

**GlobalSCAPE,Inc.**

**Notesto Consolidated Financial Statements**

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

# **Nature of Business**

GlobalSCAPE, Inc. (GlobalSCAPE), founded in April 1996, develops anddistributes secure file management software that enables users to safely senddata over the internet. Our software is used worldwide across a wide range ofindustries. Through the end of 2005, we had sold approximately 1,300,000software licenses and our customer base includes individual consumers, small tomedium-sized businesses, as well as some of the largest corporations in theworld.

Our file transfer products guarantee the privacy of criticalinformation such as medical records, financial data, customer files and othersimilar documents. In addition, our products ensure compliance with governmentregulations relating to the protection of information while allowing users toreduce IT costs, increase efficiency, track and audit transactions and automateprocesses.

Through Availl Inc. (Availl), our recently acquired, wholly-ownedsubsidiary, we also provide Wide Area Files Systems (WAFS) and Continuous DataProtection (CDP) software.  This additionexpands GlobalSCAPE’s technology base into data replication, acceleration offile transfer, sharing/collaboration and continuous data backup andrecovery.  We believe that our expandedproduct offering uniquely positions us to provide comprehensive, securetransfer, sharing, and replication of files that need to be transmitted insidethe user’s firewall to distributed offices, or outside the user’s firewall tobusiness and trading partners.

During the nine months ended September 30,2006, approximately 66% of our revenues were generated from customers withinthe United States, with the remaining 34% concentrated mostly in WesternEurope, Canada and Australia. Virtually all of our 2006 revenues were derivedfrom sales of software licenses and support agreements. The combined sales ofCuteFTP Home and CuteFTP Pro accounted for 69% and 50% of our revenues in 2004and 2005, respectively, and 33% of our revenues for the nine months endedSeptember 30, 2006. The combined sales of our Secure Server and Enhanced FileTransfer products grew from 14% of our revenues in 2004 to 38% in 2005, and 63%for the nine months ended September 30, 2006.

***CorporateStructure***

Prior to September 22, 2006, all of the Company’s operations wereconducted by GlobalSCAPE Texas, LP, a Texas limited partnership.  The partners of GlobalSCAPE Texas, LP are twoNevada limited liability companies, which are both wholly-owned subsidiaries ofGlobalSCAPE, Inc., a Delaware corporation.

On September 22, 2006, GlobalSCAPE acquired one hundred percent (100%)of the issued and outstanding capital stock of Availl, a privately heldcorporation, pursuant to an Agreement and Plan of Merger with Availl and itsstockholders.  The initial purchase pricewas $9.65 million of which $7.65 million was paid in cash and $2.0 million waspaid in shares of GlobalSCAPE common stock. The former Availl stockholders are also entitled to up to an additional$100,000 in cash depending upon the achievement of certain revenue targets forAvaill for the third and fourth quarters of 2006.

Availl will continue to operate as a wholly-owned subsidiary ofGlobalSCAPE, Inc. based in Andover, Mass. GlobalSCAPE, Inc. is a holding company and conducts no operations;however, the stock of GlobalSCAPE, Inc. is quoted on the OTC BulletinBoard.  References to “GlobalSCAPE” orthe “Company” refer collectively to all of these entities unless otherwiseindicated.

5

----

# **Basis of Presentation**

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

The Balance Sheet at December 31, 2005 has been derived from theaudited financial statements at that date but does not include all the informationand footnotes required by generally accepted accounting principles for completefinancial statements.  For furtherinformation, refer to the financial statements and footnotes included inGlobalSCAPE’s Annual Report on Form 10-K/A Number 1 for the year ended December31, 2005.

# **Principles of Consolidation**

The consolidated financial statements include all subsidiaries.  Availl became a subsidiary on September 22,2006; therefore the consolidated financial statements only include Availl’sfinancial results and activities from the date of acquisition until September30, 2006.  All inter-company transactionsand balances have been eliminated.

# **Liquidity**

The use of our capital resources is drivenprincipally by our need to enhance our existing products and to develop oracquire new products.  The amount of ourexpenditures has a direct impact on our ability to offer enhanced and newproducts to our customers.  Our principalsource of funds is cash flow from operations which, in turn, is highlydependent on our sales revenue.  Duringthe nine months ended September 30, 2006, the Company generated $2.0 millionfrom operations, which was used along with other funds in the acquisition ofAvaill, resulting in a net decrease in cash through three quarters of 2006 of($683,502).

Prior to 2006,we relied heavily on sales of CuteFTP Home and CuteFTP Professional, whichaccounted for approximately 50%****and 30% oftotal revenues in the quarters ended September 30, 2005 and 2006,respectively.  Our newer products EnhancedFile Transfer and SecureFTP Server, have increased our total revenue in 2006while reducing the percentage of total revenue previously held by the twoCuteFTP products. Much of the decline in percentage of revenues from the saleof CuteFTP products was offset by sales of other products in the first ninemonths of 2006, namely, SecureFTP Server, Enhanced File Transfer and CascadeServer (formerly PublishXML), which collectively accounted for 38% and 63% ofrevenues in the nine months ended September 30, 2005 and 2006,respectively.  Total revenues increased51% when comparing the third quarter of 2006 to the same period in 2005 and 50%when comparing the first nine months of 2006 with the same period of 2005.  On a pro forma basis, when including theresults of operations of Availl for the entire third quarter, GlobalSCAPE’shistorical revenues for the three months ended 2006 would have increased byapproximately 92% over the same period of 2005.

As of September 30, 2006, the Company had cash and cash equivalents of$1,345,971 and had net working capital of ($826,935).  Management believes this level of workingcapital, together with availability under the Company’s revolving creditfacility with Silicon Valley Bank and the excess cash generated by theprofitable operation of the business, is adequate to finance the Company’scurrent level of operations.

The Company entered into a new loan agreement with Silicon Valley Bankon September 22, 2006 which involved a $5,000,000 term loan agreement which weused to finance part of the cash portion of the purchase price for Availl.  The initial interest rate is 9.5% and issubject to change as the bank’s prime rate changes.  The term loan matures on September 22,2009.  Interest and principal are payablein 36 equal monthly installments on the first day of each calendar monthbeginning October 1, 2006.  The loanagreement also established a $750,000 revolving line of credit for two years atan interest rate of prime plus 1.0%.  Inconnection with the term loan and line of credit, GlobalSCAPE granted the banka security interest in all accounts receivable, equipment, and other tangibleand intangible assets.  As of September30, 2006, the Company had no borrowings under the revolving line of creditagreement.

6

----

***Reclassifications***

***Certain prior period amounts have been reclassified to conform to thecurrent year presentation. These reclassifications had no impact on operatingincome as previously reported.***

***Sale /Disposal of Assets***

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

**Goodwill**

As of September 30, 2006, GlobalSCAPE had goodwillin the amount of $9.6 million associated with the acquisition of Availl.  This acquisition was accounted for using thepurchase method of accounting. See Acquisitions note for a description of theacquisition. In accordance with SFAS No. 142 *Goodwill and Other Intangible Assets*, the Company willassess the impairment of goodwill annually in the fourth quarter, or morefrequently if other indicators of potential impairment arise. Goodwill andother intangible assets consist of the following:
| ** **  | ** ** | **September 30, 2005** | ** ** | **September 30, 2006** | ** ** |
|-------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **  | ** ** | **Gross Carrying  Amount**  | ** ** | **Accumulated  Amortization**    | ** ** | **Net** | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
| Goodwill(1) |       | —                           |       | —                           |       | — |   | 9,581,366 |   | — |   | 9,581,366 |   |
|        |       |                             |       |                             |       |   |   |   |   |   |   |   |   |
|        |       | —                           |       | —                           |       | — |   | 9,581,366 |   | — |   | 9,581,366 |   |

 

----

(1)                                  No allocation has been made to intangibleassets as of the September 30, 2006. Management will determine the proper value of intangible assets acquiredfrom Availl, Inc. and allocate a portion of the goodwill to intangible assetswithin the next twelve months.

**Acquisitions**

On September 22, 2006, the Company completed theacquisition of all of the issued and outstanding shares of Availl, a privatelyheld provider of Wide Area Files Systems (WAFS) and Continuous Data Protection(CDP) software, for $7.65 million in cash and $2.0 million in the form of 716,846shares of GlobalSCAPE common stock. The Company incurred direct acquisitioncosts of approximately $127,000. In connection with the acquisition, $850,000of the cash consideration in this acquisition was placed into an escrow accountfor purposes of settling indemnification claims for the eighteen-month periodfollowing the closing. In accordance with EITF Issue No. 99-12, *Determination of the Measurement Date for the MarketPrice of Acquirer Securities Issued in a Purchase Business Combination*,we have used $2.79 as the per share amount to value the common stockconsideration paid to Availl shareholders (representing the average of theclosing prices of GlobalSCAPE’s common stock for the thirty days before themerger agreement date of September 22, 2006). Pursuant to the terms of theacquisition, the Company granted stock options to the former Availl stockholderswho were also employees under the GlobalSCAPE, Inc. 2000 Stock Option Plan. Exercisingthe options under this plan is contingent upon the individual’s continuedemployment with the Company and will be vested over three years in three annualinstallments.

The Availl acquisition was accounted for using thepurchase method of accounting. The purchase price was paid on theSeptember 22, 2006 closing date.  The purchase price includes a provision forthe former Availl stockholders to earn up to an additional $100,000 in cashdepending upon the achievement of certain revenue targets for Availl for thethird and fourth quarters of 2006. The purchase price was allocated to theassets acquired, including intangible assets and liabilities assumed, based onestimated fair values at the date of the acquisition. The value of assets andliabilities was estimated based on purchase price and future intended use.

Goodwill represents the excess of the purchase priceover the fair value of the net identifiable assets acquired. This premium paidfor the acquisitions is based on management’s belief that the acquiredtechnologies, businesses

7

----

and engineering talent were of strategic importance inthe Company’s growth strategy. Operating results from the acquired business isincluded in the condensed consolidated statements of operations from the dateof acquisition.

A summary of the purchase price allocation is asfollows:
|                                                            | ** ** | **Availl** | ** ** |
|------------------------------------------------------------|------------|------------|------------|
| Purchase price -                                           |       | $          |       |   |
| Cash paid                                                  |       | 7,650,000  |       |
| Stock issued                                               |       | 2,000,000  |       |
|                                                       |       |       |       |
| Legal & Other Acquisition Costs                        |       | 126,931    |       |
|                                                       |       |       |       |
| Acquisition  costs                                         |       | 9,776,931  |       |
| Net fair value  of assets acquired and liabilities assumed |       | (195,565   | )          |
|                                                       |       |       |       |
| Goodwill acquired                                          |       | 9,581,366  |       |
|                                                            |            |            |            |  |

 

The following unaudited pro forma financialinformation presents the results of operations for the three and nine monthperiods ended September 30, 2005 and 2006 as if the acquisition hadoccurred at the beginning of each period presented. The pro forma financialinformation has been adjusted for the effect of interest paid on the term loan.The pro forma financial information for the combined entities has been preparedfor comparative purposes only and is not indicative of what actual resultswould have been if the acquisitions had taken place at the beginning of eachperiod presented, or of future results.
| ** **                       | ** ** | **Three Months Ended**                                   | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------|------------|--------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **September 30,**                                             | ** ** | **September 30,**          | ** ** |
| ** **                       | ** ** | **2005**                                                           | ** ** | **2006**                        | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                       | ** ** | **(in thousands, except per share data)** | ** ** |
| Pro forma net  revenues          |       | $                                                                  | 2,060      |                            | $          | 3,308 |   | $ | 5,822 |   | $ | 9,262 |   |
| Pro forma net  income            |       | 369                                                                |       | 374                             |       | 971 |   | 1,218 |   |
|                             |       |                                                               |       |                            |       |   |   |   |   |
| Pro forma net  income per share: |       |                                                               |       |                            |       |   |   |   |   |
| Basic                            |       | $                                                                  | 0.03       |                            | $          | 0.03 |   | $ | 0.07 |   | $ | 0.09 |   |
|                             |       |                                                               |       |                            |       |   |   |   |   |
| Diluted                          |       | $                                                                  | 0.02       |                            | $          | 0.02 |   | $ | 0.06 |   | $ | 0.08 |   |

 

# **Stock-Based Compensation**

Stock-Based Compensation Plans

GlobalSCAPE hasstock-based compensation plans available to grant incentive stock options toemployees. Under the GlobalSCAPE, Inc. 2000 Stock Option Plan (the Plan), whichwas approved by the Board of Directors and became effective on May 17, 2001, amaximum of 3,660,000 shares of GlobalSCAPE common stock may be awarded. Throughthe nine months ended September 30, 2006, options were granted for 915,000shares of common stock.

8

----

The exercise price, termand other conditions applicable to each stock option granted under the Plan aregenerally determined by the Board of Directors. The exercise price of stockoptions is set on the grant date and may not be less than the fair market valueper share of our stock on that date. The options generally become exercisableover a three-year period and expire after ten years.

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-based compensation toemployees in accordance with Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (APB No. 25), and related interpretations. Wealso followed the disclosure requirements of Statement of Financial AccountingStandards No. 123, “Accounting for Stock-Based Compensation”, as amended byStatement of Financial Accounting Standards No. 148, “Accounting forStock-Based Compensation-Transition and Disclosure”. We adopted SFAS No. 123Rusing the modified prospective method and, accordingly, financial statementamounts for prior periods presented in this Form 10-Q have not been restated toreflect the fair value method of recognizing compensation cost relating tostock options.

There was $204,935 of compensationcost related to stock options recognized in operating results in the ninemonths ended September 30, 2006.

The fair value of eachoption award is estimated on the date of grant using the Black-Scholesoption-pricing model. Expected volatility is based on historical volatility ofGlobalSCAPE stock. We used the simplified method to derive an expected term.The expected term represents an estimate of the time options are expected toremain outstanding. The risk-free rate for periods within the contractual lifeof the option is based on the U.S. treasury yield curve in effect at the timeof grant. The following table sets forth the assumptions used to determinecompensation cost for our stock options consistent with the requirements ofSFAS No. 123R.
|                                 | ** ** | **Three Months Ended  September 30, 2006** | ** ** |
|---------------------------------|------------|----------------------------------------------------------------|------------|
| Expected  volatility            |       | 105                                                            | %          |
| Expected annual  dividend yield |       | 0.0                                                            | %          |
| Risk free rate  of return       |       | 4.67                                                           | %          |
| Expected option term  (years)   |       | 6.01                                                           |       |

 

Under APB No. 25 therewas no compensation cost recognized for our stock options awarded in the threeor nine months ended September 30, 2005 as these stock options had an exerciseprice equal to the market value of the underlying stock at the grant date. Thefollowing table sets forth pro forma information as if compensation cost hadbeen determined consistent with the requirements of SFAS No. 123.
|                                                                                                                                                    | ** ** | **Three Months Ended  September 30, 2005** | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Net income, as  adjusted                                                                                                                           |       | $                                                              | 393,728    |                                                          | $          | 1,077,911 |   |
| Deduct: Total  stock-based employee compensation cost determined under fair value method for  fixed stock option plans, net of related tax effects |       | (16,059                                                        | )          | (48,052                                                       | )          |
|                                                                                                                                               |       |                                                           |       |                                                          |       |
| Pro forma net  income                                                                                                                              |       | $                                                              | 377,669    |                                                          | $          | 1,029,859 |   |
|                                                                                                                                               |       |                                                           |       |                                                          |       |
| Earnings per  share of common stock:                                                                                                               |       |                                                           |       |                                                          |       |
| Basic - as adjusted                                                                                                                                |       | $                                                              | 0.03       |                                                          | $          | 0.08 |   |
|                                                                                                                                               |       |                                                           |       |                                                          |       |
| Basic – pro forma                                                                                                                             |       | $                                                              | 0.03       |                                                          | $          | 0.08 |   |
|                                                                                                                                               |       |                                                           |       |                                                          |       |
| Earnings per  share of common stock:                                                                                                               |       |                                                           |       |                                                          |       |
| Assuming dilution - as adjusted                                                                                                                    |       | $                                                              | 0.03       |                                                          | $          | 0.07 |   |
|                                                                                                                                               |       |                                                           |       |                                                          |       |
| Assuming  dilution - pro forma                                                                                                                     |       | $                                                              | 0.03       |                                                          | $          | 0.07 |   |

 

9

----

The following table summarizes information about stockoption activity for the nine months ended September 30, 2006:
|                                    | ** ** | **Number  of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (years)** | ** ** | **Aggregate  Intrinsic  Value ($M)** | ** ** |
|------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|------------------------------------------------------------------|------------|-------------------------------------------|------------|
|                               |       |                    |       |                                   |       |                                                             |       |                                      |       |
| Outstanding at  December 31, 2005  |       | 2,394,171               |       | $                                      | .25        |                                                             | 6.5        |                                      |       |   |
| Granted                            |       | 915,000                 |       | 2.82                                   |       |                                                             |       |                                      |       |
| Exercised                          |       | (623,181                | )          | .05                                    |       |                                                             |       |                                      |       |
| Lapsed or canceled                 |       | (125,350                | )          | .14                                    |       |                                                             |       |                                      |       |
|                               |       |                    |       |                                   |       |                                                             |       |                                      |       |
| Outstanding at  September 30, 2006 |       | 2,560,640               |       | $                                      | 1.23       |                                                             | 7.58       |                                      | $          | 4.66 |   |
|                               |       |                    |       |                                   |       |                                                             |       |                                      |       |
| Exercisable at  September 30, 2006 |       | 1,242,110               |       | $                                      | .51        |                                                             | 5.53       |                                      | $          | 3.16 |   |

 

The weighted average fairvalue of options granted during the three months ended September 30, 2006 was$2.61. The total intrinsic value of options (which is the amount by which thestock price exceeded the exercise price of the options on the date of exercise)exercised during the three months ended September 30, 2006 was $0 as none wereexercised during the period. During the nine months ended September 30, 2006, theamount of cash received from the exercise of stock options was $28,968 with noassociated tax benefit. The following table summarizes information aboutnonvested stock option awards as of September 30, 2006 and changes for the ninemonths ended September 30, 2006.
|                                   | ** ** | **Number  Of  Options** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|-----------------------------------|------------|-------------------------|------------|-------------------------------------------------------------|------------|
| Non-vested at  December 31, 2005  |       | 772,457                 |       | $                                                           | .25        |   |
| Granted                           |       | 915,000                 |       | 2.82                                                        |       |
| Vested                            |       | (287,535                | )          | .27                                                         |       |
| Forfeited                         |       | (81,392                 | )          | .14                                                         |       |
| Non-vested at September  30, 2006 |       | 1,318,530               |       | $                                                           | 1.96       |   |

 

At September 30, 2006,there was $1,995,337 of total unrecognized compensation cost related tonon-vested stock option awards which is expected to be recognized over aweighted-average period of 3 years. There were 72,540 options that becamevested during the three months ended September 30, 2006.

# **2.             Earnings per Common Share**

Basic and diluted net income per common share is presented inconformity with Statement of Financial Accounting Standards No. 128, “EarningsPer Share” (SFAS 128) for all periods presented. Basic earnings per share isbased on the weighted effect of all common shares issued and outstanding, andis calculated by dividing net income (loss) available to common stockholders bythe weighted average shares outstanding during the period. Diluted earnings pershare is calculated by dividing net income (loss) available to commonstockholders by the weighted average number of common shares used in the basicearnings per share calculation plus the number of 

10

----

common shares that would be issued assuming conversionof all potentially dilutive common shares outstanding.  Below is a reconciliation of the numeratorsand denominators of basic and diluted earnings per share for each of the periodspresented:
|                                                         | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                              | ** ** | **2005**                                                 | ** ** | **2006**                                                | ** ** | **2005** | ** ** | **2006** | ** ** |
| Numerators                                              |       |                                                     |       |                                                    |       |   |   |   |   |
| Numerators for  basic and diluted earnings per share:   |       |                                                     |       |                                                    |       |   |   |   |   |
| Net income                                              |       | $                                                        | 393,728    |                                                    | $          | 538,085 |   | $ | 1,077,911 |   | $ | 1,587,072 |   |
|                                                    |       |                                                     |       |                                                    |       |   |   |   |   |
| Denominators                                            |       |                                                     |       |                                                    |       |   |   |   |   |
| Denominators for  basic and diluted earnings per share: |       |                                                     |       |                                                    |       |   |   |   |   |
| Weighted average shares outstanding – basic        |       | 13,776,969                                               |       | 14,484,319                                              |       | 13,774,483 |   | 14,152,932 |   |
|                                                    |       |                                                     |       |                                                    |       |   |   |   |   |
| Dilutive  potential common shares                       |       |                                                     |       |                                                    |       |   |   |   |   |
| Stock options  (1)                                      |       | 1,805,279                                                |       | 1,406,979                                               |       | 1,162,891 |   | 1,396,445 |   |
| Denominator for  dilutive earnings per share            |       | 15,582,248                                               |       | 15,891,298                                              |       | 14,937,374 |   | 15,549,377 |   |
| Net income per  common share                            |       | $                                                        | 0.03       |                                                    | $          | 0.04 |   | $ | 0.08 |   | $ | 0.11 |   |
| Net income per common  share – assuming dilution   |       | $                                                        | 0.03       |                                                    | $          | 0.03 |   | $ | 0.07 |   | $ | 0.10 |   |

 

----

(1)          For the three and ninemonths ended September 30, 2005, all outstanding options have been included indilutive shares.  For the three and ninemonths ended September 30, 2006, 715,000 options have not been included indilutive shares, as the effect would be anti-dilutive.

11

----

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

This Quarterly Report on Form 10-Q contains “forward-looking statements”within the meaning of Section 27A of the Securities Act of 1933, as amended,and Section 21E of the Securities and Exchange Act of 1934, as amended.  “Forward looking statements” are thosestatements that describe management’s beliefs and expectations about thefuture.  We have identifiedforward-looking statements by using words such as “anticipate,” “believe,” “could,”“estimate,” “may,” “expect,” and “intend.” Although we believe these expectations are reasonable, our operationsinvolve a number of risks and uncertainties, including those described in the “RiskFactors” section of our Annual Report on Form 10-K/A Number 1 and otherdocuments filed with the Securities and Exchange Commission.  GlobalSCAPE’s actual results could differmaterially from those discussed in any forward-looking statements included inthis Quarterly Report.

**Overview**

GlobalSCAPE develops and distributes secure file management softwarefor individuals and business users to safely send data over the internet.  Our file management products guarantee theprivacy of critical information such as financial data, medical records,customer files and other similar documents. In addition, these products ensure compliance with governmentregulations relating to the protection of information while allowing users toreduce IT costs, increase efficiency, track and audit transaction and automateprocesses.  With the recent acquisitionof Availl, we now also develop and distribute Wide-Area File System (WAFS) collaborationand Continuous Data Protection(CDP) products.  These products providedata replication, acceleration of file transfer, sharing/collaboration andcontinuous data backup and recovery to our customers.  With these additional capabilities,  GlobalSCAPE believes that it is uniquelypositioned to provide comprehensive, secure transfer, sharing, and replicationof files that need to be transmitted inside the user’s firewall to distributedoffices, or outside the user’s firewall to business and trading partners.

The following is a brief description of our products:

·                  **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 forsecurity using technology similar to a Web browser. The products consist ofthree product categories; client, server and compression transfer. Our FileManagement product line includes CuteFTP Home, Cute FTP Professional, SecureFTPServer, and Enhanced File Transfer.

·                  **Wide-Area File System (WAFS)Products** – Our WAFS products provide a file sharing and collaboration solution over multiple sites.  Bykeeping all data updated on each location’s file server, each site has instantaccess to the very latest version.  Our WAFS products help ensure that noone can ever open an old file version without user conflicts. Changes made to data on any server are mirrored on all otherservers.

·                  **Continuous Data Protection (CDP)Products** – Our CDP products consolidate remote backupfor file servers.  As files change, the servers backup in real time to thecustomer’s backup site which can be at the same or a remotelocation.  The backup server can keep any number of past versions ofeach file (and deleted files) which gives the customer instant restore, as wellas the ability in perform point-in-time snapshots.

Our strategyis to continue enhancing our file transfer products to meet the demands of bothindividual and enterprise users, while improving the security features of ourcurrent product line, and to expand into growing markets through theacquisition of compatible companies and products.  We acquired Availl, a leading provider ofWide-Area File System(WAFS) collaboration and continuous data protection (CDP) products as part ofthis strategy.  This acquisition expands the Company’s technology base intodata replication, acceleration of file transfer, sharing/collaboration andcontinuous data backup and recovery. These new products give us entry into two large and rapidly growingmarkets.

12

----

We believethat our continued growth will come not only through the further development ofour SecureFTP Server and Enhanced File Transfer products and the growing demandfor file security when transferring information across the internet, but alsothough the aggressive exploitation of these two new market areas.  Based upon estimates by Gartner, Inc., andother consulting groups in our markets, we believe that the WANoptimization/WAFS market is currently $300 million annually and growing at 20%- 30% per year, and the CDP market is of similar size but in the early stagesof adoption and growing rapidly.  Inaddition, we believe that the WAFS and CDP products are highly complementary toour traditional Secure File Transfer products facilitating cross sales and newcustomer penetration.

##### **Liquidity and Capital Resources**

The Companycontinues to enjoy a strong working capital position resulting from solid net profitsfrom operations over the last ten quarters, including the quarter endedSeptember 30, 2006. ** **During September 2006, the Companydeployed $3.3 million of its cash as part of the cash consideration in theacquisition of Availl.  At September 30,2006, we had cash available of $1.3 million and we continue to generate cash inexcess of our operational needs.  Inaddition, the Company has a $750,000 line of credit with Silicon Valley Bankwhich is unused at this time.

Our capitalrequirements are driven principally by our need to enhance our existingproducts and to develop or acquire new products.  The amount of our expenditures has a directimpact on our ability to offer enhanced and new products to our customers.  We rely heavily on cash flows from operationsand these cash flows, prior to 2006, were significantly dependent upon sales ofCuteFTP Home and CuteFTP Professional, which accounted for 56%****and 33% of our revenues in the nine months ended September30, 2005 and 2006, respectively.  Thesales of these products have remained relatively flat over the prior two yearswhile becoming an increasingly smaller portion of our total revenue.  Much of the percentage decline of revenuesfrom the sale of these two products was caused by significant increases in thesales of other products in the first nine months of 2006, namely, SecureFTPServer and Enhanced File Transfer, which collectively accounted for 38% and 63%of our revenues in the nine months ended September 30, 2005 and 2006,respectively.  Revenues in totalincreased 51% when comparing the third quarter of 2006 to the same period in2005 and 50% when comparing the first nine months of 2006 with the same periodof 2005.  On a pro forma basis, whenincluding the results of operations of Availl for the entire third quarter,GlobalSCAPE’s historical revenues for the three months ended 2006 would haveincreased by approximately 92% over the same period of 2005.

Our principal sources of capital are cash on hand and cash flow fromoperations.  To the extent that salesdecline, our cash flow from operations will also decline.  If sales decline or our liquidity otherwiserequires, management may substantially reduce personnel and personnel-relatedcosts, reduce or substantially eliminate capital expenditures and/or reduce orsubstantially eliminate research and development expenditures.  We also have $750,000 of availability underour revolving line of credit and, if necessary, we may also sell equitysecurities or enter into other credit arrangements in order to finance futureacquisitions or licensing activities.

Net cash provided by operating activities was $892,323 in the ninemonths ended September 30, 2005 as compared to $1,996,608 for the nine monthsended September 30, 2006.  Cash providedby operations for the nine months ended September 30, 2006, was primarily theresult of net income, increases in deferred revenue, federal income taxpayable, stock-based compensation, and accounts payable, and offset by asignificant increase in accounts receivable largely related to the Availlacquisition.

Net cash used in investing activities for the nine months endedSeptember 30, 2005 and 2006 was $88,035 and $7,709,079, respectively.  In 2005, the cash used in investing activitywas primarily for the purchase of computer equipment, software, and lease holdimprovements, while in 2006, the unusually large amount of cash used ininvesting activities was a result of the Availl acquisition.

Net cash provided by financing activities during the nine months endedSeptember 30, 2005 and 2006 were $6,960 and $5,028,969 respectively.  The increase in cash provided from financingactivities in 2005 was from

13

----

issuance of stock from exercised options, while theAvaill acquisition significantly inflated the same category in 2006.

As of September 30, 2006, we had $1,345,971 in cash and cashequivalents, total current assets of $3,214,376 and current liabilities of$4,041,311, resulting in working capital of ($826,935).  The primary components of our currentliabilities are $1,666,667 representing the current portion of the term loan weincurred in connection with the Availl acquisition and $1,302,336 of deferredrevenues which will be recognized over the remaining term (one to twelvemonths) of the maintenance and support contracts.  Besides the term loan, our principalcommitments consist of obligations outstanding under operating leases, salesbonuses, royalty agreements with third parties, federal income tax and tradeaccounts payable.  We plan to continue toexpend significant resources on product development in future periods and mayalso use our cash to acquire or license technology, products or businessesrelated to our current business. The facility that we currently occupy isexpected to be sufficient for our growth over the next twelve months.  We do not anticipate significant expendituresfor leasehold improvements or furniture for 2006.

In order to finance the cashportion of the purchase price in the merger with Availl, GlobalSCAPE enteredinto a Loan and Security Agreement dated September 22, 2006 with Silicon ValleyBank.  The Loan Agreement provides for a$5.0 million term loan and a $750,000 revolving credit facility.  GlobalSCAPE borrowed $5.0 million pursuant tothe term loan on September 22, 2006. The entire amount of the revolving credit facility remainsavailable.  The term loan bears interestat 1.25% above the Bank’s prime rate and matures on September 22, 2009.  Interest and principal are payable in 36equal monthly installments on the first day of each calendar month beginningOctober 1, 2006.  The term loan may beprepaid at anytime but if it is prepaid on or before December 31, 2006,GlobalSCAPE must pay the Bank a premium of $60,000.

Borrowings under therevolving credit facility bear interest at 1.00% above the Bank’s prime rateand mature on September 22, 2008. Interest payments are due on the first day of each calendar month.

Both the term loan and therevolving credit facility are secured by substantially all of the assets ofGlobalSCAPE and its subsidiaries including Availl.  The Loan Agreement contains customarycovenants including covenants relating to maintaining legal existence and goodstanding, complying with applicable laws, delivery of financial statements,maintenance of inventory, payment of taxes, maintaining insurance, andprotection of intellectual property rights. GlobalSCAPE and its subsidiaries are also prohibited from selling any oftheir assets other than in the ordinary course of business, acquiring any otherentities, changing the types of business they are engaged in, incurringindebtedness other than that permitted by the Loan Agreement, incurring anyliens on their assets other than those permitted by the Loan Agreement, makingcertain investments or paying any dividends on, or acquiring, any shares oftheir capital stock.  The Loan Agreementcontains two financial covenants. GlobalSCAPE and its subsidiaries must maintain:

·                  a ratio of (A) EBITDA less the sum of (i)cash taxes paid and (ii) non-financed capital expenditures, to (B) the sum of(i) principal plus (ii) interest paid to Bank, of at least 1.5 to 1.00; and

·                  a ratio of total funded debt to EBITDA of notmore than 2.00 to 1.00.

Theloan agreement also contains customary events of default including the failureto make payments of principal and interests, the breach of principal andinterests, the breach of any covenants, the occurrence of a material adversechange, certain bankruptcy and insolvency events, the breach of otheragreements creating indebtedness of $50,000 or more and the entry of a judgmentof $50,000 or more against GlobalSCAPE or any of its subsidiaries.

14

----

**Contractual Obligations**

The following table sets forth the future minimum payments requiredunder contractual commitments at September 30, 2006**:  **
|                                  | ** ** | **Payments Due by Fiscal Year** | ** ** |
|----------------------------------|------------|-----------------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **2006 (1)**                                   | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| Operating Lease                  |       | $                                                   | 47,665     |   | $ | 190,659 |   | $ | 95,329 |   | $ | — |   | — |   | $ | 333,653 |   |
| Equipment Leases                 |       | 1,775                                               |       | 4,350 |   | 1,743 |   | — |   | — |   | 7,868 |   |
| Term Note                        |       | 416,667                                             |       | 1,666,667 |   | 1,666,667 |   | 1,249,999 |   |   |   | 5,000,000 |   |
| Total Cash Obligations           |       | $                                                   | 466,107    |   | $ | 1,861,676 |   | $ | 1,763,739 |   | $ | 1,249,999 |   | — |   | $ | 5,341,521 |   |

 

----

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

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

# ***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 UnitedStates.  The preparation of thesefinancial statements requires management to make estimates and assumptions thataffect the reported amount of assets and liabilities.  On an ongoing basis, management evaluates itsestimates and judgments, including those related to revenue recognition,allowance for doubtful accounts, accounts receivable, long-lived and intangibleassets, income taxes and contingencies. Management bases its estimates on historical experience, observable trends,and various other assumptions that are believed to be reasonable under thecircumstances.  Management uses thisinformation to make judgments about the carrying values of assets andliabilities that are not readily apparent from other sources.  Actual results may differ from the estimatesunder different assumptions or conditions.

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

***Revenue Recognition***

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

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

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

The Companybegan selling technical support and maintenance services for some of itssoftware products in 2001 and had deferred recognition of approximately $11,000in revenue at the end of that year. Deferred revenue grew to a balance of approximately $178,000 and$560,578 at December 31, 2004 and 2005, respectively. Sales of these agreementscontinued to grow into the first nine months of 2006 with more deferrals thatare due largely to the enterprise type software they are supporting. For thenine months ended September 30, 2005 and 2006, the deferred revenue balance was$344,957 and $1,302,336, respectively. If the level of sales of technicalsupport and maintenance agreements remains the same or declines, the balance ofdeferred revenues will stabilize or decline.

15

----

However if sales grow, the balance will increase,resulting in the deferred recognition of a significant amount of revenue infuture periods.

***Business Acquisitions andIntangible Assets***

***We account for acquired businesses usingthe purchase method of accounting which requires that the assets acquired andliabilities assumed be recorded at the date of acquisition at their respectivefair market value.  The judgments made indetermining the estimated fair values assigned to each class of assets acquiredand liabilities assumed, as well as asset lives, can materially impact netincome.  Accordingly, for significantitems, we typically obtain assistance from independent valuation specialists.***

***Goodwill represents the acquisition costsin excess of the fair value of net tangible and intangible assets of businessespurchased.  Intangible assets consistprimarily of the value of intellectual property, customer relationships,non-compete agreements, trademarks and goodwill. Goodwill is evaluated annuallyfor impairment, or earlier if indicators of impairment exist. The determinationas to whether or not goodwill or other intangible assets have become impairedinvolves a significant level of judgment in the assumptions underlying theapproach used to determine the value of the reporting units.  Changes in our operating strategy and ourmarket conditions could significantly impact these judgments and requireadjustments to recorded amounts of intangible assets.***

***We have adopted a policy to reviewgoodwill and indefinite-lived intangibles for impairment using a discountedcash flow approach that uses forward-looking information regarding marketshare, revenues and costs for the reporting unit as well as appropriatediscount rates.  As a result, changes inthese assumptions could materially change the outcome of the reporting unit’sfair value determination in future periods, which could require a furtherpermanent write-down of goodwill.***

***Allowance for DoubtfulAccounts***

We providecredit, in the normal course of business, to a number of companies and performongoing evaluations of our credit risk. We require no collateral from our customers and we estimate theallowance for uncollectible accounts based on our historical experience and currentcredit evaluations.  One customer accountedfor 3.6% of revenues in the first nine months of 2005. In the first nine monthsof 2006, no single customer individually accounted for more than 2% of netrevenues.

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

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

***Stock-Based Compensation***

Effective January 1, 2006, we adopted the provisionsof Statement of 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 Issued toEmployees” (APB No. 25), and related interpretations. We also followed thedisclosure 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 using themodified prospective method and, accordingly, financial statement amounts forprior periods presented in this Form 10-Q have not been restated to reflect thefair value method of recognizing compensation cost relating to stock options.

16

----

In the third quarter of 2006, 590,000 options were granted, no optionswere exercised, 117,540 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 September 30, 2005 and 2006, we spent $230,947 and$302,363, respectively, on research and development.  For the nine months ended September 30, 2005and 2006, we spent $614,756 and $799,168, respectively, on research anddevelopment.  No research and developmentexpenses were capitalized in either period and all previously capitalizedresearch and development expenses were fully amortized at December 31, 2002.

# ***Income Taxes***

GlobalSCAPEaccounts for income taxes using the liability method in accordance with Statementof Financial Accounting Standards No. 109, *Accountingfor Income Taxes*. The liability method provides that the deferredtax assets and liabilities are recorded based on the difference between thebook and tax basis of assets and liabilities and their carrying amount forfinancial reporting purposes, as measured by the enacted tax rates and lawsthat will be in effect when the differences are expected to reverse.  Deferred tax assets are carried on thebalance sheet with the presumption that they will be realizable in futureperiods when pre-tax income is generated. GlobalSCAPE recorded a deferred taxasset at September 30, 2006 of $63,932 based on its taxable income for thequarter.

Statement ofFinancial Accounting Standards (SFAS) No. 109 requires a valuation allowance toreduce the deferred tax assets reported if, based on the weight of theevidence, it is more likely than not that some portion or all of the deferredtax assets will not be realized. After consideration of all the evidence, bothpositive and negative, management determined that no valuation allowance wasnecessary at September 30, 2006. During the quarter the deferred tax asset wasincreased by $12,773. During the nine months ended September 30, 2006 thedeferred tax asset was increased by $11,949.

##### ***Inflation***

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

##### ***Seasonality***

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

# **Comparison of the Three Monthsended September 30, 2005 and 2006**

| ** **                                    | ** ** | **2005**  | ** ** | **2006**  | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|-----------------------------------------------|------------|-----------|------------|-----------|------------|-------------------|------------|-------------------|------------|
| Software product  revenues(1)                 |       | $         | 1,723,685  |      | $          | 2,603,236         |       | $                 | 879,551    |   | 51 | % |
| Cost of revenues                              |       | 66,709    |       | 145,646   |       | 78,937            |       | 118               | %          |
| Selling, general  and administrative Expenses |       | 1,014,011 |       | 1,318,952 |       | 304,941           |       | 30                | %          |
| Research and  development expenses            |       | 230,947   |       | 302,363   |       | 71,416            |       | 31                | %          |
| Depreciation and  amortization                |       | 22,714    |       | 25,046    |       | 2,332             |       | 10                | %          |
| Total operating  expense                      |       | 1,334,381 |       | 1,792,007 |       | 457,626           |       | 34                | %          |
| Income (loss)  from operations                |       | 389,304   |       | 811,229   |       | 421,925           |       | 108               | %          |
| Other Income  (expense)                       |       | 4,424     |       | 21,412    |       | 16,988            |       | 384               | %          |
| Income tax  expense                           |       |      |       | (294,556  | )          | (294,556          | )          | 100               | %          |
| Net Income                                    |       | $         | 393,728    |      | $          | 538,085           |       | $                 | 144,357    |   | 37 | % |

 

17

----

----

(1)   On a pro forma basis, whenincluding the results of operations of Availl for the entire third quarter,total revenues would have been approximately $3,308,000, an increase ofapproximately 92% over GlobalSCAPE’s historical revenues for the same period of2005.

***Revenue.***  For the three months ended September 30, 2005and 2006, total revenues increased $879,551 or approximately 51% from$1,723,685 to $2,603,236 largely due to the increase in revenues from SecureFTPServer and Enhanced File Transfer which continues to gain acceptance in themarket, especially with large companies. Revenues from CuteFTP Home and CuteFTPProfessional declined by 11% as compared to the quarter ended September 30,2005 due to the industry trend of including FTP capabilities in otherapplications thus reducing the need for standalone FTP software. CuteFTP Homeand CuteFTP Professional accounted for approximately 50% and 30% of totalrevenues for the three months ended September 30, 2005 and 2006respectively.  SecureFTP Server andEnhanced File Transfer accounted for approximately 50% and 66% of totalrevenues for the three months ended September 30, 2005 and 2006 respectively.

The following table reflects revenue byproduct including the related maintenance and support for each product:
|                                                                                                          | ** ** | **Revenue for**                            | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **Quarter ending September 30,** | ** ** |
| **Product**                                                                                              | ** ** | **2005**                                        | ** ** | **2006** | ** ** |
| Enhanced File  Transfer                                                                                  |       | $                                               | 303,390    |   | 17.6 | % | $ | 1,010,912 |   | 38.8 | % |
| CuteFTP  Professional                                                                                    |       | 564,732                                         |       | 32.8 | % | 531,647 |   | 20.4 | % |
| CuteFTP Home                                                                                             |       | 299,793                                         |       | 17.4 | % | 237,862 |   | 9.1 | % |
| SecureFTP Server                                                                                         |       | 563,389                                         |       | 32.7 | % | 707,736 |   | 27.2 | % |
| All Others                                                                                               |       | 73,457                                          |       | 4.2 | % | 207,870 |   | 8.0 | % |
| Deferred Revenue  adjustment                                                                             |       | (81,076                                         | )          | -4.7 | % | (92,791 | ) | -3.5 | % |
| Total Operating Revenues                                                                                 |       | $                                               | 1,723,685  |   | 100.0 | % | $ | 2,603,236 |   | 100.0 | % |
| Gross maintenance and  support included above before recognition of the net adjustment to defer  revenue |       | $                                               | 516,171    |   | 29.9 | % | $ | 693,038 |   | 25.9 | % |

 

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

***Cost of Revenues.***  Cost of revenues consists primarily ofproduction, packaging and shipping costs for boxed copies of software productsas well as a portion of our bandwidth costs, certain licensing expenses androyalties.  Cost of revenues increased$78,937 or 118% between periods from $66,709 for the three months endedSeptember 30, 2005 to $145,646 for the three months ended September 30, 2006 asa result of higher royalty payments on increased sales of Cascade Server, anenterprise web content management solution. Royalties that the Company pays on software products licensed from thirdparties, which it resells, are expensed as a cost of sale when the softwareproduct is sold or earlier if the recoverability of any prepaid royalties is indoubt.  The Company has distributionagreements with Hannon Hill Corp., Trellix Corp., Perseus Development Corp.,Beehive Software, Inc., Visicom Media, Inc., and Xnet Communications GmbH.  The GlobalSCAPE software products associatedwith each of the companies are Cascade Server (formerly Publish XML), CuteSITEBuilder, Web Survey, Mac FTP,

18

----

CuteHTML Pro, and Mac FTP Pro, respectively.  GlobalSCAPE’s agreement with Hannon HillCorp. accounted for a large portion of the increase in royalty expense duringthe quarter ended September 30, 2006 due to the increase in sales of productand maintenance and support during the quarter for Cascade Server. We expectthe cost of revenues to increase as sales of Hannon Hill products increase anddecline when or if the sales decrease.

***Selling, General andAdministrative.*** Selling, general and administrative expenses consist primarily ofpersonnel and related expenses, marketing, customer support, rents, bad debtand professional fees.  For the threemonths ended September 30, 2005 and 2006, selling, general and administrativeexpenses were $1,014,011 and $1,318,952, respectively, an increase of $304,941of which 20% or $60,944 of the increase was associated with the Availlacquisition in the form of legal and accounting fees.  GlobalSCAPE Salaries accounted for anotherthird of the increase as a result of employee headcount growth in accounting,strategic development, and other areas, and commissions and bonuses increased10% over the same period last year based on the increase in revenues. Asrequired by FAS123R, we expensed $84,398 in the third quarter of 2006 for stockbased compensation related to the granting of stock options to employees.

***Research and Development.***  Research and development expenses increased$71,416 or 31% between periods, from $230,947 to $302,363.  The increase was due largely to additionalexpenditures for external development resources and hiring of additionalpersonnel to meet the release deadlines for our software products.

***Depreciation andAmortization.*** Depreciation and amortization expense consists of depreciation expenserelated to our fixed assets, amortization of the trademark associated with ourpurchase of CuteFTP and in prior periods, amortization of capitalizeddevelopment costs. Depreciation and amortization expense increased from $22,714to $25,046, an increase of approximately 10%. This increase was due primarily to an increase in depreciation expenserelate to additions to fixed assets in current periods relative to priorperiods.

***Other Income,Expense.*** For the three months ended September 30, 2005 and 2006, interest expensedecreased from $105 to $0, respectively. The interest expense incurred during 2005 was related to financing ofinsurance premiums. We earned $3,552 and $21,412 in interest during the third quartersof 2005 and 2006, respectively, from investing our excess cash.

***Income Taxes.***  The provision for federal income taxes forthe quarter ended September 30, 2006 was $294,556. We recognized no benefitrelated to the net income in the three months ended September 30, 2005 becausewe could not be certain of the future period recoverability of tax assetsgenerated from available net operating losses at that time.

***Net Income.***  GlobalSCAPE recorded net income of $393,728and $538,085 for the three months ended September 30, 2005 and 2006, respectively.This was a increase of $144,357 quarter to quarter in net income, which waslargely a result of the 37% increase in revenues even after the substantialoffset for federal taxes.

# **Comparison of the Nine Monthsended September 30, 2005 and 2006**

| ** **                                    | ** ** | **2005**  | ** ** | **2006**  | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|-----------------------------------------------|------------|-----------|------------|-----------|------------|-------------------|------------|-------------------|------------|
| Software product  revenues(1)                 |       | $         | 4,965,442  |      | $          | 7,463,486         |       | $                 | 2,498,044  |   | 50 | % |
| Cost of revenues                              |       | 226,086   |       | 372,565   |       | 146,479           |       | 65                | %          |
| Selling, general  and administrative Expenses |       | 2,973,385 |       | 3,879,460 |       | 991,861           |       | 30                | %          |
| Research and  development expenses            |       | 614,756   |       | 799,168   |       | 184,412           |       | 30                | %          |
| Depreciation and  amortization                |       | 76,129    |       | 69,726    |       | (6,403            | )          | -8                | %          |
| Total operating  expense                      |       | 3,890,356 |       | 5,120,919 |       | 1,316,572         |       | 32                | %          |
| Income (loss)  from operations                |       | 1,075,086 |       | 2,342,567 |       | 1,267,481         |       | 118               | %          |
| Other Income  (expense)                       |       | 3,890     |       | 58,666    |       | 54,776            |       | 1,408             | %          |
| Income tax  expense                           |       | (1,065    | )          | (814,162  | )          | (813,097          | )          | 8,659             | %          |
| Net Income                                    |       | $         | 1,077,911  |      | $          | 1,587,072         |       | $                 | 494,633    |   | 47 | % |

 

19

----

----

(1)   On a pro forma basis, whenincluding the results of operations of Availl for the entire nine-month periodended September 30, 2006, total revenues would have been approximately$9,262,000, an increase of approximately 87% over GlobalSCAPE’s historicalrevenues for the same period of 2005.

***Revenue.***  For the nine months ended September 30, 2005and 2006, total revenues increased $2,498,044 or approximately 50% from$4,965,442 to $7,463,486 largely due to the increase in revenues from SecureFTPServer and Enhanced File Transfer which continues to gain acceptance in themarket, especially with large companies. Revenues from CuteFTP Home and CuteFTPProfessional declined by 13% as compared to the nine months ended September 30,2005 due to the trend of including FTP capabilities in other applications thusreducing the need for standalone FTP software. CuteFTP Home and CuteFTPProfessional accounted for approximately 56% and 33% of total revenues for thenine months ended September 30, 2005 and 2006 respectively. SecureFTP Serverand Enhanced File Transfer accounted for approximately 38% and 63% of totalrevenues for the nine months ended September 30, 2005 and 2006 respectively.

The following table reflects revenue byproduct including the related maintenance and support for each product
|                                                                                                          | ** ** | **Revenue for**                                     | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **Nine months ending September 30,** | ** ** |
| **Product**                                                                                              | ** ** | **2005**                                                 | ** ** | **2006** | ** ** |
| Enhanced File  Transfer                                                                                  |       | $                                                        | 765,946    |   | 15.4 | % | $ | 2,849,088 |   | 38.3 | % |
| CuteFTP  Professional                                                                                    |       | 1,884,392                                                |       | 38.0 | % | 1,688,022 |   | 22.6 | % |
| CuteFTP Home                                                                                             |       | 904,806                                                  |       | 18.2 | % | 749,754 |   | 10.0 | % |
| SecureFTP Server                                                                                         |       | 1,120,034                                                |       | 22.6 | % | 1,869,512 |   | 25.0 | % |
| All Others                                                                                               |       | 423,279                                                  |       | 8.5 | % | 686,113 |   | 9.2 | % |
| Deferred Revenue  adjustment                                                                             |       | (133,015                                                 | )          | -2.7 | % | (379,001 | ) | -5.0 | % |
| Total Operating Revenues                                                                                 |       | $                                                        | 4,965,442  |   | 100.0 | % | $ | 7,463,486 |   | 100.0 | % |
| Gross maintenance and  support included above before recognition of the net adjustment to defer  revenue |       | $                                                        | 1,437,650  |   | 28.9 | % | $ | 1,511,657 |   | 20.1 | % |

 

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

***Cost of Revenues.***  Cost of revenues consists primarily ofproduction, packaging and shipping costs for boxed copies of software productsas well as a portion of our bandwidth costs, certain licensing expenses androyalties.  Cost of revenues increased$146,479 or 65% between periods from $226,086 for the nine months endedSeptember 30, 2005 to $372,565 for the nine months ended September 30, 2006 asa result of higher royalty payments on increased sales of Cascade Server, anenterprise web content management solution. Royalties that the Company pays on software products licensed from thirdparties, which it resells, are expensed as a cost of sale when the softwareproduct is sold or earlier if the recoverability of any prepaid royalties is indoubt.  The Company has distributionagreements with Hannon Hill Corp., Trellix Corp., Perseus Development Corp.,Beehive Software, Inc., Visicom Media, Inc., and Xnet Communications GmbH.  The GlobalSCAPE software products associatedwith each of the companies are Cascade Server (formerly PublishXML), CuteSITEBuilder, Web Survey, Mac FTP, CuteHTML Pro, and Mac FTP Pro, respectively.  GlobalSCAPE’s agreement with Hannon HillCorp. accounted for a large portion of the increase in royalty expense duringthe nine months ended September 30, 2006 due to the increase in sales ofproduct and maintenance and support during the nine months for Cascade Server(formally PublishXML). We expect the cost of revenues to increase as sales ofHannon Hill products increase and decline when or if the sales decrease.

20

----

***Selling, General andAdministrative.*** Selling, general and administrative expenses consist primarily ofpersonnel and related expenses, marketing, customer support, rents, bad debtand professional fees.  For the ninemonths ended September 30, 2005 and 2006, selling, general and administrativeexpenses were $2,973,385 and $3,879,460, respectively, an increase ofapproximately 30%. Salaries increased $277,264 or 20% as we have hired newemployees in connection with our growth over the prior year, and commissionsand bonuses have increased 62% or $313,295, based on the increase in revenues.****As required by FAS123R, we expensed $204,935 in the nine monthsended September 30, 2006 for stock based compensation related to the grantingof stock options to employees.

***Research andDevelopment.*** Research and development expenses increased $184,412 or 30% betweenperiods, from $614,756 to $799,168.  Theincrease was due largely to additional expenditures for external developmentresources and hiring of additional personnel to meet the release deadlines forproducts.

***Depreciation andAmortization.*** Depreciation and amortization expense consists of depreciation expenserelated to our fixed assets, amortization of the trademark associated with ourpurchase of CuteFTP and in prior periods, amortization of capitalizeddevelopment costs. Depreciation and amortization expense decreased from $76,129to $69,726, a decline of approximately 8%. This decrease was due primarily to a reduction in depreciation expenseas fixed assets come to the end of their depreciable life as well as a slowdownin additions to fixed assets in current periods relative to prior periods.

***Other Income,Expense.*** For the nine months ended September 30, 2005 and 2006, interest expensedecreased from $620 to $0, respectively. The majority of interest expense incurred during 2005 was related tofinancing of insurance premiums. We earned $3,552 and $58,666 in interestduring the nine months ended September 30, 2005 and 2006, respectively, frominvesting our excess cash.

***Income Taxes.***  The provision for federal income taxes forthe nine months ended September 30, 2005 and 2006 was $1,065 and $814,162,respectively.  The increase in federalincome taxes versus last year is the result of increased revenue and resultingincome upon which tax is due, plus the absence of prior year’s operating losseswhich were used in 2005 to substantially reduce the federal taxes in that year.

***Net Income.***  GlobalSCAPE recorded net income of $1,077,911and $1,587,072 for the nine months ended September 30, 2005 and 2006,respectively. This was an increase of $494,633 period to period in net income.The net income was largely a result of the acceptance of our SecureFTP Serverand Enhanced File Transfer products over the last year, resulting in higherrevenues, while controlling expenses.

21

----

# **Item 3. Quantitative and Qualitative Disclosures About Market Risk**

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

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

# **Item 4. Controls and Procedures**

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

Therewere no significant changes in our internal control over financial reportingduring the last fiscal year and/or up to and including the date of this filingthat we believe materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting, except for improvementsin the internal controls to strengthen the process of capturing and reportingof deferred revenue.

22

----

## **Part II. Other Information**

# **Item 1.****              LegalProceedings**

We are not currently involved in any material legal proceedings.

**Item 1A.**           Risk Factors.

In addition to the other information set forth in this report, youshould carefully consider the factors discussed in Part I, “Item 1A. RiskFactors” in our Annual Report on Form 10-K for the year ended December 31,2005, which could materially affect our business, financial condition or futureresults.  The risks described in ourAnnual Report on Form 10-K are not the only risks facing GlobalSCAPE.  Additional risks and uncertainties notcurrently known to us or that we currently deem to be immaterial also maymaterially adversely affect our business, financial condition and/or operatingresults.

# **Item 2.****              UnregisteredSales of Equity Securities and Use of Proceeds**

In connection with the merger of Availl, on September 22, 2006,GlobalSCAPE issued a total of 716,846 shares of its common stock to threeformer stockholders of Availl pursuant to the exemption set forth in Section4(2) of the Securities Act of 1933, as amended.

# **Item 3.****              DefaultsUpon Senior Securities**

Not applicable.

# **Item 4.****              Submissionof Matters to a Vote of Security Holders**

Nonein the third quarter of 2006.

# **Item 5.****              OtherInformation**

On September 21, 2006,GlobalSCAPE appointed Phillip M. Renfro as a director.  Mr. Renfro will also serve as the Chairman ofGlobalSCAPE’s Audit Committee.  Mr.Renfro was awarded options to purchase 20,000 shares of GlobalSCAPE commonstock at an exercise price of $3.14 per share as an inducement grant and willbe paid a quarterly fee of $3,000 for serving as a member of the Board ofDirectors and $1,000 per quarter for serving as Chairman of the AuditCommittee.

# **Item 6.****              Exhibits**

**(a)**                      Exhibits

2.1     Agreementand Plan of Merger dated September 22, 2006 by and among GlobalSCAPE, Inc., GAAcquisition Corp., Availl, Inc., Chuck Shavit, Ellen Ohlenbusch, Craig Randall,Ronald Lachman, Lachman Goldman Ventures LLC, and Chuck Shavit as Stockholders’Representative.  (Previously filed asExhibit 2.1 to GlobalSCAPE’s Current Report on Form 8-K filed on September 27,2006)

10.1   Loan andSecurity Agreement dated September 22, 2006, by and between GlobalSCAPE, Inc.and Silicon Valley Bank.  (Previouslyfiled as Exhibit 10.1 to GlobalSCAPE’s Current Report on Form 8-K filed onSeptember 27, 2006)

10.2   Form of Non-Qualified Stock Option Agreementunder the GlobalSCAPE, Inc. 2000 Stock Option Plan.

23

----

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

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

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

24

----

**Signatures**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|        |               |   | GLOBALSCAPE,  INC.                    |
|--------|--------------------|--------|---------------------------------------|
|   |               |   |                                  |
|   |               |   |                                  |
|   | November 13,  2006 |   | By:                                   |   | /s/ Charles R. Poole |   |
| Date   |               |   | Charles R. Poole                      |
|   |               |   | President and Chief Executive Officer |
|   |               |   |                                  |
|   | November 13,  2006 |   | By:                                   |   | /s/ Bernard N. Schneider |   |
| Date   |               |   | Bernard N. Schneider                  |
|   |               |   | Chief Financial Officer               |
|        |                    |        |                                       |  |  |  |  |

 

25

----