**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-Q/A**

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

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

**OR**

**o****                                 ****TRANSITION REPORT PURSUANT TOSECTION 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.

ý 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 large acceleratedfiler” in Rule 12b-2 of the Exchange Act (check one):

LargeAccelerated filer o    Accelerated filer o    Non-Accelerated filer ý

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

o Yes    ý 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, based upon the closing salesprice of $3.05  per share on such date onthe NASD’s OTC Bulletin Board.

As of November  13, 2006, therewere 15,138,146 shares of common stock outstanding.

 

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Explanatory Note

This amendment is beingfiled to provide additional information identified upon the completion of theForm 8-K/A filed on December 08, 2006. Goodwill has increased by $71,693 related to the recognition of the sameamount of deferred tax liability associated with the acquisition of Availl,Inc. The pro forma financial information presenting the results of the combinedoperation for the nine months ended September 30, 2005 and 2006 as if theacquisition had occurred at the beginning of each period, has also beenchanged.  After the Form 10-Q for thequarter ended September 30, 2006 was filed, a review of the nine months endedSeptember 30, 2005 of Availl was performed in connection with the Form 8-K/A filedon December 8, 2006 converting the formally cash basis financial information ofAvaill to the accrual basis for the quarter ended September 30, 2005.  On an accrual basis, Availl’s net income wasreduced by $304,053 which resulted in a reduction in the pro forma net incomefor the nine months ended September 30, 2005.

 

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**GlobalSCAPE Inc.**

** **

**Quarterly Report on Form 10-Q**

**For the Quarter ended September30, 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 ended September 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                                                                                                                                        |       | —                |       | 9,653,059              |       |
| 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  |                   | $          | 13,221,633 |   |

 

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 tax liability                                                                                                                                                                      |       | —                |       | 71,693                 |       |
| Deferred revenue                                                                                                                                                                            |       | 560,578               |       | 1,302,336              |       |
| Term loan - current                                                                                                                                                                         |       | —                |       | 1,666,667              |       |
| Total current  liabilities                                                                                                                                                                  |       | 944,151               |       | 4,113,004              |       |
|                                                                                                                                                                                        |       |                  |       |                   |       |
|                                                                                                                                                                                        |       |                  |       |                   |       |
| 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, 486,610             |       |
|                                                                                                                                                                                        |       |                  |       |                   |       |
| 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  |                   | $          | 13,221,633 |   |

See accompanying notes.

2

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**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

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**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

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**GlobalSCAPE, Inc.**

**Notes to Consolidated Financial Statements**

**1.****             Overview of theBusiness and Significant Accounting Policies**

# **Nature ofBusiness**

GlobalSCAPE, Inc. (GlobalSCAPE), founded inApril 1996, develops and distributes secure file management software thatenables users to safely send data over the internet. Our software is usedworldwide across a wide range of industries. Through the end of 2005, we hadsold approximately 1,300,000 software licenses and our customer base includesindividual consumers, small to medium-sized businesses, as well as some of thelargest corporations in the world.

Our file transfer products guarantee theprivacy of critical information such as medical records, financial data,customer files and other similar documents. In addition, our products ensurecompliance with government regulations relating to the protection ofinformation while allowing users to reduce IT costs, increase efficiency, trackand audit transactions and automate processes.

Through Availl Inc. (Availl), our recentlyacquired, wholly-owned subsidiary, we also provide Wide Area Files Systems(WAFS) and Continuous Data Protection (CDP) software.  This addition expands GlobalSCAPE’stechnology base into data replication, acceleration of file transfer, sharing/collaborationand continuous data backup and recovery. We believe that our expanded product offering uniquely positions us toprovide comprehensive, secure transfer, sharing, and replication of files thatneed to be transmitted inside the user’s firewall to distributed offices, oroutside the user’s firewall to business and trading partners.

During the nine months endedSeptember 30, 2006, approximately 66% of our revenues were generated fromcustomers within the United States, with the remaining 34% concentrated mostlyin Western Europe, Canada and Australia. Virtually all of our 2006 revenueswere derived from sales of software licenses and support agreements. Thecombined sales of CuteFTP Home and CuteFTP Pro accounted for 69% and 50% of ourrevenues in 2004 and 2005, respectively, and 33% of our revenues for the ninemonths ended September 30, 2006. The combined sales of our Secure Server andEnhanced File Transfer products grew from 14% of our revenues in 2004 to 38% in2005, and 63% for the nine months ended September 30, 2006.

***Corporate Structure***

Prior to September 22, 2006, all of theCompany’s operations were conducted by GlobalSCAPE Texas, LP, a Texas limitedpartnership.  The partners of GlobalSCAPETexas, LP are two Nevada limited liability companies, which are bothwholly-owned subsidiaries of GlobalSCAPE, Inc., a Delaware corporation.

On September 22, 2006, GlobalSCAPE acquiredone hundred percent (100%) of the issued and outstanding capital stock ofAvaill, a privately held corporation, pursuant to an Agreement and Plan ofMerger with Availl and its stockholders. The initial purchase price was $9.65 million of which $7.65 million waspaid in cash and $2.0 million was paid in shares of GlobalSCAPE common stock.  The former Availl stockholders are alsoentitled to up to an additional $100,000 in cash depending upon the achievementof certain revenue targets for Availl for the third and fourth quarters of2006.

Availl will continue to operate as awholly-owned subsidiary of GlobalSCAPE, Inc. based in Andover, Mass.   GlobalSCAPE, Inc. is a holding company andconducts no operations; however, the stock of GlobalSCAPE, Inc. is quoted onthe OTC Bulletin Board.  References to “GlobalSCAPE”or the “Company” refer collectively to all of these entities unless otherwiseindicated.

5

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# **Basis ofPresentation**

The accompanying unaudited financialstatements have been prepared in accordance with Rule 10-01 of Regulation S-X, “InterimFinancial Statements.”  Accordingly, theydo not include all information and footnotes required under generally acceptedaccounting principles for complete financial statements.  In the opinion of management, all adjustments(consisting of normally recurring accruals) considered necessary for a fairpresentation have been made.  The resultsof operations for any interim period are not necessarily indicative of theresults to be expected for the full year.

The Balance Sheet at December 31, 2005 hasbeen derived from the audited financial statements at that date but does notinclude all the information and footnotes required by generally acceptedaccounting principles for complete financial statements.  For further information, refer to thefinancial statements and footnotes included in GlobalSCAPE’s Annual Report onForm 10-K/A Number 1 for the year ended December 31, 2005.

# **Principlesof Consolidation**

The consolidated financial statements includeall subsidiaries.  Availl became asubsidiary on September 22, 2006; therefore the consolidated financialstatements only include Availl’s financial results and activities from the dateof acquisition until September 30, 2006. All inter-company transactions and balances have been eliminated.

# **Liquidity**

The use of our capitalresources is driven principally by our need to enhance our existing products andto develop or acquire new products.  Theamount of our expenditures has a direct impact on our ability to offer enhancedand new products to our customers.  Ourprincipal source of funds is cash flow from operations which, in turn, ishighly dependent on our sales revenue. During the nine months ended September 30, 2006, the Company generated$2.0 million from operations, which was used along with other funds in theacquisition of Availl, resulting in a net decrease in cash through threequarters of 2006 of ($683,502).

Prior to 2006, we relied heavily on sales of CuteFTP Home and CuteFTPProfessional, which accounted for approximately 50%****and30% of total 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 the resultsof operations of Availl for the entire third quarter, GlobalSCAPE’s historicalrevenues for the three months ended 2006 would have increased by approximately92% over the same period of 2005.

As of September 30, 2006, the Company hadcash and cash equivalents of $1,345,971 and had net working capital of($826,935).  Management believes thislevel of working capital, together with availability under the Company’srevolving credit facility with Silicon Valley Bank and the excess cashgenerated by the profitable operation of the business, is adequate to financethe Company’s current level of operations.

The Company entered into a new loan agreementwith Silicon Valley Bank on September 22, 2006 which involved a $5,000,000 termloan agreement which we used to finance part of the cash portion of thepurchase price for Availl.  The initialinterest rate is 9.5% and is subject to change as the bank’s prime ratechanges.  The term loan matures onSeptember 22, 2009.  Interest andprincipal are payable in 36 equal monthly installments on the first day of eachcalendar month beginning October 1, 2006. The loan agreement also established a $750,000 revolving line of creditfor two years at an interest rate of prime plus 1.0%.  In connection with the term loan and line ofcredit, GlobalSCAPE granted the bank a security interest in all accountsreceivable, equipment, and other tangible and intangible assets.  As of September 30, 2006, the Company had noborrowings under the revolving line of credit agreement.

6

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***Reclassifications***

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

***Sale / Disposal of Assets***

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

**Goodwill**

As of September 30, 2006, GlobalSCAPE hadgoodwill in the amount of $9.7 million associated with the acquisition ofAvaill.  This acquisition was accountedfor using the purchase method of accounting. See Acquisitions note for adescription of the acquisition. In accordance with SFAS No. 142 *Goodwill and Other Intangible Assets*, theCompany will assess the impairment of goodwill annually in the fourth quarter,or more frequently if other indicators of potential impairment arise. Goodwilland other 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) |       | —                           |       | —                           |       | — |   | 9,653,059 |   | — |   | 9,653,059 |   |
|        |       | —                           |       | —                           |       | — |   | 9,653,059 |   | — |   | 9,653,059 |   |

 

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(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 of716,846 shares of GlobalSCAPE common stock. The Company incurred directacquisition costs of approximately $127,000. In connection with theacquisition, $850,000 of the cash consideration in this acquisition was placedinto an escrow account for purposes of settling indemnification claims for theeighteen-month period following the closing. In accordance with EITF Issue No.99-12, *Determination of the Measurement Datefor the Market Price 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 Availlstockholders who were also employees under the GlobalSCAPE, Inc. 2000 StockOption Plan. Exercising the options under this plan is contingent upon theindividual’s continued employment with the Company and will be vested overthree years in three annual installments.

The Availl acquisition was accounted for using thepurchase method of accounting. The purchase price was paid on the September 22,2006 closing date.  The purchase priceincludes a provision for the former Availl stockholders to earn up to anadditional $100,000 in cash depending upon the achievement of certain revenuetargets for Availl for the third and fourth quarters of 2006. The purchaseprice was allocated to the assets acquired, including intangible assets andliabilities assumed, based on estimated fair values at the date of theacquisition. The value of assets and liabilities was estimated based onpurchase 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

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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 |       | (123,872   | )          |
|                                                       |       |       |       |
| Goodwill acquired                                          |       | 9,653,059  |       |
|                                                            |            |            |            |  |

 

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 had occurredat the beginning of each period presented. The pro forma financial informationhas been adjusted for the effect of interest paid on the term loan. The proforma financial information for the combined entities has been prepared forcomparative purposes only and is not indicative of what actual results wouldhave been if the acquisitions had taken place at the beginning of each periodpresented, or of future results.
| ** **                       | ** ** | **Three Months Ended  September 30,**               | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                       | ** ** | **2005**                                                           | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2006** | ** ** |
| ** **                       | ** ** | **(in thousands, except per share data)** | ** ** |
| Pro forma net  revenues          |       | $                                                                  | 2,060      |                                                | $          | 3,308 |   | $ | 5,777 |   | $ | 9,262 |   |
| Pro forma net  income            |       | 369                                                                |       | 374                                                 |       | 667 |   | 1,230 |   |
|                             |       |                                                               |       |                                                |       |   |   |   |   |
| Pro forma net  income per share: |       |                                                               |       |                                                |       |   |   |   |   |
| Basic                            |       | $                                                                  | 0.03       |                                                | $          | 0.03 |   | $ | 0.05 |   | $ | 0.08 |   |
| Diluted                          |       | $                                                                  | 0.02       |                                                | $          | 0.02 |   | $ | 0.04 |   | $ | 0.08 |   |

 

# **Stock-BasedCompensation**

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.

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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 StandardsNo. 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 ofcompensation cost related to stock options recognized in operating results inthe nine months 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 |   |

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The following tablesummarizes information about stock option activity for the nine months endedSeptember 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,the amount of cash received from the exercise of stock options was $28,968 withno associated tax benefit. The following table summarizes informationabout nonvested stock option awards as of September 30, 2006 and changes forthe nine months 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 CommonShare**

Basic and diluted net income per common shareis presented in conformity with Statement of Financial Accounting Standards No.128, “Earnings Per Share” (SFAS 128) for all periods presented. Basic earningsper share is based on the weighted effect of all common shares issued andoutstanding, and is calculated by dividing net income (loss) available tocommon stockholders by the weighted average shares outstanding during theperiod. Diluted earnings per share is calculated by dividing net income (loss)available to common stockholders by the weighted average number of commonshares used in the basic earnings per share calculation plus the number of

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common sharesthat would be issued assuming conversion of all potentially dilutive commonshares outstanding.  Below is areconciliation of the numerators and denominators of basic and diluted earningsper share for each of the periods presented:
|                                                         | ** ** | **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 |   |

 

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(1)          For thethree and nine months ended September 30, 2005, all outstanding options havebeen included in dilutive shares.  Forthe three and nine months ended September 30, 2006, 715,000 options have notbeen included in dilutive shares, as the effect would be anti-dilutive.

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# **Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

This Quarterly Report on Form 10-Q contains “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities and Exchange Act of 1934, asamended.  “Forward looking statements”are those statements that describe management’s beliefs and expectations aboutthe future.  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 securefile management software for individuals and business users to safely send dataover the internet.  Our file managementproducts guarantee the privacy of critical information such as financial data,medical records, customer files and other similar documents.  In addition, these products ensure compliancewith government regulations relating to the protection of information whileallowing users to reduce IT costs, increase efficiency, track and audittransaction and automate processes.  Withthe recent acquisition of 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 and continuousdata backup and recovery to our customers. With these additional capabilities, GlobalSCAPE believes that it is uniquely positioned to providecomprehensive, secure transfer, sharing, and replication of files that need tobe transmitted inside the user’s firewall to distributed offices, or outsidethe user’s firewall to business and trading partners.

The following is a brief description of ourproducts:

·                  **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-AreaFile System (WAFS) Products** –Our WAFS products provide a file sharing and collaboration solutionover multiple sites.  By keeping all data updated on each location’s fileserver, each site has instant access to the very latest version.  Our WAFSproducts help ensure that no one can ever open an old file version without userconflicts. Changes made to dataon any server are mirrored onall other servers.

·                  **Continuous Data Protection (CDP)Products** – Our CDP products consolidate remote backup forfile servers.  As files change, the servers backup in real time to thecustomer’s backup site which can be at the same or a remote location..   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 to perform point-in-time snapshots.

Our strategy is to continue enhancing our file transfer products tomeet the demands of both individual and enterprise users, while improving thesecurity features of our current product line, and to expand into growingmarkets through the acquisition 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.

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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.

##### **Liquidityand Capital Resources**

The Companycontinues to enjoy a strong working capital position resulting from solid netprofits from 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

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issuance of stock from exercised options,while the Availl 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:

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

·                  aratio of total funded debt to EBITDA of not more 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.

**Contractual Obligations**

The following table sets forth the future minimum payments requiredunder contractual commitments at September 30, 2006**:**

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|                                  | ** ** | **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 |   |

 

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

##### **CriticalAccounting Policies**

# ***Use of 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, observabletrends, 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 those products.  Revenues are comprised of the grossselling price of the software, including shipping charges and the earnedportion of support and maintenance agreements. The Company recognizes revenue in accordance with the American Instituteof Certified Public Accountants Statement of Position (“SOP”) 97-2, *Software Revenue Recognition*, as modifiedby SOP 98-9, *Modification of SOP 97-2,Software Revenue Recognition, With Respect to Certain Transactions*.

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

We also sell technicalsupport 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 element arrangementwhereby VSOE of fair value of all undelivered elements exists but VSOE of fairvalue does not exist for one or more delivered elements, revenue is recognizedusing the residual method. Under the residual method, the fair value of theundelivered elements is deferred and the remaining portion of the arrangementfee 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.

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However if sales grow, the balance will increase, resulting in thedeferred recognition of a significant amount of revenue in future 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’s fairvalue determination in future periods, which could require a further permanentwrite-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 andcurrent credit evaluations.  One customeraccounted for 3.6% of revenues in the first nine months of 2005. In the firstnine months of 2006, no single customer individually accounted for more than 2%of net revenues.

***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.

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

 

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(1)          On a pro forma basis,when including the results of operations of Availl for the entire thirdquarter, total revenues would have been approximately $3,308,000, an increaseof approximately 92% over GlobalSCAPE’s historical revenues for the same periodof 2005.

***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 2006 respectively.  SecureFTP Server and Enhanced File Transferaccounted for approximately 50% and 66% of total revenues for the three monthsended 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 Server andEnhanced File Transfer, continue to grow. Maintenance and support pricing isreflective 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 ended September30, 2005 to $145,646 for the three months ended September 30, 2006 as a resultof higher royalty payments on increased sales of Cascade Server, an enterpriseweb 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,

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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, strategicdevelopment, and other areas, and commissions and bonuses increased 10% overthe same period last year based on the increase in revenues. As required byFAS123R, we expensed $84,398 in the third quarter of 2006 for stock basedcompensation 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 thirdquarters of 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 was largely a result of the 37% increase in revenues even after thesubstantial offset 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 | % |

 

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(1)          On a pro forma basis,when including the results of operations of Availl for the entire nine-monthperiod ended 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.

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***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 ninemonths ended September 30, 2006 for stock based compensation related to thegranting of 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.

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

 

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

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

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.

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**PartII.  Other Information**

 

**Item 1.****    Legal Proceedings**

 

 We arenot currently involved in any material legal proceedings.

**Item 1A.**     Risk Factors.

  Inaddition to the other information set forth in this report, you shouldcarefully consider the factors discussed in Part I, “Item 1A. Risk Factors” inour Annual Report on Form 10-K for the year ended December 31, 2005, whichcould 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 itscommon stock to three former stockholders of Availl pursuant to the exemptionset forth in Section 4(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**

 None in the thirdquarter 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         Loanand Security Agreement dated September 22, 2006, by and between GlobalSCAPE,Inc. and Silicon Valley Bank. (Previously filed as Exhibit 10.1 to GlobalSCAPE’s Current Report onForm 8-K filed on September 27, 2006)

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

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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.

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**Signatures**

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

 
|              | GLOBALSCAPE, INC. |
|-------------------|-------------------|
|              |              |
|              |              |
| December 13, 2006 |              | By: | /s/ Charles R.  Poole |   |
| Date              |              |   | Charles R. Poole |
|              |              | President and  Chief Executive Officer |
|              |              |
| December 13, 2006 |              | By: | /s/ Bernard N.  Schneider |   |
| Date              |              |   | Bernard N.  Schneider |
|              |              | Chief Financial  Officer |

 

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