**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

**FORM 10-K**

**(Mark One)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe fiscal year ended December 31, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe transition period from ________ to ________.**

**CommissionFile No. 000-30617**

**GlobalSCAPE, Inc.**

(Exact name of registrantas specified 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)

Securitiesregistered pursuant to Section 12(b) of the Act:

**None**

Securitiesregistered pursuant to Section 12(g) of the Act:

**Common Stock, par value$0.001 per share**

(Title of Class)

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o   No  x

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  o   No  x

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes  x   No  o

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K (§ 229.405 of this chapter) is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K.  o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act (check one):

Large Accelerated filer  o            Acceleratedfiler  o            Non-Acceleratedfiler  x

Indicate by check mark if the registrant is a shellcompany (as defined in Rule 12b-2 of the Act).  Yes  o   No  x

The aggregate marketvalue of the registrant’s outstanding common stock held by non-affiliates wasapproximately $11,147,000 as of the last business day of the registrant’s mostrecently completed second fiscal quarter, based upon the closing sales price of$2.50 per share on such date on the NASD’s OTC Bulletin Board.

As of March 22, 2007there were 17,225,226 shares of common stock outstanding.

**DocumentsIncorporated by Reference**

Portions of theRegistrant’s Proxy Statement for the 2007 Annual Meeting of Stockholders to beheld on June 1, 2007, are incorporated by reference in Part III hereof.

 

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**TABLE OF CONTENTS**
|            | ** **                                                                                                  | ** ** | **Page** |
|------------|-------------------------------------------------------------------------------------------------------------|------------|----------|
|       | **PART I**                                                                                                  |       |     |
| Item  1.   | Business                                                                                                    |       | 1        |
| Item  1A.  | Risk  Factors                                                                                               |       | 10       |
| Item 1B.   | Unresolved Staff  Comments                                                                                  |       | 17       |
| Item  2.   | Properties                                                                                                  |       | 17       |
| Item  3.   | Legal  Proceedings                                                                                          |       | 17       |
| Item 4.    | Submission of  Matters to a Vote of Security Holders                                                        |       | 17       |
| Item 4A.   | Executive  Officers of the Company                                                                          |       | 17       |
|       | **PART II**                                                                                                 |       |     |
| Item 5.    | Market for  Registrant’s Common Equity and Related Stockholder Matters and Issuer  Purchases of Equity |       | 20       |
| Item 6.    | Selected Financial  Data                                                                                    |       | 22       |
| Item 7.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operation                  |       | 23       |
| Item 7A.   | Quantitative  and Qualitative Disclosures About Market Risk                                                 |       | 31       |
| Item 8.    | Financial  Statements and Supplementary Data                                                                |       | 33       |
| Item 9.    | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                       |       | 58       |
| Item 9A.   | Controls and  Procedures                                                                                    |       | 58       |
| Item 9B.   | Other Information                                                                                           |       | 58       |
| ** ** | **PART III**                                                                                                |       |     |
| Item 10.   | Directors,  Executive Officers and Corporate Governance                                                     |       | 59       |
| Item 11.   | Executive  Compensation                                                                                     |       | 59       |
| Item 12.   | Security Ownership  of Certain Beneficial Owners and Management and Related Stockholder Matters             |       | 59       |
| Item 13.   | Certain  Relationships and Related Transactions, and Director Independence                                  |       | 59       |
| Item 14.   | Principal  Accountant Fees and Services.                                                                    |       | 59       |
| ** ** | **PART IV**                                                                                                 |       |     |
| Item 15.   | Exhibits,  Financial Statement Schedules                                                                    |       | 60       |

 

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**PreliminaryNotes**

GlobalSCAPE®, CuteFTP®, CuteSITE Builder®, PureCMS®,CuteZIP®, CuteHTML® and CuteMAP® are registered trademarks of GlobalSCAPETexas, LP.  GlobalSCAPE Secure FTP Server, GlobalSCAPE Transfer Engine,and GlobalSCAPE Enhances File Transfer Server are trademarks of GlobalSCAPETexas, LP.  Other trademarks and tradenames in this Annual Report are theproperty of their respective owners.

In this report, we use the following terms:

“HTTP” or Hyper Text Transfer Protocol is a protocolcommonly used to transfer hypertext documents between a web server and a webbrowser.

“S/Key” is a security system in which a one-timechallenge-response password scheme is used to authenticate access to data.  The purpose of S/Key is to eliminate the needfor the same password to be sent over a network each time a password is neededfor access.

“SSH2” or Secure Shell is a protocol that providesencrypted network communications between two computers.

“SSL” or Secure Socket Layer uses cryptography toencrypt data between the web server and the web browser.

**Forward-Looking Statements**

This Annual Report on Form 10-K and the documentsincorporated by reference herein contain “forward-looking statements” withinthe meaning of Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities and Exchange Act of 1934, as amended.  “Forward-looking statements” are thosestatements that are not of historical fact, but describe management’s beliefsand expectations.  We have identifiedmany of the forward-looking statements in this Annual Report by using wordssuch as “anticipate,” “believe,” “could,” “estimate,” “may,” “expect,” and “intend.”  Although we believe these beliefs andexpectations are reasonable, our operations involve a number of risks and uncertainties,including those described in the “Risk Factors” section of this Annual Reportand other documents filed with the Securities and Exchange Commission.  Therefore, GlobalSCAPE’s actual results coulddiffer materially from those discussed in this Annual Report.

**PART I**

**Item 1.**                          Business

**Company Overview**

We develop and distribute secure file managementsoftware for individuals and business users to safely send data over theinternet and Wide-Area File System (WAFS) collaboration and Continuous Data Protection(CDP) products.  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 audittransactions and automate processes.  OurWAFS and CDP products provide data replication, acceleration of file transfer,sharing/collaboration and continuous data backup and recovery to ourcustomers.  We believe that we areuniquely positioned to provide secure transfer, sharing, and replication offiles that need to be transmitted inside the user’s firewall to distributedoffices, or outside the user’s firewall to business and trading partners.

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Our initial product,CuteFTP, a file transfer protocol client program, was first distributed in 1996and has achieved significant success and popularity.  We built on this success by steadily addingcomplementary products and believe we now have a reputation as a provider ofeasy-to use, affordable software for both individual and enterprise users.  Since 2000, we have focused on enhancing ourportfolio of products to meet the increasing demand for data security,overcoming the challenges of latency and bandwidth limitations for supportingbranch offices and geographically distributed locations, allowing enterprisesto backup data across their LAN and WAN as changes are made, and offering solutionsthat permit non-technical personnel to contribute content to theirorganizations’ Web sites.  Our softwareis used worldwide across a wide range of industries.  Through the end of 2006, we had soldapproximately 1.6 million software licenses and our customer base includesindividual consumers, small to medium-sized businesses, as well as some of thelargest corporations in the world.

**Industry Background**

The internet has become an integral part of operationsfor companies of all sizes, not only for e-commerce, but also as a means ofmanaging information between central and remote locations and with employees,partners and suppliers.  Corporateinformation managers must protect business assets, ensure that policies andprocesses meet regulations governing the management of sensitive information,and ensure that the right people have access to the right information at theright time.  Global operations, diversebusiness partners and networks further emphasize the need for common standardsto ensure compatibility, scalability and cost-effective integration.

Organizations that use the internet for data transferare also faced with a daunting array of security challenges stemming fromvarious regulatory and business requirements for data privacy and confidentiality.  Regulatory and privacy requirements includelegislation such as the Health Insurance Portability and Accountability Act(HIPAA), California Senate Bill (SB) 1386, and the Gramm-Leach-Bliley Act(GLBA) in the US, and the European Union’s Privacy Directive, some of whichimpose severe penalties for improper disclosure of confidentialinformation.  Additionally, industrybest-practices and self-imposed business requirements include intellectualproperty and trade secrets protection and controls regarding disclosure ofproprietary information to minimize corporate risk from the devastatingconsequences of security breaches.  Ascorporate Web operations mature, we believe we will see an increasing demandfor solutions to facilitate secure file transfers on the internet and forproducts that provide data replication, acceleration of file transfer,sharing/collaboration and continuous data backup and recovery.

**Products**

Our current products include Windows®-based, Macbased, browser-based and server software applications.

**FTP Client Programs**

File transfer protocol, or FTP, is the language usedfor file transfers from computer to computer across the internet.  FTP is most commonly used to download a filefrom a server using the internet or to upload a file to a server.

***CuteFTP*.**  CuteFTP is a “client-side” program, meaningthat it permits a user to request a file from or send a file to an FTP serveror host computer.  The user base for thisprogram ranges from corporate IT professionals who use it to transfer databetween locations via the internet, to individual Web site operators who use itto upload their Web pages to their Web hosting provider.  CuteFTP simplifies use of file transferprotocol by hiding the technical processes behind a user-friendly, graphicalinterface, which allows users to “drag `n drop” files between computers.  It includes an automatic reconnection featurethat resumes broken transfers, a transfer queue and a built in HTML editor thatallows remote editing of Web pages. CuteFTP has won several awards, including the CNet Editors’ Choiceaward, and has been favorably reviewed in leading online and print tradejournals such as PC Magazine, WindowsNT, Yahoo Internet Life, CNet’sDownload.com and Tucows, as being the most powerful, easy-to-use file transfer 

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protocol programavailable.  We offer CuteFTP in German,French, Spanish, Japanese and Traditional and Simplified Chinese.  CuteFTP was first released in February 1995by its original author, and was first distributed as a commercial product byGlobalSCAPE in April 1996.  In October2003, GlobalSCAPE released CuteFTP Mac, our easy-to use FTP client for theMacintosh operating system.  CuteFTP Macincorporates many of the popular features of CuteFTP for Windows, whileadhering to Apple’s Aqua® interface and usability guidelines.

***CuteFTP Pro*.**  CuteFTP Pro is a secure FTP client programdesigned for advanced users and information technology professionals.  CuteFTP Pro incorporates standards forencrypted transfers using SSL, HTTP, and SSH2, as well as advanced S/KEYpassword encryption.  It includes variousfeatures attractive to advanced users such as multi-part and concurrent filetransfers to maximize transfer speed, scheduled file transfers, automated sitebackups and scripting ability for automating FTP tasks.  CuteFTP Pro has been favorably reviewed byleading online publications including CNet’s Download.com, ZDNet and PCReview.  CuteFTP Pro was released inMarch 2001 and CuteFTP MAC Pro was released in April 2004.

**File Transfer Servers**

FTP transfers require two software programs:  a client program to start a transfer and aserver to accept the connection.  FTPservers are designed to provide businesses with increased security and speedierfile transport when compared to e-mail.

*** Secure FTP Server*.**  Secure FTP Server complements CuteFTP Pro andother professional FTP clients by enabling encrypted transfers using SSL, SSH2and advanced S/KEY password encryption. When used with CuteFTP Pro, Secure FTP Server offers a complete digitalcertificate management system, giving system administrators the ability tocreate, sign, import, export and add digital certificates, as well as kick offback-end processes.  The latterfunctionality can be used as a partial or total replacement for more complex enterprise-levelelectronic data interchange systems (EDI). Additional features include full remote management capability, theability to operate multiple FTP sites with unique directory structures from asingle server and manage user accounts with advanced restriction settings formaximum security and control.  Secure FTPServer has been favorably reviewed by leading online publications includingServer Watch and File Forum.  GlobalSCAPESecure FTP Server was first released in January 2002.

***Enhanced File TransferServer. ***EnhancedFile Transfer Server is a hardened file server for enterprise-levelsolutions.  Building on Secure FTP Serverwith digital certificate management, Secure SSL and S/KEY password encryption,remote administration, multiple site hosting and management, and extensiveautomation with a full featured event rule library and Component Object Model(COM) extensions, Enhanced File Transfer Server adds repository encryption,additional protocol support, SSH security, data offload capabilities, andautomated notification. The latest version, EFT Server 4, helps customersachieve regulatory compliance with legislation such as HIPAA, Sarbanes-Oxleyand Gramm-Leach by providing security functionalities such as secureauthentication, secure data transfers, secure storage and advanced encryptionand signing.    EFT also offers modules that can beintegrated into the solution such as DMZ Gateway, which provides amulti-layered security solution implementing the highest levels of security fordata storage and retrieval, authentication and firewall transversal and secureSMTP Gateway, which transparently secures outbound e-mails by holding sensitivemessages and sending an e-mail notification in advance of retrieving themessage and any attachments over a secured HTTPS channel.

**Data Replication Products**

Businesses withmultiple locations have a need to access data in a timely, efficient manner andto be able to move and share data throughout their organizations.  Our data replication products allow users tomaintain and synchronize their live data files in multiple remote serverlocations and to restore data to any point in time.

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***Wide Area File System (WAFS)****.*  Our Wide Area FileSystem (WAFS) product delivers a unified and accelerated file access system,instant file-sharing and server-to-server mirroring across any distance, withfull coherency and at local hard-drive access speeds.  WAFS delivers a true wide area file solutionfor any distance, and any number and any complexity of files.  Continuous, real-time multi-directionalacceleration and mirroring technology ensures that data exists in multipleplaces simultaneously and in complete synchronization, no matter where a changein any file is made.  The data mirrorsbetween servers on the LAN, VPN, or crossing firewalls in real time.  In addition, users can leverage FileLocking capabilities across the LAN and WAN. Our WAFS ensures bandwidth efficient WAN utilization; ensures thatusers have access to the most recent data and the off-line mode ensures continuedata access in the event of WAN or Server outage.  Our WAFS software is easy to deploy andmanage remotely.

***CDP****.*  Our continuousbackup software inexpensively delivers true real-time continuous dataprotection.  Our software only solutionsupports the ability to backup any number of branch servers or remote laptopsto one or more centrally located systems.   Availl’s CDPtransparently and continuously captures data from local and remote servers,eliminating the backup window and restoring data instantly. Bandwidthrequirements are minimal since only file differences are transferred to thebackup system.

***DatabaseBackup****.*  Our continuous database backup/disasterrecovery software inexpensively delivers real-time disaster preparedness fordatabase information.  Any changes todatabase files are continuously captured and mirrored as they occur in realtime.  The product replicates any numberof database files, and non-database files, of any size from one or more sourcefile-servers to one or more target file-servers over any connections.

***Enterprise****.*  Enterprise isdesignated for companies that need both WAFS or multi-directional mirroring andreal-time backup.  It includes all thefeatures of the entire WAFS and CDP product line.

**WebContent Management**

Content management generally refers to software thatstreamlines the process for managing information on a Web site or intranet.

***Cascade Server***.  Cascade Server (formerly PublishXML) is ourWeb content management solution.  Theproduct is designed to solve basic problems endemic to maintaining currentinformation on a Web site such as bottlenecks in the IT department, lack ofcontrol and accountability, and miscommunication between content authors andWeb developers.  GlobalSCAPE markets theproduct on its website and provides all leads to Hannon-Hill Corp.  Hannon-Hill acts as the sales agent for thisproduct, and revenues from the sales are split based upon an agreement betweenthe parties with all invoicing and collections being processed byGlobalSCAPE.  Using Cascade Server,developed by Hannon-Hill, a company’s Web administrator may give non-technicalpersonnel the ability to directly revise designated content.  For example, the marketing department couldmodify pricing, product descriptions and graphics while the human resourcesdepartment updated its job postings, all without the involvement of technicalpersonnel.  Access by non-technicalpersonnel is limited, however, so that the Web site administrator’s ability toprotect the overall infrastructure and design of the site is notcompromised.  The program isbrowser-based with a Windows-like interface, so users can easily access andwork on Web sites, eliminating the need for special training.  Changes are made to a copy of an organization’sWeb site in a staging area and published to the live site only after groupleaders or Web site administrators approve the content for publishing.  Additional features include WYSIWYG (what yousee is what you get) editing, visual comparison of proposed changes to the livesite, e-mail notification of changes and activity, site statistics, versioningand archiving.  Cascade Server works withany Web site development tool including popular applications such as Front Pageand Dreamweaver, and can be implemented without deconstructing (re-building)the existing Web site.  The program isscaled to meet the needs of small to medium-sized businesses, but can be usedby large organizations for intranet or independent Web site management.  Cascade Server was released in April 2004under the name PublishXML.

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**Internet Products**

Weoffer a variety of software products that can be purchased and downloadeddirectly from our automated website. These products range in price from $3.99 to $249.00 for a singlelicense.  Products for web page contentmanagement and design include CuteHTML, CuteHTML Pro and CuteMAP.  We also offer CuteZIP, a file compressionproduct.

Theseproducts are easy to install and use, making them good products to attractusers to our website.

**RecentDevelopments**

On September 22, 2006, we and our wholly-ownedsubsidiary, GA Acquisition Corp., entered into an agreement and plan of mergerwith Availl, Inc. and the stockholders of Availl pursuant to which we acquiredall of the issued and outstanding shares of the capital stock of Availl.  The initial purchase price was $9.65 millionof which $7.65 million was paid in cash and $2.0 million was payable in sharesof our common stock (a total of 716,846 shares).

In order to finance the cash portion of the purchaseprice in the merger with Availl, we entered into a loan and security agreementdated September 22, 2006 with Silicon Valley Bank.  The loan agreement provides for a $5.0million term loan and a $750,000 revolving credit facility. The term loan bearsinterest at 1.25% above the bank’s prime rate and matures on September 22,2009.  Interest and principal are payablein 36 equal monthly installments on the first day of each calendar monthbeginning October 1, 2006.  The term loanmay be prepaid at anytime. We borrowed $5.0 million pursuant to the term loanon September 22, 2006 and, in addition to the regular monthly payments, werepaid $3.2 million and $.5 million on January 10, 2007 and February 16, 2007respectively.   The entire amount of therevolving credit facility remains available. Borrowings under the revolving credit facility bear interest at 1.00%above the bank’s prime rate and mature on September 22, 2008.  Interest payments are due on the first day ofeach calendar month.

We entered into a securities purchase agreement, datedNovember 13, 2006, with certain accredited investors, who paid us an aggregateof $3.4 million in gross proceeds in consideration for 1,352,000 shares of ourcommon stock at a price of $2.50 per share. We also granted warrants to purchase 1,352,000 shares of our commonstock to the investors with an exercise price of $3.15 per share.  The proceeds from this offering were used, inpart, to make the $3.2 million repayment under our term loan in January2007.  In addition, Thomas W. Brown, theChairman of the Board, and David L. Mann, a member of our board of directors,sold a total of 2,028,000 shares, at a price of $2.50 per share in a privatetransaction with the investors.  Thetransactions closed on November 16, 2006. Each of the investors that purchasedshares of our common stock represented that it had acquired the shares forinvestment purposes only and with no present intention of distributing thoseshares, except in compliance with all applicable securities laws. In addition,each of the investors represented that it qualified as an “accredited investor”as that term is defined in Rule 501 under the Securities Act of 1933. As partof this transaction, we filed a registration statement to register the resaleof these shares by the investors.

## If the registration statement is not declared effective by the SEC by April15, 2007,  the effective date specifiedin the securities purchase agreement, then in addition to any other rights thepurchasers may have under the registration rights agreement, on each monthlyanniversary of the specified effective date, until the registration is declaredeffective, the Company shall pay to each holder of the registrable securitiesan amount in cash as partial liquidated damages equal to 1.5% of the aggregatepurchase price for any of the shares sold by the Company; provided thatliquidated damages shall not exceed 12% of the aggregate purchase price. TheCompany has not accrued any liquidated damages as of December 31, 2006.

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##  

**Strategy**

Our goal is to build uponour successful market position in FTP, WAFS and CDP, to provide business userswith secure and efficient solutions for their growing file access, filetransfer, and data replication and protection needs.  We continue to enhance and develop high quality,affordable software that enables organizations and individuals to easilycreate, move and manage Web and file-based data in a secure, collaborativeenvironment.  We have successfullyestablished a brand in the market for internet software productivity tools withour file management products, CuteFTP and CuteFTP Pro.  We believe that our continued growth willcome not only through the further development of our SecureFTP Server andEnhanced File Transfer products and the growing demand for file security whentransferring information across the internet, but also through the aggressivesales and marketing of our WAFS and CDP products, which represent two highgrowth markets that are new markets for GlobalSCAPE.  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.

GlobalSCAPE believes thatour products represent a low cost solution for businesses for their access,secure file transfer, and data replication and protection requirements becausewe do not require the purchase of a whole suite of products. Our Secure FTPServer, Enhanced File Transfer, WAFS and CDP products offer modules to form thecomprehensive solutions needed by businesses to solve their particular needs.Maintenance and support agreements are purchased with most of our higher-endserver products by businesses. We will also continue to market our contentmanagement solutions that help non-technical professionals manage theirorganization’s Web sites without reliance on information technologyprofessionals.

Key elements of our strategyare:

***Continue to enhance anddevelop security features of our products. ***Corporateand individual users are increasingly concerned with security and datareplication and protection.  We haveadded the Enhanced File Transfer (EFT) enterprise solution to our product linefor businesses to meet the needs of security issues when transferring files inand out of their servers across the internet and we acquired Availl in 2006 inorder to offer customers a data replication and protection solution.  We intend to continue to develop and addfeatures throughout 2006 to meet the demand for file transfer security and datareplication and protection through Enhanced File Transfer Server, WAFS and CDPand to consumers and smaller businesses through our other well known FTPproducts, CuteFTP Home and CuteFTP Professional and Secure FTP Server.

***Pursue strategic productand acquisition opportunities*****.**  In 2005, we added modules and furtherdeveloped our Secure FTP Server and EFT products.  In September 2006, we acquired Availl whichallowed us to add our WAFS and CDP products. We will continue to look for opportunities to develop, acquire or addsynergistic products or technologies that enhance the success of theseproducts.

***Continue sales of CascadeServer. ***We have invested considerable time and effortin the marketing of Cascade Server (formerly PublishXML), our contentmanagement product introduced in April 2004. We continue to believe that the demand for Web content managementsolutions is strong.  We have releasednew versions of this product and continue to evaluate all aspects of ourmanagement of this product, including pricing, ease of installation and use,program functionality, and marketing and sales strategies.  We intend to continue to pursue sales anddistribution of this product. In order to concentrate our efforts in this areaon Cascade Server, we discontinued the sale of PureCMS through our salesagreement with Hannon-Hill in 2005.

***Continue to develop a morerobust reseller channel*****.**  During 2005 and 2006, we continued ouremphasis on the development of third party reseller channels by hiring salespeople with reseller sales backgrounds and developing relationships with newresellers. In particular, we attempt to reach “value-

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added”resellers such as system design consultants. We believe sales will be significantly enhanced if we are able torecruit numerous resellers who have existing relationships with prospectivecustomers.

***Increase our maintenanceand support business***.  Maintenance and support contracts are animportant part of our product offering for our Enhanced File Transfer Server, WAFSand CDP.  Our maintenance and supportrevenues increased by 168% from 2004 to 2005 and by 115% from 2005 to 2006.

***Develop internal salesstaff****.* During 2005 and 2006, we continued the development of our internaldirect sales force to better sell more complex products, such as Enhanced FileTransfer, Secure FTP Server, WAFS, CDP and Cascade Server.  We intend to continue to develop our salesstaff through further training and certification.

***Continue to develop onlinemarketing capabilities****. *We believe we have significant expertise in driving online sales viaonline marketing activities, including product placement on third party sitessuch as search engines and referral sites, and electronic mail campaigns.  This type of sales activity is particularlywell suited to certain lower priced products because of the lower cost ofsale.  We intend to continue to leverageour established Web presence to drive online sales as well as supporting directand reseller sales efforts.

**Sales andMarketing**

Since 2003, we have increased our emphasis ondeveloping our internal sales staff and reseller channels to capture thosesales that require personal attention, such as sales of our more complexproducts Enhanced File Transfer Server, WAFS and CDP, sales to larger enterprisesand sales of maintenance and support contracts. We require training, testingand professional development of our sales people to insure that they arecapable of meeting the needs of our customers.

We also sell our FTP Client Programs, Secure FTP Serverand our internet products via download from our Web site, **www.globalscape.com**.  Prospective buyers may use our softwareproducts free during an evaluation period of up to thirty days.  The programs are automatically disabled if alicense is not purchased by the end of the trial period.  Our current products typically range in pricefrom $3.95 to $490.00 per license. Historically, the majority of our software sales have been made onlineusing a credit card.  Our software isalso available for download from a variety of independent internet softwaresites such as CNet’s Download.com, as well as sites in Western Europe, Canada,Australia, and Asia.  We distribute alimited number of copies on CD in Fry’s and Micro Center stores in the UnitedStates and through numerous international resellers.  We provide free customer support via asearchable knowledge base on our Web site and sell “live” support andmaintenance packages.

**Seasonality**

Historically,our internet sales have been subject to seasonal variations. We experiencesignificantly less sales volume during national holidays and weekends whencompared to normal business days.  In thefourth quarter of 2005, our sales revenues decreased approximately 5% over theprior quarter.  However, this trend didnot exist in 2006 where the internet sales increased in the fourth quarter by7% over the third quarter of the same year. Over the past two years internet sales have remained relatively flatwhile sales of our file transfer server products have increased by 130% growingto become 61% of total sales.  As aresult of this change in mix of products and the apparent reversal of theinternet sales seasonality in 2006, we do not expect seasonality to have asignificant impact on sales in 2007.

**Network andEquipment**

We have contracted with various network providers forinternet access.  Our arrangementsprovide for redundancy in the event of a failure, and also for rapid expansionof available bandwidth in the event 

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that there is a dramaticincrease in demand.  To protect criticalcustomer data, GlobalSCAPE’s secure server utilizes Secure Sockets Layerencryption.  We have dedicated servers onand off site and expansion plans in place to allow rapid and cost effectivescalability.

**Research andDevelopment**

Our internal software engineers are responsible forsoftware design, managing the development process, testing and qualityassurance.  We utilize offshoredevelopers for a large portion of the coding phase of software development.  All phases of development, including scopeapproval, functional and implementation design, object modeling andprogramming, are subject to internal quality assurance testing.  Our use of external developers allows us totap into a highly skilled labor pool, maintain a 24-hour development schedule,decrease time to market, and minimize programming costs.

For the years 2004, 2005 and 2006, GlobalSCAPE spentapproximately $728,000, $870,000 and $1,230,400, respectively, on research anddevelopment, all of which were expensed.

**Competition**

The file management, content management and Webdevelopment software market sectors are intensely competitive, subject to rapidchange and are significantly affected by new product introductions and otheractivities of market participants.  Ourprimary competitors vary by product and are listed below.

***CuteFTP*.**  CuteFTP exists in a highly competitiveenvironment with several hundred FTP software utilities available on theinternet.  We believe our primarycompetitors are WS_FTP from Ipswitch, Inc. and FTP Voyager by Rhino Software,Inc.  CuteFTP was the secondWindows-based FTP client to market and is consistently the most frequentlydownloaded FTP client on popular download sites.  CuteFTP Mac, our FTP client for the Macintoshplatform, competes with Fetch, by Fetch Softworks, Interachry, by Stairways Software Pty Ltd., and Transmit FTP,by Panic Inc.

***CuteFTP Pro*.**  CuteFTP Professional competes in the higherend of the same market as CuteFTP, targeting the security-minded ITprofessional.  CuteFTP Professional ispositioned as one of the only secure FTP client programs that support a widerange of security standards related to the FTP protocol.  Competitors in the general FTP market offerproducts that support a smaller subset of these security standards and addressa narrower segment of the secure FTP market. Competitors include Van Dyke, Inc., Ipswitch, Inc., and Rhino Software,Inc.

***Secure FTP Server***.  Secure FTP Server competes against a limitednumber of secure Windows-based FTP servers. We believe our primary competitors are WS_FTP Server and Serve-U.  Secure FTP Server has the advantage ofleveraging the success of CuteFTP Pro through product integration, offeringproprietary extensions to the FTP protocol, and cross-marketing efforts to anexisting customer base.

***Enhanced FileTransfer Server. ***EnhancedFile Transfer Server competes in the managed file transfer server market.  We believe our primary competitors areTumbleweed, Sterling, Proginet, and SSH’s Tectia.  Enhanced File Transfer Server has theadvantage of being very cost effective in its market while leveraging andextending the security and file management features of our other FTP products.

***Cascade Server***.  The “content management” market is diverseand encompasses the areas of knowledge management, document management, digitalasset management and Web content management. Cascade Server is designed for Web content management.  The market for Web content managementsolutions for Fortune 500 companies and other large organizations is dominatedby companies such as Vignette, Interwoven, Documentum, Stellant and Microsoft,each of which offers solutions that can cost hundreds of thousands ofdollars.  We do not intend to compete inthis market but are focused on small to medium-sized businesses with a simpler,affordably priced solution.  We believethat we have a competitive advantage in that we are better known than some ofour competitors among technology professionals who are already familiar withour file management programs, CuteFTP and CuteFTP Pro.

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We offer Cascade Server as a packaged solution.  A “packaged solution” means that we license acopy of the software to the customer for a one-time fee to install and use ontheir own servers.  Our competitorsinclude providers of online solutions, such as Atomz, Crown Peak, and iUpload,and providers of packaged solutions, including Macromedia’s Contribute,Userland, Infosquare and Ektron.  CascadeServer also competes against software that incorporate subsets of Web contentmanagement functions in Web authoring programs, such as Microsoft’s FrontPage,and Macromedia’s Dreamweaver and Contribute.

***CuteHTML*.**  CuteHTML exists in a highly competitiveenvironment with approximately one hundred text-based HTML editors.  CuteHTML’s competition includes HomeSite fromAllaire, Inc.  CuteHTML’s advantage isthat it doesn’t add extraneous code to Web pages, an attribute preferred bymany professional Web masters.

***CuteHTML Pro***.  CuteHTML Pro faces heavy competition fromvisual or “WYSIWYG” editors such as Front Page, by Microsoft, Dreamweaver, byMacromedia Inc, and competition from other direct editors*,*such as Homesite, also by MacromediaInc.  CuteHTML Pro’s advantage is itsappeal to professional Webmasters who typically shun visual editors in favor ofthe extra features and added control provided by direct editors such asCuteHTML Pro.

***CuteMAP*.**  CuteMAP competes against approximately 65image-mapping utilities, which exist in a niche market.  Primary competitors include CoffeeCup ImageMapper, Ulead Smart Saver and MapEdit. CuteMAP has the advantage of being able to leverage the success ofCuteHTML through product integration and cross-marketing efforts to an existingcustomer base.

***CuteZIP*.**  CuteZIP exists in the highly competitive filecompression utility market, competing against several hundred file compressionutilities.  Its main competitors includeWinZIP, the current market leader, and NetZIP. CuteZIP’s main advantage is that it is one of the only compressionutilities offering 128-bit encryption to secure compressed files.  In addition, users can create self-extractingencrypted archives that recipients may open even if they don’t have a ziputility installed.

***WAFS. ***WAFS competes in the Wide Area File System/Storage market.  We believe our primary competitors areRiverbed, Packeteer and Cisco, who are delivering proprietary basedappliances.  WAFS has theadvantage of being a software only solution which leverages corporateinfrastructure and minimizes the total cost of ownership.

***CDP. ***Continuous Data Protection competes in the highly competitive CDPmarket.  We believe our primarycompetitors are CA XOsoft, Doubletake and Symantec/Veritas.  CDP has the advantage of transparently andcontinuously capturing data from local and remote servers, eliminating the backupwindow and restoring data instantly.

We have limited information regarding our products’market shares in their respective categories. Many of our competitors have substantially greater financial, technical,sales, marketing, personnel, and other resources, as well as greater namerecognition and a larger customer base than we do.  Significant competition characterizes themarkets for our products and we anticipate that we will face increasing pricingpressures from competitors in the future. Moreover, given that there are low barriers to entry into the softwaremarket, and the market is rapidly evolving and subject to rapid technologicalchange, we believe that competition will persist and intensify in thefuture.  We have experienced pricedeclines on some products over the last several years.  A reduction in the price of our productswould negatively affect gross margins as a percentage of net revenues, andwould require us to increase software unit sales, in order to maintain netrevenues at existing levels.  For morediscussion on the risks associated with our competition, you should read theinformation under “Risk Factors — Risks Related to Operations.”

 

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**IntellectualProperty**

Our trademarks, copyrights and technology are centralto our business.  We protect ourintellectual property rights through a combination of licenses, trademarks,service marks, copyrights, trade secret laws and restrictions on disclosure.

We currently have registered trademarks forGlobalSCAPE, CuteFTP, CuteFTP Pro, PureCMS, CuteHTML, CuteZIP, CuteMAP andCuteSITE Builder.  We have obtainedUnited States copyright registrations for all but the most recently developedversions of our software applications, and have applied for registration forthe most recently developed versions.

We seek to protect our software, documentation andother written materials under trade secret and copyright laws, which affordonly limited protection.  Despite ourefforts to protect our proprietary rights, unauthorized parties may attempt tocopy aspects of our products or to obtain and use information that we regard asproprietary.  Policing unauthorized useof our products is difficult, and while we are unable to determine the extentto which piracy of our software products exists, software piracy can beexpected to be a persistent problem.  Inselling our products, we rely primarily on click-wrap licenses that are notsigned by licensees, and may be unenforceable under the laws of certainjurisdictions.  In addition, the laws ofsome foreign countries do not protect our proprietary rights to as great anextent as do the laws of the United States. In addition, the number of patents applied for and granted for softwareinventions is increasing.  Consequently,there is a growing risk of third parties asserting patent claims against us. Wehave received, and may receive in the future, communications from third partiesasserting that our products infringe, or may infringe, the proprietary rightsof third parties, seeking indemnification against such infringement orindicating that we may be required to obtain a license or royalty from suchthird parties.  For more discussion onthe risks associated with our intellectual property, you should read theinformation under “Risk Factors,” especially “Risks Related to LegalUncertainty.”

**Employees**

As of March 1, 2007, wehad 56 full-time and part-time employees organized within seven functionalareas.  The employee distributionaccording to function is as follows:

|                                | **Department** | ** ** | ** ** | **Number of  Employees** |
|--------------------------------|----------------|------------|------------|--------------------------|
| Management and  Administration |           | 9          |
| Research and  Development      |           | 5          |
| Quality Assurance              |           | 3          |
| Marketing                      |           | 7          |
| Information Services           |           | 5          |
| Sales                          |           | 16         |
| Customer Support               |           | 11         |

None of our employees arecovered by collective bargaining agreements and we believe our employeerelations are good.

**Item 1A.**                 Risk Factors

We have described below risks that we are aware ofthat could have a material adverse effect on your stock ownership and ourbusiness.

**Risks Related to Operations**

***If weare unable to develop new and enhanced products and services that achievewidespread market acceptance, or if we are unable to continually improve theperformance, features, and reliability of our existing products and services,our business and operating results could be adversely affected.***

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Our future success depends on our ability to respondto the rapidly changing needs of our customers by developing or introducing newproducts, product upgrades, and services on a timely basis.  We have in the past incurred, and we believethat we will continue to incur, significant research and development expensesas we strive to remain competitive.  Newproduct development and introduction involves a significant commitment of timeand resources and is subject to a number of risks and challenges including:

·                                         Managingthe length of the development cycle for new products and product enhancements,which has frequently been longer than we originally expected.

·                                         Adaptingto emerging and evolving industry standards and to technological developmentsby our competitors and customers.

·                                         Extendingthe operation of our products and services to new platforms and operatingsystems.

·                                         Enteringinto new or unproven markets with which we have limited experience.

·                                         Managingnew product and service strategies, including integrating our various securityand storage technologies, management solutions, customer service, and supportinto unified enterprise security and storage solutions.

·                                         Incorporatingacquired products and technologies.

·                                         Developingor expanding efficient sales channels.

·                                         Obtainingsufficient licenses to technology and technical access from operating systemsoftware vendors on reasonable terms to enable the development and deploymentof interoperable products, including source code licenses for certain productswith deep technical integration into operating systems.

If we are not successful in managing these risks andchallenges, or if our new products, product upgrades, and services are nottechnologically competitive or do not achieve market acceptance, we could haveexpended substantial resources and capital without realizing sufficientrevenues in return, and our business and operating results could be adversely affected.

***Fluctuationsin demand for our products and services are driven by many factors and adecrease in demand for our products could adversely affect our financialresults.***

We are subject to fluctuations in demand for ourproducts and services due to a variety of factors, including competition,product obsolescence, technological change, budget constraints of our actualand potential customers, level of broadband usage, awareness of securitythreats to IT systems, and other factors. While such factors may, in some periods, increase product sales,fluctuations in demand can also negatively impact our product sales.  If demand for our products declines, ourrevenues and gross margin could be adversely affected.

***Wemay not be able to develop our sales force as needed to successfully market ournew products.***

Prior to 2005, we relied heavily on internet sales.However, our enterprise programs, Secure FTP Server, Enhanced File Transfer(EFT), WAFS and CDP require a more complex distribution model, including relianceon value-added resellers such as Web development and system consultants. Inaddition, our internal sales force must be skilled at managing a complex andmulti-stage sales process appropriate for these products. We experienced noturnover among our internal sales personnel during 2006.  However when it does occur, the recruitingand training of new employees takes time and can result in a loss of sales dueto the absence of technical skills needed to sell our enterprise type software.Future turnover could 

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have an immediate anddirect effect on our revenues. Continued turnover, especially of key personnel,could cause revenues to decline dramatically.

***Ourproducts are complex and operate in a wide variety of computer configurations,which could result in errors or product failures.***

Because we offer very complex products, undetectederrors, failures, or bugs may occur, especially when products are firstintroduced or when new versions are released. Our products are often installed and used in large-scale computingenvironments with different operating systems, system management software, andequipment and networking configurations, which may cause errors or failures inour products or may expose undetected errors, failures, or bugs in ourproducts.  Our customers’ computingenvironments are often characterized by a wide variety of standard andnon-standard configurations that make pre-release testing for programming orcompatibility errors very difficult and time-consuming.  In addition, despite testing by us andothers, errors, failures, or bugs may not be found in new products or releasesuntil after commencement of commercial shipments.  In the past, we have discovered softwareerrors, failures, and bugs in certain of our product offerings after theirintroduction and have experienced delayed or lost revenues during the periodrequired to correct these errors.

Errors, failures, or bugs in products released by uscould result in negative publicity, product returns, loss of or delay in marketacceptance of our products, loss of competitive position, or claims bycustomers or others.  Many of ourend-user customers use our products in applications that are critical to theirbusinesses and may have a greater sensitivity to defects in our products thanto defects in other, less critical, software products.  In addition, if an actual or perceived breachof information integrity or availability occurs in one of our end-user customer’ssystems, regardless of whether the breach is attributable to our products, themarket perception of the effectiveness of our products could be harmed.  Alleviating any of these problems couldrequire significant expenditures of our capital and other resources and couldcause interruptions, delays, or cessation of our product licensing, which couldcause us to lose existing or potential customers and could adversely affect ouroperating results.

***Wehave grown, and may continue to grow, through acquisitions that give rise torisks and challenges that could adversely affect our future financial results.***

Wehave in the past acquired, and we expect to acquire in the future, otherbusinesses, business units and technologies. Acquisitions involve a number of special risks and challenges,including:

·                  Complexity,time, and costs associated with the integration of acquired businessoperations, workforce, products, and technologies into our existing business,sales force, employee base, product lines, and technology.

·                  Diversionof management time and attention from our existing business and other businessopportunities.

·                  Lossor termination of employees, including costs associated with the termination orreplacement of those employees.

·                  Assumptionof debt or other liabilities of the acquired business, including litigationrelated to alleged liabilities of the acquired business.

·                  Theincurrence of additional acquisition-related debt as well as increased expensesand working capital requirements.

·                  Dilutionof stock ownership of existing stockholders, or earnings per share.

·                  Increasedcosts and efforts in connection with compliance with Section 404 of theSarbanes-Oxley Act.

·                  Substantialaccounting charges for restructuring and related expenses, write-off ofin-process research and development, impairment of goodwill, amortization ofintangible assets, and stock-based compensation expense.

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Ifintegration of our acquired businesses is not successful, we may not realizethe potential benefits of an acquisition or undergo other adverse effects thatwe currently do not foresee.  Tointegrate acquired businesses, we must implement our technology systems in theacquired operations and integrate and manage the personnel of the acquiredoperations.  We also must effectivelyintegrate the different cultures of acquired business organizations into our ownin a way that aligns various interests, and may need to enter new markets inwhich we have no or limited experience and where competitions in such marketshave stronger market positions.

Anyof the foregoing, and other factors, could harm our ability to achieveanticipated levels of profitability from acquired businesses or to realizeother anticipated benefits of acquisitions. In addition, because acquisitions of high technology companies areinherently risky, no assurance can be given that our previous or futureacquisitions will be successful and will not adversely affect our business,operating results, or financial condition.

***Weutilize “open source” software in some of our products.***

The open source software community develops softwaretechnology for free use by anyone. We have relied on open source technology forthe encryption features in our CuteFTP Pro and GlobalSCAPE Secure FTP Serverproducts. Our reliance on open source code software may impose limitations onour ability to commercialize our solution and may subject us to possibleintellectual property litigation.

We incorporate a limited amount of open source codesoftware into our products, and we may use more open source code software inthe future. Open source code may impose limitations on our ability tocommercialize our products because, among other reasons, open source licenseterms may be ambiguous and may result in unanticipated obligations regardingour solution, and open source software cannot be protected under trade secretlaw. In addition, it may be difficult for us to accurately determine thedevelopers of the open source code and whether the acquired software infringesthird-party intellectual property rights. As a result, we could be subject tosuits by parties claiming ownership of what we believe to be open sourcesoftware. Claims of infringement or misappropriation against us could be costlyfor us to defend and could require us to seek to obtain licenses from thirdparties in order to continue offering our solution, to re-engineer our solutionor to discontinue the sale of our solution in the event re-engineering couldnot be accomplished on a timely basis. If this occurs, our business andoperating results could be harmed.

In addition, from time to time there have been claimschallenging the ownership of open source software against companies thatincorporate open source software into their products. We use a limited amountof open source software in our solution and may use more open source softwarein the future. As a result, we could be subject to suits by parties claimingownership of what we believe to be open source software. Any of this litigationcould be costly for us to defend, hurt our results of operations and financialcondition or require us to devote additional research and development resourcesto change our solution.

***If welose key personnel we may not be able to execute our business plan.***

Our future success depends on the continued servicesof key members of our management team. We did not experience turnover in ourmanagement team during 2005, but in 2006 we had two vice president levelemployees leave. These individuals are difficult to replace because of theintense competition for similarly skilled people. In addition, new members ofthe management team may not be productive for weeks or months as they learnabout our products and the administration within GlobalSCAPE.  We were able to replace the losses withcompetent and experienced individuals allowing us to keep moving our productsand revenues forward.

***Wemay not be able to compete effectively with larger, better-positionedcompanies, resulting in lower margins and loss of market share.***

We operate in intensely competitive markets thatexperience rapid technological developments, changes in industry standards,changes in customer requirements, and frequent new product introductions 

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and improvements.  If we are unable to anticipate or react tothese competitive challenges or if existing or new competitors gain marketshare in any of our markets, our competitive position could weaken and we couldexperience a drop in revenues that could adversely affect our business andoperating results.  To competesuccessfully, we must maintain a successful research and development effort todevelop new products and services and enhance existing products and services,effectively adapt to changes in the technology or product rights held by ourcompetitors, appropriately respond to competitive strategy, and effectivelyadapt to technological changes and changes in the ways that our information isaccessed, used, and stored within our enterprise and consumer markets.  If we are unsuccessful in responding to ourcompetitors or to changing technological and customer demands, we could experiencea negative effect on our competitive position and our financial results.

We compete with a variety of companies who havesignificantly greater revenues and financial resources than GlobalSCAPE as wellas greater personnel and technical resources. For example, CuteFTP and CuteFTPPro compete with products offered by Ipswitch, Inc. and Microsoft Corporation,EFT competes with products from Sterling Commerce and several other vendors,and WAFS competes with Riverbed Technology which recently completed an initialpublic offering.  Large companies may beable to develop new technologies more quickly than we can, to offer a broaderarray of products, and to respond more quickly to new opportunities, industrystandards or customer requirements. For example, Sterling Commerce receivesapproximately $50 million in maintenance contract revenue annually, providingthem with significant resources for product development and marketing.  Some competitors may also be able to adoptmore aggressive pricing strategies. For example, Ipswitch gives an older versionof its file transfer protocol program away for free for non-commercial use, andMicrosoft includes file transfer protocol functionality in its internetbrowser, which it distributes for free. Increased competition may result inlower operating margins and loss of market share. Additional competitors mayenter the market and may have significantly greater capabilities and resourcesthan we do.

***Itmay be difficult for us to recruit software developers and other technical andmanagement personnel because we are a relatively small company.***

We compete intensely with other internet softwaredevelopment and distribution companies internationally to recruit and hire froma limited pool of qualified personnel. Some qualified candidates prefer to workfor larger, better known companies. Failure to attract and maintain qualifiedpersonnel would impede our development and maintenance of new and existingproducts.

***Ourability to develop our software will be seriously impaired if we are not ableto use our foreign subcontractors.***

We rely on foreign subcontractors to help us developour software. If these programmers decided to stop working for us, or if wewere unable to continue using them because of political or economicinstability, we would have difficulty finding comparably skilled developers. Inaddition, we would likely have to pay considerably more for the same work,especially if we used U.S. personnel. If we could not replace the programmers,it would take us significantly longer to develop our products.

***We mayincur losses as we attempt to expand our business.***

We intend to expand our business and therefore expectto expend significant additional resources on developing our sales force,developing a more robust reseller program, research and development, marketingand product development. As a result, we may need to expend significantresources to accomplish these goals. If we fail to successfully develop andmarket new products or improve our direct and channel sales results, we may notbe able to achieve the necessary revenue growth and may not be profitable.

***Ouroperations are vulnerable to security breaches that could harm the quality ofour products and services or disrupt our ability to deliver our products andservices.***

Third parties may breach our system security anddamage our products and services or misappropriate confidential customerinformation. This might cause us to lose customers, or even cause 

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customers to make claimson us for damages to them. In addition, we may be required to expend significantresources to protect against security breaches and/or to address problemscaused by such breaches.

***Ourproducts may expose customers to invasion of privacy, causing customerdissatisfaction.***

Our Secure FTP Server and Enhanced File Transfer areintended to provide outsiders access to a customer’s computer, making thecustomer vulnerable to security breaches, which could result in the loss oftheir privacy or property. Customers suffering invasions of privacy or otherharm could result in customer dissatisfaction and possible claims against usfor any resulting damages.

**RisksRelated to Stock Ownership**

***Ourstock is a penny stock, which makes it more difficult to sell.***

A “penny stock” is any stock which is not traded on anational exchange or quoted on NASDAQ and which falls below a selling price of$5.00 per share in the public market. Our common stock is quoted on the NASD’sOTC Bulletin Board and not on an exchange or the NASDAQ, and it has traded from$0.10 to $4.90 since it began active trading in February 2002. The SEC’s pennystock rules require brokers and dealers to take certain steps before trading ina penny stock, making it more difficult to sell a penny stock than other stock.A sale of penny stock does not usually take place as quickly as a sale of otherstock. You may decide to sell your stock when the market price is desirable toyou, but by the time the sale is complete, the price of the stock may havefallen to the point that the sale is no longer desirable. The price of pennystocks is typically more volatile than other stocks, exacerbating this problem.Also, some brokers are unwilling to trade in shares of penny stocks.

***Ourstock price is/may be volatile.***

The trading price of our common stock has been andcould continue to be subject to wide fluctuations in response to certainfactors, including:

·                                         Quarter-to-quartervariations in results of operations;

·                                         Ourannouncements of new products;

·                                         Ourcompetitors’ announcements of new products;

·                                         Ourproduct development or release schedule;

·                                         Generalconditions in the software industry; and

·                                         Investorperceptions and expectations regarding our products, plans and strategicposition and those of our competitors and customers.

In addition, the public stock markets experienceextreme price and trading volume volatility, particularly in high-technologysectors of the market. This volatility has significantly affected the marketprices of securities of many technology companies for reasons often unrelatedto the operating performance of the specific companies. The broad marketfluctuations may adversely affect the market price of our common stock.

***We donot pay dividends on our common stock.***

We have not paid a dividend on our common stock andhave no plan to do so in the near future. In addition, the terms of our revolving credit facility prohibit thepayment of dividends.

***Anti-takeoverprovisions in our charter and Delaware law could inhibit others from acquiringus.***

Some of the provisions of our certificate ofincorporation and bylaws and in Delaware law could, together or separately:

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·                             discouragepotential acquisition proposals;

·                             delayor prevent a change in control; and

·                             limitthe price that investors may be willing to pay in the future for shares of ourcommon stock.

In particular, our certificate of incorporation andbylaws prohibit stockholders from voting by written consent or calling meetingsof the stockholders.  We are also subjectto Section 203 of the Delaware General Corporation Law, which generallyprohibits a Delaware corporation from engaging in any of a broad range ofbusiness combinations with any interested stockholder, as defined in thestatute, for a period of three years following the date on which thestockholder became an interested stockholder.

***Ourdirectors and executive officers  continue to have substantial controlover us***

Our directors and executive officers, together withtheir affiliates and related persons,  beneficially own, in the aggregate,approximately 54% of our outstanding common stock. As a result, these stockholders,acting together, would have the ability to control GlobalSCAPE and direct itspolicies including the outcome of matters submitted to our stockholders forapproval, such as the election of directors and any merger, consolidationor sale of all or substantially all of our assets. In addition, our certificateof incorporation and bylaws provide for our Board of Directors to be dividedinto three classes of directors serving staggered three-year terms.  As aresult, approximately one-third of our Board of Directors will be elected eachyear.

***Stockholders’ownership of our stock may be significantly diluted, affecting the value of thestock.***

There were options for 1,745,560 shares outstandingunder our employee stock option plans as March 1, 2007, of which 630,980 werevested as of March 1, 2007. We have filed a registration statement under theSecurities Act, covering stock issued upon the exercise of options bynon-affiliates, and we may file a registration statement covering options heldby affiliates as well. If we do not file a registration statement coveringaffiliates, affiliates who exercise their options may choose to sell the stockunder an exemption from registration, such as Rule 144 under the SecuritiesAct. The exercise of these options and sale of the resulting stock coulddepress the value of our stock.

**RisksRelate**d**to Legal Uncertainty**

***Weare vulnerable to claims that our products infringe third-party intellectualproperty rights particularly because our products are partially developed byindependent parties.***

We may be exposed to future litigation based on claimsthat our products infringe the intellectual property rights of others. Thisrisk is exacerbated by the fact that some of the code in our products isdeveloped by independent parties or licensed from third parties over whom wehave less control than we exercise over internal developers. In addition, weexpect that infringement claims against software developers will become moreprevalent as the number of products and developers grows and the functionalityof software programs in the market increasingly overlaps. Claims ofinfringement could require us to re-engineer our products or seek to obtainlicenses from third parties in order to continue offering its products. Inaddition, an adverse legal decision affecting our intellectual property, or theuse of significant resources to defend against this type of claim could place asignificant strain on our financial resources and harm our reputation.

***Wemay not be able to protect our intellectual property rights.***

Our software code, and trade and service marks aresome of our most valuable assets. Given the global nature of the internet andour business, we are vulnerable to the misappropriation of this intellectualproperty, particularly in foreign markets, such as China and Eastern Europe,where laws or law 

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enforcement practices areless developed. The global nature of the internet makes it difficult to controlthe ultimate destination or security of our software making it more likely thatunauthorized third parties will copy certain portions of our proprietaryinformation or reverse engineer the proprietary information used in itsprograms. If our proprietary rights were infringed by a third-party, and we didnot have adequate legal recourse, our ability to earn profits, which are highlydependent on those rights, would be severely diminished.

***Othercompanies may own, obtain or claim trademarks that could prevent limit orinterfere with our use of our trademarks.***

Our various trademarks are important to our business.If we were to lose the use of any of our trademarks, our business would beharmed and we would have to devote substantial resources towards developing anindependent brand identity. Defending or enforcing our trademark rights at a localand international level could result in the expenditure of significantfinancial and managerial resources.

**Item 1B.**                 Unresolved StaffComments

None.

**Item 2.**                          Properties

Our corporate office islocated in a technical park in northwest San Antonio called University ParkTech Center II.  Our lease for the 14,700square foot facility expires in September 2008. Our annual rent is approximately $191,000.  Availl is located in an office park in Andover, Massachusetts calledBrickstone Square.  Our lease for the3920 square foot facility expires in October, 2009.  Our annual rent is approximately$90,800.  We believe thesefacilities will be suitable for our current business needs and that suitableadditional space will be available on acceptable terms when needed.

**Item 3.**                          LegalProceedings

We are not currently involved in any material pendinglegal proceedings, but may become subject to legal proceedings in the ordinarycourse of our business.  Such claims mayresult in the expenditure of significant financial and managerial resources.

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

None.

**Item 4A.**                 ExecutiveOfficers of the Company

***Charles R. Poole***.** **Mr.Poole currently serves as GlobalSCAPE’s President and has served in suchcapacity since February 2004.  Mr. Poolealso currently serves as a director of GlobalSCAPE and has served in suchcapacity since February 2004.  FromSeptember 2003 until February 2004, he served as GlobalSCAPE’s Vice Presidentof Sales and Marketing.  Mr. Poole hasover twenty years of experience in senior management and sales withtelecommunications companies, most recently as the President of GlobalSCAPE’sformer parent company, ATSI Communications, Inc., from 1998 - 2001.  Mr. Poole served as a Senior Vice Presidentfor A+ Communications, responsible for paging, cellular and telemessaging salesfrom 1995 - 1997, as General Manager of American Paging, Texas from 1994 -1995, as a Division Manager of Data Documents, Inc. of Omaha, Nebraska from1992 - 1994, as President of GeoCom Partners, a satellite-basedtelecommunications company from 1989 - 1992, as Senior Vice President ofMobileComm (a BellSouth Company) from 1984-1989, and as Regional Vice Presidentof Burroughs Corp (now Unisys) from 1966-1984.

***Jeffrey Gehring****.***  **Mr. Gehring serves as GlobalSCAPE’sVice President of Sales and has been with GlobalSCAPE since November 2004 inthat capacity. Mr. Gehring is responsible for the company’s 

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inbound sales, corporatesales and the reseller program. Mr. Gehring was employed by Nextel Partners asDirector of Sales in 2004, where he coordinated sales across the country. From2003 to 2004, Mr. Gehring was Sales Manager for GlobalSCAPE, performing theduties he presently holds. From 2002 to 2003, Mr. Gehring was a principal in astart up business, ConnectOne Telecom, where he got the business off the groundfrom the organizational stage to operations. Prior to 2002, Mr. Gehring wasDirector of Sales and Marketing at UDP, a telecommunications billing, order management and customerservice software company. In addition to his UDPexperience, he has more than 20 years of operational and sales managementexperience in large and medium-sized businesses, including Unisys, Bell Southand Metrocall. His experience includes strategic planning and implementationfor companies that require rapid growth, as well as establishing processes andpolicies that foster world-class sales organizations.

***Gregory Hoffer.***  Mr. Hoffer serves as Vice President and Chief Technology Officer and hasbeen employed by GlobalSCAPE since May 2000. Mr. Hoffer is responsible foroverseeing all software development and Web development at GlobalSCAPE. Beforejoining GlobalSCAPE, Mr. Hoffer held software development positions at theconsulting firm of Marotz, Inc. Prior to that, Mr. Hoffer managed the ITdepartment and was head of the computer science department at Saint Mary’sHall, a private school in San Antonio, Texas. Mr. Hoffer received a bachelor’sdegree in computer science from Trinity University and is pursuing his master’sdegree in computer science.

***Ellen Ohlenbusch.*** Ms. Ohlenbusch serves as Vice President of Marketing and StrategicAlliances.  She is responsible foroverall marketing strategy and strategic partnerships that encompass technicaland business relationships. She joined GlobalSCAPE in September 2006 via theacquisition of Availl, Inc., where she was Co-Founder and Senior Vice Presidentof Sales and Business Development.   Shewas instrumental in securing initial funding and defining the go to market strategyfor the company’s products and successfully led the rapid growth of the companyrevenue.  Ms. Ohlenbusch has 20+ years ofmarketing, sales, business and corporate development experience with a trackrecord of success in early stage start-up ventures.  Prior to Availl she held the position of VicePresident of Business Development at InfiniumSoftware, a developer ofenterprise business solutions, where she drove partner strategies anddevelopment of product offerings. As founding member of the management team andSr. Vice President of Sales and Corporate Support at Omtool, a developer ofenterprise communication and secure document routing solutions, she developedand implemented the worldwide sales strategy, from the initial enterprise saleto over $38 million in sales and was instrumental in taking the company to asuccessful IPO.  Ms. Ohlenbusch has heldvarious sales and marketing positions with Texas Instruments, Analog Devices,and LTC.

***K.Earl Posey. ***Mr.Posey serves as GlobalSCAPE’s Vice-President of Investor Relations/BusinessOperations. In this capacity he is responsible for mergers and acquisitions,investor relations and human resources. Mr. Posey’s background includes timespent with Black and Decker and Nortel Networks in various positions in humanresources and manufacturing. In addition, he has been a professor at theuniversity level teaching courses in management and labor relations.Immediately prior to joining GlobalSCAPE Mr. Posey was managing principal andfounder of Gossyppia Partners, a consultancy that specialized in thedevelopment of strategic plans for corporations. Mr. Posey did his graduate andpost-graduate work at Vanderbilt University.

***Timothy J. Barton***. Mr. Barton serves asGlobalSCAPE’s Vice President of Operations. He is responsible for productdefinition, development, and testing, and for the GlobalSCAPE IT infrastructureand web site development.  Mr. Bartonjoined GlobalSCAPE in March of 2006 as the Vice President of Product Developmentand Quality Assurance. Prior to joining GlobalSCAPE, he served as ChiefArchitect of Secure Logix Corporation, where he was responsible forrequirements definition and product design. Mr. Barton was employed by SecureLogix form 1998 to 2006 and held positions of Director of Software Engineeringand ETM Development Manager prior to becoming Chief Architect in 2005. Prior toSecure Logix, Mr. Barton held positions of Research Analyst and Senior ResearchAnalyst at Southwest Research Institute where he developed software for the USMilitary and NASA. Mr. Barton holds a B.S. in Computer Science from SlipperyRock University.

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***Bernard Schneider.*** Mr. Schneider serves as GlobalSCAPE’s Chief FinancialOfficer. Prior to joining GlobalSCAPE in June 2006, from 1992 until June 2006,Mr. Schneider served as Chief Financial Officer of Friedrich Air ConditioningCompany. Mr. Schneider’s background also includes time spent with Ernst &Whinney (now Ernst & Young), Litton Industries and Chrysler in variouspositions in consulting and information technology.  Mr. Schneider received his B.S. in Accountingfrom LSU and his MBA from Mississippi College. He received his CPA license inTexas in 1975.

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**PART II**

**Item 5.**                          Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity

Ourcommon stock is listed on the NASD’s OTC Bulletin Board under the symbolGSCP.  As of December 29, 2006, therewere approximately 7,100 holders of record of our common stock representingapproximately 12,000 beneficial owners. GlobalSCAPE stock began trading on February 15, 2002.  The table below sets forth the quarterly highand low bid prices for our common stock for the last two fiscal years.

**Common Stock Price**

|                                      | ** ** | **Fiscal Year ended December 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                           | ** ** | **2005**                                               | ** ** | **2006** | ** ** |
| ** **                           | ** ** | **High**                                               | ** ** | **Low** | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter (ending  March 31)     |       | $                                                      | 0.32       |   | $ | 0.16 |   | $ | 3.17 |   | $ | 1.08 |   |
| Second Quarter (ending  June 30)     |       | $                                                      | 0.40       |   | $ | 0.25 |   | $ | 3.70 |   | $ | 2.21 |   |
| Third Quarter (ending  September 30) |       | $                                                      | 3.00       |   | $ | 0.31 |   | $ | 3.20 |   | $ | 2.54 |   |
| Fourth Quarter (ending  December 31) |       | $                                                      | 4.90       |   | $ | 1.08 |   | $ | 3.35 |   | $ | 2.40 |   |
|                                 |       |                                                   |       |   |   |   |   |   |   |
| Annual                               |       | $                                                      | 4.90       |   | $ | 0.16 |   | $ | 3.70 |   | $ | 1.08 |   |

 

The closing bid price on March 21, 2007 was$2.87.  Over-the-counter marketquotations reflect inter-dealer prices, without retail mark-up, mark-down, orcommission and may not necessarily represent actual transactions.

On December 28, 2006, weapplied for listing of our common stock on the American Stock Exchange.

We have never paid a cash dividend, and do not expectto do so in the foreseeable future.  Theterms of our revolving credit facility prohibit the payment of dividends.

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**Performance Graph**

GlobalSCAPE’scommon stock began trading on the OTC Bulletin Board in February 2002.  The following graph depicts GlobalSCAPE’stotal return to stockholders from February 2002 through December 31, 2006,relative to the performance of the AMEX Computer Technology Index and theS&P Small Cap 600 Index. All of the cumulative total returns are computedassuming the value of the investment in GlobalSCAPE common stock and eachindexed as $100.00 on February 28, 2002 and the reinvestment of dividends atthe frequency with which dividends were paid during applicable years. The stockprice performance shown on the following graph is not necessarily indicative offuture stock price performance.

Thisperformance graph shall not be deemed “filed” for purposes of Section 18of the Exchange Act or otherwise subject to liability under that Section andshall not be deemed to be incorporated by reference into any filing we makeunder the Exchange Act.
| ** **                         | ** ** | ** **    | ** ** | **INDEXED RETURNS** | ** ** |
|------------------------------------|------------|---------------|------------|--------------------------|------------|
| ** **                         | ** ** | **Base**      | ** ** | **Years Ending**    | ** ** |
| ** **                         | ** ** | **Period**    | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Company / Index**      | ** ** | **2-15-2002** | ** ** | **2002**                 | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| **GLOBALSCAPE INC**                | ** ** | **100**       |       | 43.33                    |       | 53.33 |   | 53.33 |   | 799.96 |   | 993.31 |   |
| **S&P SMALLCAP 600 INDEX**     | ** ** | **100**       |       | 76.54                    |       | 112.15 |   | 129.52 |   | 153.21 |   | 164.57 |   |
| **AMEX COMPUTER TECHNOLOGY INDEX** | ** ** | **100**       |       | 68.83                    |       | 102.87 |   | 96.51 |   | 102.84 |   | 113.43 |   |

 

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**Item 6.**                          SelectedFinancial Data

The selected financial data presented below for theyears ended December 31, 2002, 2003, 2004, 2005 and 2006 are derived from ouraudited financial statements.

**Statement of Operations Data:**
| ** **                                                                            | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                            | ** ** | **2002**                                    | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
| Revenues:                                                                             |       |                                        |       |   |   |   |   |   |   |   |   |
| Software product  revenues                                                            |       | $                                           | 5,186,824  |   | $ | 4,734,105 |   | $ | 4,713,191 |   | $ | 6,096,045 |   | $ | 9,395,445 |   |
| Maintenance and  support (net of deferred revenue)                                    |       | 82,679                                      |       | 113,014 |   | 217,469 |   | 582,570 |   | 1,578,236 |   |
| Total revenues                                                                        |       | 5,269,503                                   |       | 4,847,119 |   | 4,930,660 |   | 6,678,615 |   | 10,973,681 |   |
| Operating expenses:                                                                   |       |                                        |       |   |   |   |   |   |   |   |   |
| Cost of revenues  (exclusive of depreciation and amortization shown separately below) |       | 353,918                                     |       | 532,910 |   | 371,242 |   | 279,964 |   | 468,515 |   |
| Selling, general  and administrative                                                  |       | 3,580,361                                   |       | 3,613,759 |   | 3,456,598 |   | 3,986,047 |   | 6,142,299 |   |
| Research and  development                                                             |       | 848,212                                     |       | 945,395 |   | 727,423 |   | 869,155 |   | 1,230,400 |   |
| Depreciation and  amortization                                                        |       | 544,063                                     |       | 390,154 |   | 171,834 |   | 98,071 |   | 99,213 |   |
| Settlement with  ATSI Comm. Inc.                                                      |       | 392,905                                     |       | - |   | - |   | - |   | - |   |
| Total operating  expenses                                                             |       | 5,719,459                                   |       | 5,482,218 |   | 4,727,097 |   | 5,233,237 |   | 7,940,427 |   |
| Income (loss) from  operations                                                        |       | (449,956                                    | )          | (635,099 | ) | 203,563 |   | 1,445,378 |   | 3,033,254 |   |
| Interest expense, net                                                                 |       | 11,783                                      |       | (5,016 | ) | (1,651 | ) | (620 | ) | (128,362 | ) |
| Interest income                                                                       |       | -                                           |       | - |   | - |   | 10,685 |   | 60,639 |   |
| Gain (loss) on sale of  assets                                                        |       | -                                           |       | (1,486 | ) | - |   | 1,242 |   | 619 |   |
| Income (loss) before  provision for income taxes                                      |       | (438,173                                    | )          | (641,601 | ) | 201,912 |   | 1,456,685 |   | 2,966,150 |   |
| Total income tax  provision (benefit)                                                 |       | 175,202                                     |       | 1,400 |   | 1,489 |   | 9,981 |   | 1,003,618 |   |
| Net income (loss)                                                                     |       | ($613,375                                   | )          | ($643,001 | ) | $ | 200,423 |   | $ | 1,446,704 |   | $ | 1,962,532 |   |
| Net income  (loss) per common share - basic                                           |       | ($0.05                                      | )          | ($0.05 | ) | $ | 0.01 |   | $ | 0.10 |   | $ | 0.13 |   |
| Net income (loss) per  common share -assuming dilution                                |       | ($0.05                                      | )          | ($0.05 | ) | $ | 0.01 |   | $ | 0.09 |   | $ | 0.12 |   |
|                                                                                       |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

** **

**Balance Sheet Data:**

** **
| ** **                                                                | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                | ** ** | **2002**              | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
|                                                                      |       |                  |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                                |       | $                     | 480,609    |   | $ | 342,433 |   | $ | 572,959 |   | $ | 2,029,473 |   | $ | 4,632,666 |   |
| Working capital                                                           |       | 368,567               |       | 19,203 |   | 341,749 |   | 1,741,354 |   | 2,749,266 |   |
| Total assets                                                              |       | 1,412,042             |       | 918,278 |   | 971,857 |   | 2,901,671 |   | 16,367,749 |   |
| Long term debt  including capital lease obligations, less current portion |       | 15,477                |       | — |   | — |   | — |   | 3,076,698 |   |
| Cash dividends per common share                                           |       | $                     | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |

##  

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##  

**Item 7.**                          Management’sDiscussion and Analysis of Financial Condition and Results of Operation

The following Management’s Discussion and Analysis ofFinancial Condition and Results of Operations should be read in conjunctionwith our financial statements for the years ended December 31, 2004, 2005and 2006 and related notes included elsewhere in this document.

**Overview**

We develop and distribute secure file managementsoftware for individuals and business users to safely send data over theinternet and Wide-Area File System (WAFS) collaboration and Continuous DataProtection (CDP) products.  Our filemanagement products guarantee the privacy of critical information such asfinancial 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.  OurWAFS and CDP products provide data replication, acceleration of file transfer,sharing/collaboration and continuous data backup and recovery to ourcustomers.  We believe that we areuniquely positioned to provide secure transfer, sharing, and replication offiles that need to be transmitted inside the user’s firewall to distributedoffices, or outside the user’s firewall to business and trading partners.

The following is a brief description of our products:

·                                         FileManagement Products — Our File Management products are best known for the “CuteFTP”product line. They primarily consist of products that help users securely moveand copy files on the internet. A substantial portion of our revenues arederived from licensing our File Management products. Some of our productsencrypt the transfers for security using technology similar to a Web browser.The products consist of three product categories; client, server andcompression transfer. Our File Management product line includes CuteFTP Home,Cute FTP Professional, SecureFTP Server, and Enhanced File Transfer.

·                                         Wide-AreaFile System (WAFS) Products — Our WAFS products provide a file sharing andcollaboration solution over multiple sites. By keeping all data updated on each location’s file server, each sitehas instant access to the very latest version. Our WAFS products help ensure that no one can ever open an old fileversion without user conflicts. Changes made to data on any server are mirroredon all other servers.

·                                         ContinuousData Protection (CDP) Products — Our CDP products consolidate remote backup forfile servers.  As files change, theservers backup in real time to the customer’s backup site which can be at thesame or a remote location.   The backupserver can keep any number of past versions of each file (and deleted files)which gives the customer instant restore, as well as the ability to performpoint-in-time snapshots.

Our strategy is to continue enhancing our filetransfer products to meet the demands of both individual and enterprise users,while improving the security features of our current product line, and toexpand into growing markets through the acquisition of compatible companies andproducts.  We acquired Availl, a leadingprovider of Wide-Area File System (WAFS) collaboration and continuous dataprotection (CDP) products as part of this strategy.  This acquisition expands our technology baseinto data replication, acceleration of file transfer, sharing/collaboration andcontinuous data backup and recovery.  Webelieve that these new products give us entry into two large and rapidly growingmarkets.

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We believe that our continued growth will come notonly through the further development of our SecureFTP Server and Enhanced FileTransfer products and the growing demand for file security when transferringinformation across the internet, but also though the aggressive exploitation ofthe data replication and protection markets. Based upon estimates by Gartner, Inc., and other consulting groups inour markets, we believe that the WAN optimization/WAFS market is currently $300million annually and growing at 20% - 30% per year, and the CDP market is ofsimilar size but in the early stages of adoption and growing rapidly.  In addition, we believe that the WAFS and CDPproducts are highly complementary to our traditional Secure File Transferproducts facilitating cross sales and new customer penetration.

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

The Company continues to enjoy a strong workingcapital position resulting from solid net profits from operations over the lasteleven quarters, including the quarter ended December 31, 2006. ** **During September2006, the Company deployed $3.3 million of its cash as part of the cashconsideration in the acquisition of Availl. At December 31, 2006, we had cash available of $4.6 million and wecontinue to generate cash in excess of our operational needs.  In addition, the Company has a $750,000 lineof credit with Silicon Valley Bank which is unused at this time.

Our capital requirements principally relate to ourneed to enhance our existing products and to develop new products.  The amount of our capital expenditures has adirect impact on our ability to offer enhanced and new products to ourcustomers.  We rely heavily on cash flowsfrom operations and these cash flows, prior to 2006, were significantlydependent upon sales of CuteFTP Home and CuteFTP Professional, which accountedfor 50%****and 30% of our revenues in the yearsended December 31, 2005 and 2006, respectively. The sales of these products have remained relatively flat over the priortwo years while becoming an increasingly smaller portion of our totalrevenue.  Much of the percentage declineof revenues from the sale of these two products was caused by significantincreases in the sales of other products in 2006, namely, SecureFTP Server andEnhanced File Transfer, which collectively accounted for 43% and 61% of ourrevenues in the years ended December 31, 2005 and 2006, respectively.  Revenues in total increased 64% whencomparing 2006 to 2005.   On a pro formabasis, when including the results of operations of Availl for the entire year,GlobalSCAPE’s historical revenues for the year ended December 31, 2006 wouldhave increased by approximately 81% over 2005.

Our principal sources of capital are cash on hand andcash flow from operations.  To the extentthat sales decline, 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 under our revolving line of credit and, if necessary,we may also sell equity securities or enter into other credit arrangements inorder to finance future acquisitions or licensing activities.

Net cash provided by operating activities was$384,314, $1,549,636 and $2,604,274 in 2004, 2005 and 2006, respectively.  In 2004, net cash provided resulted from anincrease in net income primarily as a result of increased revenues, adjustmentsrelated to depreciation and amortization as well as decreased accountsreceivable.  Net cash provided byoperating activities in 2005 was primarily due to an increase in net incomeresulting from increased revenues plus the favorable cash impact of deferredrevenue, offset by an increase in accounts receivable.  Net cash provided by operating activities in2006 was primarily due to an increase in net income resulting from increasedrevenues plus the favorable cash impact of deferred revenue, stock compensationexpense, and accounts payable.  Thesecash generating items were offset by an increase in accounts receivable and adecrease in federal income taxes payable.

Net cash used in investing activities for 2004, 2005and 2006 was $42,250, $102,062 and $7,745,963, respectively.  The purchase of Availl, Inc. was the primarycause of the significant increase in cash used in investing activities in 2006.  Also in 2004, 2005 and 2006, we capitalizedthe purchase of $42,250, $103,304 and $150,926 in equipment and software,respectively.

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Net cash provided (used) in financing activitiesduring 2004, 2005 and 2006 was ($111,538), $8,940 and $7,744,882,respectively.  In 2004, we made principalpayments on notes payable of $100,000 and made principal payments of $15,294 oncapital lease obligations and received $3,756 for the exercise of stockoptions.  In 2005 and 2006, we received$8,940 and $28,968 respectively for the exercise of stock options.  In 2006, $3,155,068 was received from thesale of common stock resulting from a securities purchase agreement withcertain accredited investors.  And alsoin 2006 the Company obtained a $5 million term loan from Silicon ValleyBank.  We did not enter into any newcapital leases in 2004, 2005 or 2006.

As of December 31, 2006, we had $4,632,666 in cash andcash equivalents, current assets of $6,414,791 and current liabilities of$3,665,525, resulting in working capital of $2,749,266.  The primary components of our currentliabilities at December 31, 2006 were $1,539,455 representing the currentportion of the term loan we incurred in connection with the Availl acquisitionand $1,377,037 of deferred revenues which will be recognized over the remainingterm (one to twelve months) of the maintenance and support contracts.  Besides the term loan, at December 31, 2006,our principal commitments consisted of obligations outstanding under operatingleases as well as royalty agreements with third parties, federal income tax andtrade accounts payable.   The commitmentsrelated to royalty agreements are contingent on sales volumes.  We plan to continue to expend significantresources on product development in future periods and may also use our cash toacquire or license technology, products or businesses related to our currentbusiness.  The facility that we currentlyoccupy is expected to be sufficient for the next twelve months.

In order to finance the cash portion of the purchaseprice in the merger with Availl, GlobalSCAPE entered into a Loan and SecurityAgreement dated September 22, 2006 with Silicon Valley Bank.  The Loan Agreement provides for a $5.0million term loan and a $750,000 revolving credit facility.  The term loan bears interest at 1.25% abovethe 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. We borrowed $5.0 million pursuant to the term loan on September22, 2006 and repaid $4.5 million at March 1, 2007.   The entire amount of the revolving creditfacility remains available.  Borrowingsunder the revolving credit facility bear interest at 1.00% above the Bank’sprime rate and mature on September 22, 2008. Interest payments are due on the first day of each calendar month.

The term loan and the revolving credit facility aresecured by substantially all of the assets of GlobalSCAPE and its subsidiariesincluding Availl.  The Loan Agreementcontains customary covenants including covenants relating to maintaining legalexistence and good standing, complying with applicable laws, delivery offinancial statements, maintenance of inventory, payment of taxes, maintaininginsurance, and protection of intellectual property rights.  GlobalSCAPE and its subsidiaries are alsoprohibited from selling any of their assets other than in the ordinary courseof business, acquiring any other entities, changing the types of business theyare engaged in, incurring indebtedness other than that permitted by the LoanAgreement, incurring any liens on their assets other than those permitted bythe Loan Agreement, making certain investments or paying any dividends on, oracquiring, any shares of their capital stock. The Loan Agreement contains two financial covenants.  GlobalSCAPE and its subsidiaries mustmaintain:

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

·             a ratio of totalfunded debt to EBITDA of not more than 2.00 to 1.00.

At March 22, 2007, wewere in compliance with these covenants.

The loan agreement also contains customary events ofdefault including the failure to make payments of principal and interests, thebreach of principal and interests, the breach of any covenants, the 

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occurrence of a materialadverse change, 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.  The Company failed the first covenant in the fourthquarter of 2006 but received a waiver from the Bank.

The following tablesummarizes our contractual obligations at December 31, 2006, consisting offuture minimum capital lease payments and future minimum payments underoperating leases:
| ** **                   | ** ** | **Payments Due by Fiscal Year** | ** ** |
|------------------------------|------------|---------------------------------|------------|
| **Contractual  Obligations** | ** ** | ** **                      | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| Operating Lease              |       | $281,472                        |       | $190,063 |   | $81,667 |   | — |   | $553,202 |   |
| Equipment Leases             |       | 3,378                           |       | — |   | — |   | — |   | $3,378 |   |
| Term Note                    |       | 4,610,212                       |       | — |   | — |   | — |   | $4,610,212 |   |
| Total Cash Obligations       |       | $4,895,062                      |       | $190,063 |   | $81,667 |   | — |   | $5,166,792 |   |
|                              |            |                                 |            |  |  |  |  |  |  |  |  |  |  |

 

##### **CriticalAccounting Policies**

***Use of Estimates***

Management’s Discussion and Analysis of FinancialCondition and Results of Operations is based upon the Company’s financialstatements, which have been prepared in accordance with accounting principlesgenerally accepted in the Unites States. The preparation of these financial statements requires management tomake estimates and assumptions that affect the reported amount of assets andliabilities.  On an ongoing basis,management evaluates its estimates and judgments, including those related torevenue recognition, allowance for doubtful accounts receivable, long-lived andintangible assets, income taxes and contingencies.  Management bases its estimates on historicalexperience, observable trends, and various other assumptions that are believedto be reasonable under the circumstances. Management uses this information to make judgments about the carryingvalues of assets and liabilities that are not readily apparent form othersources.  Actual results may differ fromthe estimates under different assumptions or conditions.

Management believes the following critical accountingpolicies affect its more significant judgments and estimates used in thepreparation of its financial statements.

***Revenue Recognition***

Our revenue is generated primarily by licensing oursoftware products and providing support for those products.  Revenues are comprised of the gross sellingprice of the software, including shipping charges and the earned portion ofsupport and maintenance agreements.  Inperiods where we had revenue from advertising, we recognized the net proceedsreceived from advertisers as revenue. 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 from the sale of software products arerecognized and completely earned upon shipment or electronic delivery of theproduct provided that persuasive evidence of an arrangement exists, collectionis probable, payment terms are fixed and determinable and no significantobligations remain.  The majority of oursales are delivered electronically via email.

We also sell technical support and maintenanceagreements (post contract customer support “PCS”), which are sometimes bundledwith the software.  When vendor specificobjective evidence (“VSOE”) of fair value exists for all elements in a multipleelement arrangement, revenue is allocated to each element based on the relativefair value of each of the elements.  VSOEof fair value is established by the price charged when the same element is soldseparately.  In a multiple elementarrangement whereby 

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VSOE of fair value of allundelivered elements exists but VSOE of fair value does not exist for one ormore delivered elements, revenue is recognized using the residual method.  Under the residual method, the fair value ofthe undelivered elements is deferred and the remaining portion of thearrangement fee is recognized as revenue, assuming collection is probable.  Revenue allocated to PCS is recognizedratably over the contractual term, typically one year.  We sometimes sell installation and trainingservices with our PureCMS and EFT products. Revenue for installation and training is recognized when performed.

The Company began selling technical support andmaintenance services for some of its software products in 2001.  Deferred revenue grew to a balance ofapproximately $142,000 at December 31, 2002 and remained relatively flat,ending 2003 with a balance of approximately $140,000.  With higher priced support and maintenancefor our enterprise class software products and our efforts to renew agreementsupon their expiration, sales of these agreements grew in 2004, 2005 and 2006 to$217,000, $583,000 and $1,578,000 respectively. Growth in the sales of maintenance and support agreements may result inthe deferred recognition of a significant amount of revenue in future periods.

***Allowance forDoubtful Accounts***

We provide credit, in the normal course of business,to a number of companies and perform ongoing evaluations of our creditrisk.  We require no collateral from ourcustomers and we estimate the allowance for uncollectible accounts based on ourhistorical experience and current credit evaluations.  No single customer accounted for more than 2%of net revenues in 2004 and 2006.  In2005, we had one customer that accounted for approximately 2.7% of netrevenues.

***Valuation of Long-Lived andIntangible Assets***

The Company assesses the impairment of long-lived andintangible assets whenever events or changes in circumstances indicate that thecarrying value may not be recoverable. Factors considered important which could trigger an impairment reviewincluded the following:  significantunderperformance relative to historical or projected future cash flows;significant changes in the manner of use of the assets or the strategy for theoverall business; and significant negative industry trends.  When management determines that the carryingvalue of long-lived and intangible assets may not be recoverable, impairment ismeasured based on the excess of the assets’ carrying value over the estimatedfair value.  No impairment was recognizedin 2004, 2005 or 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-K have not been restated to reflect thefair value method of recognizing compensation cost relating to stock options.

See note 9 to the financial statements under theheading “Stock Options and Stock Based Compensation.”

***Research and Development***

Research and development expenses include all directcosts, primarily salaries for personnel and expenditures with externaldevelopment sources, related to the development of new products and 

27

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significant enhancementsto existing products and are expensed as incurred until such time astechnological feasibility is achieved. For the years 2004, 2005 and 2006, we spent approximately $728,000,$869,000 and $1,230,000, respectively, on research and development.  No research and development expenses werecapitalized in 2004, 2005 or 2006.

***Income Taxes***

GlobalSCAPE accounts for income taxes using theliability method in accordance with Statement of Financial Accounting StandardsNo. 109, *Accounting for Income Taxes*.  The liability method provides that thedeferred tax assets and liabilities are recorded based on the differencebetween the tax bases of assets and liabilities and their carrying amount forfinancial reporting purposes, as measured by the enacted tax rates and lawsthat will be in effect when the differences are expected to reverse.  Deferred tax assets and liabilities arecarried on the balance sheet with the presumption that they will be realizablein future periods when pre-tax income is generated.  Predicting the ability to realize theseassets or liabilities in future periods requires a great deal of judgment bymanagement.  GlobalSCAPE recorded a deferredtax asset at December 31, 2006 of $8,724.

Statement of Financial Accounting Standards (SFAS) No.109 requires a valuation allowance to reduce the deferred tax assets reportedif, based on the weight of the evidence, it is more likely than not that someportion or all of the deferred tax assets will not be realized.  After consideration of all of the evidence,both positive and negative, management determined that a $484,853 valuationallowance at December 31, 2004 was necessary to reduce the deferred tax assetsto the amount that will more likely than not be realized. No allowance wasconsidered necessary at December 31, 2005 or 2006.

##### **Comparisonof Year Ended December 31, 2006 to Year Ended December 31, 2005**

| ** **                                   | ** ** | **2006**    | ** ** | **2005**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|----------------------------------------------|------------|-------------|------------|------------|------------|-------------------|------------|--------------|------------|
| Software product revenues                    |       | $10,973,681 |       | $6,678,615 |       | $4,295,066        |       | 64           | %          |
| Cost of revenues                             |       | 468,515     |       | 279,964    |       | 188,551           |       | 67           | %          |
| Selling, general and administrative expenses |       | 6,142,299   |       | 3,986,047  |       | 2,156,252         |       | 54           | %          |
| Research and development expenses            |       | 1,230,400   |       | 869,155    |       | 361,245           |       | 42           | %          |
| Depreciation and amortization                |       | 99,213      |       | 98,071     |       | 1,142             |       | 1            | %          |
| Total operating expense                      |       | 7,940,427   |       | 5,233,237  |       | 2,707,190         |       | 52           | %          |
| Income (loss) from operations                |       | 3,033,254   |       | 1,445,378  |       | 1,633,556         |       | 110          | %          |
| Other Income (expense)                       |       | (67,104     | )          | 11,307     |       | (78,411           | )          | (693         | %)         |
| Income tax expense                           |       | 1,003,618   |       | 9,981      |       | 993,637           |       | 9,955        | %          |
| Net Income                                   |       | $1,962,532  |       | $1,446,704 |       | $515,828          |       | 36           | %          |

 

***Revenue.***  We derive our revenues primarily fromsoftware sales.  Revenue is comprised ofthe gross selling price of software, including shipping charges and the earnedportion of support and maintenance agreements. Revenues increased approximately 64% from 2005 to 2006, from $6,678,615in 2005 to $10,973,681 in 2006.  Unitvolume increased with approximately 240,000 licenses sold in 2005 versus270,000 sold in 2006.  The 12.5% increasein unit volumes with a richer sales mix of our higher priced enhanced filetransfer offerings resulted in an increase in the average selling price of ourproducts from $29.33 in 2005 to $39.87 in 2006. In addition, the revenue from our Availl acquisition has been includedsince September 22, 2006 and totaled $683,934. In 2005 and 2006, approximately50% and 30%, respectively, of our revenues were generated from sales of CuteFTPand CuteFTP Pro.  Combined sales of theseproducts decreased approximately 4% in revenue year over year. Sales of CuteFTPdeclined approximately 9% while sales of CuteFTP Pro declined approximately 2%.Those changes were the result of the continuing maturity of CuteFTP and CuteFTPPro, and the availability of low cost alternatives to occasional users.  Our reliance on these products may negativelyimpact future results from operations if we are unable to maintain revenuesfrom these products or successfully introduce new product offerings.  

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The small decline insales performance of CuteFTP and CuteFTP Pro was offset by an increase in salesof our Secure Server and Enhanced File Transfer products.  Sales of these products grew from 43% of ourrevenues in 2005 to 61% in 2006.  Thisincrease was the result of an increased emphasis of our internal sales group tomarket and sell these products to meet the needs of businesses to transferfiles in a secure fashion using business or enterprise level software. Inaddition, because of the more complex nature of these products, purchasersrequire increased maintenance and support. As a result, our maintenance and support revenues increased by 171% from2005 to 2006 from $582,570 in 2005 to $1,578,236 in 2006, net of deferredrevenue. Our maintenance and support revenues are generally recognized over thelife of the agreement, which is discussed further under the Deferred Revenuesection of Item 7.

***Cost of Revenues.***  Cost of revenues consists primarily ofroyalties, a portion of our bandwidth costs as well as production, packagingand shipping costs for boxed copies of software products.  Cost of revenues increased by approximately67% between periods from $279,964 in 2005 to $468,515 in 2006 due to a increasein royalty expenses related to our software distribution agreements with thirdparties.  Royalties that we pay onsoftware products licensed from third parties, which we resell, are expensed asa cost of sales when the software product is sold or earlier if therecoverability of any prepaid royalties is in doubt.  Cost of sales as a percent of total revenueswas 4.2% and 4.3% respectively for 2005 and 2006.

***Selling, Generaland Administrative.*** Selling, general and administrative expenses consist primarily ofpersonnel and related expenses, marketing, customer support, professional fees,rent, bad debt and credit card transaction fees.  Selling, general and administrative expensesincreased by approximately 54% from $3,986,047 in 2005 to $6,142,299 in 2006.  A major portion of this increase is attributableto increased wages and commissions which included the employee headcountincrease of fifteen, most of which was associated with the Availlacquisition.  Another large portion ofthe SG&A increase was caused by compensation expense for 2006 required bythe adoption of SFAS 123(r) totaling $497,895 which had no effect on expensesin the prior years.

***Research andDevelopment.*** Research and development expenses increased by approximately 42% from$869,155 in 2005 to $1,230,400 in 2006. Virtually all of the increase wascaused by increases in wages, fringe benefits and contract labor.  A major portion of the increased wages andfringe cost was the result of reclassification of a Vice President levelemployee from marketing to R&D.  Included in the research and development expenses, external developmentcosts decreased approximately 1% from 2005 to 2006.

***Depreciation andAmortization.*** Depreciation and amortization expense consists of depreciation expenserelated to our fixed assets. Depreciation and amortization expense declined by $1,142, orapproximately 1%, year over year. Depreciation expense has declined due to a slowdown in additions tofixed assets in current periods relative to prior periods.

***Other Income(Expense), Net.***  In2005, we had interest expense of $620 related primarily to the financing ofinsurance premiums.  During 2005, we hadinterest income of $10,685 as a result of interest earned on excess cashbalances, and a gain of $1,242 on the sale of fully depreciated fixed assets.During 2006, we had interest expense of $128,362 related primarily to thefinancing of the Availl acquisition, interest income of $60,639 as a result ofinterest earned on excess cash balances and a gain of $619 on sale of fullydepreciated fixed assets.

***Income Taxes.***  The provision for state income taxes in 2005was $1,065 and the provision for federal income taxes was $8,916 in 2005.  GlobalSCAPE’s effective income tax rate is0.7% and differs from the federal rate primarily because of a change in thevaluation allowance for deferred tax assets.  The Company utilized remaining net operating loss carryforwards in 2005to substantially reduce its Federal income tax expense. The provision for stateincome taxes in 2006 was $3,533 and the provision for federal income taxes was$1,000,085 in 2006.  GlobalSCAPE’seffective income tax rate is 34.5% and differs from the federal rate primarilybecause of state taxes.

***Net Income.***  In 2005, net income was primarily the resultof the introduction of our Enhanced File Transfer product and the featuresadded to our Secure FTP Server product, resulting in an increase in 

29

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revenue, while wecontinued to control expenses. In addition, our 2005 income tax expense wasminimized by the use of loss caryforwards from prior years.  Without loss carryforwards in 2006, we paidan additional $993,637 in income taxes and still increased net income by$515,828 over the prior year.  Theincrease in net income was the result of continued growth of sales of theEnhanced File Transfer and Secure FTP Server products.

**Comparison of Year Ended December 31, 2005 to YearEnded December 31, 2004**
| ** **                                   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|----------------------------------------------|------------|------------|------------|------------|------------|-------------------|------------|--------------|------------|
| Software product revenues                    |       | $6,678,615 |       | $4,930,660 |       | $1,747,955        |       | 35           | %          |
| Cost of revenues                             |       | 279,964    |       | 371,242    |       | (91,278           | )          | 25           | %          |
| Selling, general and administrative expenses |       | 3,986,047  |       | 3,456,598  |       | 529,449           |       | 15           | %          |
| Research and development expenses            |       | 869,155    |       | 727,423    |       | 141,732           |       | 19           | %          |
| Depreciation and amortization                |       | 98,071     |       | 171,834    |       | (73,763           | )          | (43          | %)         |
| Total operating expense                      |       | 5,233,237  |       | 4,727,097  |       | 506,140           |       | 11           | %          |
| Income (loss) from operations                |       | 1,445,378  |       | 203,563    |       | 1,241,815         |       | 610          | %          |
| Other Income (expense)                       |       | 11,307     |       | (1,651     | )          | 12,958            |       | (785         | %)         |
| Income tax expense                           |       | 9,981      |       | 1,489      |       | 8,492             |       | 570          | %          |
| Net Income                                   |       | $1,446,704 |       | $200,423   |       | $1,246,281        |       | 622          | %          |

 

***Revenue.***  We derive our revenues primarily fromsoftware sales.  Revenue is comprised ofthe gross selling price of software, including shipping charges and the earnedportion of support and maintenance agreements. Revenues increased approximately 35% from 2004 to 2005, from $4,930,660in 2004 to $6,678,615 in 2005.  Unitvolume decreased with approximately 285,000 licenses sold in 2004 versus240,000 sold in 2005.  The decrease inunit volumes was offset by an increase in the average selling price of ourproducts from $17.43 in 2004 to $29.33 in 2005 as a result of increased salesof our enhanced file transfer offerings. The increase in revenues was up quarter over quarter in 2005 compared tothe same quarters in 2004.  We believethe economic uncertainty in the first three quarters of 2004 contributed tothose periods’ poor performance along with the turnover in our salesforce.  Our fourth quarter revenues in2004 increased approximately 11% over the same quarter in 2003 andapproximately 43% in the fourth quarter 2005 over 2004.

In 2004 and 2005, approximately 69% and 50%,respectively, of our revenues were generated from sales of CuteFTP and CuteFTPPro.  Combined sales of these productsincreased approximately 1% in revenue year over year. Sales of CuteFTP declinedapproximately 22% while sales of CuteFTP Pro increased approximately 18%. Thosechanges were the result of the continuing maturity of CuteFTP and theincreasing demand by business users of CuteFTP Pro. CuteFTP Pro has morefeatures and is designed for business use, whereas CuteFTP is for home useonly. Users are moving to CuteFTP Pro for the advanced features and securitylevels. Our reliance on these products may negatively impact future resultsfrom operations if we are unable to maintain revenues from these products orsuccessfully introduce new product offerings. The relatively flat sales performance of CuteFTP and CuteFTP Pro wasoffset by an increase in sales of our Secure Server and Enhanced File Transfer products.  Sales of these products grew from 14% of ourrevenues in 2004 to 43% in 2005.  Thisincrease was the result of an increased emphasis of our internal sales group tomarket and sell these products to meet the needs of businesses to transferfiles in a secure fashion using business or enterprise level software. Inaddition, because of the more complex nature of these products, purchasersrequire increased maintenance and support. As a result, our maintenance and support revenues increased by 168% from2004 to 2005 from $217,469 in 2004 to $582,570 in 2005, net of deferredrevenue. Our maintenance and support revenues are generally recognized over thelife of the agreement, which is discussed further under the Deferred Revenuesection of Item 7.

 

30

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***Cost of Revenues.***  Cost of revenues consists primarily ofroyalties, a portion of our bandwidth costs as well as production, packagingand shipping costs for boxed copies of software products.  Cost of revenues decreased by approximately25% between periods from $371,242 in 2004 to $279,964 in 2005 due to a decreasein royalty expenses related to our software distribution agreements with thirdparties.  Royalties that we pay onsoftware products licensed from third parties, which we resell, are expensed asa cost of sales when the software product is sold or earlier if therecoverability of any prepaid royalties is in doubt.

***Selling, Generaland Administrative.*** Selling, general and administrative expenses consist primarily ofpersonnel and related expenses, marketing, customer support, professional fees,rent, bad debt and credit card transaction fees.  Selling, general and administrative expensesincreased by approximately 15% from $3,456,598 in 2004 to $3,986,047 in 2005 asa result of the reduction in the number GlobalSCAPE employees from 45 to 36 inFebruary 2004.

***Research andDevelopment.*** Research and development expenses increased by approximately 19% from$727,423 in 2004 to $869,155 in 2005. Included in the research and developmentexpenses, external development costs increased approximately 48% from 2004 to2005.  External development was increasedin order to maintain the scheduled releases of CuteFTP, CuteFTP Pro, Secure FTPServer, and EFT.

***Depreciation andAmortization.*** Depreciation and amortization expense consists of depreciation expenserelated to our fixed assets and the amortization of the trademark associatedwith our purchase of CuteFTP in 1998. Depreciation and amortization expense declined by $73,763 orapproximately 43% year over year.  Inaddition, depreciation expense has declined due to a slowdown in additions tofixed assets in current periods relative to prior periods.

***Other Income(Expense), Net.***  In2004, we had interest expense of $1,651 related primarily to an advance on ourline of credit and financing of insurance premiums.  In 2005, we had interest expense of $620related primarily to the financing of insurance premiums.  During 2005, we had interest income of$10,685 as a result of interest earned on excess cash balances.  During 2005, we had a gain of $1,242 on thesale of fully depreciated fixed assets.

***Income Taxes.***  The provision for state income taxes in 2004was $1,489 and there was no provision for federal income taxes in 2004.  GlobalSCAPE’s effective income tax rate was0.8% and differs from the federal rate primarily because of a change in thevaluation allowance for deferred tax assets. The provision for state income taxes in 2005 was $1,065 and theprovision for federal income taxes was $8,916 in 2005.  GlobalSCAPE’s effective income tax rate is..8% and differs from the federal rate primarily because of a change in thevaluation allowance for deferred tax assets.  The Company utilized net operating loss carryforwards in 2004 toeliminate its Federal income tax expense and utilized the remaining netoperating loss carryforwards in 2005 to substantially reduce its Federal incometax expense.

***Net Income.***  In 2004, net income was primarily the resultof a slight increase in revenue, a decrease in the cost of revenues, SG&A,research and development and depreciation costs.  Significant effort was put in to controllingexpenses in 2004, including the layoff of 9 employees.  In 2005, net income was primarily the resultof the introduction of our Enhanced File Transfer product and the featuresadded to our Secure FTP Server product, resulting in an increase in revenue,while we continued to control expenses.

###### **Item7A.   Quantitative and Qualitative Disclosures About Market Risk**

To date, we have not utilized derivative financialinstruments or derivative commodity instruments.  We do not expect to employ these or otherstrategies to hedge market risk in the foreseeable future.  We may invest our cash in money market funds,which are subject to minimal credit and market risk.  We believe that the interest rate risk andother relevant market risks associated with these financial instruments areimmaterial.

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In 2006 approximately 33% of our revenues came fromcustomers outside the United States.  Allrevenues are received in U.S. dollars so we have no exchange rate risk withregard to the sale.  However, as of July1, 2003, the European Union (EU) enacted Value Added Taxes (VAT) on electronicpurchases.  These taxes are charged toour non-business customers in the EU and, in our case, are remitted quarterlyin pound sterling.  We expect that theimpact of any currency translation involved in the remittance of VAT taxes willnot be material to our business.

 

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##  

**Item 8.**                          FinancialStatements and Supplementary Data

**GlobalSCAPE,Inc.**

**Indexto Consolidated Financial Statements**

**Yearsending December 31, 2004, 2005 and 2006Contents**
| Report of Independent Registered Public  Accounting Firm - PMB Helin Donovan, LLP |   | 34     |
|-----------------------------------------------------------------------------------|--------|--------|
|                                                                              |   |   |
| Financial Statements                                                              |   |   |
| Consolidated  Balance Sheets                                                      |   | 35     |
| Consolidated  Statements of Operations                                            |   | 37     |
| Consolidated  Statements of Stockholders’ Equity                             |   | 38     |
| Consolidated  Statements of Cash Flows                                            |   | 39     |
| Notes to Consolidated Financial Statements                                        |   | 41     |

 

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** **

**Report of IndependentRegistered Public Accounting Firm**

The Board of Directors and Shareholders

GlobalSCAPE, Inc.:

We have audited the accompanying consolidated balance sheets of GlobalSCAPE, Inc. (the Company) as of December 31, 2005 and 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years ended December 31, 2004, 2005 and 2006.  These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion,the consolidated financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of GlobalSCAPE, Inc. as ofDecember 31, 2005 and 2006, and the results of their operations and their cashflows for the years ended December 31, 2004, 2005 and 2006 in conformity withgenerally accepted accounting principles in the United States of America.

**PMB Helin Donovan**

March 21, 2007

Austin, Texas

 

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**GlobalSCAPE,Inc.**

**Consolidated Balance Sheets**
| ** **                                                                                                           | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                           | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Assets                                                                                                               |       |                  |       |   |   |
| Current assets:                                                                                                      |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                           |       | $                     | 2,029,473  |   | $ | 4,632,666 |   |
| Accounts  receivable (net of allowance for doubtful accounts of $12,273 and $59,458 in  2005 and 2006, respectively) |       | 590,715               |       | 1,592,846 |   |
| Federal income  tax receivable                                                                                       |       | —                |       | 73,525 |   |
| Prepaid expenses                                                                                                     |       | 65,317                |       | 115,754 |   |
| Total current assets                                                                                                 |       | 2,685,505             |       | 6,414,791 |   |
|                                                                                                                 |       |                  |       |   |   |
| Property and equipment:                                                                                              |       |                  |       |   |   |
| Furniture and  fixtures                                                                                              |       | 334,063               |       | 343,702 |   |
| Software                                                                                                             |       | 284,621               |       | 323,161 |   |
| Equipment                                                                                                            |       | 604,517               |       | 720,107 |   |
| Leasehold  improvements                                                                                              |       | 167,762               |       | 191,090 |   |
|                                                                                                                 |       | 1,390,963             |       | 1,578,060 |   |
| Accumulated  depreciation and amortization                                                                           |       | 1,238,392             |       | 1,345,881 |   |
| Net property and  equipment                                                                                          |       | 152,571               |       | 232,179 |   |
|                                                                                                                 |       |                  |       |   |   |
| Other assets:                                                                                                        |       |                  |       |   |   |
| Goodwill                                                                                                             |       | -                     |       | 9,653,059 |   |
| Deferred tax  asset                                                                                                  |       | 51,983                |       | 8,724 |   |
| Other                                                                                                                |       | 11,612                |       | 58,996 |   |
| Total other assets                                                                                                   |       | 63,595                |       | 9,720,779 |   |
|                                                                                                                 |       |                  |       |   |   |
| Total assets                                                                                                         |       | $                     | 2,901,671  |   | $ | 16,367,749 |   |

 

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**GlobalSCAPE,Inc.**

**Consolidated Balance Sheets**
| ** **                                                                                                                                                                     | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                     | ** ** | **2005**              | ** ** | **2006** | ** ** |
| Liabilities and  Stockholders’ Equity                                                                                                                                     |       |                  |       |   |   |
| Current liabilities:                                                                                                                                                           |       |                  |       |   |   |
| Accounts payable                                                                                                                                                               |       | $                     | 91,763     |   | $ | 371,093 |   |
| Accrued expenses                                                                                                                                                               |       | 230,911               |       | 377,940 |   |
| Federal income  tax payable                                                                                                                                                    |       | 60,899                |       | - |   |
| Long-term debt,  current portion                                                                                                                                               |       | -                     |       | 1,539,455 |   |
| Deferred revenue                                                                                                                                                               |       | 560,578               |       | 1,377,037 |   |
| Total current  liabilities                                                                                                                                                     |       | 944,151               |       | 3,665,525 |   |
|                                                                                                                                                                           |       |                  |       |   |   |
| Long-term liabilities:                                                                                                                                                         |       |                  |       |   |   |
| Deferred  compensation                                                                                                                                                         |       | 12,121                |       | 52,487 |   |
| Long-term debt,  non-current portion                                                                                                                                           |       | -                     |       | 3,070,757 |   |
| Other long-term  liabilities                                                                                                                                                   |       | 16,823                |       | 5,941 |   |
| Total long-term  liabilities                                                                                                                                                   |       | 28,944                |       | 3,129,185 |   |
|                                                                                                                                                                           |       |                  |       |   |   |
| Total Liabilities                                                                                                                                                              |       | 973,095               |       | 6,794,710 |   |
|                                                                                                                                                                           |       |                  |       |   |   |
| 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  16,490,146 shares issued and Outstanding at December 31, 2005 and 2006,  respectively |       | 13,798                |       | 16,490 |   |
| Additional  paid-in capital                                                                                                                                                    |       | 684,281               |       | 6,363,520 |   |
| Retained  earnings                                                                                                                                                             |       | 1,230,497             |       | 3,193,029 |   |
| Total stockholders’  equity                                                                                                                                               |       | 1,928,576             |       | 9,573,039 |   |
| Total liabilities and stockholders’ equity                                                                                                                                |       | $                     | 2,901,671  |   | $ | 16,367,749 |   |

See accompanying notes.

 

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**GlobalSCAPE,Inc.**

**Consolidated Statements of Operations**
| ** **                                                                            | ** ** | **For the Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2004**                                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Operating revenues:                                                                   |       |                                                          |       |   |   |   |   |
| Software product  revenues                                                            |       | $                                                             | 4,713,191  |   | $ | 6,096,045 |   | 9,395,445 |   |
| Maintenance and  support (net of deferred revenues)                                   |       | 217,469                                                       |       | 582,570 |   | 1,578,236 |   |
| Total revenues                                                                        |       | 4,930,660                                                     |       | 6,678,615 |   | 10,973,681 |   |
|                                                                                  |       |                                                          |       |   |   |   |   |
| Operating expenses:                                                                   |       |                                                          |       |   |   |   |   |
| Cost of revenues  (exclusive of depreciation and amortization shown separately below) |       | 371,242                                                       |       | 279,964 |   | 468,515 |   |
| Selling, general  and administrative Expenses                                         |       | 3,456,598                                                     |       | 3,986,047 |   | 6,142,299 |   |
| Research and  development expenses                                                    |       | 727,423                                                       |       | 869,155 |   | 1,230,400 |   |
| Depreciation and  amortization                                                        |       | 171,834                                                       |       | 98,071 |   | 99,213 |   |
| Total operating  expense                                                              |       | 4,727,097                                                     |       | 5,233,237 |   | 7,940,427 |   |
| Income from operations                                                                |       | 203,563                                                       |       | 1,445,378 |   | 3,033,254 |   |
|                                                                                  |       |                                                          |       |   |   |   |   |
| Other income (expense):                                                               |       |                                                          |       |   |   |   |   |
| Interest expense                                                                      |       | (1,651                                                        | )          | (620 | ) | (128,362 | ) |
| Interest income                                                                       |       | -                                                             |       | 10,685 |   | 60,639 |   |
| Gain on sale of  assets                                                               |       | -                                                             |       | 1,242 |   | 619 |   |
| Total other  income (expense)                                                         |       | (1,651                                                        | )          | 11,307 |   | (67,104 | ) |
| Income before income  taxes                                                           |       | 201,912                                                       |       | 1,456,685 |   | 2,966,150 |   |
|                                                                                  |       |                                                          |       |   |   |   |   |
| Income tax provision:                                                                 |       |                                                          |       |   |   |   |   |
| Current:                                                                              |       |                                                          |       |   |   |   |   |
| Federal                                                                               |       | -                                                             |       | 60,899 |   | 1,027,865 |   |
| State                                                                                 |       | 1,489                                                         |       | 1,065 |   | 3,533 |   |
| Deferred:                                                                             |       |                                                          |       |   |   |   |   |
| Federal  (benefit)                                                                    |       | -                                                             |       | (51,983 | ) | (27,780 | ) |
| State                                                                                 |       | -                                                             |       | - |   |   |   |
| Total income tax  provision                                                           |       | 1,489                                                         |       | 9,981 |   | 1,003,618 |   |
|                                                                                  |       |                                                          |       |   |   |   |   |
| Net income                                                                            |       | $                                                             | 200,423    |   | $ | 1,446,704 |   | $ | 1,962,532 |   |
|                                                                                  |       |                                                          |       |   |   |   |   |
| Net income per common  share — basic                                             |       | $                                                             | 0.01       |   | $ | 0.10 |   | $ | 0.13 |   |
| Net income per common  share - assuming dilution                                      |       | $                                                             | 0.01       |   | $ | 0.09 |   | $ | 0.12 |   |
|                                                                                  |       |                                                          |       |   |   |   |   |
| Weighted average shares  outstanding- basic                                           |       | 13,668,800                                                    |       | 13,778,989 |   | 14,744,635 |   |
| Weighted average shares outstanding- assuming dilution                                |       | 14,262,796                                                    |       | 15,442,524 |   | 16,160,839 |   |

 

See accompanying notes.

 

37

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**GlobalSCAPE,Inc.**

**Consolidated Statements of Stockholders’ Equity**
| ** **                                          | ** ** | **Common Stock** | ** ** | **Additional paid in** | ** ** | **Retained Earnings** | ** ** | ** **    | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|----------------------------------|------------|----------------------------|------------|---------------|------------|
| ** **                                          | ** ** | **Shares**            | ** ** | **Amount**                       | ** ** | **Capital**                | ** ** | **(Deficit)** | ** ** | **Total** | ** ** |
| Balances at December  31, 2003                      |       | 13,488,619            |       | 13,489                           |       | 671,893                    |       | (416,630      | )          | 268,752 |   |
| Net income                                          |       | -                     |       | -                                |       | -                          |       | 200,423       |       | 200,423 |   |
| Exercise of options                                 |       | 284,600               |       | 284                              |       | 3,472                      |       | -             |       | 3,756 |   |
| Balances at December  31, 2004                      |       | 13,773,219            |       | 13,773                           |       | 675,365                    |       | (216,207      | )          | 472,931 |   |
| Net income                                          |       | -                     |       | -                                |       | -                          |       | 1,446,704     |       | 1,446,704 |   |
| Exercise of options                                 |       | 24,900                |       | 25                               |       | 8,915                      |       | -             |       | 8,940 |   |
| Balance at December 31,  2005                       |       | 13,798,119            |       | $                                | 13,798     |                       | $          | 684,281       |       | $ | 1,230,497 |   | $ | 1,928,576 |   |
| Net income                                          |       |                  |       |                             |       |                       |       | 1,962,532     |       | 1,962,532 |   |
| Stock based  compensation                           |       |                  |       |                             |       | 497,895                    |       |          |       | 497,895 |   |
| Common shares issued in  acquisition of Availl, Inc |       | 716,846               |       | 717                              |       | 1,999,283                  |       |          |       | 2,000,000 |   |
| Common shares and  warrants issued for cash         |       | 1,352,000             |       | 1,352                            |       | 3,153,716                  |       |          |       | 3,155,068 |   |
| Exercise of options                                 |       | 623,181               |       | 623                              |       | 28,345                     |       |          |       | 28,968 |   |
| Balance at December 31, 2006                        |       | 16,490,146            |       | 16,490                           |       | 6,363,520                  |       | 3,193,029     |       | 9,573,039 |   |
|                                                     |            |                       |            |                                  |            |                            |            |               |            |  |  |  |  |  |  |

See accompanying notes.

38

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**GlobalSCAPE,Inc.**

**Consolidated Statements of Cash Flows**
| ** **                                                                         | ** ** | **For the Years ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Operating Activities:                                                              |       |                                                          |       |   |   |   |   |
| Net income                                                                         |       | $                                                             | 200,423    |   | $ | 1,446,704 |   | $ | 1,962,532 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                                          |       |   |   |   |   |
| Bad debt expense  (recovery), net                                                  |       | (17,087                                                       | )          | 8,231 |   | 47,185 |   |
| Depreciation and  amortization                                                     |       | 171,833                                                       |       | 98,071 |   | 99,213 |   |
| Stock based  compensation expense                                                  |       | -                                                             |       | - |   | 497,895 |   |
| Gain on  disposition of assets                                                     |       | -                                                             |       | (1,242 | ) | (619 | ) |
| Deferred taxes                                                                     |       | -                                                             |       | (51,983 | ) | (27,780 | ) |
| Changes in  operating assets and liabilities:                                      |       |                                                          |       |   |   |   |   |
| Accounts  receivable                                                               |       | 109,167                                                       |       | (450,413 | ) | (495,518 | ) |
| Prepaid expenses                                                                   |       | (44,716                                                       | )          | 25,828 |   | (44,497 | ) |
| Other assets                                                                       |       | -                                                             |       | 269 |   | 6,579 |   |
| Accounts payable                                                                   |       | (58,438                                                       | )          | (30,353 | ) | 246,606 |   |
| Accrued expenses                                                                   |       | (3,281                                                        | )          | 60,258 |   | (46,968 | ) |
| Federal income  tax payable                                                        |       | -                                                             |       | 60,899 |   | (134,424 | ) |
| Deferred revenue                                                                   |       | 37,628                                                        |       | 382,461 |   | 453,703 |   |
| Other long-term  liabilities                                                       |       | (11,215                                                       | )          | 906 |   | 40,367 |   |
| Net cash provided by  operating activities                                         |       | 384,314                                                       |       | 1,549,636 |   | 2,604,274 |   |
| Investing Activities:                                                              |       |                                                          |       |   |   |   |   |
| Proceeds from  sale of property and equipment                                      |       | -                                                             |       | 1,242 |   | 619 |   |
| Purchase of  property and equipment                                                |       | (42,250                                                       | )          | (103,304 | ) | (150,926 | ) |
| Purchase of Availl, Inc.                                                           |       | -                                                             |       | - |   | (7,776,932 | ) |
| Cash Acquired in purchase of Availl, Inc.                                          |       | -                                                             |       | - |   | 181,276 |   |
| Net cash used in  investing activities                                             |       | (42,250                                                       | )          | (102,062 | ) | (7,745,963 | ) |
| Financing Activities:                                                              |       |                                                          |       |   |   |   |   |
| Stock options                                                                      |       | 3,756                                                         |       | 8,940 |   | 28,968 |   |
| Proceeds from  the PIPE, net of issuance costs                                     |       | -                                                             |       | - |   | 3,155,068 |   |
| Proceeds from  term loan                                                           |       | -                                                             |       | - |   | 5,000,000 |   |
| Deferred loan  costs                                                               |       | -                                                             |       | - |   | (38,484 | ) |
| Principal  payments on notes payable                                               |       | (100,000                                                      | )          | - |   | (400,670 | ) |
| Principal  payments on capital lease obligations                                   |       | (15,294                                                       | )          | - |   | — |   |
| Net cash provided  (used) in financing activities                                  |       | (111,538                                                      | )          | 8,940 |   | 7,744,882 |   |
| Net increase in cash  and cash equivalents                                         |       | 230,526                                                       |       | 1,456,514 |   | 2,603,193 |   |
| Cash at beginning of  period                                                       |       | 342,433                                                       |       | 572,959 |   | 2,029,473 |   |
| Cash at end of period                                                              |       | $                                                             | 572,959    |   | $ | 2,029,473 |   | $ | 4,632,666 |   |

 Seeaccompanying notes.

39

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**GlobalSCAPE, Inc.**

**ConsolidatedStatements of Cash Flows (continued)**

** **
| ** **                                         | ** ** | **For the Years ended December 31,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                         | ** ** | **2004**                                                      | ** ** | **2005** | ** ** | **2006** | ** ** |
| Supplemental  disclosure of cash flow information: |       |                                                          |       |   |   |   |   |
| Cash paid during  the year for:                    |       |                                                          |       |   |   |   |   |
| Interest paid                                      |       | $                                                             | 1,651      |   | $ | 620 |   | 89,323 |   |
| Income taxes  paid                                 |       | $                                                             | 1,489      |   | $ | 1,065 |   | $ | 1,162,289 |   |
|                                                    |            |                                                               |            |  |  |  |  |  |  |  |

See accompanying notes.

 

40

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**GlobalSCAPE, Inc.Notes to Consolidated Financial StatementsDecember 31, 2005 and 2006**

**1.             Overview of the Business and Significant AccountingPolicies**

***Nature of Business***

GlobalSCAPE,Inc. (GlobalSCAPE), founded in April 1996, develops and distributes secure filemanagement software that enables users to safely send data over the internet.Our software is used worldwide across a wide range of industries. Through theend of 2006, we had sold approximately 1.6 million software licenses and ourcustomer base includes individual consumers, small to medium-sized businesses,as well as some of the largest corporations in the world.

Our filetransfer products provide for the privacy of critical information such asmedical records, financial data, customer files and other similar documents. Inaddition, our products provide for compliance with government regulationsrelating to the protection of information while allowing users to reduce ITcosts, increase efficiency, track and audit transactions and automate processes.

ThroughAvaill Inc. (Availl), our recently acquired, wholly-owned subsidiary, we alsoprovide Wide Area Files Systems (WAFS) and Continuous Data Protection (CDP)software.  This addition expandsGlobalSCAPE’s technology base into data replication, acceleration of filetransfer, sharing/collaboration and continuous data backup and recovery.  We believe that our expanded product offeringuniquely positions us to provide comprehensive, secure transfer, sharing, and replicationof files that need to be transmitted inside the user’s firewall to distributedoffices, or outside the user’s firewall to business and trading partners.

During the year ended December 31, 2006, approximately 67%of our revenues were generated from customers within the United States, withthe remaining 33% concentrated mostly in Western Europe, Canada and Australia.Virtually all of our 2006 revenues were derived from sales of software licensesand support agreements. The combined sales of CuteFTP Home and CuteFTP Proaccounted for 50% and 30% of our revenues in 2005 and 2006, respectively,. Thecombined sales of our Secure Server and Enhanced File Transfer products grewfrom 43% of our revenues in 2005 to 61% in 2006.

***Corporate Structure***

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

On September22, 2006, GlobalSCAPE acquired one hundred percent (100%) of the issued andoutstanding capital stock of Availl, a privately held corporation, pursuant toan Agreement and Plan of Merger with Availl and its stockholders.  The initial purchase price was $9.65 millionof which $7.65 million was paid in cash and $2.0 million was paid in shares ofGlobalSCAPE common stock.

Availl willcontinue to operate as a wholly-owned subsidiary of GlobalSCAPE, Inc. based inAndover, Mass.   GlobalSCAPE, Inc. is a holdingcompany and conducts no operations; however, the stock of GlobalSCAPE, Inc. isquoted on the OTC Bulletin Board. References to “GlobalSCAPE” or the “Company” refer collectively to allof these entities unless otherwise indicated.

***Basis of Presentation***

The preparation of financial statements in conformitywith accounting principles generally accepted in the Unites States requiresmanagement to make estimates and assumptions that affect the amounts reportedin the financial statements and accompanying notes.  Actual results could differ from thoseestimates.

41

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***Principles of Consolidation***

The consolidated financial statements include allsubsidiaries.  All inter-companytransactions and balances have been eliminated. Availl became a subsidiaryon September 22, 2006; therefore the consolidated financial statements onlyinclude Availl’s financial results and activities from the date of acquisitionuntil December 31, 2006.

***Liquidity***

The use of capital resources is driven principally by theneed to enhance existing products and to develop or acquire new products.  The amount of our expenditures has a directimpact on the ability to offer enhanced and new products to customers.  The Company’s principal source of funds iscash flow from operations which, in turn, is highly dependent on our salesrevenue.  During the year ended December31, 2006, the Company generated $2.6 million of cash from operations, which wasused along with other funds in the acquisition of Availl. At December31, 2006, the Company had cash available of $4.6 million and we continue togenerate cash in excess of our operational needs.

The Company entered into a new loan agreement with SiliconValley Bank on September 22, 2006 which involved a $5,000,000 term loanagreement which we used to finance part of the cash portion of the purchaseprice for Availl.  The term loan matureson September 22, 2009.  Interest andprincipal are payable in 36 equal monthly installments on the first day of eachcalendar month beginning October 1, 2006. The company made two extra payments in January and February of 2007 topay down the loan balances by $3.7 million. As a result of those payments the term loan will be fully paid by July1, 2007.  The Company may choose to makeadditional extra payments before then depending upon the company’s cashposition.  The loan agreement alsoestablished a $750,000 revolving line of credit for two years at an interestrate of prime plus 1.00%.

As of December 31, 2006, theCompany had cash and cash equivalents of $4.6 million and had net workingcapital of $2.7 million.  As noted above,the Company paid down its term loan by $3.7 million in 2007.  Management believes this level of workingcapital, together with availability under the Company’s revolving creditfacility with Silicon Valley Bank and the excess cash generated by theprofitable operation of the business, is adequate to finance the Company’scurrent level of operations.

***Reclassifications***

***Certain prior periodamounts have been reclassified to conform to the current year presentation.These reclassifications had no impact on operating income as previouslyreported.***

***Revenue Recognition***

The Company recognizes revenue in accordance with theAmerican Institute of Certified Public Accountants Statement of Position (“SOP”)97-2, *Software Revenue Recognition*,as modified by SOP 98-9, *Modification of SOP97-2, Software Revenue Recognition, With Respect to Certain Transactions*.

Revenues from the sale of software products arerecognized and completely earned upon shipment or electronic delivery of theproduct provided that persuasive evidence of an arrangement exists, collectionis probable, payment terms are fixed and determinable and no significantobligations remain.

The Company also sells technical support andmaintenance agreements (post contract customer support “PCS”), which aresometimes bundled with the software. When vendor specific objective evidence (“VSOE”) of fair value existsfor all elements in a multiple element arrangement, revenue is allocated toeach element based on the relative fair value of each of the elements.  VSOE of fair value is established by theprice charged when the same element is sold separately.  In a multiple element arrangement wherebyVSOE of fair value of all undelivered elements exists but VSOE of fair valuedoes not exist for one or more delivered elements, revenue is recognized usingthe residual method.  Under the residualmethod, the fair value of the undelivered elements is deferred and the remainingportion of the arrangement fee is 

42

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recognized as revenue,assuming collection is probable.  Revenueallocated to PCS is recognized ratably over the contractual term, typically oneyear.

The Company began selling technical support andmaintenance services for some of its software products in 2001.  In 2005 and 2006, sales of enterprise classproducts resulted in higher revenues from maintenance and support agreementssold to customers and, as a result, deferred revenue at December 31, 2006 was$1,377,037

The outbound shipping charges charged to the customerare included in software product revenues and amounted to approximately$38,000, $18,000 and $14,000 in 2004, 2005 and 2006, respectively.  The costs associated with these shippingcharges are included in the software products cost of revenue.

***Royalty Costs***

Royalties that the Company pays on software productslicensed from third parties, which it resells, are expensed as a cost of saleswhen the software product is sold or earlier if the recoverability of anyprepaid royalties is in doubt.  TheCompany has distribution agreements with Hannon Hill Corp., Beehive Software,Inc., Visicom Media, Inc., ComponentOne LLC, and PGP Deutschland AG (formerlyGlueck and Kanja).  The GlobalSCAPEsoftware products associated with each of the companies are Cascade Server(formerly PublishXML), Mac FTP, CuteHTML Pro and Enhanced File Transfer (EFT),respectively.  The Company incurredapproximately $233,000, $192,000, and $392,000 in royalty expense in 2004, 2005and 2006, respectively.

***Concentrations of Credit Risk andSignificant Customers***

Financial instruments that potentially subject theCompany to concentrations of credit risk consist principally of cash and cashequivalents, and accounts receivable.  Cash is deposited in demand accounts infederally insured domestic institutions to minimize risk.  The Company provides credit, in thenormal course of business, to a number of companies and performs ongoingevaluations of its credit risk.  TheCompany requires no collateral from its customers.  Management estimates the allowance foruncollectible accounts based on their historical experience and creditevaluation.  No single customer accountedfor more than 2% of revenues in 2004 and 2006. One customer accounted for approximately 2.7% of revenues in 2005.

Cash and cash equivalents,accounts receivable, employee advances, accounts payable, accrued expenses andnotes payable, related party are reflected in the accompanying financialstatements at cost, which approximates fair value because of the short term maturityof these instruments.

***Other Concentrations***

*Sales in Foreign Markets. *In 2004, 2005 and 2006,approximately 36%, 33% and 33%, respectively, of the Company’s revenues weregenerated from sales to customers who provided addresses in foreign countries.  However, all revenues are received in U.S.dollars so there is no exchange rate risk with respect to the sale of ourproducts.  These sales were concentratedmostly in Western Europe, Canada, and Australia.  In 2004, 2005 and 2006, the UK accounted forapproximately 11%, 9%, and 8%, respectively, of total revenues.

*Labor. *GlobalSCAPE utilizesoffshore developers for a large portion of the coding phase of softwaredevelopment.  If GlobalSCAPE were unableto continue using these developers because of political or economicinstability, GlobalSCAPE may have difficulty finding comparably skilleddevelopers or may have to pay considerably more for the same work, which wouldhave a material adverse impact on results of operations.

43

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***Advertising Costs***

The Company expenses advertising costs asincurred.  Advertising expenses chargedto operations for the years ended December 31, 2004, 2005 and 2006 wereapproximately $144,000, $159,000 and $384,000, respectively, and are includedin selling, general and administrative expenses.  Advertising costs are principally for thepurchase of keywords for internet searches, a direct mail campaign for EFT,trade show participation and advertising in various publications.

***Income Taxes***

The Company accounts for income taxes using theliability method in accordance with Statement of Financial Accounting StandardsNo. 109, *Accounting for Income Taxes*.  The liability method provides that thedeferred tax assets and liabilities are recorded based on the differencebetween the tax bases of assets and liabilities and their carrying amount forfinancial reporting purposes, as measured by the enacted tax rates and lawsthat will be in effect when the differences are expected to reverse. Deferredtax assets and liabilities are carried on the balance sheet with thepresumption that they will be realizable in future periods when pre-tax incomeis generated. GlobalSCAPE had a deferred tax asset of $51,983 and $8,724 atDecember 31, 2005 and 2006, respectively.

Statement of Financial Accounting Standards (SFAS) No.109 requires a valuation allowance to reduce the deferred tax assets reportedif, based on the weight of the evidence, it is more likely than not that someportion or all of the deferred tax assets will not be realized.  After consideration of all of the evidence,both positive and negative, management determined that a valuation allowancewas necessary at December 31, 2004. During 2005 a decrease in the valuation allowance of $484,853 wasnecessary to decrease the valuation allowance for the benefit of the netoperating loss carryforward benefit utilized in that year. No valuation wasconsidered necessary at December 31, 2006.

***Research and Development***

Research and development expenses include all directcosts, primarily salaries for personnel and expenditures with externaldevelopment sources, related to the development of new products and significantenhancements to existing products and are expensed as incurred until such timeas technological feasibility is achieved. For the years 2004, 2005 and 2006, the Company expended approximately$728,000, $870,000 and $1,230,000, respectively, on research anddevelopment.  Typically technologicalfeasibility is achieved very late in the development cycle and as such noresearch and development expenses were capitalized in 2004, 2005 or 2006.

***Stock-Based Compensation***

Effective January 1, 2006, GlobalSCAPE adopted theprovisions of Statement of Financial Accounting Standards No. 123 (revised2004), “Share-Based Payment” (SFAS No.123R) requiring that compensation costrelating to share-based payment transactions be recognized in the financialstatements. The cost is measured at the grant date, based on the calculatedfair value of the award, and is recognized as an expense over the employee’srequisite service period (generally the vesting period of the equity award).Prior to January 1, 2006, the Company 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”. The Company adopted SFASNo. 123R using the modified prospective method and, accordingly, financialstatement amounts for prior periods presented in this Form 10-K have not been restatedto reflect the fair value method of recognizing compensation cost relating tostock options.

44

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          There was $497,895 of compensationcost related to stock options recognized in operating results in the year endedDecember 31, 2006.

          The fair value of each option award isestimated on the date of grant using the Black-Scholes option-pricing model.Expected volatility is based on historical volatility of GlobalSCAPE stock. TheCompany used the simplified method to derive an expected term. The expectedterm represents an estimate of the time options are expected to remainoutstanding. The risk-free rate for periods within the contractual life of theoption is based on the U.S. treasury yield curve in effect at the time ofgrant. The following table sets forth the assumptions used to determinecompensation cost for our stock options consistent with the requirements ofSFAS No. 123R.

|                                | ** ** | **Year Ended  December 31, 2006** | ** ** |
|--------------------------------|------------|--------------------------------------------------|------------|
|                           |       |                                             |       |
| Expected volatility            |       | 102                                              | %          |
| Expected annual dividend yield |       | 0                                                | %          |
| Risk free rate of return       |       | 4.67                                             | %          |
| Expected option term (years)   |       | 5.5 - 6.0                                        |       |

 

Under APB No. 25 there was no compensation cost recognizedfor our stock options awarded in the year ended December 31, 2004 or 2005 asthese stock options had an exercise price equal to the market value of theunderlying stock at the grant date. The following table sets forth pro formainformation as if compensation cost had been determined consistent with therequirements of SFAS No. 123.

|                                                                                                                                                                                             | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                                                                  | ** ** | **2004**                                    | ** ** | **2005** | ** ** |
| Net income, as  reported                                                                                                                                                                    |       | $                                           | 200,423    |   | $ | 1,446,704 |   |
| Stock based compensation included in the determination of  net income as reported, net of related tax effects                                                                               |       | -                                           |       | - |   |
| Stock-based  compensation expense that would have been included in the determination of  net income had the fair value based method been applied to all awards, net of  related tax effects |       | (19,639                                     | )          | (25,921 | ) |
| Pro forma net  income                                                                                                                                                                       |       | $                                           | 180,784    |   | $ | 1,420,783 |   |
|                                                                                                                                                                                        |       |                                        |       |   |   |
| Earnings per  share:                                                                                                                                                                        |       |                                        |       |   |   |
| Basic- as  reported                                                                                                                                                                         |       | $                                           | 0.01       |   | $ | 0.10 |   |
| Basic- pro forma                                                                                                                                                                            |       | $                                           | 0.01       |   | $ | 0.10 |   |
|                                                                                                                                                                                        |       |                                        |       |   |   |
| Diluted- as  reported                                                                                                                                                                       |       | $                                           | 0.01       |   | $ | 0.09 |   |
| Diluted- pro forma                                                                                                                                                                          |       | $                                           | 0.01       |   | $ | 0.09 |   |

 

*Refer to Note 9 - Stock* Options and Stock Based Compensation for additionaldisclosures regarding our stock compensation programs.

***Cash and cash equivalents***

Cash includes all cash and highly liquid investmentswith original maturities of three months or less.

***Property and Equipment***

Property and equipment is comprised of furniture andfixtures, software, computer equipment and leasehold improvements which arerecorded at cost and depreciated using the straight-line method over theirestimated useful lives.  Expenditures formaintenance and repairs are charged to operations as 

45

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incurred.  Property and equipment acquired under capitalleases are depreciated over their useful lives or the respective lease term, ifshorter.  Depreciation periods used forproperty and equipment range from three to five years.

Leasehold improvements are depreciated over theshorter of the lease term or the estimated useful life of the asset.

***Sale / Disposal of Assets***

During 2006, the Company disposed of equipment andsoftware with an original purchase price of $15,362 and accumulateddepreciation of $15,362.  GlobalSCAPErecognized a gain of $619 related to the disposal of these assets.  During 2005 the Company disposed of equipmentand software with an original purchase price of $29,949 and accumulateddepreciation of $29,949.  GlobalSCAPErecognized a gain of $1,242 related to the disposal of these assets.  During 2004 the Company disposed of equipmentand software with an original purchase price of $31,494 and accumulateddepreciation of $31,494.  GlobalSCAPErecognized no gain or loss related to the disposal of these assets.

***Goodwill***

As of December 31, 2006, GlobalSCAPE hadgoodwill in the amount of $9,653,059 associated with the acquisition of Availl.  This acquisition was accounted for using thepurchase method of accounting. See Acquisitions note for a description of theacquisition. In accordance with SFAS No. 142 *Goodwill andOther Intangible Assets*, the Company will assess the impairment ofgoodwill annually in the fourth quarter, or more frequently if other indicatorsof potential impairment arise. There was no goodwill as of December 31, 2005.

No allocation has been made to intangibleassets as of the December 31, 2006. Management will determine the proper value of intangible assets acquiredfrom Availl, Inc. and allocate a portion of the goodwill to intangible assets,if any, within the next nine months.

***Capitalized Software DevelopmentCosts***

Capitalization of software development costs beginsupon the establishment of technological feasibility and ceases when the productis available for general release.  Theestablishment of technological feasibility and the ongoing assessment ofrecoverability of capitalized software development costs require considerablejudgment by management concerning certain external factors including, but notlimited to, technological feasibility, anticipated future gross revenue,estimated economic life and changes in software and hardware technologies.  These software development costs wereamortized using the straight-line method over a three-year period and are onlythose costs incurred in the development of products that are sold to externalcustomers and not used for internal purposes. No research and development expenses were capitalized in 2004, 2005 or2006.  These software development costsare not related to those costs incurred for the acquisition of softwareproducts or titles.  For the years 2004,2005 and 2006, we spent approximately $728,000, $870,000 and $1,230,000,respectively, on research and development.

***Other Long-Term Assets***

Other assets include deposits for facilities, whichare anticipated to be refunded to the Company upon termination of the lease anddeferred loan costs associated with the Silicon Valley Bank loan agreements of$36,346, net of accumulated amortization of $2,138.

 

46

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***Deferred Compensation***

*Thedeferred compensation liability is related to an employment agreement with thePresident.  The deferred compensation issubject to certain terms and conditions related to his planned retirement inDecember 2008.*

***Other Long-Term Liabilities***

Other long-term liabilities relate to deferredpayments of rent expense.  The totalamount of base lease payments is being charged to expense on the straight-linemethod over the term of the lease.

***Earnings Per Common Share***

Basic and diluted net income per common share ispresented in conformity with Statement of Financial Accounting Standards No.128, *Earnings Per Share* (SFAS128) for all periods presented.  Basicearnings per share is based on the weighted effect of all common shares issuedand outstanding, and is calculated by dividing net income (loss) available tocommon stockholders by the weighted average shares outstanding during theperiod.  Diluted earnings per share iscalculated by dividing net income (loss) available to common stockholders bythe weighted average number of common shares used in the basic earnings pershare calculation plus the number of common shares that would be issuedassuming conversion of all potentially dilutive common shares outstanding.  Awards of non vested options are consideredpotentially dilutive common shares for the purpose of computing earnings percommon share.  In applying the treasurystock method to non vested options the assumed proceeds include the amount the employeemust pay to exercise the option plus the amount of unrecognized costattributable to future periods less any expected tax benefits. Below is areconciliation of the numerators and denominators of basic and diluted earningsper share for each of the following years:
| ** **                                            | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                            | ** ** | **2004 (1)**                          | ** ** | **2005 (2)** | ** ** | **2006 (3)** | ** ** |
| **Numerators**                                        |       |                                       |       |   |   |   |   |
| Numerator for basic and  diluted earnings per share:  |       |                                       |       |   |   |   |   |
| Net income                                            |       | $                                          | 200,423    |   | $ | 1,446,704 |   | $ | 1,962,532 |   |
| **Denominators**                                      |       |                                       |       |   |   |   |   |
| Denominators for basic  earnings per share:           |       |                                       |       |   |   |   |   |
| Weighed average  shares outstanding-Basic             |       | 13,668,800                                 |       | 13,778,989 |   | 14,744,635 |   |
| **Dilutive potential common  shares:**                |       |                                       |       |   |   |   |   |
| Stock options                                         |       | 593,996                                    |       | 1,663,535 |   | 1,416,204 |   |
| Denominator for  dilutive earnings per share          |       | 14,262,796                                 |       | 15,442,524 |   | 16,160,839 |   |
| Net income per common  share                          |       | $                                          | 0.01       |   | $ | 0.10 |   | $ | 0.13 |   |
| Net income per commons share — assuming dilution |       | $                                          | 0.01       |   | $ | 0.09 |   | $ | 0.12 |   |

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(1)             Forthe year ended December 31, 2004, 882,000 options have not been included indilutive shares as the effect would be anti-dilutive.

(2)             Forthe year ended December 31, 2005, all options have been included in dilutiveshares.

(3)             Forthe year ended December 31, 2006, 100,000 options and 1,352,000 warrants havenot been included in dilutive shares as the effect would be anti-dilutive.

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***Recent AccountingPronouncements***

TheCompany adopted Statement No. 123R as of January 1, 2006. Thestatement requires a public entity to measure the cost of employee servicesreceived in exchange for an award of equity instruments based on the grant-datefair value of the award. The cost is recognized over the period during which anemployee is required to provide service in exchange for the award, typicallythe vesting period. Refer to additional disclosures regarding the adoption ofthis statement within Critical Accounting Policies above and in Notes 1 and 9to the Consolidated Financial Statements.

InDecember 2004, the FASB issued Statement No. 153, “*Exchanges of Nonmonetary Assets*“ (“StatementNo. 153”). Statement No. 153 addresses the measurement of exchangesof nonmonetary assets and redefines the scope of transactions that should bemeasured based on the fair value of the assets exchanged. StatementNo. 153 is effective for fiscal periods beginning after June 15,2005. The adoption of this statement did not have a material impact on theCompany’s financial position, results of operations or cash flows.

OnJune 7, 2005, the FASB issued Statement No. 154, “*Accounting Changes and Error Corrections,”*(“StatementNo. 154”) a replacement of APB Opinion No. 20, “ *Accounting Changes*,” and FASB StatementNo. 3, “ *Reporting Accounting Changesin Interim Financial Statements.”*Statement No. 154 changes therequirements for the accounting for and reporting of changes in accountingprinciples. Previously, most voluntary changes in accounting principlesrequired recognition via a cumulative effect adjustment within net income inthe period of the change. Statement No. 154 requires retrospectiveapplication to prior periods’ financial statements unless it is impracticable todetermine either the period-specific effects or the cumulative effect of thechange. Statement No. 154 is effective for accounting changes made infiscal years beginning after December 15, 2005; however, the statementdoes not change the transition provisions of any existing accountingpronouncements. Statement No. 154 did not have a material effect on theCompany’s financial position, results of operations or cash flows.

In July2006, the FASB issued Interpretation No. 48, *“Accounting for Uncertainty in Income Taxes”*(“FIN 48”).This interpretation clarifies the accounting for uncertainty in income taxesrecognized in a company’s financial statements in accordance with FASBStatement No. 109, “*Accounting forIncome Taxes*.” This interpretation prescribes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a taxreturn. This interpretation also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure and transition. The interpretation is effective for fiscalperiods beginning after December 15, 2006. The Company will berequired to apply the provisions of FIN 48 to all tax positions upon initial adoptionwith any cumulative effect adjustment to be recognized as an adjustment toretained earnings. The Company is in the process of determining the impact ofthis interpretation on its financial position, results of operations and cashflows.

InSeptember 2006, the FASB issued Statement No. 157, “*Fair Value Measurements*“ (“StatementNo. 157”). This statement defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles and expandsdisclosure about fair value measurements. This statement is effective forfiscal periods beginning after November 15, 2007 and interim periodswithin those fiscal years. The Company is in the process of determining theimpact of Statement No. 157 on its financial position, results ofoperations and cash flows.

InSeptember 2006, the Securities and Exchange Commission issued Staff AccountingBulletin No. 108, “*Considering theEffects of Prior Year Misstatements in Current Year Financial Statements*“(“SAB No. 108”). SAB No. 108 provides guidance on how prior yearmisstatements should be taken into consideration when quantifying misstatementsin current year financial statements for purposes of determining whether thecurrent year’s financial statements are materially misstated. The adoption ofSAB No. 108 did not have a material impact on the Company’s financialposition, results of operations or cash flows.

InFebruary 2007, the FASB issued Statement No. 159, “*The Fair Value Option for Financial Assets and Financial Liabilities*“(“Statement No. 159”). Statement No. 159 permits entities to choose to measuremany financial assets and financial liabilities at fair value. Unrealized gainsand losses on items for which 

48

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the fair value option has beenelected are reported in earnings. Statement No. 159 is effective for fiscalyears beginning after November 15, 2007. The Company is currently assessing theimpact of Statement No. 159 on its financial position, results of operationsand cash flows.

In December 2006, the FASBissued FSP EITF 00-19-2, *Accounting forRegistration Payment Arrangements*(“FSP EITF 00-19-2”). FSP EITF00-19-2 specifies that the contingent obligation to make future payments orotherwise transfer consideration under a registration payment arrangementshould be separately recognized and measured in accordance withSFAS No. 5, *Accounting forContingencies.* FSP EITF 00-19-2 is effective immediately forregistration payment arrangements and the financial instruments subject tothose arrangements that are entered into or modified subsequent toDecember 21, 2006. For registration payment arrangements and financialinstruments subject to those arrangements that were entered into prior toDecember 21, 2006, the guidance in the FSP is effective for fiscal yearsbeginning after December 15, 2006. The Company early adopted FSP EITF 00-19-2 in the fourth quarter as aresult of its issuance of common stock and warrants subject to a registrationpayment agreement in the fourth quarter of 2006.  The impact is to allow the Company toclassify its warrants and common stock issued as equity instead of derivativeliabilities and temporary equity, respectively that would have been previouslyrequired.  FSP EITF00-19-2 requires that the contingent obligation to payliquidated damages under the securities purchaseagreement should be separately recognized and measured in accordance withFASB Statement No. 5 (FASB No. 5), *Accounting forContingencies*”.  The Company had not accrued any liquidateddamages as of December 31, 2006.

Effective January 1, 2006, the Company adoptedprospectively SFAS No. 155, *Accountingfor Certain Hybrid Instruments*(“SFAS 155”). SFAS 155amends SFAS No. 133, *Accountingfor Derivative Instruments and Hedging* (“SFAS 133”) andSFAS No. 140, *Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities*(“SFAS 140”).SFAS 155 allows financial instruments that have embedded derivatives to beaccounted for as a whole, eliminating the need to bifurcate the derivative fromits host, if the holder elects to account for the whole instrument on a fairvalue basis. Statement No. 155 did not have a material effect onthe Company’s financial position, results of operations or cash flows.

In March 2006, the FASBissued SFAS No. 156, *Accountingfor Servicing of Financial Assets — an amendment of FASB StatementNo. 140*(“SFAS 156”). Among other requirements,SFAS 156 requires an entity to recognize a servicing asset or servicingliability each time it undertakes an obligation to service a financial asset byentering into a servicing contract in certain situations. SFAS 156 will beapplied prospectively and is effective for fiscal years beginning afterSeptember 15, 2006. The Company does not expect SFAS 156 to have amaterial impact on the Company’s consolidated financial statements.

**2.             Acquisitions**

On September 22, 2006, the Companycompleted the acquisition of all of the issued and outstanding shares ofAvaill, a privately held provider of Wide Area Files Systems (WAFS) andContinuous Data Protection (CDP) software, for $7.65 million in cash and $2.0million in the form of 716,846 shares of GlobalSCAPE common stock. The Companyincurred direct acquisition costs of approximately $127,000. In connection withthe acquisition, $850,000 of the cash consideration in this acquisition wasplaced into an escrow account for purposes of settling indemnification claimsfor the eighteen-month period following the closing. In accordance with EITFIssue No. 99-12, *Determination of the Measurement Date forthe Market Price of Acquirer Securities Issued in a Purchase BusinessCombination*, the Company has used $2.79 as the per share amount tovalue the common stock consideration paid to Availl shareholders (representingthe average of the closing prices of GlobalSCAPE’s common stock for the thirtydays before the merger agreement date of September 22, 2006). Pursuant to theterms of the acquisition, the Company granted stock options to the formerAvaill stockholders who were also employees under the GlobalSCAPE, Inc. 

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2000Stock Option Plan. Exercising the options under this plan is contingent uponthe individual’s continued employment with the Company and will be vested overthree years in three annual installments.

                TheAvaill acquisition was accounted for using the purchase method of accounting.The purchase price was paid on the September 22, 2006 closing date.  The purchase price includes a provision forthe former Availl stockholders to earn up to an additional $100,000 in cashdepending upon the achievement of certain revenue targets for Availl for thethird and fourth quarters of 2006. Since the revenue targets were not attained,no additional payments were required.

Goodwill represents the excess of thepurchase price over the fair value of the net identifiable assets acquired.This premium paid for the acquisitions is based on management’s belief that theacquired technologies, businesses and engineering talent were of strategicimportance in the Company’s growth strategy. Operating results from theacquired business is included in the consolidated statements of operations fromthe date of acquisition.

                Asummary of the purchase price allocation is as follows:

|                                                           | ** ** | **Availl** | ** ** |
|-----------------------------------------------------------|------------|------------|------------|
| Purchase price -                                          |       | $          |       |   |
| Cash paid                                                 |       | 7,650,000  |       |
| Stock  issued                                             |       | 2,000,000  |       |
| Legal and  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 net fair value of assets acquired and liabilities assumed of Availlat the acquisition date was as follows:

| Cash                                                       |   | $        | 191,276 |   |
|------------------------------------------------------------|--------|----------|---------|--------|
| Accounts  receivable, net                                  |   | 553,798  |    |
| Fixed assets                                               |   | 26,411   |    |
| Other assets                                               |   | 13,555   |    |
| Accounts payable  and accrued expenses                     |   | (226,719 | )       |
| Deferred tax  liability                                    |   | (71,693  | )       |
| Deferred revenue                                           |   | (362,756 | )       |
|                                                       |   |     |    |
| Net fair value of  assets acquired and liabilities assumed |   | $        | 123,872 |   |

 

The following unaudited pro formafinancial information presents the results of operations for the years endedDecember 31, 2005 and 2006 as if the acquisition had occurred at the beginningof each period presented. The pro forma financial information has been adjustedfor the effect of interest paid on the term loan. The pro forma financialinformation for the combined entities has been prepared for comparative 

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purposesonly and is not indicative of what actual results would have been if theacquisitions had taken place at the beginning of each period presented, or offuture results. 

|                                 | ** ** | **Year Ended  December 31,**                             | ** ** |
|---------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                      | ** ** | **2005**                                                           | ** ** | **2006** | ** ** |
| ** **                      | ** ** | **(in thousands, except per share data)** | ** ** |
| Pro forma net revenues          |       | $                                                                  | 7,981      |   | $ | 12,088 |   |
| Pro forma net income            |       | 895                                                                |       | 1,664 |   |
|                            |       |                                                               |       |   |   |
| Pro forma net income per share: |       |                                                               |       |   |   |
| Basic                           |       | $                                                                  | 0.06       |   | $ | 0.11 |   |
| Diluted                         |       | $                                                                  | 0.06       |   | $ | 0.10 |   |

 

**3.             Accounts Receivable**

Accounts receivable, which are primarily from sales ofsoftware licenses, are presented net of an allowance for doubtfulaccounts.  The activity of the Company’sallowance for doubtful accounts for the years ended December 31, 2004, 2005 and2006 is presented in the following table:

| Balance at                       | ** ** | **Charged to **     | ** ** | ** **                  | ** ** | **Balance at ** | ** ** |
|---------------------------------------|------------|-------------------------------|------------|-----------------------------|------------|---------------------------|------------|
| **Year Ended  December 31** | ** ** | **Beginning  of Period** | ** ** | **Income or  Expense** | ** ** | **Deductions** (1)   | ** ** | **End of  Period** | ** ** |
|                                  |       |                          |       |                        |       |                      |       |   |   |
| 2004                                  |       | $                             | 43,581     |                        | (17,087    | )                         | (16,299    | ) | $ | 10,195 |   |
| 2005                                  |       | $                             | 10,195     |                        | 8,231      |                      | (6,153     | ) | $ | 12,273 |   |
| 2006                                  |       | $                             | 12,273     |                        | 47,185     |                      | (5,910     | ) | $ | 59,458 |   |

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(1)             Representsamounts written off as uncollectible accounts receivable.

**4.             Debt**

On September 22, 2006, the company obtained a$5,000,000 term loan from. from the Silicon Valley Bank.  The term loan was used to finance part of thecash portion of the purchase price of the Availl acquisition. 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 Company made a $3.2 million repayment under the term loan in January2007 plus a $.5 million repayment in February 2007.

The termloan is secured by substantially all of the assets of GlobalSCAPE and itssubsidiaries.  The Loan Agreementcontains customary covenants including covenants relating to maintaining legalexistence and good standing, complying with applicable laws, delivery offinancial statements, maintenance of inventory, payment of taxes, maintaininginsurance, and protection of intellectual property rights.  GlobalSCAPE and its subsidiaries are alsoprohibited from selling any of their assets other than in the ordinary courseof business, acquiring any other entities, changing the types of business theyare engaged in, incurring indebtedness other than that permitted by the LoanAgreement, incurring any liens on their assets other than those permitted by theLoan Agreement, making certain investments or paying any 

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dividends on, or acquiring, anyshares of their capital stock.  The LoanAgreement contains two financial covenants. GlobalSCAPE and its subsidiaries must maintain:

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

·                  a ratio of total funded debt to EBITDA of not morethan 2.00 to 1.00.

The loanagreement also contains customary events of default including the failure tomake payments of principal and interests, the breach of any covenants, theoccurrence of a material adverse change, certain bankruptcy and insolvencyevents, the breach of other agreements creating indebtedness of $50,000 or moreand the entry of a judgment of $50,000 or more against GlobalSCAPE or any ofits subsidiaries. The Company failed the first of the two covenants at December31, 2006 and obtained a waiver from the Bank.

Principalmaturities of long-term debt as of December 31, 2006 are as follows:

 

|            | **Year Ending December 31,** | ** ** | ** ** | ** ** | ** ** |
|------------|---------------------------------------------|------------|------------|------------|------------|
| 2007       |                                        | $          | 1,539,455  |       |
| 2008       |                                        | 1,692,242  |       |
| 2009       |                                        | 1,378,815  |       |
| Thereafter |                                        | —     |       |
|       |                                        | $          | 4,610,212  |       |

 

The Company had a $250,000 revolving line of creditagreement with a commercial bank.  Theline of credit expired in December 2004. The interest rate was indexed to the bank’s prime rate.  In connection with the line of credit, GlobalSCAPEentered into a Commercial Security Agreement with the bank whereby GlobalSCAPEgranted a security interest in all its accounts receivable and property andequipment.

The loan agreement provides for a $750,000 revolvingcredit facility. The entire amount of the revolving credit facility remainsavailable.  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.

**5.             Commitments and Contingencies**

**OperatingLeases**

Minimum future lease payments on non-cancelableoperating leases for office facilities are as follows for the years endingDecember 31:

| 2007   |   | $       | 281,472 |   |
|--------|--------|---------|---------|--------|
| 2008   |   | 190,063 |    |
| 2009   |   | 81,667  |    |
|   |   | $       | 553,202 |   |

 

The lease for the corporate office provides theCompany with two successive 5-year renewal options.  Operating lease expense amounted toapproximately $179,000, in each of 2004 and 2005, and approximately $188,000 in2006.

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**Contingencies**

TheCompany from time to time may be involved in litigation relating to claimsarising out of its ordinary course of business. There are no pending claims against the Company that would have amaterial adverse effect on the financial statements of the Company.

OnNovember 13, 2006, GlobalSCAPE, Inc. (the “Company”) entered into a securitiesPurchase Agreement.  The Company hasagreed to use its commercially reasonable efforts to cause the RegistrationStatement to become effective.  If the Registration Statement is not filedand made effective by approximately April 15, 2007 then on each monthlyanniversary of each such Event Date until the applicable Event is cured, theCompany shall pay to each Holder an amount in cash as partial liquidated damagesand not as a penalty, equal to 1.5% of the aggregate purchase price paid bysuch Holder pursuant to the Purchase Agreement for any of the shares sold bythe Company and Warrant Shares then held by such Holder; provided , that suchliquidated damages shall not exceed 12% of the aggregate purchase price paid byall Holders pursuant to the Purchase Agreement for such shares.  The maximum exposure is approximately$917,000.  Management’sinterpretation is that it is currently (at issuance and at December 31, 2006)not probable that there will be a payment due under the Registration PaymentArrangements (RRA) as the Company’s management believes that it will obtainapproval of its registration statement within the prescribed period and thatthe Company will be able to maintain current filing status with the SEC overthe prescribed period.

**6.             Related Party Transactions**

The Brown and Mann-GlobalSCAPE Joint Venture is 70%owned by Thomas W. Brown and 30% owned by David L. Mann, both of whom are membersof GlobalSCAPE’s Board of Directors.  InOctober 2004 the Brown and Mann-GlobalSCAPE Joint Venture distributed allshares held by the partnership to its two partners with the exception of 17,856shares, which were distributed in 2005.

The Company entered into a securities purchaseagreement, dated November 13, 2006, with certain accredited investors, Inaddition, Thomas W. Brown, the Chairman of the Board, and David L. Mann, amember of our board of directors, sold a total of 2,028,000 shares, at a priceof $2.50 per share in a private transaction with the investors.  The transactions closed on November 16, 2006.

**7.             Income Taxes**

Deferred income taxes reflect the net tax effects oftemporary differences between the carrying amounts of assets and liabilitiesfor financial reporting purposes and the amounts used for income taxpurposes.  Significant components of theCompany’s deferred tax assets and liabilities are related to the following:

|                                              | ** ** | **2005** | ** ** | **2006** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|
| Total deferred tax  liabilities              |       | $        | —     |     | $          | (91,884 | ) |
|                                         |       |     |       |     |       |
| Deferred tax assets:                         |       |     |       |     |       |
| Accrued expenses                             |       | 14,828   |       | 20,326   |       |
| Allowance for  doubtful accounts             |       | 4,173    |       | 20,216   |       |
| Deferred  compensation                       |       | 4,121    |       | 17,846   |       |
| Depreciation and  amortization               |       | 28,861   |       | 7,491    |       |
| Net operating  loss carryforwards            |       | -        |       | 34,792   |       |
| Total deferred tax  assets                   |       | 51,983   |       | 100,608  |       |
| Valuation allowance for  deferred tax assets |       | -        |       | -        |       |
| Net deferred tax assets                      |       | $        | 51,983     |     | $          | 8,724 |   |

 

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A reconciliation of income tax expense and the amountcomputed by applying the statutory federal income tax rate (34%) to incomebefore income taxes is as follows:
| ** **                                                  | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Taxes computed at  federal statutory rate                   |       | $        | 68,655     |     | $          | 494,911  |       | $ | 1,007,289 |   |
| Increases in taxes  resulting from:                         |       |     |       |     |       |     |       |
| State taxes, net  of federal benefit                        |       | 983      |       | 703      |       | 2,333    |       |
| Non-deductible  incentive stock option compensation charges |       | -        |       | -        |       | -        |       |
| Other  non-deductible expenses                              |       | 2,368    |       | 5,653    |       | 2142     |       |
| Change in  valuation allowance                              |       | (55,497  | )          | (484,853 | )          | -        |       |
| Research &  Development Credit                          |       | -        |       | -        |       | 10,000   |       |
| Other                                                       |       | (15,020  | )          | (6,433   | )          | 1,854    |       |
| Total                                                       |       | $        | 1,489      |     | $          | 9,981    |       | $ | 1,003,618 |   |

 

At December 31, 2006 the Company has utilized its availablenet operating loss carryforwards for both financial reporting and Federalincome tax reporting purposes.

**8.             Employee Benefit Plan**

The Company has a 401(k) plan that coverssubstantially all employees with at least six months of service.  Under the plan, employees may elect tocontribute a percentage of their annual salary subject to the Internal RevenueCode maximum limitations.  The planprovides for employer matching and discretionary contributions, the amounts ofwhich are to be determined annually by the Board of Directors.  The Company made contributions to the plan of$8,910, $15,864 and $16,296 for the years ended December 31, 2004, 2005 and2006, respectively.

**9.             Stock Options and Stock Based Compensation**

GlobalSCAPE has stock-based compensation plans available togrant incentive stock options to employees. Under the GlobalSCAPE, Inc. 2000Stock Option Plan (the Plan), which was approved by the Board of Directors andbecame effective on May 17, 2001, a maximum of 3,660,000 shares of GlobalSCAPEcommon stock may be awarded. Through the year ended December 31, 2006, optionswere granted for 2,480,640 shares of common stock.

          The exercise price, term and otherconditions applicable to each stock option granted under the Plan are generallydetermined by the Board of Directors. The exercise price of stock options isset on the grant date and may not be less than the fair market value per shareof our stock on that date. The options generally become exercisable over athree-year period and expire after ten years.

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

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          There was $497,895 of compensationcost related to stock options recognized in operating results in the year endedDecember 31, 2006.

The following table summarizes information about stockoption activity for the year ended December 31, 2006:
| ** **                        | ** ** | **Number  of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (years)** | ** ** | **Aggregate  Intrinsic  Value ($M)** | ** ** |
|-----------------------------------|------------|-------------------------|------------|----------------------------------------|------------|------------------------------------------------------------------|------------|-------------------------------------------|------------|
| 2004                              |       |                    |       |                                   |       |                                                             |       |                                      |       |
|                              |       |                    |       |                                   |       |                                                             |       |                                      |       |
| Outstanding at December  31, 2003 |       |                    |       |                                   |       |                                                             |       |                                      |       |
| Granted                           |       | 581,000                 |       | 0.12                                   |       |                                                             |       |                                      |       |
| Expired                           |       | 182,500                 |       | 0.28                                   |       |                                                             |       |                                      |       |
| Exercised                         |       | 284,600                 |       | 0.01                                   |       |                                                             |       |                                      |       |
|                              |       |                    |       |                                   |       |                                                             |       |                                      |       |
| Outstanding December  31, 2004    |       | 1,970,071               |       | $                                      | 0.24       |                                                             | 6.5        |                                      | -          |   |
| 2005                              |       |                    |       |                                   |       |                                                             |       |                                      |       |
| Granted                           |       | 469,000                 |       | 0.32                                   |       |                                                             |       |                                      |       |
| Expired                           |       | 20,000                  |       | 0.16                                   |       |                                                             |       |                                      |       |
| Exercised                         |       | 24,900                  |       | 0.36                                   |       |                                                             |       |                                      |       |
|                              |       |                    |       |                                   |       |                                                             |       |                                      |       |
| Outstanding at December 31, 2005  |       | 2,394,171               |       | $                                      | 0.25       |                                                             | 6.5        |                                      | $          | 2.06 |   |
|                              |       |                    |       |                                   |       |                                                             |       |                                      |       |
| 2006                              |       |                    |       |                                   |       |                                                             |       |                                      |       |
| Granted                           |       | 935,000                 |       | 2.81                                   |       |                                                             |       |                                      |       |
| Exercised                         |       | 623,181                 |       | 0.05                                   |       |                                                             |       |                                      |       |
| Lapsed or canceled                |       | 225,350                 |       | 1.47                                   |       |                                                             |       |                                      |       |
|                              |       |                    |       |                                   |       |                                                             |       |                                      |       |
| Outstanding at December 31, 2006  |       | 2,480,640               |       | $                                      | 1.16       |                                                             | 7.25       |                                      | $          | 4.34 |   |
|                              |       |                    |       |                                   |       |                                                             |       |                                      |       |
| Exercisable  at December 31, 2006 |       | 1,300,060               |       | $                                      | 0.53       |                                                             | 5.63       |                                      | $          | 3.10 |   |

 

The weighted average fair value of options granted duringthe year ended December 31, 2006 was $1.52. The total intrinsic value ofoptions (which is the amount by which the stock price exceeded the exerciseprice of the options on the date of exercise) exercised during the year endedDecember 31, 2006 was $903,725. During the year ended December 31, 2006, theamount of cash received from the exercise of stock options was $28,968. Thefollowing table summarizes information about nonvested stock option awards asof December 31, 2006 and changes for the year.

|                                  | ** ** | **Number  Of  Options** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|----------------------------------|------------|-------------------------|------------|-------------------------------------------------------------|------------|
| Non-vested at December 31, 2005  |       | 816,415                 |       | $                                                           | 0.27       |   |
|                             |       |                    |       |                                                        |       |
| Granted                          |       | 935,000                 |       | 2.81                                                        |       |
| Vested                           |       | (345,485                | )          | 0.69                                                        |       |
| Forfeited                        |       | (225,350                | )          | 1.47                                                        |       |
|                             |       |                    |       |                                                        |       |
| Non-vested at December 31,  2006 |       | 1,180,580               |       | $                                                           | 1.52       |   |

 

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          At December 31, 2006, there was$1,508,333 of total unrecognized compensation cost related to non-vested stockoption awards which is expected to be recognized over a weighted-average periodof 3 years. There were 345,485 options that became vested during the year endedDecember 31, 2006.

The following table shows information about outstandingstock options at December 31, 2006.
| ** **                              | ** ** | ** **               | ** ** | **Options Outstanding**                                    | ** ** | **Options Exercisable**                   | ** ** |
|-----------------------------------------|------------|--------------------------|------------|-----------------------------------------------------------------|------------|------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Options  Outstanding** | ** ** | **Weighted Average  Remaining Contractual Life** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Number of  Options** | ** ** | **Weighted Average  Exercise Price** | ** ** |
| $.01 - $1.00                            |       | 1,645,640                |       | 6.1                                                             |       | $                                              | 0.38       |   | 1,220,060 |   | $ | 0.35 |   |
| $1.01 - $2.00                           |       | 100,000                  |       | 9.0                                                             |       | $                                              | 1.10       |   | — |   | $ | — |   |
| $2.01 - $3.00                           |       | 210,000                  |       | 9.4                                                             |       | $                                              | 2.72       |   | 60,000 |   | $ | 2.70 |   |
| $3.01 - $4.00                           |       | 525,000                  |       | 9.7                                                             |       | $                                              | 3.10       |   | 20,000 |   | $ | 3.10 |   |
|                                    |       | 2,480,640                |       |                                                            |       |                                           |       | 1,300,060 |   |   |   |

 

**10.          CommonStock and Warrants**

**On November 13, 2006, we enteredinto a securities purchase agreement with accredited investors, who paid us anaggregate of $3.4 million in gross proceeds in consideration for 1,352,000shares of our common stock at a price of $2.50 per share.  We also granted warrants to purchase1,352,000 shares of our common stock to the investors with an exercise price of$3.15 per share.  The warrants have a5-year term and will be exercisable beginning May 15, 2007.**  As part of this transaction, we filed a registration statement toregister the resale of these shares by the investors.

## If the registration statement is not declared effective by the SEC by April15, 2007,  the effective date specifiedin the securities purchase agreement, then in addition to any other rights thepurchasers may have under the registration rights agreement, on each monthlyanniversary of the specified effective date, until the registration is declaredeffective, the Company shall pay to each holder of the registrable securitiesan amount in cash as partial liquidated damages equal to 1.5% of the aggregatepurchase price for any of the shares sold by the Company; provided thatliquidated damages shall not exceed 12% of the aggregate purchase price.   No liquidated damages had been accrued atDecember 31, 2006.

Thereis an adjustment provision in which the warrant’s exercise price can be reducedto a minimum of $2.81 (which could reduce cash proceeds by $459,680 to$3,799,120) in the event that from November 13, 2006 (the closing date) to sixmonths later (or May 13, 2007) the Company issues or is deemed to issue additionalshares of Common Stock for a consideration per share less than the ExercisePrice in effect immediately prior to the issuance of such shares, the ExercisePrice shall be reduced by the Company to the price equal to the considerationper share received or receivable.

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**Item 8B.**                 QuarterlyFinancial Information (unaudited)
| ** **                                    | ** ** | **Fiscal Year 2005** | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | **1st Quarter**           | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** |
|                                          |       |                           |       |   |   |   |   |   |   |
| Total revenues                                |       | $                              | 1,422,381  |   | $ | 1,819,376 |   | $ | 1,723,685 |   | $ | 1,713,173 |   |
| Total operating  expenses                     |       | 1,262,418                      |       | 1,293,747 |   | 1,334,381 |   | 1,342,691 |   |
| Other Income (expense)                        |       | (328                           | )          | (15 | ) | 4,424 |   | 7,417 |   |
| Net income before  provision for income taxes |       | 159,963                        |       | 525,614 |   | 393,728 |   | 377,380 |   |
| Net income                                    |       | 158,570                        |       | 525,614 |   | 393,728 |   | 368,792 |   |
|                                          |       |                           |       |   |   |   |   |   |   |
| Net income per share:                         |       |                           |       |   |   |   |   |   |   |
| Basic                                         |       | $                              | 0.012      |   | $ | 0.038 |   | $ | 0.029 |   | $ | 0.027 |   |
| Diluted                                       |       | $                              | 0.011      |   | $ | 0.036 |   | $ | 0.025 |   | $ | 0.024 |   |
| Weighted average shares  outstanding:         |       |                           |       |   |   |   |   |   |   |
| Basic                                         |       | 13,773,219                     |       | 13,773,219 |   | 13,776,969 |   | 13,792,523 |   |
| Diluted                                       |       | 14,366,506                     |       | 14,584,284 |   | 15,582,248 |   | 15,794,293 |   |

 

**Item 8C.**
| ** **                                    | ** ** | **Fiscal Year 2006** | ** ** |
|-----------------------------------------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | **1st Quarter**           | ** ** | **2nd Quarter** | ** ** | **3rd Quarter** | ** ** | **4th Quarter** | ** ** |
|                                          |       |                           |       |   |   |   |   |   |   |
| Total revenues                                |       | $                              | 2,414,923  |   | $ | 2,445,327 |   | $ | 2,603,236 |   | 3,510,195 |   |
| Total operating  expenses                     |       | 1,605,516                      |       | 1,723,395 |   | 1,792,007 |   | 2,819,509 |   |
| Other Income (expense)                        |       | 14,352                         |       | 22,902 |   | 21,412 |   | (125,770 | ) |
| Net income before  provision for income taxes |       | 823,759                        |       | 744,834 |   | 832,641 |   | 564,916 |   |
| Net income                                    |       | 548,932                        |       | 500,056 |   | 538,085 |   | 375,459 |   |
|                                          |       |                           |       |   |   |   |   |   |   |
| Net income per share:                         |       |                           |       |   |   |   |   |   |   |
| Basic                                         |       | $                              | 0.04       |   | $ | 0.03 |   | $ | 0.04 |   | $ | 0.02 |   |
| Diluted                                       |       | $                              | 0.03       |   | $ | 0.03 |   | $ | 0.03 |   | $ | 0.02 |   |
| Weighted average shares  outstanding:         |       |                           |       |   |   |   |   |   |   |
| Basic                                         |       | 14,284,348                     |       | 14,379,061 |   | 14,484,319 |   | 15,821,575 |   |
| Diluted                                       |       | 15,971,013                     |       | 15,081,666 |   | 15,891,298 |   | 17,251,219 |   |

 

 

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**Item 9.**                          Changesin and Disagreements with Accountants on Accounting and Financial Disclosure

None.

**Item 9A.**                 Controls andProcedures

(a)GlobalSCAPE  maintains disclosurecontrols and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”)) that are designed to ensure that information required to be disclosed inits reports filed or submitted under the Exchange Act is processed, recorded,summarized and reported within the time periods specified in the SEC’srules and forms, and that such information is accumulated and communicatedto GlobalSCAPE ‘s management, including its Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow for timely decisions regarding requireddisclosure.  In designing and evaluating the disclosure controls andprocedures, management recognizes that any controls and procedures, no matterhow well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives.

Asrequired by SEC Rule 13a-15(b), GlobalSCAPE carried out an evaluation,under the supervision and with the participation of management, including itsChief Executive Officer and Chief Financial Officer, of the effectiveness ofthe design and operation of GlobalSCAPE’s disclosure controls and procedures asof the end of the period covered by this Annual Report.  Based on thisevaluation, management concluded that GlobalSCAPE’s disclosure controls andprocedures were effective as of December 31, 2006 to ensure that theinformation required to be disclosed by us in the reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in SEC rules and forms.

 (b) Changes in internal control over financialreporting. There were no significant changes in our internal control overfinancial reporting during the last fiscal year and/or up to and including thedate of this filing that we believe materially affected, or are reasonably likelyto materially affect, our internal control over financial reporting.

**Item 9B.**                 Other Information

None.

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**PART III**

**Item 10.**                   Directors,Executive Officers and Corporate Governance

The information called for by Item 10 of Form 10-K asto Directors is incorporated herein by reference to such information includedin our Proxy Statement for the 2007 Annual Meeting of Stockholders to be heldon June 1, 2007 under the caption “Election of Directors.”  Also see Item 4A of Part I of this Form10-K.  The information called for by Item10 of Form 10-K as to compliance with Section 16(a) of the Exchange Act isincorporated herein by reference to such information included in our ProxyStatement for the 2007 Annual Meeting of Stockholders to be held on June 1,2007 under the caption “Executive Officers.”

GlobalSCAPE hasadopted a Code of Ethics that applies to all its employees, including itsPresident (its chief executive officer) and its Vice President of Finance andOperations (its chief financial officer).  GlobalSCAPE will provide a copyof its Code of Ethics to any person without charge upon written request to:

Bernard Schneider

Chief Financial Officer

GlobalSCAPE, Inc.

6000 Northwest Parkway,Suite 100

San Antonio,Texas  78249

**Item 11.**                   ExecutiveCompensation

The information called for by Item 11 of Form 10-K isincorporated herein by reference to such information included in our ProxyStatement for the 2007 Annual Meeting of Stockholders to be held on June 1,2007, under the caption “Executive Compensation” except for those parts underthe captions “ Compensation Committee Report on Executive Compensation”.

**Item 12.**                   SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters

The information called for by Item 12 of Form 10-K isincorporated herein by reference to such information included in our ProxyStatement for the 2007 Annual Meeting of Stockholders to be held on June 1,2007, under the caption “Security Ownership of Certain Beneficial Owners andManagement.”

**Item 13.**                   CertainRelationships and Related Transactions and Director Independence

The information called for by Item 13 of Form 10-K isincorporated herein by reference to such information included in our ProxyStatement for the 2006 Annual Meeting of Stockholders to be held on June 1,2007, under the caption “Certain Relationships and Related Transactions.”

**Item 14.**                   PrincipalAccountant Fees and Services.

The information calledfor by Item 14 of Form 10-K is incorporated herein by reference to suchinformation included in our Proxy Statement for the 2007 Annual Meeting ofStockholders to be held on June 1, 2007 under the caption “Principal AccountantFees and Services.”

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**PART IV**

**Item 15.**                   Exhibits,Financial Statement Schedules

(a)(1)       Financial Statements and Schedules

The following financial statements of GlobalSCAPE, Inc. are included in Item 8:

·                  Consolidated balance sheets — December 31, 2005 and 2006

·                  Consolidated statements of operations — Years ended December 31, 2004, 2005 and 2006

·                  Consolidated statements of stockholders’ equity — Years ended December 31, 2004, 2005 and 2006

·                  Consolidated statements of cash flows — Years ended December 31, 2004, 2005 and 2006

·                  Notes to consolidated financial statements — December 31, 2006

(2)                      Schedules not listed above have been omitted because they are not applicable or required, or the information required to be set forth therein is included in the Financial Statements or Notes thereto.

(3)       Exhibits

 
| Exhibit   Number | ** ** | **Description** |
|------------------|------------|-----------------|
|             | 2.1        |            |   | Agreement and Plan of Merger dated September 22,  2006 by and among GlobalSCAPE, Inc., GA Acquisition Corporation, Availl,  Inc., Chuck Shavit, Ellen Ohlenbusch, Craig Randall, Ronald Lachman, Lachman  Goldman Ventures LLC and Chuck Shavit as Stockholders’ Representative (Filed  as Exhibit 2.1 to Form 8-K filed September 27, 2006) |
|             | 3.1        |            |   | Amended Restated Certificate of Incorporation (Filed  as Exhibit 3.1 to Form 8-Kfiled November 17, 2006). |
|             | 3.2        |            |   | Amended and Restated Bylaws of the Company effective  as of November 13, 2006 (Filed as Exhibit 3.2 to Form 8-K filed November 17,  2006). |
|             | 4.1        |            |   | Specimen of Stock Certificate (Filed as Exhibit 4.1  to Annual Report on Form 10-K filed April 2, 2001). |
|             | 4.2        |            |   | Registration Rights Agreement dated November 16,  2006 by and between GlobalSCAPE, Inc. and the Purchasers signatory thereto  (filed as Exhibit 4.1 to Form 8-K filed November 17, 2006) |
|             | *10.1      |            |   | 1998 Stock Option Plan as amended May 13, 1999  (Filed as Exhibit 4.2 to Form 10 filed May 12, 2000). |
|             | *10.2      |            |   | 2000 Stock Option Plan dated May 8, 2000 (Filed as  Exhibit 4.3 to Form 10 filed May 12, 2000). |
|             | *10.3      |            |   | Form of 1998 Stock Option Plan Rights Termination  Letter Agreement of Directors to Agree Not to Claim Any Right of Adjustment  dated February 4, 2000 (Filed as Exhibit 4.6 to Form 10 filed May 12, 2000). |
|             | *10.4      |            |   | Form of 1998 Stock Option Plan Rights Termination  Letter Agreement for Employees and Consultants to Cancel Options dated  February 8, 2000 (Filed as Exhibit 4.7 to Form 10, filed May 12, 2000). |
|             | *10.5      |            |   | Form of 1998 Stock Option Plan Rights Termination  Letter of Officer to Agree Not to Claim Any Right of Adjustment dated  February 8, 2000 (Filed as Exhibit 4.8 to Form 10 filed May 12, 2000). |

 

60

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| Exhibit   Number | ** ** | **Description** |
|------------------|------------|-----------------|
|             | *10.6      |            |   | Form of 1998 Stock Option Plan Rights Termination  Letter Agreement of Officer to Agree Not to Exercise Options dated February  8, 2000 (Filed as Exhibit 4.9 to Form 10 filed May 12, 2000). |
|             | *10.7      |            |   | Form of 1998 Stock Option Plan Reinstatement and  Adjustment Letter for Employees dated December 19, 2000 (Filed as Exhibit  10.17 to Annual Report on Form 10-K filed April 2, 2001). |
|             | *10.8      |            |   | Form of Release and Indemnity Agreement between  GlobalSCAPE, Inc. and Employees dated December 19, 2000 (Filed as Exhibit  10.18 to Annual Report on Form 10-K filed April 2, 2001). |
|             | 10.9       |            |   | Commercial Lease Agreement between ACLP University  Park S.A. II, L.P. and the Company dated April 13, 1999 (Filed as Exhibit  10.1 to Form 10 filed May 12, 2000). |
|             | *10.10     |            |   | Release and Indemnity Agreement between GlobalSCAPE,  Inc. and Sandra Poole-Christal dated April 2, 2001 (Filed as Exhibit 10.17 to  Annual Report on Form 10-K filed April 1, 2002). |
|             | *10.11     |            |   | Granting letter for 808,571 options to Sandra  Poole-Christal under GlobalSCAPE, Inc. 1998 Stock Option Plan dated April 20,  2001 (Filed as Exhibit 10.18 to Annual Report on Form 10-K filed April 1,  2002). |
|             | *10.12     |            |   | Bonus letter for Sandra Poole-Christal in connection  with grant of 808,571 options under 1998 Stock Option Plan (Filed as Exhibit  10.19 to Annual Report on Form 10-K filed April 1, 2002). |
|             | *10.13     |            |   | Incentive Stock Option Agreement between  GlobalSCAPE, Inc. and Sandra Poole Christal dated April 20, 2001 (Filed as  Exhibit 10.20 to Annual Report on Form 10-K filed April 1, 2002). |
|             | *10.14     |            |   | Form of Incentive Stock Option Agreement under  GlobalSCAPE, Inc. 2000 Stock Option Plan (Filed as Exhibit 10.21 to Annual  Report on Form 10-K filed April 1, 2002). |
|             | *10.15     |            |   | Employment Agreement between GlobalSCAPE, Inc. and  Charles R. Poole dated effective July 1, 2005 (Filed as exhibit 10.1 on Form  8-K filed June 20, 2005). |
|             | *10.16     |            |   | Incentive Stock Option Agreement between  GlobalSCAPE, Inc. and Charles R. Poole dated June 15, 2005 (Filed as Exhibit  10.2 on Form 8-K filed June 20, 2005). |
|             | 10.17      |            |   | Securities Purchase Agreement dated November 13,  2006 by and among GlobalSCAPE, Inc., the Stockholders named in Schedule I  thereto and the Purchasers named therein (Filed as Exhibit 10.1 to Form 8-K  filed November 17, 2006). |
|             | 10.18      |            |   | Form of Common Stock Purchase Warrant (Filed as  Exhibit 10.2 to Form 8-K filed November 17, 2006). |
|             | 10.19      |            |   | Loan and Security Agreement dated September 22, 2006  by and between GlobalSCAPE, Inc. and Silicon Valley Bank (filed as Exhibit  10.1 to Form 8-K filed September 27, 2006). |
|             | *10.20     |            |   | Form of Non-Qualified Stock Option Agreement under  the GlobalSCAPE, Inc. 2000 Stock Option Plan (Filed as Exhibit 10.2 to Form  10-Q filed November 13, 2006) |
|             | 21         |            |   | Subsidiaries (Filed as Exhibit 21 on Form 10-K filed  March 24, 2005). |
|             | 23.1       |            |   | Consent of PMB Helin Donovan, LLP (filed herewith). |
|             | 31.1       |            |   | Rule 13a-14(a)/15d - 14(a) Certification of Charles  R. Poole, President and Chief Executive Officer of GlobalSCAPE, Inc. (filed  herewith). |
|             | 31.2       |            |   | Rule 13a-14(a)/15d - 14(a) Certification of Bernard  N. Schneider, Chief Financial Officer (filed herewith). |
|             | 32.1       |            |   | Certificate pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (filed  herewith). |
|             |       |            |   |   |

 

* Management CompensatoryPlan or Agreement

61

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**Signatures**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized, inSan Antonio, Texas on March 22, 2007.
|            | ** ** | **GlobalSCAPE, Inc.** |
|------------|------------|-----------------------|
| ** ** | ** ** | ** **            |
|       |       | By:                   | /s/ CHARLES R.  POOLE |
|       |       |                  | Charles R. Poole |
|       |       |                  | President and Chief Executive Officer |
|       |       |                  |   |
|       |       | By:                   | /s/ BERNARD  SCHNEIDER |
|       |       |                  | Bernard Schneider |
|       |       |                  | Chief Financial Officer |

 

Pursuant to the requirements of the Securities Act of1934, this report has been signed below by the following persons on behalf ofthe registrant in the capacities indicated on March 22, 2007.
|                           | **Signature** | ** **                                   | ** ** | ** ** | **Title** | ** ** |
|---------------------------|---------------|----------------------------------------------|------------|------------|-----------|------------|
|                      |          |                                         |
| /s/  CHARLES R. POOLE     |          | President, CEO and  Director                 |
| Charles  R. Poole         |          | (Principal Executive  Officer)               |
|                      |          |                                         |
| /s/  THOMAS W. BROWN      |          | Chairman of the Board  and Director          |
| Thomas  W. Brown          |          |                                         |
|                      |          |                                         |
| /s/  DAVID L. MANN        |          | Director                                     |
| David  L. Mann            |          |                                         |
|                      |          |                                         |
| /s/  PHILLIP M. RENFRO    |          | Director                                     |
| Phillip  M. Renfro        |          |                                         |
|                      |          |                                         |
| /s/  FRANK M. MORGAN      |          | Director                                     |
| Frank  M. Morgan          |          |                                         |
|                      |          |                                         |
| /s/  BERNARD N. SCHNEIDER |          | Chief Financial  Officer,                    |
| Bernard  N. Schneider     |          | Secretary                                    |
|                      |          | (Principal Accounting and Financial Officer) |

 

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