** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

### **FORM10-K**

 

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

** **

**For the fiscal year ended December 31, 2003**

** **

**OR**

** **

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

** **

**For the transition period from             to            .**

 

**Commission File No. 000-30617**

** **

**GlobalSCAPE, Inc.**

(Exact name of registrant as specified in itscharter)

 

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

 

| **(210) 308-8267**                                           |
|--------------------------------------------------------------|
| (Registrant’s Telephone Number, Including  Area Code)   |
|                                                         |
| Securities registered pursuant to Section  12(b) of the Act: |
| **None**                                                     |
|                                                         |
| Securities registered pursuant to Section  12(g) of the Act: |
| **Common Stock, par value $0.001 per share**                 |
| (Title of Class)                                             |
|                                                         |

 

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

ý  Yes       o  No

** **

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein,and will not be contained, to the best of registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K.    o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Act).

o  Yes       ý  No

 

The aggregatemarket value of the registrant’s outstanding common stock held bynon-affiliates was approximately $465,528 as of the last business day of theregistrant’s most recently completed second fiscal quarter, based upon theclosing sales price of $0.13 per share on such date on the NASD’s OTC BulletinBoard.  As of March 26, 2004 there were13,488,619 common shares outstanding, of which 3,580,985 were held bynon-affiliates.

 

**Documents Incorporated by Reference**

 

Portions of the Registrant’s Proxy Statement for the 2004 AnnualMeeting of Stockholders to be held in June 2004, are incorporated by referencein Part III hereof.

 

 

----

 

**TABLE OF CONTENTS**

** **
|                              | **PART I**                                                                                                     |   |
|-----------------------------------|----------------------------------------------------------------------------------------------------------------|--------|
| **Item 1.**                       | **Business**                                                                                                   |   |
|                              |                                                                                                           |   |
| **Item 2.**                       | **Properties**                                                                                                 |   |
|                              |                                                                                                           |   |
| **Item 3.**                       | **Legal Proceedings**                                                                                          |   |
|                              |                                                                                                           |   |
| **Item 4.**                       | **Submission of Matters to a Vote of Security  Holders**                                                       |   |
|                              |                                                                                                           |   |
| **Item 4A.**                      | **Information Regarding Executive Officers**                                                                   |   |
|                              |                                                                                                           |   |
|                              | **PART II**                                                                                                    |   |
|                              |                                                                                                           |   |
| **Item 5.**                       | **Market for Registrant’s Common Equity and  Related Stockholder Matters and Issuer Purchases of Equity** |   |
|                              |                                                                                                           |   |
| **Item 6.**                       | **Selected Financial Data**                                                                                    |   |
|                              |                                                                                                           |   |
| **Item 7.**                       | **Management’s Discussion and Analysis of  Financial Condition and Results of Operation**                 |   |
|                              |                                                                                                           |   |
| **Item 7A.**                      | **Quantitative and Qualitative Disclosures  About Market Risk**                                                |   |
|                              |                                                                                                           |   |
| **Item 8.**                       | **Financial Statements and Supplementary Data**                                                                |   |
|                              |                                                                                                           |   |
| **Item 9.**                       | **Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure**                      |   |
|                              |                                                                                                           |   |
| **Item 9A.**                      | **Controls and Procedures**                                                                                    |   |
|                              |                                                                                                           |   |
|                              | **PART III**                                                                                                   |   |
|                              |                                                                                                           |   |
| **Item 10.**                      | **Directors and Executive Officers of the  Registrant**                                                        |   |
|                              |                                                                                                           |   |
| **Item 11.**                      | **Executive Compensation**                                                                                     |   |
|                              |                                                                                                           |   |
| **Item 12.**                      | **Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters**            |   |
|                              |                                                                                                           |   |
| **Item 13.**                      | **Certain Relationships and Related  Transactions**                                                            |   |
|                              |                                                                                                           |   |
| **Item 14.**                      | **Principal Accountant Fees and Services**                                                                     |   |
|                              |                                                                                                           |   |
|                              | **PART IV**                                                                                                    |   |
|                              |                                                                                                           |   |
| **Item 15.**                      | **Exhibits, Financial Statement Schedule, and  Reports on Form 8-K**                                           |   |
|                              |                                                                                                           |   |
| **Signatures and Certifications** |                                                                                                           |

 

----

 

###### **Preliminary Notes**

 

GlobalSCAPE®,PureCMS®, CuteFTP Pro®, CuteFTP®, CuteZIP®, CuteHTML®, CuteMAP® and CuteSITEBuilder® are registered trademarks of GlobalSCAPE Texas, LP.  GlobalSCAPE Secure FTP Server, WebSurvey,and GlobalSCAPE Transfer Engine are trademarks of GlobalSCAPE Texas, LP.  Other trademarks and tradenames in thisannual report are the property of their respective owners.

 

In May 2000,our board of directors approved a 7.6 for 1 stock split.  All information in this Annual Report hasbeen adjusted to reflect the effects of this stock split.

 

###### **Forward-LookingStatements**

 

This AnnualReport on Form 10-K and the documents incorporated by reference herein contain“forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities and ExchangeAct of 1934, as amended. “Forward-looking statements” are those statements that are not ofhistorical fact, but describe management’s beliefs and expectations.  We have identified many of theforward-looking statements in this Annual Report by using words such as“anticipate,” “believe,” “could,” “estimate,” “may,” “expect,” and“intend.”  Although we believe thesebeliefs and expectations are reasonable, our operations involve a number ofrisks and uncertainties, including those described in the “Risk Factors”section of this Annual Report and other documents filed with the Securities andExchange Commission.  Therefore,GlobalSCAPE’s actual results could differ materially from those discussed inthis Annual Report.

 

# **PART I**

 

##### **Item 1. Business**

 

###### **Company Overview**

 

GlobalSCAPEdevelops and distributes Internet related software, including file management,content management and Web development tools.*** ***Westarted in 1996 with the distribution of CuteFTP and have achieved significantsuccess and popularity with this product. We built on this success by steadily adding complementary products andbelieve we now have a reputation as a provider of easy-to use, affordablesoftware.  Since 2000 we have focused onenhancing our portfolio of products to meet the increasing demand for datasecurity, and for solutions that permit non-technical personnel to contributecontent to their organizations’ Web sites. Our software is used worldwide across a wide range of industries.  We have sold approximately one millionsoftware licenses to date and our customer base includes individual consumers,small to medium-sized businesses, as well as some of the largest corporationsin the world.

 

We distributeour software primarily via download from our Web site, **www.globalscape.com**. Prospective buyers mayuse our software products for free for a thirty-day evaluation period.  The programs are automatically disabled if alicense is not purchased by the end of the trial period.  Our current products range in price from$19.95 to $485 per license. Historically, the majority of software purchases have been made onlineusing a credit card.  During 2003 weincreased our emphasis on developing our internal sales staff and resellerchannels to capture those sales that require personal attention, such as salesof our more complex products and sales to larger enterprises.    Our software is also available fordownload from a variety of independent Internet software sites such as CNet’sDownload.com, as well as sites in Western Europe, Canada, Australia, andAsia.  We distribute a limited number ofcopies on CD in Fry’s and Micro Center stores in the United States and throughnumerous international resellers.  Weprovide free customer support via a searchable knowledge base on our Web siteand sell “live” support and maintenance packages.

 

1

----

 

During 2003approximately 65% of our revenues were generated from customers within theUnited States, with the remaining 35% concentrated mostly in Western Europe,Canada and Australia.  Virtually all ofour 2003 revenues were derived from sales of software licenses and supportagreements.  The combined sales ofCuteFTP and CuteFTP Pro accounted for 85% and 75% of our revenues in 2002 and2003, respectively.

 

###### **Products**

###### ** **

Our currentproducts include Windows®-based, browser-based and server softwareapplications.

 

***CuteFTP*.**  CuteFTP is a file transfer protocol, or“FTP”, client.  Although the term “FTP”is not a household word, the protocol is well known and heavily used in theinformation technology world.   Like themore widely known “HTTP” that underlies the World Wide Web, FTP is simply aformat that allows computers to exchange information over the Internet or othernetworks.  CuteFTP is a “client-side”program, meaning that it permits a user to request a file from or send a fileto an FTP server or host computer.  Theuser base for this program ranges from corporate MIS professionals who use itto transfer data between locations via the Internet, to individual Web siteoperators who use it to upload their Web pages to their Web hostingprovider.  CuteFTP simplifies filetransfer protocol by hiding the technical processes behind a user-friendly,graphical interface, which allows users to “drag `n drop” files betweencomputers.  It includes an automaticreconnection feature that resumes broken transfers, a transfer queue and abuilt in HTML editor that allows remote editing of Web pages.  CuteFTP has won several awards, includingthe CNet Editors’ Choice award, and has been favorably reviewed in leadingonline and print trade journals such as PC Magazine, WindowsNT, Yahoo InternetLife, CNet’s Download.com and Tucows, as being the most powerful, easy-to-usefile transfer protocol program available. We offer CuteFTP in German, French, Spanish, Japanese and Traditionaland Simplified Chinese.  CuteFTP wasfirst released in February 1995 by its original author, and was firstdistributed as a commercial product by GlobalSCAPE in April 1996.   In October 2003 we released CuteFTP Mac,our easy-to use ftp client for the Macintosh operating system.  CuteFTP Mac incorporates many of the popularfeatures of CuteFTP for Windows, while adhering to Apple’s Aqua® interface andusability guidelines.

 

***CuteFTP Pro*.**  CuteFTP Pro is a secure FTP client designedfor advanced users and information technology professionals.  CuteFTP Pro incorporates standards forencrypted transfers using Secure Socket Layer (SSL), HTTP, and SSH2, as well asadvanced S/KEY password encryption.   Itincludes various features attractive to advanced users such as multi-part andconcurrent file transfers to maximize transfer speed, scheduled file transfers,automated site backups 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.

 

***GlobalSCAPE Secure FTP Server*.**  GlobalSCAPE Secure FTP Server complementsCuteFTP Pro and other professional FTP clients by enabling encrypted transfersusing Secure Socket Layer (SSL), Secure Shell (SSH2) and advanced S/KEYpassword encryption.  When used withCuteFTP Pro, Secure FTP Server offers a complete digital certificate managementsystem, giving system administrators the ability to create, sign, import,export and add digital certificates, as well as kick off back-end processes.The latter functionality can be used as a partial or total replacement for morecomplex enterprise-level electronic data interchange systems (EDI).  Additional features include full remotemanagement capability, the ability to operate multiple FTP sites with uniquedirectory structures from a single server and manage user accounts withadvanced restriction settings for maximum security and control.  Secure FTP Server has been favorablyreviewed by leading online publications including Server Watch and File Forum.GlobalSCAPE Secure FTP Server was first released in January 2002.

 

***CuteSite Builder***.  CuteSITE Builder is a WYSIWYG (what you seeis what you get) Web site creation tool enabling anyone, regardless of skilllevel, to easily create, publish and manage a high quality Web site withouthaving to learn HTML, FTP or graphic design. Users choose the design and type of Web site they would like to createfrom professionally designed templates, add personalized content such as familyphotos, images and links and publish their Web site with just one click.  This program is based on

 

2

----

 

technologylicensed from Trellix Corporation and previously distributed as TrellixWeb.  CuteSITE Builder was firstreleased by GlobalSCAPE in June 2001.

 

***PureCMS***.  PureCMS is our Web content managementsolution.   “Content management”generally refers to software that streamlines the process for managinginformation on a Web site or intranet. PureCMS is designed to solve basic problems endemic to maintainingcurrent information on a Web site such as bottlenecks in the IT department,lack of control and accountability, and miscommunication between contentauthors and Web developers.  UsingPureCMS, a company’s Web administrator may give non-technical personnel theability to directly revise designated content. For example, the marketing department could modify pricing, productdescriptions and graphics while the human resources department updated its jobpostings, all without the involvement of technical personnel.  Access by non-technical personnel islimited, however, so that the Web site administrator’s ability to protect theoverall infrastructure and design of the site is not compromised.  The program is browser-based with aWindows-like interface, so users can easily access and work on Web sites,eliminating the need for special training. Changes are made to a copy of an organization’s Web site in a stagingarea and published to the live site only after group leaders or Web siteadministrators approve the content for publishing.   Additional features include WYSIWYG (what you see is what youget) editing, visual comparison of proposed changes to the live site, e-mailnotification of changes and activity, site statistics, versioning andarchiving.  PureCMS works with any Website development tool including popular applications such as Front Page andDreamweaver, and can be implemented without deconstructing (re-building) theexisting 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.  PureCMS was released in January 2003.

 

In January2004 we also made the software available as an application service model. Wehost the software for use on our servers in exchange for a periodic fee, ratherthan licensing a copy to the customer for use on the customer’s server.

 

***Web Survey***.  Web Survey is an easy-to-use program forconducting surveys on Web sites.  Usersmay design and publish questionnaires and gather results in their e-mailin-box, without the need for custom programming.  The program includes tools for the analysis and presentation ofresults.  Web Survey was released in May2003.

 

***CuteZIP*.**  CuteZIP is a file compression program thatenables users to shrink and encrypt files for secure transfer and storage using“strong” or 128-bit encryption.  Users maycompress files across multiple disks or within a directory for easy download orstorage.  Users may also createencrypted self-extracting files that may be opened by a recipient without theuse of a zip utility.   CuteZIP has wonthe CNet Editors’ Choice award and has been favorably reviewed by leadingonline publications such as CNet’s Download.com, MP3.com and Tucows.   CuteZIP was first released in September1999.

 

***CuteHTML*.**  CuteHTML is a text-based HTML (hypertextmarkup language) editor used to create Web pages.  CuteHTML is a direct editing**tool,meaning that the user creates and edits HTML code directly, as opposed to a visual editingor WYSIWIG tool like CuteSITE Builder, which does not require the user tounderstand HTML coding.   It includes variousproductivity enhancing features such as color coded tags for easy codeidentification, tag tips for quick access to standard HTML tags, multipledocument find and replace, spell check, code for individual browsers, tabbedinterface and the ability to edit files on remote servers when used inconjunction with CuteFTP.  CuteHTML hasbeen favorably reviewed in leading online and print publications includingCNet’s Download.com, ZDNET and Tucows. CuteHTML was first released in January 1999.

 

***CuteHTML Pro***.  CuteHTML Pro is our professional Web editingtool, offering Web masters even more control over Web projects, code and sitequality.  Code created with CuteHTML Promeets strict HTML specifications, such as those defined by the Word Wide WebConsortium, and does not add extraneous or non-standards compliant code.  CuteHTML Pro includes features attractive toadvanced users of HTML editors, such a comprehensive Script Generator, hundredsof ready-to-use Java and DHTML scripts, extended string/paragraph Search &Replace, inline Perl and PHP parser, built in FTP module, Document Evaluation,and a robust multi-language Reference Editor. In addition, Web masters can quickly

 

3

----

 

generatecomplex code such as tables, frames, image maps, forms and text formatting withwizard-like dialogs, recall commonly used code snippets using a singlekeystroke sequence, and create pages using one of the many pre-built pagetemplates.  The software also includesproject control features such as built in File, Project, To-Do List andBookmark Management tools, and permits users to easily check spelling, optimizecode, validate links and check CSS, HTML, and JavaScript Syntax for error freesites.  In addition, the softwarepermits users to preview HTML pages without launching an external browser andhighlights syntax for Perl, XML, WML, ASP, PHP, ColdFusion, CSS, and JavaScriptlanguages.

 

***CuteMAP***.  CuteMAP is an image-mapping tool designed tohelp HTML users create clickable images on their Web site graphics for improvednavigation.  Users select the area of animage that they want “hot,” and tell CuteMAP where the image should point.  CuteMAP automatically creates the image mapcode, which can be copied to an existing HTML document.  CuteMAP has been favorably reviewed inleading online and print publications including CNet’s Download.com, ZDNET,Tucows and LockerGnome. CuteMAP was first released in September 1999.

 

In December2003, we released Protect IIS, an application firewall for use in securingMicrosoft IIS Web Servers from Internet based attacks.  We received only lukewarm response to thisprogram, and decided in February 2004 to discontinue distribution.  The program was licensed to us on a trialbasis by Turillion Software Technologies, Inc., so we experienced minimal costsin developing and launching the program.

 

We alsodiscontinued our Web Hosting product in 2003 after experiencing disappointingsales results.  The service was providedon a trial basis by FortuneCity.com, Inc., so we experienced minimal costs indeveloping and launching this service as well.

 

###### **History and RecentDevelopments**

###### ** **

GlobalSCAPEwas organized as a Delaware corporation in April 1996 when we obtained theright to distribute CuteFTP from its original author.  Our former parent, ATSI Communications, Inc. (ATSI), establishedGlobalSCAPE as a wholly owned subsidiary dedicated to the development,marketing and support of Internet software products and the execution of otherstrategies unrelated to ATSI’s core telecommunications business.  In 1998, we purchased all rights to CuteFTPfrom its author and in 1999 began developing and selling complementary productsunder the “Cute” brand such as CuteHTML and CuteMAP.  In September 2000, ATSI distributed approximately 27% of itsGlobalSCAPE common stock to its shareholders. As a result of this partial spin off, we became a reporting companyunder the Securities Exchange Act of 1934. In June 2002, ATSI sold its remaining interest in the company to a SanAntonio-based joint venture.

 

Significantrecent developments are as follows:

 

•                  **January 2003**:      The Company completed a corporaterestructuring whereby all of the assets and liabilities of GlobalSCAPE, Inc.were transferred to a newly created, wholly owned operating subsidiary,GlobalSCAPE Texas, LP.  This structurepermits the Company to achieve certain tax benefits, and may also provideflexibility in the management and financing of the Company in the future.  The entire interest in the new operatingentity, GlobalSCAPE Texas, LP, is owned by GlobalSCAPE, Inc. via its ownershipof the entire interest in the two partners comprising GlobalSCAPE Texas,LP.  The management of GlobalSCAPETexas, LP is under the control of the Board of Directors of GlobalSCAPE,Inc.  The Company reports its financialresults and condition on a consolidated basis.

 

•                  **January 2003**:      We released PureCMS, ourcontent management solution.

 

•                  **January 2003**:      Sandra Poole-Christalwas elected to the Board of Directors.

 

•                  **May 2003**:             Wereleased Web Survey, our easy-to-use tool for creating online surveys.

 

4

----

 

•                  **July 2003**:             Weimplemented a new pricing and usage scheme for CuteFTP and CuteFTP Pro to giveour customers a broader range of choices for these products.  We eliminated the 30-day trial and gavecustomers the option to purchase these products for 1, 3, 7 or 30 days as wellas perpetual licenses.

 

•                  **October 2003**:      We released CuteFTP Mac, making our popular FTP clientavailable for the Macintosh operating system.

 

•                  **November 2003**:   We released PureCMS Version 2.0, including the Docucomp® documentcomparison engine, an enhanced Web page editor and other enhancements.

 

•                  **December 2003**:  We released CuteHTML Pro, our Professional Web editor.

 

•                  **December 2003**:  We re-instituted the 30-day trial for CuteFTP and CuteFTP Pro,eliminating the 1, 3, 7 and 30-day versions.

 

•                  **January 2004**:      We announced the availability of PureCMS as a hosted contentmanagement service.

 

•                  **January 2004**:      The federal General Services Administration approvedGlobalSCAPE as a government supplier via the award of a five-year contractunder the multiple award schedule program. This approval enables government agencies to purchase GlobalSCAPE’ssoftware without completing the cumbersome procurement procedures required fornon-scheduled suppliers.

 

•                  **February 2004**:    Sandra Poole-Christal stepped down as President and ChiefOperating Officer and was succeeded as President by Charles R. Poole.  Ms. Poole-Christal will continue to serve asthe Company’s Vice President of Marketing. Ms. Poole-Christal also resigned her seat on the Board of Directors, andMr. Poole was elected to complete her term by the remaining Board members.  Along with the change in management, theCompany laid off 9 employees, approximately 20% of its workforce, as part of anexpense control measure.

 

**Industry Background**

 

The Internethas become an integral part of operations for companies of all sizes, not onlyfor e-commerce, but also as a means of managing information between central andremote locations and with employees, partners and suppliers.  We believe that the Internet will continueto grow and that this growth will continue to create demand for our products.  As corporate Web operations mature, webelieve we will see an increasing demand for solutions that streamline themanagement of Web content and shift control and accountability for Web sites tonon-technical personnel.

 

###### **Strategy**

 

Our goal is tobe the leading developer of high quality, affordable software that enablesorganizations and individuals to easily create, move and manage Web andfile-based data in a secure, collaborative environment.  We have successfully established a brand inthe market for Internet software productivity tools with our file managementproducts, CuteFTP and CuteFTP Pro.  Webelieve the next phase of our growth will come through the provision of contentmanagement solutions that help non-technical professionals manage theirorganization’s Web sites without reliance on information technologyprofessionals.

 

Key elementsof our strategy are:

 

***Increase sales of PureCMS. ***We haveinvested considerable funds and effort in both the development and marketing ofPureCMS, our content management product introduced in January 2003. Although wehave been disappointed with our sales of this program to date, we continue tobelieve that the demand for Web

 

5

----

 

contentmanagement solutions is strong.   We arecurrently evaluating all aspects of our management of this product, includingpricing, ease of installation and use, program functionality, and marketing andsales strategies.  We intend to continueto aggressively pursue sales and distribution of this product.  The product launch and the related sellingand development activities for PureCMS consumed a significant portion of ourfinancial resources in 2003 and we will continue to devote significantresources to this effort in 2004.

 

***Continue to enhance security features of ourproducts. ***Corporateand individual users are increasingly concerned with security.  We intend to continue enhancing the securityfeatures of our programs to satisfy this demand.

 

***Develop a more robust reseller channel*.**  During 2003 we increased our emphasis on thedevelopment of our third party reseller channels, and we intend to continuethis effort.  In particular, we wish toreach “value-added” resellers such as Web design consultants.  We believe sales will be significantlyenhanced if we are able to recruit numerous resellers who have existingrelationships with prospective customers.

 

***Develop our internalsales staff****.*  During 2003 we devoted significant resourcesto the development of our internal direct sales force to better sell our morecomplex products, such as Secure FTP Server and PureCMS.  We intend to continue to develop our salesstaff through training and additional hiring as appropriate.

 

***Continue to develop online marketingcapabilities****. *We believe we have significantexpertise in driving online sales via online marketing activities, includingproduct placement on third party sites such as search engines and referralsites, and electronic mail campaigns. This type of sales activity is particularly well suited to certain ofour lower priced products because of the lower cost of sale.  We intend to continue to leverage ourestablished Web presence to drive online sales as well as supporting our directand reseller sales efforts.

 

***Pursue strategic product opportunities*.**  In 2003 we added Web Survey, CuteFTP for Macand CuteHTML Pro to our product portfolio. We will continue to look for opportunities to acquire or add synergisticproducts or technologies that enhance the online management of Web and filebased data to our portfolio.

 

###### **Seasonality**

###### ** **

We believe our sales aresubject to seasonal variations and we experience significantly less salesvolume during national holidays and weekends when compared to normal businessdays.  In 2000, we experienced a declinein software sales from the third to fourth quarter, primarily due to lowerDecember sales.  Third and fourthquarter revenues in 2001 were comparable, however, we believe this was theresult of unusually weak demand in September which skewed the comparison.  In 2002, fourth quarter revenues wereslightly higher than the third quarter due to a fourth quarter upgrade releaseof CuteFTP Pro that bolstered revenues for the period.  In 2003, fourth quarter sales were 19% lowerthan third quarter sales primarily due to weakness in November and December,although it is not clear that the decline was due solely to seasonal factors asturnover in our sales force may also have contributed to the decline inrevenues.  We expect that in futureperiods we will see weakness in the fourth quarter when compared to the third quarterdue to the holiday season.

 

###### **Network and Equipment**

###### ** **

We havecontracted with various network providers for Internet access.  Our arrangements provide for redundancy inthe event of a failure, and also for rapid expansion of available bandwidth inthe event that there is a dramatic increase in demand.  To protect critical customer data,GlobalSCAPE’s secure server utilizes Secure Sockets Layer encryption.  We have dedicated servers on and off siteand expansion plans in place to allow rapid and cost effective scalability.

 

###### **Research and Development**

###### ** **

Our internalsoftware engineers are responsible for software design, managing thedevelopment process, testing and quality assurance. We utilize offshoredevelopers for a large portion of the coding

 

6

----

 

phase ofsoftware development.  All phases ofdevelopment, including scope approval, functional and implementation design,object modeling and programming, are subject to internal quality assurancetesting.  Our use of external developersallows us to tap into a highly skilled labor pool, maintain a 24-hourdevelopment schedule, decrease time to market, and minimize programming costs.

 

For the years2001, 2002, and 2003 GlobalSCAPE spent approximately $1,177,000, $848,000, and$945,000, respectively, on research and development.  No research and development costs were capitalized in 2001, 2002or 2003 and all previously capitalized development costs fully amortized atDecember 31, 2002.

 

###### **Competition**

###### ** **

The file management,content management and Web development software market sectors are intenselycompetitive, subject to rapid change and are significantly affected by newproduct introductions and other activities of market participants.  Our primary competitors vary by product andare listed below.

 

***CuteFTP*.**  CuteFTP exists in a highly competitiveenvironment with several hundred FTP software utilities available on theInternet. We believe our primary competitors are WS_FTP from Ipswitch, Inc. andFTP Voyager by Rhino Software, Inc. CuteFTP was the second Windows-based FTP client to market and isconsistently the most frequently downloaded FTP client on popular downloadsites.  CuteFTP Mac, our FTP client forthe Macintosh platform competes with Fetch, by Fetch Softworks, Interachry, by Stairways Software Pty Ltd., and Transmit FTP,by Panic Inc.

 

***CuteFTP Pro*.**  CuteFTP Pro competes in the higher end ofthe same market as CuteFTP, targeting the security minded IT professional.  CuteFTP Pro is positioned as one of the onlysecure FTP clients that support a wide range of security standards related tothe FTP protocol.  Competitors in thegeneral FTP market offer products that support a smaller subset of thesesecurity standards and address a narrower segment of the secure FTPmarket.  Competitors include Van Dyke,Inc., Ipswitch, Inc., and Rhino Software, Inc.

 

***GlobalSCAPE Secure FTP Server***.  GlobalSCAPE Secure FTP Server (GSFTPS)competes against a limited number of secure Windows-based FTP servers.  We believe our primary competitors areWS_FTP Server and Serve-U.  GSFTPS hasthe advantage of leveraging the success of CuteFTP Pro through productintegration, offering proprietary extensions to the FTP protocol, andcross-marketing efforts to an existing customer base.

 

***CuteSITE Builder***.  CuteSITE Builder competes againstapproximately one hundred WYSIWYG editors, including MS FrontPage, Macromedia’sDreamweaver, HotMetal and HotDog. CuteSITE Builder offers most of the features available in FrontPage,however, the product was developed to further simplify the Web site creationprocess and is arguably easier to use, better serving the novice.  In addition, the product is priced wellbelow FrontPage.

 

***PureCMS***.  The “content management” market is diverseand encompasses the areas of knowledge management, document management, digitalasset management and Web content management. PureCMS 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 offer 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.

 

We offerPureCMS both as a packaged solution and as an online service over theInternet.  A “packaged solution” meansthat we license a copy of the software to the customer for a one-time fee toinstall and use on their own servers. If a customer elects to use PureCMS as a service, they access thesoftware on GlobalSCAPE’s servers via the Internet and pay a monthly or otherperiodic fee.  Our

 

7

----

 

competitors include providers of online solutions, such as Atomz, CrownPeak, and iUpload, and providers of packaged solutions, including Macromedia’sContribute, Userland, Infosquare and Ektron. We believe that by offering PureCMS both as a service and a packagedsolution we can capture those customers who prefer to have control over thesolution rather than an ongoing dependency on a technology provider, as well asthose customers who prefer to pay a monthly or other periodic fee rather than ahigher one-time license fee.

 

PureCMS alsocompetes against software that incorporate subsets of Web content managementfunctions in Web authoring programs, such as Microsoft’s FrontPage, andMacromedia’s Dreamweaver and Contribute.

 

***Web Survey. ***Competitive products include bothapplications and services including Zoomerang, WebSurveyor, EZSurvey andSurveyMonkey.  We believe Web Survey hasan advantage of a lower total cost of ownership than the competition.

 

***CuteHTML*.**  CuteHTML exists in a highly competitiveenvironment with approximately one hundred text-based HTML editors. CuteHTML’scompetition includes HomeSite from Allaire, Inc. CuteHTML’s advantage is thatit doesn’t add extraneous code to Web pages, an attribute preferred by manyprofessional 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 ableto leverage the success of CuteHTML through product integration andcross-marketing efforts to an existing customer base.

 

***CuteZIP*.**  CuteZIP exists in the highly competitivefile compression utility market, competing against several hundred filecompression utilities. Its main competitors include WinZIP, the current marketleader, and NetZIP.  CuteZIP’s mainadvantage is that it is one of the only compression utilities offering 128-bitencryption to secure compressed files. In addition, users can create self-extracting encrypted archives thatrecipients may open even if they don’t have a zip utility installed.

 

We havelimited information regarding our products’ market shares in their respectivecategories. For more discussion on the risks associated with our competition,you should read the information under “Risk Factors.”

 

###### **Intellectual Property**

 

Ourtrademarks, copyrights and technology are central to our business.  We protect our intellectual property rightsthrough a combination of licenses, trademarks, service marks, copyrights, tradesecret laws and restrictions on disclosure.

 

We currentlyhave registered trademarks for GlobalSCAPE, CuteFTP, CuteFTP Pro, PureCMS,CuteHTML, CuteZIP, CuteMAP and CuteSITE Builder.  We have obtained United States copyright registrations for allbut the most recently developed versions of our software applications, and haveapplied for registration for the most recently developed versions.

 

For morediscussion on the risks associated with our intellectual property, you shouldread the information under “Risk Factors,” especially “Risks Related to LegalUncertainty.”

 

8

----

 

###### **Employees**

###### ** **

As of March15, 2004, we had 35 full-time and part-time employees organized within sevenfunctional areas.  The employeedistribution according to function is as follows:

 
| **Department**                |   | **Number of  Employees** |   |
|-------------------------------|--------|--------------------------|--------|
| Management and Administration |   | 5                        |   |
| Research and Development      |   | 4                        |   |
| Quality Assurance             |   | 2                        |   |
| Marketing                     |   | 5                        |   |
| Information Services          |   | 4                        |   |
| Sales                         |   | 11                       |   |
| Customer Support              |   | 4                        |   |

 

None of ouremployees are covered by collective bargaining agreements and we believe ouremployee relations are good.

 

###### **Risk Factors**

 

We havedescribed below risks that we are aware of that could have a material adverseeffect on your stock ownership and our business.

 

###### **Risks Related toOperations**

###### ** **

***GlobalSCAPEdepends on two products for a substantial portion of its revenues.***

*** ***

GlobalSCAPEdepends on two products, CuteFTP and CuteFTP Pro, for approximately 75% of itsrevenues.  In addition, GlobalSCAPE’sability to produce revenues related to other products and new products dependssubstantially on exploiting the traffic to GlobalSCAPE’s Web site generated bythe demand for CuteFTP and CuteFTP Pro. If GlobalSCAPE is not able to maintain its competitive position withthese products, its revenues could decline dramatically and GlobalSCAPE’s plansto expand its business could be substantially impaired.  From 1996 to 2000, sales of licenses forCuteFTP increased significantly year to year. In 2002, revenues recognized from CuteFTP and CuteFTP Pro declined fromthe prior year by approximately 7%.  In2003, revenues recognized from CuteFTP and CuteFTP Pro declined from 2002 byapproximately 21%.  This decline wasprimarily in sales of CuteFTP, which declined 29%.  Sales of CuteFTP Pro declined only 2% year over year.  Substantially all software productsultimately reach a point in their lifecycle in which sales can be expected toplateau or decline.  While it cannot bedetermined with certainty, these products may have reached such a point theirlifecycles.

 

***Ifwe do not increase revenues or decrease expenses we will not be able to continueas a going concern.***

*** ***

The Companyincurred significant operating losses during the last three years and hascontinued, in January and February of 2004, to incur significant operatinglosses.  In January and February 2004,the Company’s operating losses related primarily to disappointing revenueperformance.  These results have reducedthe Company’s working capital substantially at February 29, 2004.  If we fail to increase our revenues ordecrease expenses, we will not be able to continue as a going concern.

 

***GlobalSCAPE’s new product introductions mayfail to generate sufficient revenue.***

 

We haveinvested considerable time and financial resources in the development andmarketing of PureCMS, our content management program released in January2003.  To date we have realized limitedrevenue from this product and will not recoup the expenses of bringing thisproduct to market unless sales increase dramatically.  We have also experienced disappointing results with our serversecurity product, Protect IIS and our Web hosting service.   If revenues from CuteFTP and CuteFTP Procontinue to decline and our new products fail to generate sufficient revenue toreplace the declining revenues, our revenues will continue to decline.

 

9

----

 

***GlobalSCAPE may fail to develop or licensethe intellectual property needed to launch new products.***

 

Our strategyfor future growth depends significantly on the addition of new products.  If we fail to timely license and/or developnew programs, or if our new programs are not functionally competitive withother programs in this market, our revenue growth could be substantiallyimpaired.

 

***GlobalSCAPEmay not be able to develop its sales force as needed to successfully market itsnew products.***

*** ***

GlobalSCAPEhas relied heavily on Internet sales in the past.  However, our newer enterprise programs, PureCMS and Secure FTPServer, require a more complex distribution model, including heavy reliance onvalue-added resellers such as Web development consultants.  In addition, we must develop an internalsales force that is skilled at managing a complex and multi-stage sales processappropriate for these products.  ThePureCMS product may not provide sufficient revenue to offset development andmarketing costs if we are not able to successfully implement thesechanges.  We have experiencedsignificant turnover among our internal sales personnel during 2003, possiblyas a result of the changing demands we are placing on our sales staff.  This turnover has had an immediate anddirect effect on our revenues. Continued turnover, especially of key personnel, could cause revenues todecline dramatically.

 

***IfGlobalSCAPE loses key personnel it may not be able to execute its businessplan.***

*** ***

GlobalSCAPE’sfuture success depends on the continued services of key members of its salesteam. GlobalSCAPE has experienced significant turnover in its sales departmentduring 2003, possibly due to changing demands placed on sales personnel as thecompany works toward development of a larger and more skilled sales staff.  These individuals are difficult to replacebecause of the intense competition for similarly skilled people.  In addition, new employees in the salesdepartment may not be productive for weeks or months as they learn aboutGlobalSCAPE’s products.

 

***GlobalSCAPE’sposition in the Internet software market is continuously threatened because themarket is intensely competitive and technology is constantly changing.***

*** ***

The softwareindustry is characterized by rapid technological change.  GlobalSCAPE’s competitors are constantlyreleasing improved versions of their products. The needs and expectations ofGlobalSCAPE’s customers are also evolving. Therefore, GlobalSCAPE must continually enhance its products and developnew products to remain competitive. When a new product is brought to market with functionality better suitedto a particular use, the demand for currently available products may decrease.    All of GlobalSCAPE’s products are subjectto the threat of reduced market share resulting from the introduction ofcompetitive products.  GlobalSCAPE mayfail to develop new products and functionalities as quickly as is necessary inthe future to avoid losing its position in the Internet software market.

 

In addition tostand-alone FTP clients, CuteFTP competes with browsers, open source filesharing communities and download utilities, which provide subsets of the filetransfer protocol functionality.  Thesecompeting products may reduce the demand for CuteFTP.

 

In addition,software development generally requires substantial lead-time, so GlobalSCAPEmust accurately predict what changes will be needed.  GlobalSCAPE may fail to predict these changes far enough inadvance, or it may not have sufficient technical personnel to make suchchanges.  If GlobalSCAPE cannot keeppace, its products will lose their position in the market.

 

***GlobalSCAPE utilizes “open source” softwarein some of its products.***

 

The opensource software community develops software technology for free use byanyone.  We have relied on open sourcetechnology for the encryption features in our CuteFTP Pro and GlobalSCAPESecure FTP Server products.  For theseproducts to remain competitive, we must continue to enhance their features,including the encryption features.  Ifthe open source community does not continue to develop and enhance theencryption technologies we rely on, we would have to license thistechnology.  We may have

 

10

----

 

to pay substantial fees forsuch a license, and it is possible that we would not be able to license thistechnology on any acceptable terms.

 

***Future government regulation may increase ourcost of doing business and reduce demand for our products*.**

 

New laws maybe adopted to address areas such as taxation, privacy, copyrights, and qualityof services, and existing laws may be applied to the Internet in unexpectedways.  New laws and unexpectedapplication of existing laws related to the Internet could create uncertaintyin the Internet market place, which could increase our cost of doing business,reduce demand for our products, and have a material adverse effect on ourbusiness, financial condition and operations.

 

***If an effective Internet sales tax scheme isimplemented, demand for our products could be decreased.***

 

GlobalSCAPE isnot currently required to collect sales tax on its online sales except tocustomers in certain states.  Ingeneral, state laws require that if the seller does not collect sales tax,residents who purchase goods online should remit sales tax to the appropriatetaxing agency in the state where they live. However, state agencies rarely enforce this rule and we believe thatless than 1% of our customers actually remit sales tax to their state taxingagencies.  For practical purposes, mostof our customers who do not pay sales tax to us purchase their license on atax-free basis.    If an effectiveInternet sales tax scheme is implemented it would effectively increase the costof our software in the eyes of our customers and therefore likely have atendency to decrease demand for our software.

 

***Taxes imposed by foreign governments maydecrease demand for our products in those markets.***

 

On July 1,2003, the European Union (EU) enacted Value Added Taxes (VAT) on electronicpurchases.  These taxes are charged toour non-business customers in the EU member nations and rates vary bycountry.  Western European countriesaccount for a substantial portion of our international sales.  These taxes, which vary in rate from 15% to25%, may decrease demand for our products in these markets.  Expansion in the number of the EU membernations may also decrease demand for our products as these taxes are imposed onmore of our customers.

 

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

*** ***

GlobalSCAPEcompetes with a variety of companies who have significantly greater revenuesand financial resources than GlobalSCAPE as well as greater personnel andtechnical resources.   For example,CuteFTP and CuteFTP Pro compete with products offered by Ipswitch, Inc. andMicrosoft Corporation, PureCMS competes with Macromedia Inc.’s software, andCuteSite Builder competes with Microsoft and Macromedia software.  Large companies may be able to develop newtechnologies more quickly than GlobalSCAPE, to offer a broader array ofproducts, and to respond more quickly to new opportunities, industry standardsor customer requirements.  For example,Macromedia’s Dreamweaver is one of the most popular Web authoring programs forconsumers and small businesses, providing them with a huge established customerbase to which they are able to directly market their content managementproduct, Contribute.  Some competitors mayalso be able to adopt more 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 in lower operating margins and loss ofmarket share. Additional competitors may enter the market and may havesignificantly greater capabilities and resources than GlobalSCAPE.  You should read the information under“Business-Competition” for more information on our competitors.

 

11

----

 

***Itmay be difficult for GlobalSCAPE to recruit software developers and othertechnical and management personnel because GlobalSCAPE is a relatively smallcompany.***

*** ***

GlobalSCAPEcompetes intensely with other Internet software development and distributioncompanies internationally to recruit and hire from a limited pool of qualifiedpersonnel.  Some qualified candidatesprefer to work for larger, better known companies.  Failure to attract and maintain qualified personnel would impedeour development and maintenance of new and existing products.

 

***GlobalSCAPE’sability to develop its software will be seriously impaired if it is not able touse its foreign subcontractors.***

*** ***

GlobalSCAPErelies on foreign subcontractors to help it develop its software.  If these programmers decided to stop workingfor GlobalSCAPE, or if GlobalSCAPE were unable to continue using them becauseof political or economic instability, GlobalSCAPE would have difficulty findingcomparably skilled developers.  Inaddition, GlobalSCAPE would likely have to pay considerably more for the samework, especially if it used U.S. personnel. If GlobalSCAPE could not replace the programmers, it would take itsignificantly longer to develop its products.

 

***GlobalSCAPEmay incur losses as it attempts to expand its business.***

*** ***

GlobalSCAPEintends to expand its business and therefore expects to expend significantadditional resources on developing its sales force, developing a more robustreseller program, research and development, marketing and productdevelopment.   As a result, GlobalSCAPEmay need to expend significant resources to accomplish these goals.  If GlobalSCAPE fails to successfully developand market new products or improve its direct and channel sales results, it maynot be able to achieve the necessary revenue growth and may not be profitable.

 

***GlobalSCAPE’soperations are vulnerable to security breaches that could harm the quality ofits products and services or disrupt its ability to deliver its products andservices.***

*** ***

Third partiesmay breach GlobalSCAPE’s system security and damage its products and servicesor misappropriate confidential customer information.  This might cause GlobalSCAPE to lose customers, or even causecustomers to make claims on GlobalSCAPE for damages to them. In addition,GlobalSCAPE may be required to expend significant resources to protect againstsecurity breaches and/or to address problems caused by such breaches.

 

***GlobalSCAPE’sproducts may expose customers to invasion of privacy, causing customerdissatisfaction.***

*** ***

GlobalSCAPE’sSecure FTP Server is intended to provide outsiders access to a customer’scomputer, making the customer vulnerable to security breaches, which couldresult in the loss of their privacy or property.  If customers suffer invasions of privacy or other harm, this mayresult in customer dissatisfaction and possible claims against us for any resultingdamages.

 

***GlobalSCAPE’sproducts may contain defects that may be costly to correct, delay marketacceptance of its products and damage its reputation.***

*** ***

Errors may befound in GlobalSCAPE’s products after distribution.  If errors are discovered, GlobalSCAPE may have to makesignificant expenditures of capital to eliminate them and may not be able tocorrect them in a timely manner or at all. Errors and failures in GlobalSCAPE’s products could result in a loss of,or delay in, market acceptance of its products and could damage its reputation.

 

***GlobalSCAPE’sproducts rely on the prevalence of Windows-based operating systems and if thattechnology fails to maintain or improve market share, GlobalSCAPE’s productswould not be as marketable.***

*** ***

Almost all ofGlobalSCAPE’s current software products can only be used on a Windows-basedoperating system and are not compatible with other operating systems.  Anything that affects Windows market sharenegatively could have a material adverse effect on the demand for GlobalSCAPE’sproducts.

 

12

----

 

***GlobalSCAPE’sinternal controls are limited, increasing the risk of employee mismanagement orerror.***

*** ***

All of ourfinance, accounting and SEC disclosure work is managed by a single officer,Daniel P. McRedmond, Vice President of Finance and Operations, Secretary andTreasurer.  Mr. McRedmond has anaccounting staff of one person.   Due tolimited resources, we do not plan to add employees to our accounting staff inthe next fiscal year.   Without anincrease in staffing, it may be difficult for us to implement the types ofinternal controls that are common to larger corporations, and we therefore facea greater risk of mismanagement or error in these areas.

 

###### **Risks Related to Stock Ownership**

###### ** **

***Our stock is a penny stock, which makes itmore difficult to sell.***

 

A “pennystock” is any stock which is not traded on a national exchange or quoted onNASDAQ and which falls below a selling price of $5.00 per share in the publicmarket. Our common stock is quoted on the NASD’s OTC Bulletin Board and not onan exchange or the NASDAQ, and it has traded from $0.10 to $1.05 since it beganactive trading in February 2002.  TheSEC’s penny stock rules require brokers and dealers to take certain steps beforetrading in a penny stock, making it more difficult to sell a penny stock thanother stock.  A sale of penny stock doesnot usually take place as quickly as a sale of other stock.  You may decide to sell your stock when themarket price is desirable to you, but by the time the sale is complete, theprice of the stock may have fallen to the point that the sale is no longerdesirable.  The price of penny stocks istypically more volatile than other stocks, exacerbating this problem.  Also, some brokers are unwilling to trade inshares of penny stocks.

 

***Our stock price is/may be volatile.***

 

The tradingprice of our common stock has been and could continue to be subject to widefluctuations in response to certain factors, 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;

 

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

 

In addition,the public stock markets experience extreme price and trading volumevolatility, particularly in high-technology sectors of the market.  This volatility has significantly affectedthe market prices of securities of many technology companies for reasons oftenunrelated to the operating performance of the specific companies.  The broad market fluctuations may adverselyaffect the market price of our common stock.

 

***We do not pay dividends on our common stock.***

 

We have notpaid a dividend on our common stock and have no plan to do so in the nearfuture.

 

13

----

 

***GlobalSCAPE may undergo a change of controlin connection with the pledge by our majority shareholder of approximately 70%of our stock to secure a loan to the shareholder.***

 

In June 2002,ATSI Communications, Inc. sold its interest in GlobalSCAPE to Brown and Mann –GlobalSCAPE Joint Venture, a Texas general partnership.  A portion of the purchase money was borrowedfrom a bank, and the purchased stock secures that loan.  If the partnership defaults on the loan, thebank may take control of GlobalSCAPE or may dispose of the stock in a public orprivate sale.  A sale of the stock inthis way would tend to depress the value of the stock in general.  In addition, control of GlobalSCAPE could beassumed by persons having insufficient management experience and expertise toexecute GlobalSCAPE’s business plan.

 

***Our principal shareholder may control ourmanagement decisions.***

 

Brown and Mann-GlobalSCAPE Joint Venture, aTexas general partnership, owns approximately 70% of our outstanding commonstock.  Therefore, Brown andMann-GlobalSCAPE Joint Venture is able to exercise significant influence overall matters requiring shareholder approval, including the election of directorsand approval of significant corporate transactions.  This concentration of ownership may delay or prevent a change ofcontrol of GlobalSCAPE or discourage a potential acquirer from attempting toobtain control of GlobalSCAPE, either of which could have an adverse effect onthe value of our common stock.

 

***Anti-takeover provisions in GlobalSCAPE’scharter and Delaware law could inhibit others from acquiring GlobalSCAPE.***

 

Some of theprovisions of GlobalSCAPE’s certificate of incorporation and bylaws and inDelaware law could, together or separately:

 

•                  discouragepotential acquisition proposals;

 

•                  delayor prevent a change in control; and

 

•                  limitthe price that investors may be willing to pay in the future for shares ofGlobalSCAPE’s common stock.

 

In particular,GlobalSCAPE’s certificate of incorporation and bylaws provide for, among otherthings, limitations on the individuals that may call meetings of thestockholders and do not allow for cumulative voting.  GlobalSCAPE is also subject to Section 203 of the DelawareGeneral Corporation Law, which generally prohibits a Delaware corporation fromengaging in any of a broad range of business combinations with any interestedstockholder, as defined in the statute, for a period of three years followingthe date on which the stockholder became an interested stockholder.

 

***Stockholders’ownership of GlobalSCAPE stock may be significantly diluted, affecting thevalue of the stock.***

*** ***

There areoptions for 1,856,171 shares currently outstanding under GlobalSCAPE’s employeestock option plans as of the date of this report.   Of the 1,856,171 options, 1,788,338 are vested.   We have filed a registration statementunder the Securities Act of 1933, as amended (the “Securities Act”) coveringstock issued upon the exercise of options by non-affiliates, and we may file aregistration statement covering options held by affiliates as well.  If we do not file a registration statementcovering affiliates, affiliates who exercise their options may choose to sellthe stock under an exemption from registration, such as Rule 144 under theSecurities Act.  The exercise of these optionsand sale of the resulting stock could depress the value of our stock.

 

14

----

 

###### **Risks Related to LegalUncertainty**

 

***GlobalSCAPEis vulnerable to claims that GlobalSCAPE’s products infringe third-partyintellectual property rights particularly because GlobalSCAPE’s products arepartially developed by independent parties.***

*** ***

GlobalSCAPEmay be exposed to future litigation based on claims that GlobalSCAPE’s productsinfringe the intellectual property rights of others. This risk is exacerbatedby the fact that some of the code in GlobalSCAPE’s products is developed byindependent parties or licensed from third parties over whom GlobalSCAPE hasless control than it exercises over internal developers.  In addition, we expect that infringementclaims against software developers will become more prevalent as the number ofproducts and developers grows and the functionality of software programs in themarket increasingly overlaps.  Claims ofinfringement could require GlobalSCAPE to re-engineer its products or seek toobtain licenses from third parties in order to continue offering itsproducts.  In addition, an adverse legaldecision affecting GlobalSCAPE’s intellectual property, or the use ofsignificant resources to defend against this type of claim could place asignificant strain on GlobalSCAPE’s financial resources and harm itsreputation.

 

***GlobalSCAPEmay not be able to protect its intellectual property rights.***

*** ***

GlobalSCAPE’ssoftware code, and trade and service marks are some of GlobalSCAPE’s mostvaluable assets.  Given the globalnature of the Internet and GlobalSCAPE’s business, GlobalSCAPE is vulnerable tothe misappropriation of this intellectual property, particularly in foreignmarkets, such as China and Eastern Europe, where laws or law enforcementpractices are less developed.  Theglobal nature of the Internet makes it difficult to control the ultimatedestination or security of GlobalSCAPE’s software making it more likely thatunauthorized third parties will copy certain portions of GlobalSCAPE’sproprietary information or reverse engineer the proprietary information used inits programs.  If GlobalSCAPE’sproprietary rights were infringed by a third-party, and GlobalSCAPE did nothave adequate legal recourse, GlobalSCAPE’s ability to earn profits, which arehighly dependent on those rights, would be severely diminished.

 

***Othercompanies may own, obtain or claim trademarks that could prevent, limit orinterfere with GlobalSCAPE’s use of its trademarks.***

*** ***

GlobalSCAPE’svarious trademarks are important to its business.  If GlobalSCAPE were to lose the use of any its trademarks, itsbusiness would be harmed and GlobalSCAPE would have to devote substantialresources towards developing an independent brand identity.  Defending or enforcing GlobalSCAPE’s trademarkrights at a local and international level could result in the expenditure ofsignificant financial and managerial resources.

 

**Item 2.  Properties**

** **

Our corporateoffice is located in a technical park in northwest San Antonio calledUniversity Park Tech Center II. Our lease for the 14,700 square foot facilityexpires in September 2008. Our annual rent is approximately $191,000. Webelieve these facilities will be suitable for our current business needs andthat suitable additional space will be available on acceptable terms whenneeded.

 

# **Item 3.  Legal Proceedings**

# ** **

We are notcurrently involved in any material pending legal proceedings, but may becomesubject to legal proceedings in the ordinary course of our business.  Such claims may result in the expenditure ofsignificant financial and managerial resources.

 

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

 

None.

 

15

----

 

**Item 4A.**  **InformationRegarding Executive Officers**

 

***Charles R. Poole*. **Mr. Poole has served as GlobalSCAPE’s President since February 2004.  From September 2003 until February 2004, heserved as the company’s Vice President of Sales and Marketing.  Mr. Poole has over twenty years ofexperience in senior management and sales with telecommunications companies,most recently as the President of GlobalSCAPE’s former parent company, ATSICommunications, Inc., from 1998 – 2001. Mr. Poole has served as a Senior Vice President for A+ Communications,responsible for paging, cellular and telemessaging sales from 1995 – 1997, asGeneral Manager of American Paging, Texas from 1994 – 1995, as a DivisionManager of Data Documents, Inc. of Omaha, Nebraska from 1992 – 1994, asPresident of GeoCom Partners, a satellite-based telecommunications company from1989 – 1992, as Senior Vice President of MobileComm (a BellSouth Company) from1984-1989, and as Regional Vice President of Burroughs Corp (now Unisys) from1966-1984.

 

***Sandra Poole-Christal***.  Ms. Poole-Christal has served as thecompany’s Vice President of Marketing since February 2004.  Ms. Poole-Christal launched GlobalSCAPE inApril 1996 as a spin off from ATSI Communications, Inc. and served as itsPresident and Chief Operating officer from inception until February 2004.   A 13-year veteran of the communications andsoftware industries, Poole-Christal received the 2001 San Antonio BusinessJournal’s “Forty Under Forty Rising Stars” award, which honors young executivesfor their outstanding accomplishments. Prior to founding GlobalSCAPE, Inc.,Poole-Christal held key sales and marketing positions for ATSI Communicationsand Geo Communications.   During hertenure as President of GlobalSCAPE, Poole-Christal was responsible forstrategic planning, daily operations and achievement of growth andprofitability goals set by the board of directors, of which she was a member.She holds a B.A. in communications from Baylor University.

 

***Daniel McRedmond. ***Mr. McRedmond serves asGlobalSCAPE’s Treasurer, Secretary, and Vice President of Finance and Operations.  He is responsible for all finance andaccounting functions as well as information systems, quality assurance andhuman resource management.  Mr.McRedmond joined GlobalSCAPE in July 1999 after serving as Treasurer forGlobalSCAPE’s former parent, ATSI Communications Inc.  Prior to his role as Treasurer for ATSI, he served as BudgetingDirector and other management positions for Metrocall Inc.’s Southeastregion.  Mr. McRedmond holds a B.B.A.and M.S. in Finance from Texas A&M University.

 

# **Part II**

# ** **

##### **Item 5.  Market for Registrant’s Common Equity andRelated Stockholder Matters and Issuer Purchases of Equity**

 

Our common stock is listed on the NASD’s OTC Bulletin Board under thesymbol GSCP. As of March 19th, 2004, there were 2,620 holders ofrecord of our common stock representing approximately 9,000 beneficialowners.  GlobalSCAPE stock began tradingon February 15th, 2002.   Thetable below sets forth the quarterly high and low bid prices for our commonstock for the Company’s last two fiscal years.

 

**CommonStock Price**

** **
|                                |   | **2002** |   | **2003** |   |
|-------------------------------------|--------|----------|--------|----------|--------|
| **Fiscal Year ended December 31,**  |   | **High** |   | **Low**  |   | **High** |   | **Low** |   |
| Annual                              |   | $        | 1.05   |     | $      | 0.10 |   | $ | 0.36 |   | $ | 0.10 |   |
| First Quarter (ending March 31      |   | $        | 1.05   |     | $      | 0.15 |   | $ | 0.13 |   | $ | 0.10 |   |
| Second Quarter (ending June 30)     |   | $        | 0.30   |     | $      | 0.15 |   | $ | 0.36 |   | $ | 0.11 |   |
| Third Quarter (ending September 30) |   | $        | 0.26   |     | $      | 0.12 |   | $ | 0.23 |   | $ | 0.12 |   |
| Fourth Quarter (ending December 31) |   | $        | 0.15   |     | $      | 0.10 |   | $ | 0.16 |   | $ | 0.13 |   |

 

16

----

 

The closingbid price on March 18, 2004 was $0.20. Over-the-counter market quotations reflect inter-dealer prices, withoutretail mark-up, mark-down, or commission and may not necessarily representactual transactions.

 

We have neverpaid a cash dividend, and do not expect to do so in the foreseeablefuture.  We expect to reinvest all ofour earnings in the further growth of the business.

 

Theinformation required to be disclosed by Item 201(d) of Regulation S-K isdisclosed in Item 12 of this annual report.

 

##### **Item 6.  Selected Financial Data**

 

The selectedfinancial data presented below for the years ended December 31, 1999, 2000,2001, 2002 and 2003 are derived from our audited financial statements.

 
|                                                                                  |   | **Years  ended December 31,** |      |
|---------------------------------------------------------------------------------------|--------|-------------------------------|-----------|
|                                                                                  |   | **1999**                      |      | **2000** |   | **2001** |   | **2002** |   | **2003** |   |
| Revenues:                                                                             |   |                          |      |   |   |   |   |   |   |   |   |
| Software product revenues                                                             |   | $                             | 2,922,141 |   | $ | 5,165,668 |   | $ | 5,259,148 |   | $ | 5,269,503 |   | $ | 4,847,119 |   |
| Advertising revenues                                                                  |   | 328,895                       |      | 570,008 |   | 38,540 |   | — |   | — |   |
| Total revenues                                                                        |   | 3,251,036                     |      | 5,735,676 |   | 5,297,688 |   | 5,269,503 |   | 4,847,119 |   |
| Operating expenses:                                                                   |   |                          |      |   |   |   |   |   |   |   |   |
| Cost of revenues (exclusive of depreciation  and amortization shown separately below) |   | 105,026                       |      | 200,118 |   | 323,309 |   | 353,918 |   | 532,910 |   |
| Selling, general and administrative                                                   |   | 1,625,004                     |      | 3,463,044 |   | 3,551,498 |   | 3,580,361 |   | 3,613,759 |   |
| Research and development                                                              |   | 139,953                       |      | 961,002 |   | 1,176,714 |   | 848,212 |   | 945,395 |   |
| Depreciation and amortization                                                         |   | 253,896                       |      | 430,221 |   | 546,017 |   | 544,063 |   | 390,154 |   |
| Settlement with ATSI Comm. Inc.                                                       |   | —                        |      | — |   | — |   | 392,905 |   | — |   |
| Total operating expenses                                                              |   | 2,123,879                     |      | 5,054,385 |   | 5,597,538 |   | 5,719,459 |   | 5,482,218 |   |
| Income (loss) from operations                                                         |   | 1,127,157                     |      | 681,291 |   | (299,850 | ) | (449,956 | ) | (635,099 | ) |
| Interest expense, net                                                                 |   | (56,847                       | )         | (42,839 | ) | 4,420 |   | 11,783 |   | (5,016 | ) |
| Gain (loss) on sale of assets                                                         |   | —                        |      | (13,687 | ) | — |   | — |   | (1,486 | ) |
| Income (loss) before provision for income  taxes                                      |   | 1,070,310                     |      | 624,765 |   | (295,430 | ) | (438,173 | ) | (641,601 | ) |
| Income tax provision (benefit):                                                       |   |                          |      |   |   |   |   |   |   |   |   |
| Current                                                                               |   |                          |      |   |   |   |   |   |   |   |   |
| Federal income taxes                                                                  |   | 372,532                       |      | 329,215 |   | 30,952 |   | — |   | — |   |
| State income taxes                                                                    |   | 51,629                        |      | 22,532 |   | (166 | ) | 15,040 |   | 1,400 |   |
| Deferred                                                                              |   |                          |      |   |   |   |   |   |   |   |   |
| Federal income taxes                                                                  |   | (24,353                       | )         | (38,246 | ) | (75,861 | ) | 146,932 |   | — |   |
| State income taxes                                                                    |   | (3,375                        | )         | (3,375 | ) | 6,780 |   | 13,230 |   | — |   |
| Total income tax provision (benefit)                                                  |   | 396,433                       |      | 310,126 |   | (38,295 | ) | 175,202 |   | 1,400 |   |
| Net income (loss)                                                                     |   | $                             | 673,877   |   | $ | 314,639 |   | $ | (257,135 | ) | $ | (613,375 | ) | $ | (643,001 | ) |
| Net income (loss) per common share - basic                                            |   | $                             | 0.05      |   | $ | 0.02 |   | $ | (0.02 | ) | $ | (0.05 | ) | $ | (0.05 | ) |
| Net income (loss) per common share -assuming  dilution                                |   | $                             | 0.05      |   | $ | 0.02 |   | $ | (0.02 | ) | $ | (0.05 | ) | $ | (0.05 | ) |

 

17

----

 
|                                                                      |   | **December 31,** |   |
|---------------------------------------------------------------------------|--------|------------------|--------|
|                                                                      |   | **1999**         |   | **2000** |   | **2001** |   | **2002** |   | **2003** |   |
|                                                                      |   |             |   |   |   |   |   |   |   |   |   |
| Cash                                                                      |   | $                | 16,361 |   | $ | 113,591 |   | $ | 134,537 |   | $ | 480,609 |   | $ | 342,433 |   |
| Working capital (deficit)                                                 |   | (160,171         | )      | 161,939 |   | 498,134 |   | 368,567 |   | 19,203 |   |
| Total assets                                                              |   | 1,471,299        |   | 2,122,094 |   | 2,009,806 |   | 1,412,042 |   | 918,278 |   |
| Long term debt including capital lease  obligations, less current portion |   | 56,924           |   | 149,074 |   | 77,080 |   | 15,477 |   | — |   |
| Cash dividends per common share                                           |   | $                | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |

 

##### **Item 7.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operation**

 

**Overview**

 

GlobalSCAPEdevelops and distributes Internet related software including file management,content management and Web development tools. We distribute our software primarily via download from our Internetwebsite.  During 2003, approximately 65%of our revenues were generated from customers within the United States, withthe remaining 35% concentrated mostly in Western Europe, Canada and Australia.CuteFTP and CuteFTP Pro accounted for approximately 85% and 75% of totalrevenues in 2002 and 2003, respectively. Combined sales of these two products declined approximately 21% from the2002 to 2003.  This decline wasprimarily in sales of CuteFTP, which declined approximately 29%.  Sales of CuteFTP Pro declined only 2% yearover year and sales of Secure Server, a companion product to CuteFTP Pro,increased 58%.  However, Secure Serveronly accounted for approximately 7% of total revenues.

 

Substantiallyall software products ultimately reach a point in their lifecycle in whichsales can be expected to plateau or decline. While it cannot be determined with certainty, CuteFTP and CuteFTP Promay have reached such a point their lifecycles.  Management believes that the market for stand-alone FTP clientsfor home consumers may be declining. However, we have not seen the same decline in the market for secure FTPclients and servers such as CuteFTP Pro and Secure Server which we believebetter target the needs of businesses.

 

Our strategyis to continue to introduce new products while enhancing the features of ourcurrent product line.  We have dedicatedconsiderable resources in the fourth quarter of 2002 and in 2003 to thedevelopment and market launch of PureCMS, our content management product.  To date, we have not been as successful inselling this product as we had anticipated. We laid out a plan in our 2002 Annual Report to address the liquidityissues caused by the expense of the PureCMS market launch and disappointingrevenue figures in the first quarter of 2003. We successfully executed the plan and produced positive net income inboth the second and third quarters.  Wefell short of our revenue expectations in the fourth quarter of 2003 and againaddressed the liquidity issues caused by this shortfall.  We laid off 9 of 45 employees on February12, 2004 in order to bring our expenses in line with our current operatingperformance.  We have the ability tomake further cuts in external development, capital expenditures and, ifnecessary, in employees in order to manage the financial health of GlobalSCAPE.

 

Our success in2004 is, to a great extent, dependent on our ability to market and sell thePureCMS product effectively as well as our ability to maintain the revenuesgenerated by CuteFTP and CuteFTP Pro. In general, our success depends on our ability to introduce new productsand the market’s acceptance of these products. We intend to release new versions of CuteFTP, CuteFTP Pro and SecureServer early in 2004 and we believe we can slow the decline in sales of CuteFTPand improve sales of CuteFTP Pro and Secure Server.

 

The followingManagement’s Discussion and Analysis of Financial Condition and Results ofOperations should be read in conjunction with our financial statements for theyears ended December 31, 2001, 2002 and 2003 and related notes includedelsewhere in this document.

 

18

----

 

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

 

We relyheavily on cash flows from operations and these cash flows are directly linkedto CuteFTP and CuteFTP Pro, which accounted for 85% and 75% of our revenues in2002 and 2003, respectively.  Anythingthat has a negative impact on these products will negatively impact our cashflow from operations and our ability to meet our commitments.  Demand for our products could be affected bymany factors including rapid technological obsolescence.  For more discussion on the risks that mightaffect demand for our products, you should read the information under “RiskFactors” in this Annual Report.

 

We incurredsignificant operating losses during the years ended December 31, 2002 and 2003and continued, in January and February of 2004, to incur significant operatinglosses.  In February 2004 we reduced ourworkforce by 20%, laying off 9 of the 45 people then employed by theCompany.  This workforce reduction was anecessary step in improving the overall financial health of the organization.  We had anticipated stronger revenueperformance in January and February after poorer than expected sales in thefourth quarter and had maintained staffing levels with this objective.  These higher revenue targets were not met,further reducing the Company’s liquidity position.

 

The Company ishighly dependent on the sale of two software products, CuteFTP and CuteFTP Pro,which are subject to technological and competitive obsolescence.  Sales from these two products, whichrepresented 75% of the Company’s revenues in 2003, declined 21% from theprevious year.  This decline wasprimarily in sales of CuteFTP, which declined 29%.  Sales of CuteFTP Pro declined only 2% year over year and sales ofSecure Server, the companion product to CuteFTP Pro, increased 58%.  Secure Server accounted for approximately 7%of total revenues.  Substantially allsoftware products ultimately reach a point in their lifecycle in which salescan be expected to plateau or decline. While it cannot be determined with certainty, these products may havereached such a point their lifecycles. Management believes that the market for stand-alone FTP clients for homeconsumers may be declining.  However, wehave not seen the same decline in the market for secure FTP clients and serverssuch as CuteFTP Pro and Secure Server which we believe better target the needsof businesses.

 

The Company’sliquidity could be further reduced in 2004 if sales of CuteFTP continue todecline and the Company is unable to successfully introduce new products orincrease sales of existing products.

 

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

 

In addition,the Company could draw on its $250,000 line of credit, if necessary.  This line of credit, which originallymatured in March 2004, has been extended through June 2004.  The interest rate is subject to change andis indexed to the bank’s prime rate. The rate is 6.00%.  In connectionwith the line of credit, GlobalSCAPE entered into a commercial securityagreement with the bank whereby GlobalSCAPE granted a security interest in allits accounts and equipment.  The Companyborrowed $100,000 on September 11, 2003 under this agreement.  This amount remained outstanding as ofDecember 31, 2003 but was repaid in February 2004.  The credit facility is available to the Company at any pointduring its term.

 

The Company’sflexibility in reacting to changes in the operating environment and to changingeconomic conditions may be limited by the Company’s current liquidityposition.  However, management believesthat, if required, it will be able to effect some or all of the components ofthe plan set forth above, which are sufficient in the aggregate to enable theCompany to continue as a going concern through at least December 31, 2004.  Accordingly, the financial statements of theCompany do not include any adjustments to reflect the possible future effectsor the recoverability and classification of assets or the amounts andclassification of liabilities that may result if the Company cannot improve itsworking capital position.

 

19

----

 

Net cashprovided (used) by operating activities was $676,970, $483,077 and ($105,548)in 2001, 2002 and 2003, respectively. In 2001, operating cash flow resulted from adjustments related todepreciation and amortization as well as non-cash compensation charges, offsetby a loss from operations, increased deferred tax assets and decreased accountspayable.  Net cash provided by operatingactivities in 2002 was primarily due to adjustments related to depreciation andamortization and the settlement with ATSI, offset by the loss for theperiod.  Net cash used in operatingactivities in 2003 was primarily the result of the net loss for the periodoffset somewhat by depreciation and amortization charges for the period.

 

Net cash usedin investing activities for 2001, 2002 and 2003 was $545,801, $87,822 and$73,027, respectively.  In 2001, wecapitalized $205,801 related to the purchase of software, computer equipment,furniture and leasehold improvements and loaned $340,000 to our former parent,ATSI.  In 2002, we loaned an additional$200,000 to ATSI but received $200,000 in cash as part of the settlementagreement.  In addition, we purchased$87,822 in computer hardware and software in 2002.  In 2003, we capitalized the purchase of $73,027 in equipment andsoftware.

 

Net cashprovided (used) in financing activities during 2001, 2002 and 2003 was($110,223), ($49,183) and $40,399, respectively.  In 2001, we made principal payments of $47,108 on notes payableand $71,715 on capital lease obligations. In 2002, we made principal payments of $71,321 on capital leaseobligations and received $22,138 for the exercise of stock options.  In 2003, we made principal payments of$61,317 on capital lease obligations and borrowed $100,000 under our line ofcredit.  We did not enter any newcapital leases in 2003.

 

As of December31, 2003, we had $342,433 in cash, current assets of $629,476 and currentliabilities of $610,273, resulting in working capital of $19,203.  Our principal commitments consisted ofobligations outstanding under operating leases as well as royalty agreementswith third parties.  The commitmentsrelated to royalty agreements are not fixed, rather they are contingent onsales.  We plan to continue to expendsignificant resources on product development in future periods and may also useour cash to acquire or license technology, products or businesses related toour current business.  We expect thatoperating expenses will continue to be a material use of our cash resources aswell but will manage the business based on the immediately foreseeableoperating cash flows.  The facility thatwe currently occupy is expected to be sufficient for the next twelvemonths.  Consequently, we do notanticipate significant expenditures for leasehold improvements or furniture for2004.

 

The followingtable summarizes our contractual obligations at December 31, 2003, consistingof future minimum capital lease payments and future minimum payments underoperating leases:

 
|                        |   | **Payments  due by period** |    |
|-----------------------------|--------|-----------------------------|---------|
| **Contractual obligations** |   | **Total**                   |    | **Less than  1  year** |   | **1-3 years** |   | **3-5 years** |   | **More than  5 years** |   |
| Capital lease obligations   |   | 15,477                      |    | 15,477 |   | — |   | — |   | — |   |
| Operating lease obligations |   | 857,965                     |    | 190,659 |   | 381,318 |   | 285,988 |   |   |   |
| Total                       |   | $                           | 873,259 |   | $ | 205,953 |   | $ | 381,318 |   | $ | 285,988 |   | $ | — |   |
|                             |        |                             |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

# ***Use of Estimates***

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations arebased upon the Company’s financial statements, which have been prepared inaccordance with accounting

 

20

----

 

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 historical experience,observable trends, and various other assumptions that are believed to bereasonable 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.

 

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

 

***RevenueRecognition***

* *

Our revenue is generatedprimarily by licensing our software products and providing support for thoseproducts.  Revenues are comprisedof the gross selling price of the software, including shipping charges and theearned portion of support and maintenance agreements.  In periods where we had revenue from advertising, we recognized thenet proceeds received from advertisers as revenue.  The Company recognizes revenue in accordance with the AmericanInstitute of Certified Public Accountants Statement of Position (“SOP”) 97-2, *Software Revenue Recognition*, as modifiedby SOP 98-9, *Modification of SOP 97-2,Software Revenue Recognition, With Respect to Certain Transactions*.

 

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

 

We also selltechnical support and maintenance agreements (post contract customer support“PCS”), which are sometimes bundled with the software.  When vendor specific objectiveevidence (“VSOE”) of fair value exists for all elements in a multiple elementarrangement, revenue is allocated to each element based on the relative fairvalue of each of the elements. VSOE of fair value is established by the pricecharged when the same element is sold separately.  In a multiple element arrangement whereby VSOE of fair value ofall undelivered elements exists but VSOE of fair value does not exist for oneor more delivered elements, revenue is recognized using the residual method.Under the residual method, the fair value of the undelivered elements isdeferred and the remaining portion of the arrangement fee is recognized asrevenue, assuming collection is probable. Revenue allocated to PCS is recognized ratably over the contractualterm, typically one year.  We sometimessell installation and training services with our PureCMS product.  Revenue for installation and training isrecognized when performed.

 

The Companybegan selling technical support and maintenance services for some of itssoftware products in 2001 and had deferred recognition of approximately $11,000in revenue at the end of that year. Deferred revenue grew to a balance of approximately $142,000 at December31, 2002 and remained relatively flat, ending 2003 with a balance ofapproximately $140,000.  The rate ofgrowth in deferred revenue in 2002 was due primarily to the rapid growth in thesale of technical support and maintenance agreements in the fourth quarter of2002.  Sales of these agreementscontinued to grow into the first quarter of 2003 but have flattened out sincethat time, resulting in relatively little change year over year in the amountof deferred revenue.  Growth in thesales of maintenance and support agreements may result in the deferredrecognition of a significant amount of revenue in future periods.

 

***Allowancefor Doubtful Accounts***

*** ***

We providecredit, in the normal course of business, to a number of companies and performongoing evaluations of our credit risk. We require no collateral from our customers and we estimate theallowance for uncollectible accounts based on our historical experience andcurrent credit evaluations.  No singlecustomer accounted for more than 2% of net revenues in 2001, 2002 or 2003.

 

21

----

 

***Valuationof Long-Lived and Intangible Assets***

* *

The Companyassesses the impairment of long-lived and intangible assets whenever events orchanges in circumstances indicate that the carrying value may not berecoverable.  Factors consideredimportant which could trigger an impairment review included the following:  significant underperformance relative tohistorical or projected future cash flows; significant changes in the manner ofuse of the assets or the strategy for the overall business; and significantnegative industry trends.  Whenmanagement determines that the carrying value of long-lived and intangibleassets may not be recoverable, impairment is measured based on the excess ofthe assets’ carrying value over the estimated fair value.  No impairment was recognized in 2001, 2002or 2003.

 

***Stock-BasedCompensation***

* *

The Companymeasures compensation expense for its stock-based employee compensation plans,which are described in Note 8. Statement of Financial Accounting Standards 123, *Accounting for Stock-Based Compensation*(SFAS 123), encourages, but does not require, companies to record compensationcost for stock-based employee compensation plans based on the fair market valueof options granted. The Company chose to account for stock based compensationusing the intrinsic value method prescribed in APB Opinion No. 25, *Accounting for Stock Issued to Employees*,and related interpretations. Accordingly, compensation expense is recorded tothe extent that the current market price of the underlying stock exceeds theexercise price.  On December 31, 2002,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standard 148, *Accounting forStock Based Compensation - Transition and Disclosure* (SFAS 148),which amends SFAS 123.  SFAS 148requires more prominent and frequent disclosures about the effects ofstock-based compensation. The Company will continue to account for itsstock-based compensation according to the provisions of APB Opinion No.25.  The pro forma disclosurerequirements prescribed by SFAS 123, as amended by SFAS 148 are included inNote 1 to the Financial Statements.

 

***Researchand Development***

*** ***

Research anddevelopment expenses include all direct costs, primarily salaries for personneland expenditures with external development sources, related to the developmentof new products and significant enhancements to existing products and areexpensed as incurred until such time as technological feasibility is achieved.For the years 2001, 2002 and 2003, we spent approximately $1,177,000, $848,000and $945,000, respectively, on research and development.  No research and development expenses werecapitalized in 2001, 2002 or 2003 and all previously capitalized research anddevelopment expenses were fully amortized at December 31, 2002.

 

# ***Income Taxes***

 

GlobalSCAPEaccounts for income taxes using the liability method in accordance withStatement of Financial Accounting Standards No. 109, *Accounting for Income Taxes*. The liability method providesthat the deferred tax assets and liabilities are recorded based on thedifference between the tax bases of assets and liabilities and their carryingamount for financial reporting purposes, as measured by the enacted tax ratesand laws that will be in effect when the differences are expected toreverse.  Deferred tax assets 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 these assets in future periodsrequires a great deal of judgment by management.   Although we have generated pre-tax income in previous years,unusual or infrequently occurring transactions resulted in pre-tax losses in2001 and 2002 (compensation charges in 2001 and the settlement with ATSI andtermination of CEO in 2002).  It is ourjudgment that we cannot predict with reasonable certainty that the tax assetsresulting from these losses and the loss incurred in 2003 will be fullyrealized in future periods.  Statementof Financial Accounting Standards (SFAS) No. 109 requires a valuation allowanceto reduce the deferred tax assets reported if, based on the weight of theevidence, it is more likely than not that some portion or all of the deferredtax assets will not be realized. After consideration of all of the evidence,both positive and negative, management determined that a $540,350 valuationallowance at December 31, 2003 was necessary to reduce the deferred tax assetsto the amount that will more likely than not be realized.  The change inthe valuation allowance for the current

 

22

----

 

year is a net increase of $216,515. At December 31, 2003, GlobalSCAPE has available net operating losscarryforwards of approximately $1,266,351, which expire beginning in the year2020.

 

##### **Comparison of Year Ended December 31, 2003 to YearEnded December 31, 2002**

 

***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 declined approximately 8% from 2002 to 2003, from $5,269,503 in2002 to $4,847,119 in 2003.  Unit volumewas relatively flat with approximately 172,000 sold in 2002 versus 175,000 in2003.  The decline in revenues waspronounced in the first and fourth quarters when compared to the same periodsin 2002.  We believe the economicuncertainty in the first quarter of 2003 contributed to that period’s poorperformance and the turnover in our sales force contributed to the weaker thanexpected performance in the fourth quarter of 2003.

 

In 2002 and2003, approximately 85% and 75%, respectively, of our revenues were generatedfrom sales of CuteFTP and CuteFTP Pro. Combined sales of these products declined approximately 21% year overyear.  Sales of CuteFTP declinedapproximately 29% while sales of CuteFTP Pro declined approximately 2%.  Our reliance on these products maynegatively impact future results from operations if we are unable to maintainrevenues from these products or successfully introduce new productofferings.  (For more information, youshould read the section titled *Risks Relatedto Operations.*)

 

***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 revenuesincreased approximately 51% between periods from $353,918 in 2002 to $532,910in 2003 due to an increase in royalty expenses related to our softwaredistribution agreements with third parties. Royalties that the Company pays on software products licensed from thirdparties, which it resells, are expensed as a cost of sales when the softwareproduct is sold or earlier if the recoverability of any prepaid royalties is indoubt.  The Company has distributionagreements with Hannon Hill Corp., Trellix Corp., Perseus Development Corp.,Beehive Software, Inc., Visicom Media, Inc., and Turillion SoftwareTechnologies.  The GlobalSCAPE softwareproducts associated with each of the companies are PureCMS, CuteSITE Builder,Web Survey, Mac FTP, CuteHTML Pro and Protect IIS, respectively.  GlobalSCAPE no longer distributes theProtect IIS product and expensed prepaid royalties of approximately $15,000 inDecember 2003.  GlobalSCAPE’s agreementwith Hannon Hill Corp. required a minimum royalty of $16,667 per month, asprepayment of royalties, for 12 months beginning in December 2002.  These payments were expensed as paid becausethe lower than expected sales of PureCMS raised doubt as to the realization ofbenefit from these prepayments.  Thetotal amount expensed in 2003 relating to these prepayments was $183,337.  As a result of, we expect the cost ofrevenues to decline both as a percentage of sales and in gross terms in 2004when compared to 2003.

 

***Selling, General and Administrative.***  Selling, general and administrative expensesconsist primarily of personnel and related expenses, marketing, customersupport, professional fees, rent, bad debt and credit card transaction fees.Selling, general and administrative expenses grew approximately one percentyear over year from $3,580,361 in 2002 to $3,613,759 in 2003. The number ofpersons employed by GlobalSCAPE grew from 39 at the end of 2002 to 45 byDecember 2003.

 

Forcomparative purposes, selling, general and administrative expenses for 2002includes reductions to SG&A expense of $62,396 for non-cash charges relatedto stock options and $190,000 in severance payments to our former CEO, TimNicolaou, which were not incurred in 2003. Selling, general and administrativeexpenses also include approximately $300,000 in advertising expenses in 2002,which increased to $540,000 in 2003, both of which relate primarily to thelaunch of the PureCMS product.

 

***Research and Development.***  Research and development expenses increasedapproximately 11% from $848,212 in 2002 to $945,395 due to increasedexpenditures on both internal and external product development resources.  We increased spending substantially in thefourth quarter of 2003 on external

 

23

----

 

development resources as partof the planned 2004 releases of new versions of CuteFTP, CuteFTP Pro and SecureFTP Server.

 

***Depreciation and Amortization.***  Depreciation and amortization expenseconsists of depreciation expense related to our fixed assets and theamortization of the trademark associated with our purchase of CuteFTP in 1998.  Depreciation and amortization expensedeclined $153,909 or approximately 28% year over year.  This decrease was due primarily to areduction in amortization expense. Previously capitalized software development costs were fully amortizedat December 31, 2002 and the purchase of CuteFTP was fully amortized as ofSeptember 20, 2003.  In addition,depreciation expense has declined due to a slowdown in additions to fixedassets in current periods relative to prior periods.

 

***Settlement of Due from Parent Balance. ***On June 11,2002, ATSI Communications, Inc. sold its majority interest in GlobalSCAPE, Inc.to Brown and Mann-GlobalSCAPE Joint Venture, a Texas general partnership ownedby San Antonio-based investors Thomas W. Brown and David L. Mann.  Contemporaneously with this transaction,GlobalSCAPE agreed to compromise and settle a $612,304 inter-company balanceowed to it by ATSI, which resulted in charges to GlobalSCAPE of $392,905.  The balance was settled for (i) $200,000 incash from ATSI; (ii) NTFC Capital Corporation’s release of GlobalSCAPE as aco-borrower on a capital lease executed by ATSI in 1999, and (iii) ATSI’sagreement to provide $50,000 worth of transition support services toGlobalSCAPE over the nine months ending March 11, 2003, including payrolladministration and GlobalSCAPE’s continued use of a shared accountingplatform.  However, we completed ourtransition from ATSI’s payroll and accounting systems during the third quarterof 2002 and expensed the remainder of the support services as selling, generaland administrative expenses, approximately $46,000, during that quarter.  In addition, prepaid insurance coverageunder a joint policy with ATSI was lost to GlobalSCAPE as a result of thechange in control, resulting in a charge against GlobalSCAPE’s prepaid assetsof $27,083 during the second quarter of 2002.

 

***Interest Expense, Net.***  In 2002, we had interest expense of $8,973related to capital leases and interest income of $20,756 from loans made toATSI prior to our separation and settlement of the balance owed to GlobalSCAPEby ATSI.  In 2003, we had interestexpense of $5,016 related primarily to capital leases.  We do not expect to generate interest incomein future periods.

 

***Income Taxes.***  The provision for federal income taxes was$146,932 for 2002.  The provision forstate income taxes was $28,270 for the same period.  GlobalSCAPE’s effective income tax rate was negative 40% in 2002and differs from the federal rate primarily because of a change in thevaluation allowance for deferred tax assets. The provision for state income taxes in 2003 was $1,400 and there was noprovision for federal income taxes in 2003. GlobalSCAPE’s effective income tax rate was negative 0.2% and differsfrom the federal rate primarily because of a change in the valuation allowancefor deferred tax assets.

 

***Net Income.***  In 2002, the net loss was a result of boththe settlement with ATSI and the termination of our former CEO.  These two events combined for more than$580,000 in expenses whereas our loss from operations was about $450,000.  In 2003, the net loss was primarily theresult of disappointing revenue performance in the first and fourth quartersexacerbated by the product launch expenses related to PureCMS.

 

##### **Comparison of Year Ended December 31, 2002 to YearEnded December 31, 2001**

 

***Revenue.***  Total revenues were relatively flat yearover year, declining less than 1% from $5,297,688 in 2001 to $5,269,503 in2002.  Software revenues increasedslightly from $5,259,148 in 2001 to $5,269,503 in 2002.  Unit volume declined from 191,000 licensesin 2001 to 172,000 in 2002.  The declinein unit volume was offset by the higher average selling price of our softwareproducts.   The introduction of SecureServer in 2002 contributed to the increase in average prices per license.

 

In 2001 and2002, approximately 92% and 85% of our revenues were generated from sales ofCuteFTP and CuteFTP Pro.

 

24

----

 

***Cost of Revenues.***  Cost of revenues consists primarily ofproduction, packaging and shipping costs for boxed copies of software productsas well as a portion of our bandwidth costs, certain licensing expenses androyalties.  Cost of revenues increased9% between periods from $323,309 in 2001 to $353,918 in 2002 due to an increasein royalty expenses related to our software distribution agreements with thirdparties.

 

***Selling, General and Administrative.***  Selling, general and administrative expensesconsist primarily of personnel and related expenses, marketing, customersupport, professional fees, rent, bad debt and credit card transaction fees.Selling, general and administrative expenses grew less than one percent yearover year from $3,551,498 in 2001 to $3,580,361 in 2002. The number of personsemployed by GlobalSCAPE grew from 33 at the end of 2001 to 39 at the end of2002.

 

Forcomparative purposes, selling, general and administrative expenses for 2001include non-cash charges related to stock option grants of $434,499.  SG&A for 2002 includes reductions toSG&A expense of $62,396 for non-cash charges related to stock options.  Additionally, in 2002, GlobalSCAPE announcedthe termination of its CEO, Tim Nicolaou. Mr. Nicolaou resigned from the Board of Directors and received $190,000in severance payments as provided by his employment agreement as well ascertain health benefits that were accrued in 2002.

 

***Research and Development.***  Research and development expenses declinedapproximately 28% from $1,176,714 in 2001 to $848,212 in 2002 due to reductionsin both internal and external expenditures on product development.  We reduced expenditures with externaldevelopers by about $216,000 between years.

 

***Depreciation and Amortization.***  Depreciation and amortization expenseconsists of depreciation expense related to our fixed assets and theamortization of the trademark associated with our purchase of CuteFTP in1998.  Depreciation and amortizationexpense was almost unchanged year over year from $546,017 in 2001 to $544,063in 2002.  Capital expenditures in 2002were approximately $88,000 and were primarily for computer hardware andsoftware.

 

***Settlement of Due from Parent Balance. ***On June 11,2002, ATSI Communications, Inc. sold its majority interest in GlobalSCAPE, Inc.to Brown and Mann-GlobalSCAPE Joint Venture, a Texas general partnership ownedby San Antonio-based investors Thomas W. Brown and David L. Mann.  Contemporaneously with this transaction,GlobalSCAPE agreed to compromise and settle a $612,304 inter-company balanceowed to it by ATSI, which resulted in charges to GlobalSCAPE of $392,905.  The balance was settled for (i) $200,000 incash from ATSI; (ii) NTFC Capital Corporation’s release of GlobalSCAPE as aco-borrower on a capital lease executed by ATSI in 1999, and (iii) ATSI’sagreement to provide $50,000 worth of transition support services toGlobalSCAPE over the nine months ending March 11, 2003, including payrolladministration and GlobalSCAPE’s continued use of a shared accountingplatform.  However, we completed ourtransition from ATSI’s payroll and accounting systems during the third quarterof 2002 and expensed the remainder of the support services as selling, generaland administrative expenses, approximately $46,000, during that quarter.  In addition, prepaid insurance coverageunder a joint policy with ATSI was lost to GlobalSCAPE as a result of thechange in control, resulting in a charge against GlobalSCAPE’s prepaid assetsof $27,083 during the second quarter of 2002.

 

***Interest Expense, Net.***  In 2001, we had net interest income of$4,420.  Most of the interest expenserecognized in 2001, $15,640, was for capital leases.  In addition, we recognized interest income of $20,060 from loansmade to our former parent, ATSI.  In2002, we had interest expense of $8,973 related to capital leases and interestincome of $20,756 from loans made to ATSI prior to our separation andsettlement of the balance owed to GlobalSCAPE by ATSI.

 

***Income Taxes.***  The provision (benefit) for federal incometaxes was ($44,909) and $146,932 for 2001 and 2002, respectively.  The provision for state income taxes was$6,614 and $28,270 over the same periods. GlobalSCAPE’s effective income tax rate was 13% and negative 40% for2001 and 2002, respectively. The increase in the effective income tax rate in2001 is due primarily to the financial accounting recognition of compensationexpense related to stock option grants. The effective income tax

 

25

----

 

rate in 2002differs from the federal rate primarily because of a change in the valuationallowance for deferred tax assets.

 

***Net Income.***  The net loss in 2001 was caused by therecognition of $434,499 in non-cash compensation charges.  In addition, these compensation charges didnot reduce our tax liability, as they are not deductible for federal income taxpurposes.  In 2002, the net loss was aresult of both the settlement with ATSI and the termination of our formerCEO.  These two events combined for morethan $580,000 in expenses whereas our operating loss was about $450,000.

 

##### **Inflation**

 

Increases ininflation generally result in higher interest rates and operating costs.  Our largest cost exposure is the cost ofsalaries and general and administrative expenses. To date we believe thatinflation has not had a significant impact on our operations.

 

##### **Item 7A.  Quantitative and Qualitative DisclosuresAbout Market Risk**

 

To date, wehave not utilized derivative financial instruments or derivative commodityinstruments.  We do not expect to employthese or other strategies to hedge market risk in the foreseeable future.  We may invest our cash in money marketfunds, 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.

 

In 2003,approximately 35% of our revenues came from customers outside the UnitedStates. All revenues are received in U.S. dollars so we have no exchange raterisk with regard to the sale.  However,as of July 1, 2003, the European Union (EU) enacted Value Added Taxes (VAT) onelectronic purchases.  These taxes arecharged to our non-business customers in the EU and, in our case, are remittedquarterly in pound sterling.   We expectthat the impact of any currency translation involved in the remittance of VAT taxeswill not be material to our business.

 

26

----

**Item8.  Financial Statements andSupplementary Data**

 

**GlobalSCAPE, Inc.**

** **

**Index to Consolidated Financial Statements**

** **

**Years endingDecember 31, 2001, 2002 and 2003**

** **

**Contents**

** **
| Report of Independent Auditors                        |   |
|-------------------------------------------------------|--------|
| Financial Statements                                  |   |
| Consolidated Balance Sheets                           |   |
| Consolidated Statements of Operations                 |   |
| Consolidated Statements of Stockholders’  Equity |   |
| Consolidated Statements of Cash Flows                 |   |
| Notes to Consolidated Financial Statements            |   |

** **

**27**

----

 

**Report of Independent Auditors**

** **

To the Board of Directors

GlobalSCAPE, Inc.

 

We haveaudited the accompanying consolidated balance sheets of GlobalSCAPE, Inc. as ofDecember 31, 2002 and 2003 and the related statements of operations,stockholders’ equity and cash flows for the three years in the period endedDecember 31, 2003. These financial statements are the responsibility of theCompany’s management.  Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conductedour audits in accordance with auditing standards generally accepted in theUnited States. Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In ouropinion, the financial statements referred to above present fairly, in allmaterial respects, the financial position of GlobalSCAPE, Inc. as of December31, 2002 and 2003 and the results of its operations and its cash flows for eachof the three years in the period ended December 31, 2003 in conformity withaccounting principles generally accepted in the United States.

 

 

Ernst& Young LLP

 

 

San Antonio, Texas

February 27, 2004, except for Notes 5 and 10, as towhich the date is March 30, 2004.

 

28

----

 

**GlobalSCAPE, Inc.**

** **

**ConsolidatedBalance Sheets**

** **
|                                                                                                                |   | **December  31,** |      |
|---------------------------------------------------------------------------------------------------------------------|--------|-------------------|-----------|
|                                                                                                                |   | **2002**          |      | **2003** |   |
| Assets                                                                                                              |   |              |      |   |   |
| Current assets:                                                                                                     |   |              |      |   |   |
| Cash                                                                                                                |   | $                 | 480,609   |   | $ | 342,433 |   |
| Accounts receivable (net of allowance for  doubtful accounts of $58,427 and $43,581 in 2002 and 2003, respectively) |   | 251,769           |      | 240,615 |   |
| Prepaid expenses                                                                                                    |   | 72,249            |      | 46,428 |   |
| Total current assets                                                                                                |   | 804,627           |      | 629,476 |   |
|                                                                                                                |   |              |      |   |   |
| Property and equipment:                                                                                             |   |              |      |   |   |
| Furniture and fixtures                                                                                              |   | 332,920           |      | 332,920 |   |
| Software                                                                                                            |   | 221,196           |      | 235,436 |   |
| Equipment                                                                                                           |   | 600,970           |      | 590,019 |   |
| Leasehold improvements                                                                                              |   | 154,376           |      | 154,376 |   |
|                                                                                                                |   | 1,309,462         |      | 1,312,751 |   |
| Accumulated depreciation and amortization                                                                           |   | 848,873           |      | 1,035,830 |   |
| Net property and equipment                                                                                          |   | 460,589           |      | 276,921 |   |
|                                                                                                                |   |              |      |   |   |
| Other assets:                                                                                                       |   |              |      |   |   |
| Core software technology (net of  accumulated amortization of $763,998 and $898,943 in 2002 and 2003,  respectively |   | 134,945           |      | — |   |
| Other                                                                                                               |   | 11,881            |      | 11,881 |   |
| Total other assets                                                                                                  |   | 146,826           |      | 11,881 |   |
| Total assets                                                                                                        |   | $                 | 1,412,042 |   | $ | 918,278 |   |

 

29

----

 
|                                                                                                                                                                          |   | **December  31,** |      |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|-----------|
|                                                                                                                                                                          |   | **2002**          |      | **2003** |   |
| Liabilities and Stockholders’ Equity                                                                                                                                     |   |              |      |   |   |
| Current liabilities:                                                                                                                                                          |   |              |      |   |   |
| Accounts payable                                                                                                                                                              |   | $                 | 124,895   |   | $ | 180,555 |   |
| Accrued expenses                                                                                                                                                              |   | 108,495           |      | 173,935 |   |
| Deferred revenue                                                                                                                                                              |   | 141,536           |      | 140,489 |   |
| Notes payable                                                                                                                                                                 |   | —            |      | 100,000 |   |
| Current portion of capital lease obligation                                                                                                                                   |   | 61,134            |      | 15,294 |   |
| Total current liabilities                                                                                                                                                     |   | 436,060           |      | 610,273 |   |
|                                                                                                                                                                          |   |              |      |   |   |
| Long-term liabilities:                                                                                                                                                        |   |              |      |   |   |
| Capital lease obligations, less current  portion                                                                                                                              |   | 15,477            |      | — |   |
| Other long-term liabilities                                                                                                                                                   |   | 50,468            |      | 39,253 |   |
| Total long-term liabilities                                                                                                                                                   |   | 65,945            |      | 39,253 |   |
|                                                                                                                                                                          |   |              |      |   |   |
| 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, 13,358,619 and 13,488,619 shares issued and  outstanding at December 31, 2002 and 2003, respectively |   | 13,359            |      | 13,489 |   |
| Additional paid-in capital                                                                                                                                                    |   | 670,307           |      | 671,893 |   |
| Retained earnings (deficit)                                                                                                                                                   |   | 226,371           |      | (416,630 | ) |
| Total stockholders’ equity                                                                                                                                               |   | 910,037           |      | 268,752 |   |
| Total liabilities and stockholders’ equity                                                                                                                               |   | $                 | 1,412,042 |   | $ | 918,278 |   |

 

See accompanying notes.

 

30

----

 

**GlobalSCAPE, Inc.**

** **

**ConsolidatedStatements of Operations**

** **
|                                                                                  |   | **For the  Years ended December 31,** |      |
|---------------------------------------------------------------------------------------|--------|---------------------------------------|-----------|
|                                                                                  |   | **2001**                              |      | **2002** |   | **2003** |   |
| Operating revenues:                                                                   |   |                                  |      |   |   |   |   |
| Software product revenues                                                             |   | $                                     | 5,259,148 |   | $ | 5,269,503 |   | $ | 4,847,119 |   |
| Advertising revenues                                                                  |   | 38,540                                |      | — |   | — |   |
| Total revenues                                                                        |   | 5,297,688                             |      | 5,269,503 |   | 4,847,119 |   |
|                                                                                  |   |                                  |      |   |   |   |   |
| Operating expenses:                                                                   |   |                                  |      |   |   |   |   |
| Cost of revenues (exclusive of depreciation  and amortization shown separately below) |   | 323,309                               |      | 353,918 |   | 532,910 |   |
| Selling, general and administrative  expenses                                         |   | 3,551,498                             |      | 3,580,361 |   | 3,613,759 |   |
| Research and development expenses                                                     |   | 1,176,714                             |      | 848,212 |   | 945,395 |   |
| Depreciation and amortization                                                         |   | 546,017                               |      | 544,063 |   | 390,154 |   |
| Settlement with ATSI Comm. Inc.                                                       |   | —                                |      | 392,905 |   | — |   |
| Total operating expense                                                               |   | 5,597,538                             |      | 5,719,459 |   | 5,482,218 |   |
| Loss from operations                                                                  |   | (299,850                              | )         | (449,956 | ) | (635,099 | ) |
|                                                                                  |   |                                  |      |   |   |   |   |
| Other income (expense):                                                               |   |                                  |      |   |   |   |   |
| Interest expense                                                                      |   | (15,640                               | )         | (8,973 | ) | (5,016 | ) |
| Interest income                                                                       |   | 20,060                                |      | 20,756 |   | — |   |
| (Loss) on sale of assets                                                              |   | —                                |      | — |   | (1,486 | ) |
| Total other income (expense)                                                          |   | 4,420                                 |      | 11,783 |   | (6,502 | ) |
| Loss before income taxes                                                              |   | (295,430                              | )         | (438,173 | ) | (641,601 | ) |
|                                                                                  |   |                                  |      |   |   |   |   |
| Income tax provision (benefit):                                                       |   |                                  |      |   |   |   |   |
| Current:                                                                              |   |                                  |      |   |   |   |   |
| Federal                                                                               |   | 30,952                                |      | — |   | — |   |
| State                                                                                 |   | (166                                  | )         | 15,040 |   | 1,400 |   |
| Deferred:                                                                             |   |                                  |      |   |   |   |   |
| Federal                                                                               |   | (75,861                               | )         | 146,932 |   | — |   |
| State                                                                                 |   | 6,780                                 |      | 13,230 |   | — |   |
| Total income tax provision (benefit)                                                  |   | (38,295                               | )         | 175,202 |   | 1,400 |   |
|                                                                                  |   |                                  |      |   |   |   |   |
| Net loss                                                                              |   | $                                     | (257,135  | ) | $ | (613,375 | ) | $ | (643,001 | ) |
|                                                                                  |   |                                  |      |   |   |   |   |
| Net loss per common share – basic                                                |   | $                                     | (0.02     | ) | $ | (0.05 | ) | $ | (0.05 | ) |
| Net loss per common share – assuming  dilution                                   |   | $                                     | (0.02     | ) | $ | (0.05 | ) | $ | (0.05 | ) |

 

Seeaccompanying notes.

 

31

----

 

**GlobalSCAPE, Inc.**

** **

**ConsolidatedStatements of Stockholders’ Equity**

 
|                                                                                     |   |              |   |       |   | **Additional  paid in  Capital** |   | **Retained  Earnings  (Deficit)** |   | **Total** |     |
|------------------------------------------------------------------------------------------|--------|-------------------|--------|------------|--------|----------------------------------|--------|-----------------------------------|--------|-----------|----------|
|                                                                                     |   | **Common  Stock** |   |       |   |                             |
|                                                                                     |   | **Shares**        |   | **Amount** |   |                             |   |                              |
| Balances at December 31, 2000                                                            |   | 12,936,190        |   | 12,936     |   | 264,889                          |   | 1,096,881                         |   | 1,374,706 |     |
| Net loss                                                                                 |   | —            |   | —     |   | —                           |   | (257,135                          | )      | (257,135  | )        |
| Exercise of options                                                                      |   | 86,000            |   | 86         |   | 8,514                            |   | —                            |   | 8,600     |     |
| Value of stock options granted                                                           |   | —            |   | —     |   | 434,499                          |   | —                            |   | 434,499   |     |
| Balances at December 31, 2001                                                            |   | 13,022,190        |   | 13,022     |   | 707,902                          |   | 839,746                           |   | 1,560,670 |     |
| Net loss                                                                                 |   | —            |   | —     |   | —                           |   | (613,375                          | )      | (613,375  | )        |
| Exercise of stock options                                                                |   | 326,429           |   | 327        |   | 21,811                           |   | —                            |   | 22,138    |     |
| Issuance of common stock                                                                 |   | 10,000            |   | 10         |   | 2,990                            |   | —                            |   | 3,000     |     |
| Charges related to stock options subject to  variable accounting                         |   | —            |   | —     |   | (33,690                          | )      | —                            |   | (33,690   | )        |
| Exercise of stock options for which  compensation expense had previously been recognized |   | —            |   | —     |   | (28,706                          | )      | —                            |   | (28,706   | )        |
| Balances at December 31, 2002                                                            |   | 13,358,619        |   | 13,359     |   | 670,307                          |   | 226,371                           |   | 910,037   |     |
| Net loss                                                                                 |   | —            |   | —     |   | —                           |   | (643,001                          | )      | (643,001  | )        |
| Exercise of options                                                                      |   | 130,000           |   | 130        |   | 1,586                            |   | —                            |   | 1,716     |     |
| Balances at December 31, 2003                                                            |   | 13,488,619        |   | $          | 13,489 |                             | $      | 671,893                           |   | $         | (416,630 | ) | $ | 268,752 |   |
|                                                                                          |        |                   |        |            |        |                                  |        |                                   |        |           |          |  |  |  |  |

 

See accompanying notes.

 

32

----

** **

**GlobalSCAPE, Inc.**

** **

**ConsolidatedStatements of Cash Flows**

** **
|                                                                             |   | **For the  Years ended December 31,** |     |
|----------------------------------------------------------------------------------|--------|---------------------------------------|----------|
|                                                                             |   | **2001**                              |     | **2002** |   | **2003** |   |
| Operating Activities:                                                            |   |                                  |     |   |   |   |   |
| Net Loss                                                                         |   | $                                     | (257,135 | ) | $ | (613,375 | ) | $ | (643,001 | ) |
| Adjustments to reconcile net loss to net  cash provided by operating activities: |   |                                  |     |   |   |   |   |
| Bad debt expense                                                                 |   | 99,114                                |     | 102,261 |   | 14,508 |   |
| Depreciation and amortization                                                    |   | 546,017                               |     | 544,063 |   | 390,154 |   |
| Non-cash compensation                                                            |   | 434,499                               |     | (59,396 | ) | — |   |
| Loss on disposition of assets                                                    |   | —                                |     | — |   | 1,486 |   |
| Deferred taxes                                                                   |   | (69,081                               | )        | 146,932 |   | — |   |
| Changes in operating assets and  liabilities:                                    |   |                                  |     |   |   |   |   |
| Accounts receivable                                                              |   | (41,588                               | )        | (170,234 | ) | (3,354 | ) |
| Due from ATSI, Comm. Inc.                                                        |   | 144,561                               |     | 461,124 |   | — |   |
| Prepaid expenses                                                                 |   | (7,596                                | )        | (52,488 | ) | 25,821 |   |
| Other long term assets                                                           |   | 7,608                                 |     | — |   | — |   |
| Accounts payable                                                                 |   | (178,907                              | )        | 61,181 |   | 55,660 |   |
| Accrued expenses                                                                 |   | 2,444                                 |     | (56,197 | ) | 65,440 |   |
| Deferred revenue                                                                 |   | 11,114                                |     | 130,422 |   | (1,047 | ) |
| Other long-term liabilities                                                      |   | (14,080                               | )        | (11,216 | ) | (11,215 | ) |
| Net cash provided (used) by operating  activities                                |   | 676,970                               |     | 483,077 |   | (105,548 | ) |
| Investing Activities:                                                            |   |                                  |     |   |   |   |   |
| Loans to ATSI Comm. Inc.                                                         |   | (340,000                              | )        | (200,000 | ) | — |   |
| Settlement with ATSI Comm. Inc.                                                  |   | —                                |     | 200,000 |   | — |   |
| Purchase of property and equipment                                               |   | (205,801                              | )        | (87,822 | ) | (73,027 | ) |
| Net cash used in investing activities                                            |   | (545,801                              | )        | (87,822 | ) | (73,027 | ) |
| Financing Activities:                                                            |   |                                  |     |   |   |   |   |
| Issuance of common stock                                                         |   | 8,600                                 |     | 22,138 |   | 1,716 |   |
| Borrowings under notes payable                                                   |   | —                                |     | — |   | 100,000 |   |
| Principal payments on notes payable                                              |   | (47,108                               | )        | — |   | — |   |
| Principal payments on capital lease  obligations                                 |   | (71,715                               | )        | (71,321 | ) | (61,317 | ) |
| Net cash provided (used) in financing  activities                                |   | (110,223                              | )        | (49,183 | ) | 40,399 |   |
| Net increase (decrease) in cash and cash  equivalents                            |   | 20,946                                |     | 346,072 |   | (138,176 | ) |
| Cash at beginning of period                                                      |   | 113,591                               |     | 134,537 |   | 480,609 |   |
| Cash at end of period                                                            |   | $                                     | 134,537  |   | $ | 480,609 |   | $ | 342,433 |   |
| Supplemental disclosure of cash flows  information:                              |   |                                  |     |   |   |   |   |
| Cash paid during the year for:                                                   |   |                                  |     |   |   |   |   |
| Interest                                                                         |   | $                                     | 15,640   |   | $ | 8,973 |   | $ | 4,852 |   |
| Income taxes paid                                                                |   | 28,366                                |     | 21,121 |   | 1,400 |   |

 

See accompanying notes.

 

33

----

 

## **GlobalSCAPE, Inc.**

## ** **

## **Notes to Consolidated Financial Statements**

## ** **

###### **December 31, 2002 and2003**

 

 

**1.**                                      SignificantAccounting Policies

** **

***CorporateStructure***

*** ***

All of theCompany’s operations are conducted by GlobalSCAPE Texas, LP, a Texas limitedpartnership.  The partners ofGlobalSCAPE Texas, LP are two Nevada limited liability companies, which areboth wholly owned subsidiaries of GlobalSCAPE, Inc., a Delawarecorporation.  GlobalSCAPE, Inc. isapproximately 70% owned by the Brown and Mann-GlobalSCAPE Joint Venture, withthe remainder held publicly. GlobalSCAPE, Inc. is a holding company and conducts no operations, butthe stock of GlobalSCAPE, Inc. is quoted on the OTC Bulletin Board.  References to “GlobalSCAPE” or the “Company”refer collectively to all of these entities unless otherwise indicated.

 

***Natureof Business***

* *

GlobalSCAPE,founded in April 1996, develops and distributes Internet related software.  The Company is best known for its popularfile transfer program, CuteFTP.  TheCompany derives its revenues primarily from sales of licenses to use itssoftware products.  Sales of CuteFTP andCuteFTP Pro accounted for 85% and 75% of total revenues in 2002 and 2003,respectively.  The Company is organizedand operates as one operating segment, the provision of Internet-basedsoftware, and markets its products primarily over the Internet.

 

***Basis ofPresentation***

* *

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the Unites States requires management to make estimatesand assumptions that affect the amounts reported in the financial statementsand accompanying notes.  Actual resultscould differ from those estimates.

 

***Principlesof Consolidation***

* *

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

 

***Liquidity***

* *

The Companyincurred significant operating losses during the last three years andcontinued, in January and February of 2004, to incur significant operatinglosses.  In February 2004 GlobalSCAPEreduced its workforce by 20%, laying off 9 of the 45 people then employed bythe Company.  This workforce reductionwas a necessary step in improving the overall financial health of theorganization.  The Company hadanticipated stronger revenue performance in January and February after poorerthan expected sales in the fourth quarter and had maintained staffing levelswith this objective.  These higherrevenue targets were not met, further reducing the Company’s liquidityposition.

 

The Company ishighly dependent on the sale of two software products, CuteFTP and CuteFTP Pro,which are subject to technological and competitive obsolescence.  Sales from these two products, whichrepresented 75% of the Company’s revenues in 2003, declined 21% from theprevious year.  This decline wasprimarily in sales of CuteFTP, which declined 29%.  Sales of CuteFTP Pro declined only 2% year over year and sales ofSecure Server, the companion product to CuteFTP Pro, increased 58%.  Secure Server accounted for approximately 7%of total revenues.  Substantially allsoftware products ultimately reach a point in their lifecycle in which salescan be expected to plateau or decline. While it cannot be determined with certainty, these products may havereached such a point their lifecycles. Management believes that the market for stand-alone FTP clients for homeconsumers may be declining.  However, we

 

34

----

 

have not seenthe same decline in the market for secure FTP clients and servers such asCuteFTP Pro and Secure Server which we believe better target the needs ofbusinesses.

 

The Company’sliquidity could be further reduced in 2004 if sales of CuteFTP continue todecline and the Company is unable to successfully introduce new products orincrease sales of existing products.

 

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

 

In addition,the Company could draw on its $250,000 line of credit, if necessary.  This line of credit, which originallymatured in March 2004, has been extended through June 2004.  The interest rate is subject to change andis indexed to the bank’s prime rate. The rate is 6.00%.  In connectionwith the line of credit, GlobalSCAPE entered into a commercial securityagreement with the bank whereby GlobalSCAPE granted a security interest in allits accounts and equipment.  The Companyborrowed $100,000 on September 11, 2003 under this agreement.  This amount remained outstanding as ofDecember 31, 2003 but was repaid in February 2004.  The credit facility is available to the Company at any pointduring its term.

 

The Company’sflexibility in reacting to changes in the operating environment and to changingeconomic conditions may be limited by the Company’s current liquidityposition.  However, management believesthat, if required, it will be able to effect some or all of the components ofthe plan set forth above, which are sufficient in the aggregate to enable theCompany to continue as a going concern through at least December 31, 2004.  Accordingly, the financial statements of theCompany do not include any adjustments to reflect the possible future effectsor the recoverability and classification of assets or the amounts andclassification of liabilities that may result if the Company cannot improve itsworking capital position.

 

***RevenueRecognition***

* *

The Companyrecognizes revenue in accordance with the American Institute of CertifiedPublic Accountants Statement of Position (“SOP”) 97-2, *Software Revenue Recognition*, as modifiedby SOP 98-9, *Modification of SOP 97-2,Software Revenue Recognition, With Respect to Certain Transactions*.

 

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

 

The Companyalso sells technical support and maintenance agreements (post contract customersupport “PCS”), which are sometimes bundled with the software.  When vendor specific objectiveevidence (“VSOE”) of fair value exists for all elements in a multiple elementarrangement, revenue is allocated to each element based on the relative fairvalue of each of the elements. VSOE of fair value is established by the pricecharged when the same element is sold separately.  In a multiple element arrangement whereby VSOE of fair value ofall undelivered elements exists but VSOE of fair value does not exist for oneor more delivered elements, revenue is recognized using the residual method.Under the residual method, the fair value of the undelivered elements isdeferred and the remaining portion of the arrangement fee is recognized asrevenue, assuming collection is probable. Revenue allocated to PCS is recognized ratably over the contractualterm, typically one year.

 

The Companybegan selling technical support and maintenance services for some of itssoftware products in 2001 and had deferred recognition of approximately $11,000in revenue at the end of that year. Deferred revenue grew to a balance of approximately $142,000 at December31, 2002 and remained relatively flat, ending 2003 with a balance ofapproximately $140,000.  The rate ofgrowth in deferred revenue in 2002 was due primarily to the rapid growth in thesale of technical support and maintenance agreements in the fourth quarter of2002.  Sales of these agreementscontinued to grow into the first quarter of 2003 but have flattened out sincethat time, resulting in relatively little change year over year in the

 

35

----

 

amount ofdeferred revenue.  Growth in the salesof maintenance and support agreements may result in the deferred recognition ofa significant amount of revenue in future periods.

 

The outboundshipping charges charged to the customer are included in software productrevenues and amounted to $25,000, $57,000 and $58,000 in 2001, 2002 and 2003,respectively.  The costs associated withthese shipping charges are included in the software products cost of revenue.

 

In periods inwhich advertising revenue was recognized, it was recognized as it was earned,net of any fees paid to third-party advertising agents.  Advertising was earned in the period inwhich the advertisements were displayed. The Company’s current product line does not include products containingthe modules necessary to generate advertising space.  Advertising will not be a material source of revenue in futureperiods.

 

***RoyaltyCosts***

* *

Royalties thatthe Company pays on software products licensed from third parties, which itresells, are expensed as a cost of sales when the software product is sold orearlier if the recoverability of any prepaid royalties is in doubt.  The Company has distribution agreements withHannon Hill Corp., Trellix Corp., Perseus Development Corp., Beehive Software,Inc., Visicom Media, Inc., and Turillion Software Technologies.  The GlobalSCAPE software products associatedwith each of the companies are PureCMS, CuteSITE Builder, Web Survey, Mac FTP,CuteHTML Pro and Protect IIS, respectively. GlobalSCAPE no longer distributes the Protect IIS product and expensedprepaid royalties of approximately $15,000 in December 2003.  GlobalSCAPE’s agreement with Hannon HillCorp. required a minimum royalty of $16,667 per month, as prepayment ofroyalties, for 12 months beginning in December 2002.  These payments were expensed as paid because the lower thanexpected sales of PureCMS raised doubt as to the realization of benefit fromthese prepayments.  The total amountexpensed in 2003 relating to these prepayments was $183,337.

 

***Concentrationsof Credit Risk and Significant Customers***

* *

Financialinstruments that potentially subject the Company to concentrations of creditrisk consist principally of accounts receivable.  The Company provides credit, in the normal course of business, toa number of companies and performs ongoing evaluations of its credit risk.  The Company requires no collateral from itscustomers.  Management estimates theallowance for uncollectible accounts based on their historical experience andcredit evaluation.  No single customeraccounted for more than 2% of revenues in 2001, 2002 or 2003.

 

***OtherConcentrations***

* *

*Sales in Foreign Markets. *In2001, 2002 and 2003, approximately 38%, 38% and 35%, respectively, of theCompany’s revenues were generated from sales to customers who providedaddresses in foreign countries. However, all revenues are received in U.S. dollars so there is noexchange rate risk with respect to the sale of our products.  These sales were concentrated mostly inWestern Europe, Canada, and Australia. In 2001, 2002 and 2003, the UK accounted for approximately 11.5%, 11.4%and 11.1%, respectively, of total revenues.

 

*Labor. *GlobalSCAPEutilizes offshore developers for a large portion of the coding phase ofsoftware development.  If GlobalSCAPEwere unable to 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.

 

***AdvertisingCosts***

* *

The Companyexpenses advertising costs as incurred. Advertising expenses charged to operations for the years ended December31, 2001, 2002 and 2003 were approximately $138,000, $300,000 and

 

36

----

 

$542,000,respectively, and are included in selling, general and administrativeexpenses.  The advertising expenses in2002 and 2003 relate primarily to the PureCMS product launch.

 

***IncomeTaxes***

* *

The Companyaccounts for income taxes using the liability method in accordance withStatement of Financial Accounting Standards No. 109, *Accounting for Income Taxes*. The liability method providesthat the deferred tax assets and liabilities are recorded based on thedifference between the tax bases of assets and liabilities and their carryingamount for financial reporting purposes, as measured by the enacted tax ratesand laws that will be in effect when the differences are expected toreverse.  Deferred tax assets 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 these assets in future periodsrequires a great deal of judgment by management.   Although GlobalSCAPE has generated pre-tax income in previousyears, unusual or infrequently occurring transactions resulted in pre-taxlosses in 2001 and 2002 (compensation charges in 2001 and the settlement withATSI and termination of CEO in 2002). It is our judgment that we cannot predict with reasonable certainty thatthe tax assets resulting from these losses and the loss incurred in 2003 willbe fully realized in future periods.  Statementof Financial Accounting Standards (SFAS) No. 109 requires a valuation allowanceto reduce the deferred tax assets reported if, based on the weight of theevidence, it is more likely than not that some portion or all of the deferredtax assets will not be realized.  After consideration of all of theevidence, both positive and negative, management determined that a $540,350valuation allowance at December 31, 2003 was necessary to reduce the deferredtax assets to the amount that will more likely than not be realized.  Thechange in the valuation allowance for the current year is a net increase of $216,515. At December 31, 2003, the Company has available net operating losscarryforwards of approximately $1,266,351, which expire beginning in the year2020.

 

***Researchand Development***

* *

Research anddevelopment expenses include all direct costs, primarily salaries for personneland expenditures with external development sources, related to the developmentof new products and significant enhancements to existing products and areexpensed as incurred until such time as technological feasibility is achieved.For the years 2001, 2002 and 2003, we spent approximately $1,177,000, $848,000and $945,000, respectively, on research and development.  No research and development expenses werecapitalized in 2001, 2002 or 2003 and all previously capitalized research anddevelopment expenses were fully amortized at December 31, 2002.

 

***Stock-BasedCompensation***

* *

The Companymeasures compensation expense for its stock-based employee compensation plans,which are described in Note 8. Statement of Financial Accounting Standards 123, *Accounting for Stock-Based Compensation*(SFAS 123), encourages, but does not require, companies to record compensationcost for stock-based employee compensation plans based on the fair market valueof options granted. The Company chose to account for stock based compensationusing the intrinsic value method prescribed in APB Opinion No. 25, *Accounting for Stock Issued to Employees*,and related interpretations. Accordingly, compensation expense is recorded tothe extent that the current market price of the underlying stock exceeds theexercise price.  On December 31, 2002,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standard 148, *Accounting forStock Based Compensation - Transition and Disclosure* (SFAS 148),which amends SFAS 123.  SFAS 148requires more prominent and frequent disclosures about the effects ofstock-based compensation. The Company will continue to account for itsstock-based compensation according to the provisions of APB Opinion No. 25.

 

Pro formainformation regarding net income and earnings per share is required byStatement 148, which also requires that the information be determined as if theCompany had accounted for its stock options granted subsequent to December 31,1994 under the fair value method of that Statement.  The fair value of these options was estimated at the date ofgrant using a Black-Scholes option-pricing model.

 

37

----

 

For purposesof pro forma disclosures, the estimated fair value of the options is amortizedto expense over the options’ vesting period. The Company’s pro forma information for 2001, 2002 and 2003 follows:

 
|                                                                                                                                                                                              |   | **Years  ended December 31,** |     |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------|----------|
|                                                                                                                                                                                              |   | **2001**                      |     | **2002** |   | **2003** |   |
| Net income (loss), as reported                                                                                                                                                                    |   | $                             | (257,135 | ) | $ | (613,375 | ) | $ | (643,001 | ) |
| Stock based compensation included in the determination of net income  (loss) as reported, net of related tax effects                                                                              |   | 434,499                       |     | (59,396 | ) | — |   |
| Stock-based compensation expense that would  have been included in the determination of net income (loss) had the fair  value based method been applied to all awards, net of related tax effects |   | (585,051                      | )        | (103,923 | ) | (48,057 | ) |
| Pro forma net income (loss)                                                                                                                                                                       |   | $                             | (407,687 | ) | $ | (776,694 | ) | $ | (691,058 | ) |
|                                                                                                                                                                                              |   |                          |     |   |   |   |   |
| Earnings (loss) per share:                                                                                                                                                                        |   |                          |     |   |   |   |   |
| Basic- as reported                                                                                                                                                                                |   | $                             | (0.02    | ) | $ | (0.05 | ) | $ | (0.05 | ) |
| Basic- pro forma                                                                                                                                                                                  |   | $                             | (0.03    | ) | $ | (0.06 | ) | $ | (0.05 | ) |
|                                                                                                                                                                                              |   |                          |     |   |   |   |   |
| Diluted- as reported                                                                                                                                                                              |   | $                             | (0.02    | ) | $ | (0.05 | ) | $ | (0.05 | ) |
| Diluted- pro forma                                                                                                                                                                                |   | $                             | (0.03    | ) | $ | (0.06 | ) | $ | (0.05 | ) |

 

The weightedaverage fair value of the individual stock options granted during 2001, 2002,and 2003 is estimated at $0.24, $0.13 and $0.20, respectively, on the date ofgrant.  The fair values were determinedusing a minimum value options-pricing model with the following assumptions:

 

|                     |   | **2001** |   | **2002** |   | **2003** |   |
|--------------------------|--------|----------|--------|----------|--------|----------|--------|
|                     |   |     |   |     |   |     |   |
| Dividend  yield          |   | None     |   | None     |   | None     |   |
|                     |   |     |   |     |   |     |   |
| Expected  volatility     |   | n/a      |   | 2.45     |   | 2.23     |   |
|                     |   |     |   |     |   |     |   |
| Risk-free  interest rate |   | 4.99     | %      | 1.82     | %      | 3.21     | %      |
|                     |   |     |   |     |   |     |   |
| Expected  life           |   | 5.0      |   | 5.0      |   | 5.0      |   |

 

***Cash***

* *

Cash includesall cash and highly liquid investments with original maturities of three monthsor less.

 

***Propertyand Equipment***

* *

Property andequipment is comprised of furniture and fixtures, software, computer equipmentand leasehold improvements which are recorded at cost and depreciated using thestraight-line method over their estimated useful lives.  Expenditures for maintenance and repairs arecharged to operations as incurred. Property and equipment acquired under capital leases are depreciatedover their useful lives or the respective lease term, if shorter.  Depreciation periods used for property andequipment range from three to five years.

 

Leaseholdimprovements are depreciated over the shorter of the lease term or theestimated useful life of the asset.

*** ***

***38***

----

*** ***

***Sale/ Disposal of Assets***

*** ***

During 2003the Company disposed of equipment and software with an original purchase priceof $69,738 and accumulated depreciation of $68,252.  GlobalSCAPE recognized a loss of $1,486 related to the disposalof these assets.  There were nodisposals of fixed assets during 2001 or 2002.

 

***CapitalizedSoftware Development Costs***

* *

Capitalizationof software development costs begins upon the establishment of technologicalfeasibility and ceases when the product is 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.  Amortization expense for these costsamounted to approximately $53,000 and $51,000 in 2001 and 2002, respectively.  These software development costs were amortizedusing the straight-line method over a three-year period and are only thosecosts incurred in the development of products that are sold to externalcustomers and not used for internal purposes. These software development costsare not related to those costs incurred for the acquisition of softwareproducts or titles reflected in Other Assets as Core Software Technology.  For the years 2001, 2002 and 2003, we spentapproximately $1,177,000, $848,000 and $945,000, respectively, on research anddevelopment.  No research anddevelopment expenses were capitalized in 2001, 2002 or 2003 and all previouslycapitalized research and development expenses were fully amortized at December31, 2002.

 

***OtherLong-Term Assets***

* *

Costs incurredfor acquisition of CuteFTP were capitalized and amortized over the estimateduseful life of five years using the straight-line method.  The Core Software Technology on the balancesheet represents the purchase of the source code and related trademark forCuteFTP and the related amortization of these costs.  GlobalSCAPE recognized amortization expense related to CuteFTP ofapproximately $178,000, $180,000 and $135,000 in 2001, 2002 and 2003,respectively.  The asset was fullyamortized at December 31, 2003.

 

Other assetsinclude deposits for facilities, which will be refunded to the Company upontermination of the lease.

 

***OtherLong-Term Liabilities***

 

Otherlong-term liabilities relate to deferred payments of rent expense.

 

***EarningsPer Common Share***

* *

Basic anddiluted net income per common share is presented in conformity with Statementof Financial Accounting Standards No. 128, *EarningsPer Share* (SFAS 128) for all periods presented.  Basic earnings per share is based on theweighted effect of all common shares issued and outstanding, and is calculatedby dividing net income (loss) available to common stockholders by the weightedaverage shares outstanding during the period. Diluted earnings per share is calculated by dividing net income (loss)available to common stockholders by the weighted average number of commonshares used in the basic earnings per share calculation plus the number ofcommon shares that would be issued assuming conversion of all potentiallydilutive common shares outstanding. Below is a reconciliation of the numerators and denominators of basicand diluted earnings per share for each of the following years:

 

39

----

 
|                                                 |   | **Year ended  December 31,** |     |
|------------------------------------------------------|--------|------------------------------|----------|
|                                                 |   | **2001 (1)**                 |     | **2002 (2)** |   | **2003 (3)** |   |
| **Numerators**                                       |   |                         |     |   |   |   |   |
| Numerator for basic and diluted earnings  per share: |   |                         |     |   |   |   |   |
| Net loss                                             |   | $                            | (257,135 | ) | $ | (613,375 | ) | $ | (643,001 | ) |
| **Denominators**                                     |   |                         |     |   |   |   |   |
| Denominators for basic earnings per share:           |   |                         |     |   |   |   |   |
| Weighed average shares outstanding-Basic             |   | 12,938,782                   |     | 13,279,263 |   | 13,361,706 |   |
| **Dilutive potential common shares**:                |   |                         |     |   |   |   |   |
| Stock Options                                        |   | —                       |     | — |   | — |   |
| Denominator for dilutive earnings per share          |   | 12,938,782                   |     | 13,279,263 |   | 13,361,706 |   |
| Net loss per common share                            |   | $                            | (0.02    | ) | $ | (0.05 | ) | $ | (0.05 | ) |
| Net loss per commons share – assuming  dilution |   | $                            | (0.02    | ) | $ | (0.05 | ) | $ | (0.05 | ) |

* *

----

*(1)*          For the year ended December 31, 2001, 3,557,480 options have not beenincluded in dilutive shares as the effect would be anti-dilutive.

* *

*(2)*          For the year ended December 31, 2002, 2,965,671 options have not beenincluded in dilutive shares as the effect would be anti-dilutive.

* *

*(3)*          For the year ended December 31, 2003, 1,856,171 options have not beenincluded in dilutive shares as the effect would be anti-dilutive.

* *

***RecentAccounting Pronouncements***

*** ***

***Variable Interest Entities***

*** ***

On January 1,2003, the Financial Accounting Standards Board issued Financial AccountingStandards Board Interpretation No. 46, Consolidation of Variable InterestEntities (“FIN 46”).  FIN 46 addressesconsolidation of business enterprises of variable interest entities.  FIN 46 is effective immediately for allvariable interest entities created after January 31, 2003 and for the firstfiscal year or interim period ending after December 15, 2003 for variable interestentities in which an enterprise holds a variable interest that it acquiredbefore February 1, 2003.  The Companyhas no variable interest entities, therefore, adoption of this statement didnot impact the Company’s financial position or results of operations.

 

**2.**                                      AccountsReceivable

** **

Accountsreceivable, which are primarily from sales of software licenses, are presentednet of an allowance for doubtful accounts. The activity of the Company’s allowance for doubtful accounts for theyears ended December 31, 2001, 2002 and 2003 is presented in the followingtable:

 
| **Balance at**              |   | **Charged to**           |   |                    |   | **Balance at**      |   |
|-----------------------------|--------|--------------------------|--------|-------------------------|--------|---------------------|--------|
| **Year Ended  December 31** |   | **Beginning  of Period** |   | **Income or   Expense** |   | **Deductions  (1)** |   | **End of  Period** |   |
|                        |   |                     |   |                    |   |                |   |   |   |
| 2001                        |   | $                        | 80,719 |                    | $      | 99,114              |   | $ | (154,729 | ) | $ | 25,104 |   |
| 2002                        |   | 25,104                   |   | 102,261                 |   | (68,938             | )      | 58,427 |   |
| 2003                        |   | 58,427                   |   | 14,508                  |   | (29,354             | )      | 43,581 |   |
|                             |        |                          |        |                         |        |                     |        |  |  |  |  |  |  |

 

----

(1)  Represents amounts written off asuncollectible accounts receivable.

 

40

----

 

**3.**                                      Debt

** **

The Companyobtained a 90-day extension of its $250,000 revolving line of credit agreementwith a commercial bank, extending the line through June 2004.  The line is due on demand, but if no demandis made, then in June 2004.  Theinterest rate is subject to change and is indexed to the bank’s primerate.  The rate at December 31, 2003 was6.00%.  In connection with the line ofcredit, GlobalSCAPE entered into a Commercial Security Agreement with the bankwhereby GlobalSCAPE granted a security interest in all its accounts andequipment.  The Company borrowed $100,000on September 11, 2003 under this agreement. This amount remained outstanding as of December 31, 2003 but was repaidin February 2004.

 

**4.**                                      Commitmentsand Contingencies

 

**CapitalLeases**

 

The Companyhas financed the acquisition of certain fixed assets through capital leaseobligations.  These obligations areclassified as capital leases due to the bargain purchase option containedtherein.  The present value of thefuture minimum lease payments for these leases at December 31, 2003 is asfollows:

 

| Year ended December 31:                         |   |   |   |
|-------------------------------------------------|--------|--------|--------|
| 2004                                            |   | 15,477 |   |
| Total minimum lease payments                    |   | 15,477 |   |
| Less amount representing interest               |   | 183    |   |
| Present value of minimum lease payments         |   | 15,294 |   |
| Less current portion                            |   | 15,294 |   |
| Capital lease obligation, less current  portion |   | $      | — |   |
|                                                 |        |        |        |  |

 

Property andequipment at December 31, 2002 and 2003 includes $227,000 for assets held undercapital leases, less associated accumulated depreciation of $146,000 and$203,000, respectively.  Depreciationfor assets held under capital leases is included in depreciation andamortization expense.

 

**OperatingLeases**

 

Minimum futurelease payments on non-cancelable operating leases for office facilities are asfollows for the years ending December 31:

 

| 2004       |   | 190,659 |    |
|------------|--------|---------|---------|
| 2005       |   | 190,659 |    |
| 2006       |   | 190,659 |    |
| 2007       |   | 190,659 |    |
| Thereafter |   | 95,329  |    |
|       |   | $       | 857,965 |   |
|            |        |         |         |  |

 

This leaseprovides the Company with two successive 5-year renewal options.  Operating lease expense amounted toapproximately $180,000 in each of 2001, 2002 and 2003.

 

**Contingencies**

 

There are nopending claims against the Company that would have a material adverse effect onthe financial statements of the Company.

 

**5.**                                      RelatedParty Transactions

 

On June 11,2002, ATSI sold its majority interest in GlobalSCAPE, Inc. to Brown andMann-GlobalSCAPE Joint Venture, a Texas general partnership owned by SanAntonio-based investors Thomas W. Brown and David L. Mann.  Contemporaneously with this transaction,GlobalSCAPE agreed to compromise and settle a $612,304 inter-company balanceowed to it by ATSI, which resulted in charges to

 

41

----

 

GlobalSCAPE of$392,905.  The balance was settled for(i) $200,000 in cash from ATSI; (ii) NTFC Capital Corporation’s release ofGlobalSCAPE as a co-borrower on a capital lease executed by ATSI in 1999, and(iii) ATSI’s agreement to provide $50,000 worth of transition support servicesto GlobalSCAPE over the nine months ending March 11, 2003, including payrolladministration and GlobalSCAPE’s continued use of a shared accounting platform.  However, the Company completed itstransition from ATSI’s payroll and accounting systems during the third quarterof 2002 and expensed the remainder of the support services, approximately$46,000, during the third quarter.  Inaddition, prepaid insurance coverage under a joint policy with ATSI was lost toGlobalSCAPE as a result of the change in control, resulting in a charge againstGlobalSCAPE’s prepaid assets of $27,083 during the second quarter of 2002.

 

During theyear ended December 31, 2000 and for the period from January 1, 2002 to June11, 2002, ATSI incurred various expenses for the joint benefit of ATSI andGlobalSCAPE such as premiums for health and general business insurance.  ATSI allocated a portion of these expensesto GlobalSCAPE based on GlobalSCAPE’s proportionate use of the services.  The amounts allocated to GlobalSCAPE werenot necessarily indicative of the amounts that would have been incurred ifGlobalSCAPE had acquired these services on its own, nor of the amounts thatwill be charged in the future.  However,management believes the method of allocation is reasonable.  Expenses for these services in the amount of$190,000 for the year ended December 31, 2001 and $40,131 for the periodbeginning January 1, 2002 and ending June 11, 2002 were charged to GlobalSCAPEby ATSI and are reflected in the statement of operations.  Also during 2001 and 2002, the Company madevarious loans to ATSI with interest of 12% per annum.

 

On June 21,2002, GlobalSCAPE, Inc. announced the termination of its CEO, TimNicolaou.  Mr. Nicolaou resigned fromthe Board of Directors and received $190,000 in severance payments as providedby his employment agreement and will continue to receive health benefits paidby the Company for a period not to exceed twelve months, the cost of which wasexpensed in 2002.

 

On March 30,2004, the Company obtained a $200,000 line of credit with the Brown andMann-GlobalSCAPE Joint Venture.  Theline of credit is available after June 21, 2004 if the Company fails to extenda line of credit with a bank and matures on December 31, 2004.  The interest rate is subject to change andis indexed to the prime rate published in the Wall Street Journal.  In connection with the line of credit,GlobalSCAPE entered into a Commercial Security Agreement with the Brown andMann-GlobalSCAPE Joint Venture whereby GlobalSCAPE granted a security interestin all its accounts and equipment.  TheBrown and Mann-GlobalSCAPE Joint Venture is 70% owned by Thomas W. Brown and30% owned by David L. Mann, both of whom are members of GlobalSCAPE’s Board ofDirectors.

 

**6.  Income Taxes**

 

Deferredincome taxes reflect the net tax effects of temporary differences between thecarrying amounts of assets and liabilities for financial reporting purposes andthe amounts used for income tax purposes. Significant components of the Company’s deferred tax assets andliabilities are related to the following:

 
|                                                  |   | **2002** |   | **2003** |   |
|-------------------------------------------------------|--------|----------|--------|----------|--------|
| Total deferred tax liabilities                        |   | $        | — |     | $      | — |   |
|                                                  |   |     |   |     |   |
| Deferred tax assets:                                  |   |     |   |     |   |
| Accrued expenses                                      |   | 15,566   |   | 29,292   |   |
| Allowance for doubtful accounts                       |   | 20,618   |   | 15,428   |   |
| Deferred revenue                                      |   | 48,122   |   | 47,766   |   |
| Depreciation and amortization............ |   | —   |   | 17,305   |   |
| Net operating loss carryforwards                      |   | 239,529  |   | 430,559  |   |
| Total deferred tax assets                             |   | 323,835  |   | 540,350  |   |
| Valuation allowance for deferred tax assets           |   | 323,835  |   | 540,350  |   |
| Net deferred tax assets                               |   | $        | — |     | $      | — |   |

 

Areconciliation of income tax expense and the amount computed by applying thestatutory federal income tax rate (34%) to income before income taxes is asfollows:

 

42

----

 

|                                                        |   | **2001** |     | **2002** |   | **2003** |   |
|-------------------------------------------------------------|--------|----------|----------|----------|--------|----------|--------|
| Taxes computed at federal statutory rate                    |   | $        | (100,446 | )        | $      | (148,986 | )      | $ | (218,620 | ) |
| Increases (decreases) in taxes resulting  from:             |   |     |     |     |   |     |   |
| State taxes, net of federal benefit                         |   | 4,366    |     | 18,658   |   | 924      |   |
| Non-deductible incentive stock option  compensation charges |   | 147,730  |     | (21,215  | )      | —   |   |
| Other non-deductible expenses                               |   | 2,684    |     | 2,800    |   | 2,581    |   |
| Change in valuation allowance                               |   | (92,629  | )        | 323,835  |   | 216,515  |   |
| Other                                                       |   | —   |     | 110      |   | —   |   |
| Total                                                       |   | $        | (38,295  | )        | $      | 175,202  |   | $ | 1,400 |   |

 

At December31, 2003, the Company has available net operating loss carryforwards ofapproximately $1,266,351, which expire beginning in the year 2020.

 

**7.**                                      EmployeeBenefit Plan

 

The Companyhas a 401(k) plan that covers substantially all employees with at least sixmonths of service.  Under the plan,employees may elect to contribute a percentage of their annual salary subjectto the Internal Revenue Code maximum limitations.  The plan provides for employer matching and discretionarycontributions, the amount of which are to be determined annually by the Boardof Directors.  The Company madecontributions to the plan of $7,939, $7,347 and $7,533 for the years endedDecember 31, 2001, 2002 and 2003, respectively.

 

**8.**                                      StockOptions and Stock Based Compensation

** **

In January1998, the Company approved the 1998 Stock Option Plan (the “1998 Plan”) forofficers, other employees, directors, and consultants of the Company.  Under the terms of the 1998 Plan, up to728,571 shares of the Company’s common stock may be granted in the form ofincentive stock options or non-qualified stock options, awarded, or sold toofficers, other employees, directors and consultants.  As of July 31, 2001, no additional grants could be issued underthe 1998 Plan.

 

In May 2000,the Board of Directors approved the 2000 stock option plan (the “2000 Plan”)for key employees, non-employee directors, and advisors of the Company.  Under the terms of the 2000 Plan, up to3,660,000 shares of the Company’s common stock may be granted in the form ofincentive stock options or non-qualified stock options.  The maximum aggregate number of shares ofcommon stock that may be granted to any optionee during the term of the 2000Plan may not exceed 2,000,000.  The 2000Plan provides that the purchase price per share for incentive stock options andnon-qualified stock options shall not be less than the fair market value of thecommon stock on the date of grant.  Themaximum term for an option granted is ten years from the date of grant.

 

The Companyhas adopted Statement of Financial Accounting Standards No. 123, “Accountingfor Stock Based Compensation” (SFAS No. 123), and elected to use the intrinsicvalue method in accounting for its stock option plan in accordance withAccounting Principles Board opinion No. 25, “Accounting for Stock Issued toEmployees” and related interpretations under which compensation expense isrecorded to the extent that the current market price of the underlying stockexceeds the exercise price.  No optionswere issued below fair value for the years ended December 31, 2002 and 2003.

 

During thethird quarter of 2003, 56,000 options were granted to various employees at anaverage exercise price of $0.20 per share.

 

**SupplementalDisclosures for Stock Options**

** **

The followingtable shows the number of options granted, cancelled and exercised for alloption plans for the three years ending December 31, 2002.

 

43

----

 

|                          |   | **Number of  Shares** |   | **Weighted  Avg.  Exercise Price** |   |
|-------------------------------|--------|-----------------------|--------|------------------------------------|--------|
| 2001                          |   |                  |   |                               |   |
| Outstanding December 31, 2000 |   | 1,566,409             |   | $                                  | 0.54   |   |
| Granted                       |   | 2,184,571             |   | 0.30                               |   |
| Expired                       |   | 107,500               |   | 0.46                               |   |
| Exercised                     |   | 86,000                |   | 0.10                               |   |
| Outstanding December 31, 2001 |   | 3,557,480             |   |                               |   |
|                          |   |                  |   |                               |   |
| 2002                          |   |                  |   |                               |   |
| Granted                       |   | 24,000                |   | 0.13                               |   |
| Expired                       |   | 289,380               |   | 0.79                               |   |
| Exercised                     |   | 326,429               |   | 0.07                               |   |
| Outstanding December 31, 2002 |   | 2,965,671             |   |                               |   |
|                          |   |                  |   |                               |   |
| 2003                          |   |                  |   |                               |   |
| Granted                       |   | 56,000                |   | 0.20                               |   |
| Expired                       |   | 1,035,500             |   | 0.72                               |   |
| Exercised                     |   | 130,000               |   | 0.0132                             |   |
| Outstanding December 31, 2003 |   | 1,856,171             |   |                               |   |
|                               |        |                       |        |                                    |        |  |

 

The followingtable shows information about outstanding stock options at December 31, 2003.

 
|                          |   |                     |   | **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** |   |
| $ 0.0132                      |   | 850,171                  |   | 6.95                                                |   | $                                      | 0.0132 |   | 850,171 |   | $ | 0.0132 |   |
| $ 0.11 - $0.22                |   | 78,500                   |   | 9.32                                                |   | 0.178                                  |   | 10,667 |   | 0.151 |   |
| $ 0.464                       |   | 927,500                  |   | 7.29                                                |   | 0.464                                  |   | 927,500 |   | 0.464 |   |
| $ 0.0132 - $1.00              |   | 1,856,171                |   | 7.22                                                |   | $                                      | 0.2454 |   | 1,788,338 |   | $ | 0.2478 |   |

** **

**9.**                                      QuarterlyFinancial Information (unaudited)

 
|                                                 |   | **Fiscal  Year 2002** |      |
|------------------------------------------------------|--------|-----------------------|-----------|
|                                                 |   | **1st  Quarter**      |      | **2nd  Quarter** |   | **3rd  Quarter** |   | **4th  Quarter** |   |
|                                                 |   |                  |      |   |   |   |   |   |   |
| Total revenues                                       |   | $                     | 1,305,902 |   | $ | 1,349,537 |   | $ | 1,291,169 |   | $ | 1,322,895 |   |
| Total operating expenses                             |   | 1,191,343             |      | 1,817,435 |   | 1,223,609 |   | 1,487,072 |   |
| Net income (loss) before provision for  income taxes |   | 122,610               |      | (460,540 | ) | 66,652 |   | (166,895 | ) |
| Net income (loss)                                    |   | 88,607                |      | (280,108 | ) | 41,726 |   | (463,600 | ) |
|                                                 |   |                  |      |   |   |   |   |   |   |
| Net income (loss) per share:                         |   |                  |      |   |   |   |   |   |   |
| Basic                                                |   | $                     | 0.01      |   | $ | (0.02 | ) | $ | 0.00 |   | $ | (0.03 | ) |
| Diluted                                              |   | $                     | 0.01      |   | $ | (0.02 | ) | $ | 0.00 |   | $ | (0.03 | ) |
| Weighted average shares outstanding:                 |   |                  |      |   |   |   |   |   |   |
| Basic                                                |   | 13,071,357            |      | 13,324,427 |   | 13,358,619 |   | 13,358,619 |   |
| Diluted                                              |   | 14,207,739            |      | 13,324,427 |   | 14,277,122 |   | 13,358,619 |   |

 

44

----

 
|                                                 |   | **Fiscal  Year 2003** | ** ** |
|------------------------------------------------------|--------|-----------------------|------------|
|                                                 |   | **1st  Quarter**      |       | **2nd  Quarter** | ** ** | **3rd  Quarter** | ** ** | **4th  Quarter** | ** ** |
|                                                 |   |                  |       |   |   |   |   |   |   |
| Total revenues                                       |   | $                     | 1,120,186  |   | $ | 1,309,708 |   | $ | 1,336,682 |   | $ | 1,080,543 |   |
| Total operating expenses                             |   | 1,727,968             |       | 1,207,219 |   | 1,251,682 |   | 1,295,349 |   |
| Net income (loss) before provision for  income taxes |   | (610,416              | )          | 101,582 |   | 83,984 |   | (216,751 | ) |
| Net income (loss)                                    |   | (610,416              | )          | 101,582 |   | 82,584 |   | (216,751 | ) |
|                                                 |   |                  |       |   |   |   |   |   |   |
| Net income (loss) per share:                         |   |                  |       |   |   |   |   |   |   |
| Basic                                                |   | $                     | (0.05      | ) | $ | 0.01 |   | $ | 0.01 |   | $ | (0.02 | ) |
| Diluted                                              |   | $                     | (0.05      | ) | $ | 0.01 |   | $ | 0.01 |   | $ | (0.02 | ) |
| Weighted average shares outstanding:                 |   |                  |       |   |   |   |   |   |   |
| Basic                                                |   | 13,358,619            |       | 13,358,619 |   | 13,358,619 |   | 13,370,902 |   |
| Diluted                                              |   | 13,358,619            |       | 14,284,107 |   | 14,275,292 |   | 13,370,902 |   |

 

The Companyrecognized $392,905 and $190,000 in charges related to the settlement with ATSIand in compensation expense related to the termination of its former CEO,respectively, in the second quarter of 2002. In the fourth quarter of 2002, GlobalSCAPE spent approximately $240,000on marketing related activity related to the launch of PureCMS.  GlobalSCAPE also posted a valuationallowance against deferred tax assets during the fourth quarter of 2002 of$323,835.  In the first quarter of 2003,GlobalSCAPE spent approximately $460,000 on the PureCMS product launch.  In the fourth quarter of 2003, revenues wereapproximately $242,000, or 18%, lower than the same quarter in the previousyear.  Comparisons of GlobalSCAPE’squarterly results from operations should take these items into consideration.

 

**10.**                               SubsequentEvents (unaudited)

** **

On March 12,2004, the Company executed an agreement, extending its line of credit with abank for 90 days to June 2004.  The lineof credit had an original expiration of March 2004 and is in the amount of$250,000.

 

On March 30,2004, the Company obtained a $200,000 line of credit with the Brown andMann-GlobalSCAPE Joint Venture.  Theline of credit is available after June 21, 2004 if the Company fails to extenda line of credit with a bank and matures on December 31, 2004.  The interest rate is subject to change andis indexed to the prime rate published in the Wall Street Journal.  In connection with the line of credit,GlobalSCAPE entered into a Commercial Security Agreement with the Brown andMann-GlobalSCAPE Joint Venture whereby GlobalSCAPE granted a security interestin all its accounts and equipment.

 

**Item9.  Changes in and Disagreements withAccountants on Accounting and Financial Disclosure**

 

None.

 

# **Item 9A.  Controls and Procedures**

 

As of the endof the period covered by this Annual Report, our President and Vice Presidentof Finance and Operations carried out an evaluation of the effectiveness ofGlobalSCAPE’s disclosure controls and procedures (as defined SEC Rules13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended,(the “Exchange Act”)) and concluded that the controls and procedures areeffective in recording, processing, summarizing and reporting the informationrequired to be disclosed by GlobalSCAPE in the reports it files with the SECunder the Exchange Act within the time periods specified in the SEC’s rules andforms.  There were no changes in ourinternal controls that could materially affect, or are reasonably likely tomaterially affect our financial reporting.

 

45

----

 

# **Part III**

 

**Item10.  Directors and Executive Officers ofthe Registrant**

 

Theinformation called for by Item 10 of Form 10-K as to Directors is incorporatedherein by reference to such information included in our Proxy Statement for the2004 Annual Meeting of Stockholders. The information called for by Item 10 of Form 10-K as to ExecutiveOfficers appears in Part I of this Form 10-K. The information called for by Item 10 of Form 10-K as to compliance withSection 16(a) of the Exchange Act is incorporated herein by reference to suchinformation included in our Proxy Statement for the 2004 Annual Meeting ofStockholders.

 

GlobalSCAPE has adopted a Code of Ethics that applies to all itsemployees, including its President (its chief executive officer) and its VicePresident of Finance and Operations (its chief financial officer). GlobalSCAPE will provide a copy of its Code of Ethics to any person withoutcharge upon written request to:

 

Daniel P. McRedmond

Vice President Finance and Operations

GlobalSCAPE, Inc.

6000 Northwest Parkway, Suite 100

San Antonio, Texas 78249

 

**Item11. Executive Compensation**

 

Theinformation called for by Item 11 of Form 10-K is incorporated herein byreference to such information included in our Proxy Statement for the 2004Annual Meeting of Stockholders, except for those parts under the captions“Board Report on Executive Compensation” and “Report on Repricing of Options”.

 

**Item12. Security Ownership of Certain Beneficial Owners and Management and RelatedStockholder Matters**

 

Theinformation called for by Item 12 of Form 10-K is incorporated herein byreference to such information included in our Proxy Statement for the 2004Annual Meeting of Stockholders.

 

**Item 13. Certain Relationships and RelatedTransactions**

 

Theinformation called for by Item 13 of Form 10-K is incorporated herein byreference to such information included in our Proxy Statement of the 2004Annual Meeting of Stockholders.

 

**Item 14. Principal Accountant Fees and Services.**

 

The information call for byItem 14 of Form 10-K is incorporated herein by reference to such informationincluded in our Proxy Statement of the 2004 Annual Meeting of Stockholders

 

46

----

 

# **PART IV**

 

##### **Item 15. Exhibits,Financial Statement Schedule, and Reports on Form 8-K**

 

(a)(1)                    Financial Statements and Schedules

 

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

 

•                  Consolidated balance sheets – December 31, 2002 and 2003

•                  Consolidated statements of operations – Years ended December 31, 2001, 2002 and 2003

•                  Consolidated statements of stockholders’ equity – Years ended December 31, 2001, 2002 and 2003

•                  Consolidated statements of cash flows – Years ended December 31, 2001, 2002 and 2003

•                  Notes to consolidated financial statements – December 31, 2003

 

(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**                                                                                                                                                                                              |
|---------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |   | Certificate of Incorporation of the Company dated April 17, 1996  (Filed as Exhibit 3.1 to Form 10 filed May 12, 2000).                                                                                      |
| 3.2                 |   | Certificate of Renewal and Revival of Certificate of Incorporation  for the Company dated February 16, 1999 (Filed as Exhibit 3.2 to Form 10  filed May 12, 2000).                                           |
| 3.3                 |   | Certificate of Amendment to Certificate of Incorporation dated May  11, 2000 (Filed as Exhibit 3.3 to Form 10 filed May 12, 2000).                                                                           |
| 3.4                 |   | Certificate of Amendment to Certificate of Incorporation dated  September 5, 2000 (Filed as Exhibit 3.5 to Form 10, Amendment No. 2, filed  September 12, 2000)                                              |
| 3.5                 |   | Bylaws of the Company (Filed as Exhibit 3.4 to Form 10 filed May 12,  2000).                                                                                                                                 |
| 3.6                 |   | Amended and Restated Bylaws of the Company effective as of September  1, 2000 (Filed as Exhibit 3.6 to Form 10, Amendment No. 2, filed September 12  2000).                                                  |
| 3.7                 |   | Amended and Restated Bylaws of GlobalSCAPE effective as of October  10, 2000 (Filed as Exhibit to Form 8-K filed October 10, 2000).                                                                          |
| 3.8                 |   | Amended and Restated Bylaws of GlobalSCAPE effective as of January  30, 2003 (Filed as Exhibit 3.8 to Annual Report on Form 10-K filed March 31,  2003).                                                     |
| 4.1                 |   | Specimen of Stock Certificate (Filed as Exhibit 4.1 to Annual Report  on Form 10-K filed April 2, 2001).                                                                                                     |
| *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).             |

 

47

----

 
| **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 granting letter to GlobalSCAPE, Inc. employees under  GlobalSCAPE, Inc. 2000 Stock Option Plan (Filed as Exhibit 10.21 to Annual  Report on Form 10-K filed April 1, 2002).                            |
| 21                  |   | Subsidiaries (filed herewith).                                                                                                                                                                                 |
| 23.1                |   | Consent of Ernst & Young LLP (filed herewith).                                                                                                                                                             |
| 31.1                |   | Rule 13a-14(a)/15d – 14(a) Certification of Charles R. Poole,  President and Chief Operating Officer of GlobalSCAPE, Inc. (filed herewith).                                                               |
| 31.2                |   | Rule 13a-14(a)/15d – 14(a) Certification of Daniel P. McRedmond, Vice  President Finance and Operations (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).                                                                       |

 

----

* ManagementCompensatory Plan or Agreement

 

(b) Reports onForm 8-K.  No reports on Form 8-K werefiled during the last quarter of the period covered by this report.

 

48

----

 

**Signatures**

 

Pursuant tothe requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized, in San Antonio, Texas on March 30,2004.

 

 

**GlobalSCAPE,Inc.**

 

 
|                                     | By: | /s/ Charles R. Poole |   |
|------------------------------------------|-----|----------------------|--------|
| Charles R. Poole                         |
| President and Chief Operating Officer    |
|                                     |
|                                     |
|                                     | By: | /s/ Daniel McRedmond |   |
| Daniel McRedmond                         |
| Vice President of Finance and Operations |
|                                          |     |                      |        |  |  |  |

 

Pursuant tothe requirements of the Securities Act of 1934, this report has been signedbelow by the following persons on behalf of the registrant in the capacitiesindicated on March 30, 2004.

 

 
| **Signature**              |   | **Title**                                    |
|----------------------------|--------|----------------------------------------------|
|                       |   |                                         |
| /s/  Charles R. Poole |   |                                         | President, COO 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/  Daniel McRedmond |   |                                         | Vice President of Finance and Operations, |
| Daniel McRedmond           |   | Treasurer, Secretary                         |
|                       |   | (Principal Accounting and Financial Officer) |
|                            |        |                                              |  |  |  |  |

 

49

----