U.S.
        SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON,
        D.C. 20549
 
 FORM
        10-QSB
 
 
 x  QUARTERLY
        REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
        1934
 
 For
        the
        quarterly period ended September 30, 2006
 
  ̈  TRANSITION
        REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
        ACT OF 1934
 
 Commission
        file number: 000-22711
 
 BLUEGATE
        CORPORATION
 (Exact
        name of registrant as specified in its charter)
 
 
 Nevada
              76-0640970(State
                  or Other Jurisdiction of
              (I.R.S.
                  Employer Identification No.)Incorporation
                  or Organization)
 
 
 701
                  North Post Oak, Road, Suite 600, Houston, Texas
              77024(Address
                  of Principal Executive Office)
 
 (713)
        686-1100
 (Issuer’s
        Telephone Number, Including Area Code)
 
 
 Check
        whether the issuer (1) filed all reports required to be filed by Section
        13 or
        15(d) of the Exchange Act during the past 12 months (or for such shorter
        period
        that the registrant was required to file such reports), and (2) has been
        subject
        to such filings requirements for the past 90 days. Yes x No  ̈
 
 Indicate
        by check mark whether the Registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act).
 Yes  ̈ No x
 
 APPLICABLE
        ONLY TO CORPORATE ISSUERS
 
 State
        the
        number of shares outstanding of each the issuer's classes of common equity,
        as
        of the latest practicable date: 10,680,304 common shares outstanding as of
        November 3, 2006
 
 Transitional
        Small Business Disclosure Format (Check One): Yes  ̈ No x
  
  BLUEGATE
        CORPORATION
 TABLE
        OFCONTENTS
 
  PART
        I.
        FINANCIAL INFORMATION
  ITEM
                  1.
              FINANCIAL
                  STATEMENTSUnaudited
                  Consolidated Financial Statements
              F-1Unaudited
                  Consolidated Balance Sheets as of
                  September 30, 2006 and December 31, 2005
              F-1Unaudited
                  Consolidated Statements of
                  Operations for the three months and nine months ended September
                  30, 2006
                  and 2005
              F-2Unaudited
                  Consolidated Statement of Stockholders’
                  Deficit for the nine months ended September 30, 2006
              F-3Unaudited
                  Consolidated Statements of Cash Flows for the
                  nine months ended September 30, 2006 and 2005
              F-4Notes
                  to Unaudited Consolidated Financial
                  Statements
              F-6ITEM
                  2.
              MANAGEMENT'S
                  DISCUSSION AND ANALYSIS OR PLAN OF
                  OPERATION
              I-1ITEM
                  3.
              CONTROLS
                  AND PROCEDURES
              I-6PART
                  II. OTHER INFORMATIONITEM
                  1.
              LEGAL
                  PROCEEDINGS
              II-1ITEM
                  2.
              UNREGISTERED
                  SALES OF EQUITY SECURITIES AND USE OF
                  PROCEEDS
              II-1ITEM
                  5.
              OTHER
                  INFORMATION
              II-3ITEM
                  6.
              EXHIBITS
              II-3SIGNATURES
              II-4CERTIFICATIONS
              II-5
  *Table
            of Contents*
  ITEM
                  1.
              FINANCIAL
                  STATEMENTS
 
 **BLUEGATE
        CORPORATION**
 **CONSOLIDATED
        BALANCE SHEETS**
 **UNAUDITED**
 
 **September
                  30,**
                **2006**
              
              **December
                  31**,
                **2005****ASSETS**
              
              
              
              ****Current
                  assets:Cash
                  and cash equivalents
              
              $
              192,326
              
              $
              27,791Accounts
                  receivable, net of allowance for doubtful accounts of $80,166 and
                  $118,286
              
              
              279,956
              
              
              365,131Inventory
              
              
              12,548
              
              
              -Other
              
              
              7,350
              
              
              46,809Total
                  current assets
              
              
              492,180
              
              
              439,731Property
                  and equipment, net of accumulated depreciation of $288,018 and
                  $261,468
              
              
              75,618
              
              
              106,157Goodwill
              
              
              113,021
              
              
              83,202Intangibles,
                  net of accumulated amortization of $40,967 and $2,790
              
              
              20,085
              
              
              25,912Total
                  assets
              
              $
              700,904
              
              $
              655,002**LIABILITIES
                  AND STOCKHOLDERS’ DEFICIT**Current
                  liabilities:Convertible
                  notes payable, net of unamortized discount of -0- and $242,316
              
              $
              500,000
              
              $
              257,684Note
                  payable
              
              
              12,800
              
              
              12,800Note
                  payable to individual
              
              
              100,000
              
              
              -Notes
                  payable to related parties
              
              
              498,486
              
              
              25,000Bank
                  line of credit payable
              
              
              45,218
              
              
              -Accounts
                  payable
              
              
              298,863
              
              
              491,337Accrued
                  liabilities
              
              
              133,809
              
              
              174,674Deferred
                  revenue
              
              
              345,458
              
              
              404,553Total
                  current liabilities
              
              
              1,934,634
              
              
              1,366,048Commitments
                  and contingencies
              
              
              -
              
              
              -Stockholders’
                  deficit:Series
                  A Convertible Non-Redeemable Preferred stock, $.001 par value,
                  20,000,000
                  shares authorized, 0 and 110.242 issued and outstanding at September
                  30,
                  2006 and December 31, 2005, respectively, $5,000 per share liquidation
                  preference ($551,210 aggregate liquidation preference at December
                  31,
                  2005)
              
              
              -
              
              
              -Series
                  B Convertible Non-Redeemable Preferred stock, $.001 par value,
                  10,000,000
                  shares authorized;****no
                  shares issued and outstanding
              
              
              -
              
              
              -Common
                  stock, $.001 par value, 50,000,000 shares authorized, 10,160,030
                  and
                  6,332,376 shares issued and outstanding
              
              
              10,160
              
              
              6,332Additional
                  paid-in capital
              
              
              14,307,920
              
              
              10,841,189Subscription
                  receivable
              
              
              -
              
              
              (15,007
              )Deferred
                  compensation
              
              
              -
              
              
              (34,592
              )Accumulated
                  deficit
              
              
              (15,551,810
              )
              
              (11,508,968
              )Total
                  stockholders’ deficit
              
              
              (1,233,730
              )
              
              (711,046
              )Total
                  liabilities and stockholders’ deficit
              
              $
              700,904
              
              $
              655,002
 
 See
        accompanying notes to consolidated financial statements
  F-1
 *Table
            of Contents*
  **BLUEGATE
        CORPORATION**
 **CONSOLIDATED
        STATEMENTS OF
        OPERATIONS**
 **THREE
        MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005**
 **UNAUDITED**
 
 **Three
                  Months Ended**
                **September
                  30,**
              
              **Nine
                  Months Ended**
                **September
                  30,****2006**
              
              **2005**
              
              **2006**
              
              **2005**Service
                  revenue
              
              $
              944,537
              
              $
              665,775
              
              $
              2,695,032
              
              $
              1,541,542Cost
                  of services
              
              
              408,596
              
              
              242,676
              
              
              1,175,487
              
              
              664,407Gross
                  margin
              
              
              535,941
              
              
              423,099
              
              
              1,519,545
              
              
              877,135Selling,
                  general and administrative expenses
              
              
              1,933,343
              
              
              1,185,689
              
              
              4,829,654
              
              
              3,237,415Loss
                  from operations
              
              
              (1,397,402
              )
              
              (762,590
              )
              
              (3,310,109
              )
              
              (2,360,280
              )Loss
                  on conversion of notes payable to common stock
              
              
              -
              
              
              -
              
              
              -
              
              
              892,882Interest
                  expense
              
              
              262,014
              
              
              47,681
              
              
              743,262
              
              
              118,053Other
                  (income) expense, net
              
              
              (2,947
              )
              
              12,452
              
              
              (10,529
              )
              
              7,569Net
                  loss
              
              $
              (1,656,469
              )
              $
              (822,723
              )
              $
              (4,042,842
              )
              $
              (3,378,784
              )Basic
                  and diluted loss per common share:
              
              $
              (0.18
              )
              $
              (0.15
              )
              $
              (0.50
              )
              $
              (0.79
              )Weighted
                  average shares outstanding
              
              
              9,046,291
              
              
              5,313,643
              
              
              8,060,017
              
              
              4,251,452
 
 See
        accompanying notes to consolidated financial statements
  F-2
 *Table
            of Contents*
  **BLUEGATE
        CORPORATION**
 **CONSOLIDATED
        STATEMENT OF STOCKHOLDERS'
        DEFICIT**
 **NINE
        MONTHS ENDED SEPTEMBER 30, 2006**
 **UNAUDITED**
 
 **COMMON
                  STOCK**
              
              **PREFERRED
                  STOCK**
              
              **ADDITIONAL**
                **PAID-IN**
              
              **SUBSCRIPTION**
              
              **DEFERRED**
              
              **ACCUMULATED****SHARES**
              
              **CAPITAL**
              
              **SHARES**
              
              **CAPITAL**
              
              **CAPITAL**
              
              **RECEIVABLE**
              
              **COMPENSATION**
              
              **DEFICIT**
              
              **TOTAL**Balances
                  at December 31, 2005
              
              
              6,332,376
              
              $
              6,332
              
              
              111
              
              $
              -
              
              $
              10,841,189
              
              $
              (15,007
              )
              $
              (34,592
              )
              $
              (11,508,968
              )
              $
              (711,046
              )Issuance
                  of common stock for cash
              
              
              1,473,333
              
              
              1,473
              
              
              -
              
              
              -
              
              
              868,527
              
              
              -
              
              
              -
              
              
              -
              
              
              870,000Conversion
                  of preferred stock for common stock
              
              
              1,418,681
              
              
              1,419
              
              
              (111
              )
              
              -
              
              
              (1,419
              )
              
              -
              
              
              -
              
              
              -
              
              
              -Issuance
                  of common stock for services
              
              
              311,566
              
              
              312
              
              
              -
              
              
              -
              
              
              166,409
              
              
              -
              
              
              -
              
              
              -
              
              
              166,721Contingent
                  shares issued for Trilliant acquisition accounted for as:
                -goodwill
              
              
              40,296
              
              
              40
              
              
              -
              
              
              -
              
              
              29,452
              
              
              -
              
              
              -
              
              
              -
              
              
              29,492-compensation
              
              
              367,111
              
              
              367
              
              
              -
              
              
              -
              
              
              271,622
              
              
              -
              
              
              -
              
              
              -
              
              
              271,989Write
                  off of subscription receivable
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              15,007
              
              
              -
              
              
              -
              
              
              15,007Stock
                  options and warrants issued for services
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              1,360,067
              
              
              -
              
              
              34,592
              
              
              -
              
              
              1,394,659Warrants
                  issued with note payable
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              29,484
              
              
              -
              
              
              -
              
              
              -
              
              
              29,484Issuance
                  of common stock warrants for extension of note repayment
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              392,063
              
              
              -
              
              
              -
              
              
              -
              
              
              392,063Issuance
                  of common stock and warrants for registration rights
                  extension
              
              
              216,667
              
              
              217
              
              
              -
              
              
              -
              
              
              350,526
              
              
              -
              
              
              -
              
              
              -
              
              
              350,743Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (4,042,842
              )
              
              (4,042,842
              )Balances
                  at September 30, 2006
              
              
              10,160,030
              
              $
              10,160
              
              
              -
              
              $
              -
              
              $
              14,307,920
              
              $
              -
              
              $
              -
              
              $
              (15,551,810
              )
              $
              (1,233,730
              )
 
 See
        accompanying notes to consolidated financial statements
  F-3
 *Table
            of Contents*
 
 **BLUEGATE
        CORPORATION**
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
 **NINE
        MONTHS ENDED SEPTEMBER 30, 2006 AND 2005**
 **UNAUDITED**
 
 **September
                  30,****2006**
              
              **2005**Cash
                  flows from operating activities:Net
                  loss
              
              $
              (4,042,842
              )
              $
              (3,378,784
              )Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:Amortization
                  of debt discount
              
              
              271,800
              
              
              108,170Depreciation
                  and amortization
              
              
              64,726
              
              
              60,640Common
                  stock and warrants issued for registration rights
                  extension
              
              
              350,743
              
              
              -Bad
                  debt expense
              
              
              -
              
              
              158,710Common
                  stock issued for services
              
              
              166,721
              
              
              642,156Common
                  stock options and warrants issued for services
              
              
              1,394,659
              
              
              565,753Common
                  stock warrants issued for extension of note repayment
              
              
              392,063
              
              
              -Contingent
                  shares issued for Trilliant acquisition accounted for as
                  compensation
              
              
              271,662
              
              
              -Write-off
                  of subscription receivable
              
              
              15,007
              
              
              -Loss
                  on debt conversion
              
              
              -
              
              
              892,882Changes
                  in operating assets and liabilities:Accounts
                  receivable
              
              
              85,175
              
              
              (179,791
              )Inventory
              
              
              (12,548
              )
              
              (88,165
              )Other
              
              
              7,459
              
              
              (15,631
              )Accounts
                  payable and accrued liabilities
              
              
              (164,597
              )
              
              648,262Deferred
                  revenue
              
              
              (59,095
              )
              
              -Net
                  cash used in operating activities
              
              
              (1,259,067
              )
              
              (585,798
              )Cash
                  flows from investing activities:Cash
                  paid for acquisition of Trilliant assets
              
              
              -
              
              
              (161,034
              )Payment
                  received on note receivable
              
              
              32,000
              
              
              20,768Purchase
                  of shares for long term investment
              
              
              -
              
              
              (30,000
              )Purchase
                  of property and equipment
              
              
              (28,361
              )
              
              (37,655
              )Net
                  cash provided by (used in) investing activities
              
              
              3,639
              
              
              (207,921
              )Cash
                  flows from financing activities:Change
                  in bank overdraft
              
              
              (9,620
              )
              
              -Proceeds
                  from related party short term debt
              
              
              885,412
              
              
              536,288Payments
                  on related party short term debt
              
              
              (471,047
              )
              
              (34,000
              )Net
                  change in bank line of credit
              
              
              45,218
              
              
              -Proceeds
                  from notes payable from individual
              
              
              100,000
              
              
              -Advances
                  on purchases of equity securities
              
              
              -
              
              
              265,000Proceeds
                  from subscription receivable
              
              
              -
              
              
              4,134Issuance
                  of common stock for cash
              
              
              870,000
              
              
              433,344Net
                  cash provided by financing activities
              
              
              1,419,963
              
              
              1,204,766Net
                  increase in cash and cash equivalents
              
              
              164,535
              
              
              411,047Cash
                  and cash equivalents at beginning of period
              
              
              27,791
              
              
              3,708Cash
                  and cash equivalents at end of period
              
              $
              192,326
              
              $
              414,755
 
 See
        accompanying notes to consolidated financial statements
  F-4
 *Table
            of Contents*
  **BLUEGATE
        CORPORATION**
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS (CONTINUED)**
 **UNAUDITED**
 
 **Nine
                  Months Ended****September
                  30,**
                **2006**
              
              **September
                  30,**
                **2005**Non-cash
                  investing and financing activities:Conversion
                  of preferred stock
              
              $
              1,419
              
              $
              -Contingent
                  shares issued for Trilliant acquisition accounted for as
                  goodwill
              
              
              29,819
              
              
              -Debt
                  discount from warrants issued with note payable
              
              
              29,484Issuance
                  of common stock for conversion of notes payable
              
              
              -
              
              
              75,000Issuance
                  of common stock and common stock equivalents for conversion of
                  related
                  party notes payable
              
              
              -
              
              
              355,018Issuance
                  of common stock and common stock equivalents for conversion of
                  accrued
                  interest
              
              
              -
              
              
              68,891Issuance
                  of common stock and common stock equivalents for conversion of
                  related
                  party accounts payable
              
              
              -
              
              
              154,297Issuance
                  of common stock for acquisition
              
              
              -
              
              
              105,745Nationwide
                  settlement:Accounts
                  receivable
              
              
              -
              
              
              122,429Accounts
                  payable
              
              
              -
              
              
              151,949Notes
                  receivable
              
              
              -
              
              
              128,230
 
 See
        accompanying notes to consolidated financial statements
  F-5
 *Table
            of Contents*
  BLUEGATE
        CORPORATION
 NOTESTO
        CONSOLIDATED FINANCIAL STATEMENTS
 UNAUDITED
 
 1.
              BASIS
                  OF PRESENTATION
 
 The
        accompanying unaudited interim financial statements of Bluegate Corporation,
        have been prepared in accordance with accounting principles generally accepted
        in the United States of America and the rules of the Securities and Exchange
        Commission, and should be read in conjunction with the audited financial
        statements and notes thereto contained in Bluegate's Annual Report filed
        with
        the SEC on Form 10-KSB. In the opinion of management, all adjustments,
        consisting of normal recurring adjustments, necessary for a fair presentation
        of
        financial position and the results of operations for the interim periods
        presented have been reflected herein. The results of operations for interim
        periods are not necessarily indicative of the results to be expected for
        the
        full year. Notes to the financial statements which substantially duplicate
        the
        disclosure contained in the audited financial statements for fiscal 2005
        as
        reported in the Form 10-KSB have been omitted.
 
 STOCK-BASED
        COMPENSATION
 
 Financial
        Accounting Standard No. 123R, "Accounting for Stock-Based Compensation"
        established financial accounting and reporting standards for stock-based
        employee compensation plans. It defines a fair value based method of accounting
        for an employee stock option or similar equity instrument. In January 2006,
        Bluegate implemented SFAS No. 123R, and accordingly, Bluegate accounts for
        compensation cost for stock option plans in accordance with SFAS No.
        123R.
 
 During
        fiscal year 2005 Bluegate applied APB No. 25 in accounting for its stock
        option
        plans and, accordingly, no compensation cost has been recognized in Bluegate’s
        financial statements for stock options under any of the stock plans which
        on the
        date of grant the exercise price per share was equal to or exceeded the fair
        value per share. However, compensation cost has been recognized for warrants
        and
        options granted to non-employees for services provided. The following table
        illustrates the effect on net loss and net loss per share if Bluegate had
        applied the fair value provisions of FASB Statement No. 123, Accounting for
        Stock-Based Compensation, to stock-based employee compensation during
        2005.
 
 Three
                  Months Ended
              
              Nine
                  Months EndedSeptember
                  30, 2005
              
              September
                  30, 2005Net
                  loss attributable to common shareholders as reported
              
              $
              (822,723
              )
              $
              (3,378,784
              )Stock
                  based employee compensation included in reported net loss
              
              
              32,022
              
              
              192,446Total
                  stock-based employee compensation expense determined under fair
                  value
                  based method for all options
              
              
              (144,690
              )
              
              (1,157,163
              )Pro
                  forma net loss
              
              $
              (935,391
              )
              $
              (4,343,501
              )Basic
                  and diluted loss per shareAs
                  reported:Net
                  loss
              
              $
              (0.15
              )
              $
              (0.79
              )Pro
                  forma:Net
                  loss
              
              
              (0.17
              )
              
              (1.02
              )Weighted
                  average shares outstanding:
              
              
              5,313,643
              
              
              4,251,452
  F-6
 *Table
            of Contents*
  RECLASSIFICATIONS
 
 We
        have
        reclassified certain September 30, 2005 amounts to conform to the current year’s
        presentation.
 
 2.
              GOING
                  CONCERN CONSIDERATIONS
 
 During
        the nine months ended September 30, 2006 and 2005, Bluegate has been unable
        to
        generate cash flows sufficient to support its operations and has been dependent
        on debt and equity raised from qualified individual investors. In addition
        to
        negative cash flow from operations, Bluegate has experienced recurring net
        losses, and has a negative working capital and shareholder’s deficit.
 
 These
        factors raise substantial doubt about Bluegate's ability to continue as a
        going
        concern. The consolidated financial statements do not include any adjustments
        that might be necessary if Bluegate is unable to continue as a going
        concern.
 
 3.
              ACQUISITION
                  OF TRILLIANT CORPORATION ASSETS
 
 On
        September 15, 2005, Bluegate acquired substantially all of the assets and
        assumed certain ongoing contractual obligations of Trilliant Corporation,
        a
        company that provides assessment, design, vendor selection, procurement and
        project management for large technology initiatives, particularly in the
        healthcare arena. The acquisition strengthened Bluegate as a competitor in
        the
        technology management industry. The purchase price consisted of $161,033
        cash
        and 258,302 shares of Bluegate's common stock valued at $180,811. The asset
        sale
        and purchase agreement provides for additional consideration up to 827,160
        common shares depending on the acquired business' revenue over the next two
        years and royalty payments based on sales over the next two years of certain
        software acquired. The estimated fair values of the assets acquired at September
        15, 2005 are as follows:
 
 Property
                  and equipment
              
              $
              17,270Computer
                  software
              
              
              41,893Customer
                  list
              
              
              28,702Accounts
                  receivable
              
              
              170,777Goodwill
              
              
              83,202Total
              
              $
              341,844
 
 Effective
        September 30, 2006, in accordance with the asset sale and purchase agreement,
        407,407 shares of Bluegate’s common stock valued at $301,481 was issued as
        additional consideration based upon the acquired business’ revenue calculation
        after the first year. According to EITF 95-8, “Accounting for Contingent
        Consideration Paid to the Shareholders of an Acquired Enterprise in a Purchase
        Business Combination,” whether the contingent shares are accounted for as an
        adjustment to the purchase price or as compensation for services depends
        on the
        agreement. Because the agreement required certain shareholders to remain
        employees for the term of the earnout, all shares associated with those
        employees were recorded as compensation expense. Shares issued to non-employees
        are accounted for as an adjustment to the purchase price. As a result, $29,819
        was allocated to goodwill and $271,662 was recorded as an expense.
 
 Goodwill
        will be tested periodically for impairment as required by FASB Statement
        No.
        142, "Goodwill and other Intangible Assets."
 
 The
        results of this acquisition are included in the consolidated financial
        statements from the date of acquisition. Unaudited proforma operating results
        for Bluegate, assuming the acquisition occurred on January 1, 2005, are as
        follows:
 
 Nine
                  Months Ended September 30,2006
              
              2005Service
                  revenue
              
              $
              2,695,032
              
              $
              2,317,277Net
                  loss
              
              
              (4,042,842
              )
              
              (3,219,632
              )Net
                  loss per common share
              
              
              (0.50
              )
              
              (0.79
              )
 
 The
        proforma results are not necessarily indicative of what would have occurred
        if
        the acquisition had been in effect for the periods presented. In addition,
        they
        are not intended to be a projection of future results and do not reflect
        any
        synergies that might be achieved by combining the operations.
  F-7
 *Table
            of Contents*
  4.
              NOTES
                  PAYABLE
 
 As
        of
        September 30, 2006, we had an outstanding balance of $45,218 on a bank line
        of
        credit with an interest rate of 10.75%. The line of credit is due on demand
        and
        unsecured.
 
 On
        July
        3, 2006, we borrowed $100,000 from an individual and issued warrants (see
        footnote 5 - item 16) and a note payable secured
        by Bluegate’s accounts receivable, inventory and fixed assets. The $100,000 note
        plus $5,000 was due on October 3, 2006. On September 22, 2006, we extended
        the
        repayment of $105,000 plus an additional $5,000 until November 2, 2006. Interest
        expense of $7,500 was recorded for the quarter ending September 30, 2006.
        On
        November 2, 2006 the note and accrued interest totaling $110,000 was paid
        in
        full. The carrying value of the note payable at September 30, 2006 is as
        follows:
 
 Proceeds
                  from debt issuance
              
              $
              100,000Less:
                  Discount related to warrants
              
              
              (29,484
              )Add:
                  Discount amortization
              
              
              29,484$
              100,000
 
 During
        the nine months ended September 30, 2006, we borrowed $885,412 from related
        parties with interest rates ranging from 7.35% to 29.99% on their underlying
        credit cards. The notes are due on demand and unsecured. During the same
        period,
        we made payments of $471,047 on related party notes.
 
 
 5.
              COMMON
                  STOCK, OPTIONS AND WARRANTS
 
 During
        the nine months ended September 30, 2006, Bluegate completed the following
        equity transactions:
 
 Issuance
        of common stock for cash:
 
 (1)
        In
        February 2006, we issued 50,000 shares of common stock for $50,000 proceeds
        from
        the exercise of a warrant.
 
 (2)
        In
        February and March 2006, we issued 273,333 shares of common stock, warrants
        for
        273,333 shares of our common stock at an exercise price of $0.75 per share
        and
        warrants for 136,667 shares of our common stock at an exercise price of $1.00
        per share, for $205,000 in connection with a private placement of our
        securities. Bluegate evaluated the freestanding warrants to determine if
        they
        were within the scope of SFAS 133 and EITF 00-19. Part of this evaluation
        considered the ‘Liquidated Damages’ provision in the ‘Registration Rights
        Agreement’ that covers both the warrants and the common stock. Bluegate
        concluded the freestanding warrants should not be classified as a liability
        and
        therefore are not subject to SFAS 133.
 
 (3)
        In
        May 2006 we issued 160,000 shares of stock, warrants for 160,000 shares of
        our
        common stock at an exercise price of $0.75 per share and warrants for 80,000
        shares of our common stock at an exercise price of $1.00 per share, for cash
        consideration of $120,000 in connection with a private placement. Bluegate
        evaluated the freestanding warrants to determine if they were within the
        scope
        of SFAS 133 and EITF 00-19. Part of this evaluation considered the ‘Liquidated
        Damages’ provision in the ‘Registration Rights Agreement’ that covers both the
        warrants and the common stock. Bluegate concluded the freestanding warrants
        should not be classified as a liability and therefore are not subject to
        SFAS
        133.
 
 (4)
        During the quarter ended September 30, 2006, we issued 990,000 shares of
        common
        stock, warrants for 990,000 shares of our common stock at an exercise price
        of
        $0.75 per share and warrants for 495,000 shares of our common stock at an
        exercise price of $1.00 per share, for $495,000 in connection with a private
        placement of our securities. Bluegate evaluated the freestanding warrants
        to
        determine if they were within the scope of SFAS 133 and EITF 00-19. Part
        of this
        evaluation considered the ‘Liquidated Damages’ provision in the ‘Registration
        Rights Agreement’ that covers both the warrants and the common stock. Bluegate
        concluded the freestanding warrants should not be classified as a liability
        and
        therefore are not subject to SFAS 133.
 
 Conversion
        of preferred stock for common stock:
 
 (5)
        In
        March 2006, we issued 1,418,681 shares of our common stock for conversion
        of
        110.242 shares of our Series A Convertible Non-Redeemable Preferred stock.
        As a
        result of this transaction, there are no remaining shares of our Series A
        Convertible Non-Redeemable Preferred stock outstanding.
 
 Issuance
        of common stock for services:
 
 (6)
        In
        February 2006, we issued 200,000 shares of common stock to a consultant for
        services rendered. The common stock had a market value of $104,000 on the
        date
        of issuance. We expensed $104,000 during the quarter ended March 31, 2006.
  F-8
 *Table
            of Contents*
 
 (7)
        In
        March 2006 a consultant returned, and Bluegate cancelled, 133,000 shares
        of
        common stock that was previously issued to the consultant as compensation.
        The
        fair value of the stock cancelled was $87,779.
 
 (8)
        In
        May and June 2006, we issued 105,883 shares of common stock valued at $68,000
        for consulting services.
  (9) In
        September 2006, we issued 138,683 shares of common stock valued at $82,500
        as
        payment to a vendor for services rendered.
 
 Contingent
        shares issued for Trilliant acquisition:
 
 (10)
        Effective September 30, 2006, we recorded the issuance of 407,407 shares
        of
        common stock valued at $301,481 to Trilliant Corporation in accordance with
        the
        asset sale and purchase agreement pertaining to the acquired business’ revenue
        after the first year. (See footnote 3 - Acquisition of Trilliant Corporation
        Assets). As
        a
        result of this transaction, $29,819 was allocated to goodwill and $271,662
        was
        recorded as an expense.
 
 Stock
        options and warrants issued for services:
 
 (11)
        In
        March 2006 a consultant agreed to forfeit an option to purchase 41,250 shares
        of
        our common stock at $1.00 per share. Bluegate reversed $26,290 of compensation
        expense related to the option which was previously recorded.
 
 (12)
        In
        May 2006, the employment contract of an employee expired and an option to
        purchase 233,336 shares of our common stock at $1.00 per share was forfeited.
        Bluegate reversed $35,307 of compensation expense related to the option which
        was previously recorded during the quarter ended March 31, 2006.
 
 (13)
        In
        June 2006, we issued warrants to purchase 48,000 shares of our common stock
        at
        an exercise price of $0.75 per share and warrants to purchase 24,000 shares
        of
        our common stock at an exercise price of $1.00 per share to two vendors.
        The
        warrants had a market value of $43,756 on the date of grant and expire in June
        2011. We expensed
        $43,756 during the quarter ended June 30, 2006 related to these
        warrants.
 
 (14)
        During the nine months ended September 30, 2006, Bluegate expensed $699,257
        related to previously issued stock options that vested during the
        period .
 
 (15)
        The
        following table summarizes stock options issued to employees during the nine
        months ended September 30, 2006:
 
 **Grant
                  Date**
              **Options**
              **Exercise**
                **Price**
              **Market**
                **Value**
              **Expiration**
                **Date**
              
              **Vesting**
                **Period**
              
              **2006**
                **Expense**1/30/2006
              546,600
              $0.75
              $
                  332,235
              1/30/2011
              
              Through
                  12/08
              
              $124,5875/1/2006
              5,000
              0.75
              2,540
              5/1/2011
              
              Immediately
              
              2,5406/1/2006
              600,000
              0.75
              328,759
              6/1/2011
              
              Through
                  06/08
              
              54,7927/24/2006
              550,000
              0.75
              328,811
              7/24/2011
              
              Through
                  09/08
              
              36,5348/1/2006
              1,200,000
              0.60
              717,682
              8/1/2011
              
              Through
                  08/07
              
              110,4128/1/2006
              340,000
              0.60
              203,343
              8/1/2011
              
              Through
                  08/07
              
              31,2848/1/2006
              170,000
              0.60
              101,672
              8/1/2011
              
              Through
                  08/07
              
              15,6428/17/2006
              150,000
              0.62
              92,701
              8/17/2011
              
              Immediately
              
              92,7019/21/2006
              264,250
              0.62
              237,192
              9/21/2011
              
              Immediately
              
              237,1929/14/2006
              200,000
              0.71
              141,543
              9/14/2011
              
              Through
                  08/08
              
              5,8989/26/2006
              50,000
              0.80
              39,871
              9/26/2001
              
              Through
                  08/08
              
              1,6614,075,850
              
              $2,526,349
              
              
              
              
              $713,243
 
 Warrants
        issued with note payable:
 
 (16)
        On
        July 3, 2006, for consideration of receiving a $100,000 loan from an individual,
        we issued a note payable (see footnote 4 - Notes Payable), and warrants to
        purchase 100,000 shares of our common stock at an exercise price of $0.50
        per
        share expiring in July 2007.
  F-9
 *Table
            of Contents*
  Issuance
        of common stock warrants for extension of note repayment:
 
 (17)
        In
        April 2006 we exercised our option to extend the due date of our convertible
        notes payable by 90 days to July 31, 2006. As a result, we issued warrants
        to
        purchase 349,866 shares of our common stock at $0.75 per share to the note
        holders, as required by the note agreement. We recorded interest expense
        of
        $177,735 in connection with this transaction.
 
 (18)
        In
        July 2006, we exercised our option to extend the due date of the aforementioned
        convertible notes payable by 90 days to October 31, 2006. As a result, we
        issued
        warrants to purchase 358,265 shares of our common stock at $0.50 per share
        to
        the note holders, as required by the note agreement. We recorded interest
        expense of $214,328 in connection with this transaction.
 
 Issuance
        of common stock warrants for registration rights extension:
 
 (19)
        On
        March 31, 2006 certain adjustment provisions contained in Bluegate's convertible
        notes payable warrants issued in September 2005 were triggered. Pursuant
        to the
        adjustment provisions, the exercise price of the previously issued warrants
        to
        purchase 666,667 shares of our common stock at $1.00 per share was reduced
        to
        $0.75 per share (See item 21 below).
 
 (20)
        On
        June 30, 2006, we issued 216,667 shares of our common stock, warrants for
        216,667 shares of our common stock at an exercise price of $0.75 per share
        and
        warrants for 108,333 of our common stock at an exercise price of $1.00 per
        share, for consideration of the investors agreement to extend Bluegate’s
        obligations pursuant to the Registration Rights Agreement until November
        30,
        2006. The fair value of the stock and warrants issued was $350,743. Bluegate
        evaluated the freestanding warrants to determine if they were within the
        scope
        of SFAS 133 and EITF 00-19. Part of this evaluation considered the ‘Liquidated
        Damages’ provision in the ‘Registration Rights Agreement’ that covers both the
        warrants and the common stock. Bluegate concluded the freestanding warrants
        should not be classified as a liability and therefore are not subject to
        SFAS
        133.
 
 (21)
        On
        June 30, 2006, in conjunction with the transaction to extend Bluegate’s
        obligations pursuant to the Registration Rights Agreement(see item 20 above),
        certain adjustment provisions in Bluegate’s convertible note agreements and
        warrant agreements issued in September 2005 were triggered. Pursuant to the
        adjustment provisions, the exercise price of the previously issued warrants
        to
        purchase 666,667 shares (see item 19 above) and 349,866 shares (see item
        17
        above) of our common stock at $0.75 per share was reduced to $0.50 per share.
 
 Bluegate
        used the Black-Scholes option pricing model to value stock options and warrants
        using the following assumptions: proceeds as set forth in the option agreements;
        no expected dividend yield; expected volatility of 260%; risk-free interest
        rates of 5.0%; and option terms as set forth in the options
        agreements.
  6.
                SUBSEQUENT
                    EVENTS
 
 (1) In
        October and November 2006, we issued 420,000 shares of common stock, warrants
        for 420,000 shares of our common stock at an exercise price of $0.75 per
        share
        and warrants for 210,000 shares of our common stock at an exercise price
        of
        $1.00 per share, for cash consideration of $210,000 in connection with a
        private
        placement of our securities.
  (2) In
        October 2006, we issued 15,802 shares of common stock valued at $13,690 as
        payment to two consultants for services rendered.
 
 (3)
        In
        October and November 2006, we issued 18,472 shares of common stock valued
        at
        $15,000 as payment to a vendor for services rendered.
 
 (4)
        In
        October 2006, we issued warrants to purchase 12,000 shares of our common
        stock
        at an exercise price of $0.75 per share and warrants to purchase 9,000 shares
        of
        our common stock at an exercise price of $1.00 per share to a placement agent
        for assistance with obtaining equity financing. The warrants had a market
        value
        of $18,841 on the date of grant and expire in October 2011.
 
 (5) On
        October 31, 2006, we issued 66,000 shares of common stock for the conversion
        of
        a note payable plus accrued interest amounting to $33,000. Additionally,
        the
        remaining balance of the convertible notes payable plus accrued interest
        totaling $517,000 was paid in full.
  F-10
 *Table
            of Contents*
  ITEM
                  2.
              MANAGEMENT’S
                  DISCUSSION AND ANALYSIS
 
 
 FORWARD
        LOOKING STATEMENT
 
 This
        Management's Discussion and Analysis of Financial Condition and Results of
        Operations as of September 30, 2006 and for the nine months then ended, should
        be read in conjunction with the audited financial statements and notes thereto
        set forth in our annual report on Form 10-KSB for 2005.
 
 Certain
        statements contained in this report, including, without limitation, statements
        containing the words, "likely", "forecast", "project", "believe", "anticipate",
        "expect", and other words of similar meaning, constitute "forward-looking
        statements" within the meaning of Section 27A of the Securities Act of 1933,
        as
        amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
        Such forward-looking statements involve known and unknown risks, uncertainties
        and other factors which may cause our actual results, performance or
        achievements to be materially different from any future results, performance,
        or
        achievements expressed or implied by such forward-looking statements. Given
        these uncertainties, readers are cautioned not to place undue reliance on
        such
        factors or to announce publicly the results of any revision of the
        forward-looking statements contained or incorporated by reference herein
        to
        reflect future events or developments. In addition to the forward-looking
        statements contained in this Form 10-QSB, the following forward-looking factors
        could cause our future results to differ materially from our forward-looking
        statements: competition, capital resources, credit resources, funding,
        government compliance and market acceptance of our products and
        services.
  ABOUT
        US
 Bluegate
        provides IT consulting, outsourcing, systems integration, applications development
        and managed security solutions for the health care industry.
 
 CONSULTING
        PRACTICE
 Health
        care institutions have very unique requirements not found in a typical
        commercial environment. Our consulting practice works with medium to large
        medical facilities and systems on evaluation, procurement and implementation
        of
        voice, data, video, infrastructure and applications for the health care
        environment. Our applications group also performs specific applications
        development, enhancement , coding and integration work for these projects
        when
        requested by our customers.
 
 OUTSOURCING
 Our
        outsourcing offering includes help desk support and break-fix arrangements
        as
        well as acquisition and special financing of equipment and services. It also
        can
        include provisions for technology refresh, change management and level of
        service agreements. Our target market for such services consists of
        private-practice physicians whose office staffs typically lack the in-house
        technical expertise to support mission-critical computer systems and associated
        hardware. In many cases, these private-practice physicians are affiliated
        with
        our larger medical facility clients, creating a logical foundation for Bluegate
        to establish and maintain long-term business relationships.
 
 SYSTEMS
        INTEGRATION AND MANAGED SECURITY SOLUTIONS
 Our
        systems integration and managed security group enables secure, HIPAA-compliant
        data communication between hospitals, medical facilities and physician practices
        from all locations via our Bluegate Medical Grade Network(TM) - ultimately
        enhancing patient care. We also provide affordable access to compatible
        medical-focused content and applications over the infrastructure to improve
        practice efficiency and service. We extend IT best practices to the edge
        of the
        health care network ensuring every access point for the physician and health
        care location is as secure as the hospital itself.
 
 TWO-FOLD
        MARKET OPPORTUNITY
 
 HIPAA
        COMPLIANCE FOR PHYSICIAN PRACTICES
 The
        Administrative Simplification provisions of Title II of HIPAA require the
        United
        States Department of Health and Human Services to establish national standards
        for electronic health care transactions and national identifiers for providers,
        health plans, and employers. It also addresses the security and privacy of
        health data. Adopting these standards will improve the efficiency and
        effectiveness of the nation's health care system by encouraging the widespread
        use of electronic data interchange in health care.
  I-1
 *Table
            of Contents*
  FACILITATE
        PARTICIPATION IN NATIONAL HEALTHCARE INFORMATION NETWORK (NHIN)
 Electronic
        data communication networks have vast potential for enhancing the quality
        of
        patient care, mitigating the soaring costs of health care, and protecting
        patient privacy. To harness this potential, the current administration,
        Congress, and administrative agencies are advocating that all physicians
        get
        connected to the NHIN, the proposed national health information system. A
        NHIN
        is expected to enable physicians to write electronic prescriptions (eRx)
        and
        securely share patient electronic health records (EHR), including medical
        images, with other health care providers at hospitals, clinics, and individual
        physician offices.
 
 In
        order
        to access and use the NHIN, individual physicians must have the appropriate
        information technology environment at their offices, and the hospitals where
        they admit patients. Further, the hospitals credentialed physicians must
        be on a
        common HIPAA compliant network. Once the hospital has installed the necessary
        secure electronic connectivity behind their firewall, the "last mile" of
        connectivity, the figurative distance from the telecommunication provider's
        switch to an end user (i.e. the physician), still presents a major challenge.
        In
        addition to being HIPAA-compliant, the networks also need to be interoperable,
        which requires assessing and augmenting physicians' existing IT equipment
        and
        resources and providing adequate training and technical support to ensure
        the
        highest possible network availability and security and the ability to move
        and
        manage information back and forth.
 
 Today,
        Bluegate's offering singularly solves a particularly vexing piece of
        the  HIPAA
        requirement and the "last mile" challenges of a NHIN: connecting the individual
        physician's practice to this secured network. As a result, Bluegate has
        ambitions to provide its Bluegate Medical Grade Network as the beginning
        national "grid" that all vested parties in the HIPAA initiative turn to when
        the
        concern of connecting physicians to the hospital and the insurance companies
        in
        a secured manner is addressed. As a result, Bluegate has acquired and deployed
        significant resources towards this national opportunity. Bluegate began its
        business installing Medical Grade Networks in Houston, Texas in late 2004
        and
        2005. We are in active contract negotiations with health care entities in
        Texas
        and around the country to design, develop and deploy networks that are based
        upon the success of those deployed in Houston, Texas.
 
 BLUEGATE
        STRATEGY
 
 Our
        current short term strategy is to: (1) increase our market penetration and
        dominance of the Houston hospital, centralized health care and physician
        markets; (2) commence systems in other Texas cities; and, (3) commence systems
        in other cities in the U.S. Our long term strategy is fourfold: (1) fill
        as much
        of the national HIPAA-compliant secured communications void that exists between
        the physician and the hospital as we can; (2) sell our services to the
        physicians that join our Medical Grade Network, enabling them to choose Bluegate
        as their electronic health solutions firm and as the IT outsource firm of
        choice
        for all of their technology needs; (3) to be "THE" IT solutions resource
        to
        medical institutions, health care facilities, regional health information
        organizations (RHIOs) and centralized health care organizations (HCOs) for
        all
        their information technology needs; and, (4) partner with a wide array of
        third
        party providers of software, managed systems, pharmacy benefit and many other
        applications that must run on electronic networks and be installed in hospitals,
        HCOs and medical practices.
 
 COMPETITION
 
 We
        are
        not aware of any completely direct competitors at this time. However,
        competition may include vendors of HIPAA software and Internet Protocol ("IP")
        networks whose security may or may not comply with the terms of the HIPAA
        confidentiality compliance requirements.
 
 The
        Internet, VPN and data services market is extremely competitive, highly
        fragmented and has grown dramatically in recent years. The market is
        characterized by the absence of significant barriers to entry and the rapid
        growth in Internet and VPN usage among customers. Other competitors
        are:
 
 Ÿ
              Access
                  and content providers, such as AOL, Microsoft, EarthLink and Time
                  Warner;
 Ÿ
              Local,
                  regional and national Internet service providers, such as Megapath,
                  EarthLink, XO Communications and
                  Mindspring;
 Ÿ
              Regional,
                  national and international telecommunications companies, such as
                  AT&T,
                  MCI and Allegiance Telecom;
 Ÿ
              On-line
                  services offered by incumbent cable providers such as Time
                  Warner;
 Ÿ
              DSL
                  providers such as Covad.
  I-2
 *Table
            of Contents*
  Most
        of
        our competitors have greater financial and other resources than we have,
        and
        there is no assurance that we will be able to successfully compete.
 
 Our
        web
        site is www.bluegate.com .
 
 CRITICAL
        ACCOUNTING POLICIES AND ESTIMATES
 
 Our
        discussion and analysis of our financial condition and results of operations
        are
        based upon financial statements which have been prepared in accordance with
        generally accepted accounting principles in the United States. The preparation
        of these financial statements requires us to make estimates and judgments
        that
        affect the reported amounts of assets, liabilities, revenue and expenses,
        and
        related disclosure of contingent assets and liabilities. On an ongoing basis,
        we
        evaluate these estimates. We base our estimates on historical experience
        and on
        assumptions that are believed to be reasonable. These estimates and assumptions
        provide a basis for making judgments about the carrying values of assets
        and
        liabilities that are not readily apparent from other sources. Actual results
        may
        differ from these estimates under different assumptions or conditions, and
        these
        differences may be material.
 
 We
        believe that the following critical accounting policies affect our more
        significant judgments and estimates used in the preparation of our consolidated
        financial statements.
 
 REVENUE
        RECOGNITION
 
 Revenue
        is recognized based upon contractually determined monthly service charges
        to
        individual customers. Services are billed in advance and, accordingly, revenues
        are deferred until the period in which the services are provided.
 
 STOCK-BASED
        COMPENSATION
 
 Financial
        Accounting Standard No. 123R, "Accounting for Stock-Based Compensation" ("SFAS
        No. 123R") established financial accounting and reporting standards for
        stock-based employee compensation plans. It defines a fair value based method
        of
        accounting for an employee stock option or similar equity instrument. In
        January
        2006, we implemented SFAS No. 123R, and accordingly, Bluegate accounts for
        compensation cost for stock option plans in accordance with SFAS No.
        123R.
 
 GENERAL
 
 We
        remain
        dependent on outside sources of funding for continuation of our operations.
        Our
        independent auditors included a going concern qualification in their report
        dated March 16, 2006 (included in our annual report on Form 10-KSB for the
        year
        ended December 31, 2005).
 
 During
        the nine months ended September 30, 2006, and the year ended December 31,
        2005,
        we have been unable to generate cash flows sufficient to support our operations
        and have been dependent on debt and equity raised from qualified individual
        investors.
 
 During
        the nine months ended September 30, 2006 and 2005, we experienced negative
        financial results as follows:
 
 Nine
                  Months Ended September 30,2006
              
              2005Net
                  loss
              
              $
              (4,042,842
              )
              $
              (3,378,784
              )Negative
                  cash flow from operations
              
              
              (1,259,067
              )
              
              (585,798
              )Negative
                  working capital
              
              
              (1,442,454
              )
              
              (880,925
              )Stockholders'
                  deficit
              
              
              (1,233,730
              )
              
              (722,994
              )
 
 We
        have
        supported current operations by: 1) raising additional operating cash through
        the private sale of our common stock and options, 2) selling convertible
        notes
        and 3) issuing stock and options as compensation to certain employees and
        vendors in lieu of cash payments. In addition, we are seeing positive revenue
        growth trend, which is also increasingly contributing to reducing our operating
        deficit.
 
 These
        steps have provided us with the cash flows to continue our business plan,
        and
        the improved operating revenue is resulting in some improvement in our financial
        position. We are taking steps to improve our cash flow situation that include
        raising capital through additional sale of our common stock and/or debt
        securities.
  I-3
 *Table
            of Contents*
  This
        step
        could result in substantial dilution of existing stockholders. There can
        be no
        assurance that our current financial position can be improved, that we can
        raise
        additional working capital or that we can achieve positive cash flows from
        operations. Our long-term viability as a going concern is dependent upon
        the
        following:
 
 Ÿ
              Our
                  ability to locate sources of debt or equity funding to meet current
                  commitments and near-term future
                  requirements.
 
 Ÿ
              Our
                  ability to achieve profitability and ultimately generate sufficient
                  cash
                  flow from operations to sustain our continuing
                  operations.
 
 Our
        operations are located in Houston, Texas. Our business consists of the sales
        and
        marketing of our HIPAA compliant VPN and HIPAA application software and related
        services.
 
 
 RESULTS
        OF OPERATIONS
 
 THREE
        MONTHS ENDED SEPTEMBER 30, 2006 AS COMPARED TO THE THREE MONTHS ENDED SEPTEMBER
        30, 2005
 
 During
        the three months ended September 30, 2006, our revenue was $944,537 versus
        $665,775 for the three month period ended September 30, 2005. This represents
        an
        increase of $278,762 and is primarily attributable to our
        acquisition of the assets of Trilliant Corp. and our efforts to market
        BLUEGATE(TM), our core business.
 
 Our
        cost
        of services for the three months ended September 30,2006 was $408,596 compared
        to $242,676 for the three months ended September 30,2005. The increase in
        cost
        of services of $165,920 is due to higher interconnect fees and costs associated
        with the expansion of our BLUEGATE(TM) services.
 
 Our
        gross
        margin for the three months ended September 30, 2006 was $535,941 compared
        to
        $423,099 for the three months ended September 30, 2005. Our gross margin
        as a
        percentage of sales decreased to 57% for the three months ended September
        30,
        2006 from 64% for the three months ended September 30, 2005
        due
        to higher
        interconnect fees and costs associated with the expansion of our BLUEGATE(TM)
        services.
 
 We
        incurred selling, general and administrative expenses (SG&A) of $1,933,343
        for the three months ended September 30, 2006 compared to $1,185,689 for
        the
        three months ended September 30, 2005. The increase in SG&A of $747,654 is
        primarily attributable to the expansion of our sales and marketing efforts
        and
        recording stock option and warrant related expenses as a result of our adoption
        of SFAS No. 123R in 2006.
 
 We
        incurred a net loss of $1,656,469 for the three months ended September 30,
        2006
        compared to a net loss of $822,723 for the three months ended September 30,
        2005. The increase of $833,746 is due primarily to an increase in stock option
        and warrant related expenses as a result of our adoption of SFAS No. 123R
        during
        the first quarter of 2006.
 
 NINE
        MONTHS ENDED SEPTEMBER 30, 2006 AS COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
        30, 2005
 
 During
        the nine months ended September 30, 2006, our revenue was $2,695,032 versus
        $1,541,542 for the nine month period ended September 30, 2005. This represents
        an increase of $1,153,490 and primarily
        attributable to our acquisition of the assets of Trilliant Corporation and
        our
        efforts to market BLUEGATE(TM), our core business.
 
 Our
        cost
        of services for the nine months ended September 30, 2006 was $1,175,487 compared
        to $664,407 for the nine months ended September 30, 2005. The increase in
        cost
        of services of $511,080 is due
        to
        interconnect fees and costs associated with the expansion of our BLUEGATE(TM)
        services.
 
 Our
        gross
        margin for the nine months ended September 30, 2006 was $1,519,545 compared
        to
        $877,135 for the nine months ended September 30, 2005. Our gross margin as
        a
        percentage of sales of 56% for the nine months ended September 30, 2006 did
        not
        change from 56% for the nine months ended September 30, 2005.
  I-4
 *Table
            of Contents*
  We
        incurred selling, general and administrative expenses of $4,829,654 for the
        nine
        months ended September 30, 2006 compared to $3,237,415 for the nine months
        ended
        September 30, 2005. The increase in SG&A of $1,592,239 is primarily
        attributable to the expansion of our sales and marketing efforts and recording
        stock option and warrant related expenses as a result of our adoption of
        SFAS
        No. 123R in 2006.
 
 We
        incurred a net loss of $4,042,842 for the nine months ended September 30,
        2006
        compared to a net loss of $3,378,784 for the nine months ended September
        30,
        2005, or an overall increase of $664,058. After taking into effect a non-cash
        charge to income of $892,882 in 2005 upon the conversion of notes payable
        to
        common stock, Bluegate’s net loss increased by $1,556,940 .
        The
        increase is primarily attributable to recording stock option and warrant
        related
        expenses due to the company’s adoption of SFAS No. 123R on January 1, 2006, the
        issuance of common stock and warrants to extend the company’s obligations
        pursuant to registration rights and the issuance of warrants for the extension
        of the debt payment relating to the convertibles notes payable.
 
 
 FORECAST
        OF GROWTH IN OUR “MEDICAL GRADE NETWORK” MGN CUSTOMER BASE
 
 At
        September 30, 2006, we had 1,062 “Medical
        Grade Network” MGN customers. We are forecasting only a marginal increase in the
        number of “Medical Grade Network” MGN customers through 2006. We have shifted
        our focus towards increasing our outsourced IT services to our existing
        physician customer base. Our goal is to increase the amount of revenue we
        obtain
        from each physician we serve.
 
 We
        have
        also initiated an aggressive effort to expand our Bluegate network beyond
        Houston. Although we have opened up a number of discussions with Hospital
        groups
        on other markets, we
        have
        no assurances we will be successful in these efforts.
 
 
 LIQUIDITY
        AND CAPITAL RESOURCES
 
 Operations
        for the nine month period ended September 30, 2006 have been funded by the
        issuance of common stock and options for cash in private transactions and
        loans
        from related parties. Bluegate has continued to take steps to reduce its
        monthly
        operating expenses relating to its core business and has expanded its efforts
        in
        creating a market for the health care industry.
 
 Our
        cash
        on hand at September 30, 2006 was $192,326.
 
 We
        are
        seeking additional capital to fund expected operating costs. We believe that
        future funding may be obtained from public or private offerings of equity
        securities, debt or convertible debt securities or other sources. Stockholders
        should assume that any additional funding will likely be dilutive.
 
 If
        we are
        unable to raise additional funding, we may have to limit our operations to
        an
        extent that we cannot presently determine. The effect of this on our business
        may require the sale of assets, the reduction or curtailment of new customer
        acquisition, reduction in the scope of current operations or the curtailment
        of
        business operations.
 
 Our
        ability to achieve profitability will depend upon our ability to raise
        additional operating capital, the continued growth in demand for connectivity
        services and our ability to execute and deliver high quality, reliable
        connectivity services.
 
 Our
        growth is dependent on attaining profit from our operations and our raising
        additional capital either through the sale of stock or borrowing. There is
        no
        assurance that we will be able to raise any equity financing or sell any
        of our
        products at a profit.
 
 Our
        future capital requirements will depend upon many factors, including the following:
 
 Ÿ
              The
                  cost of operating our VPN
 Ÿ
              The
                  cost of third-party software
 Ÿ
              The
                  cost of sales and marketing
 Ÿ
              The
                  rate at which we expand our
                  operations
 Ÿ
              The
                  response of competitors
 Ÿ
              Capital
                  expenditures
  I-5
 *Table
            of Contents*
  ITEM
                  3.
              CONTROLS
                  AND PROCEDURES
 
 (a)
              Evaluation
                  of disclosure controls and procedures. Based on their evaluation
                  of our
                  disclosure controls and procedures (as defined in Rule 13a-15e
                  under the
                  Securities Exchange Act of 1934), our principal executive officer
                  and
                  principal financial officer have concluded that as of the end of
                  the
                  period covered by this quarterly report on Form 10-QSB such disclosure
                  controls and procedures were not effective to ensure that information
                  required to be disclosed by us in reports that we file or submit
                  under the
                  Exchange Act is recorded, processed, summarized and reported within
                  the
                  time periods specified in Securities and Exchange Commission rules
                  and
                  forms, because of certain adjustments required by our auditors.
                  Specifically, our independent auditors identified deficiencies
                  in our
                  internal controls and disclosure controls related to revenue and
                  expense
                  recognition for one of our new programs. Appropriate adjustments
                  have been
                  recorded and disclosed in our Interim Report on Form 10-QSB. We
                  are in the
                  process of improving our internal controls in an effort to remediate
                  these
                  deficiencies. Since being appointed on June 1, 2006, our Chief
                  Financial
                  Officer has implemented revisions and instituted certain checks
                  and
                  balances to our accounting system. Additionally, he has addressed
                  tighter
                  controls over all aspects of financial revenue and expense recognition,
                  as
                  well as improving supervision and training of our accounting staff.
                  We are
                  continuing our efforts to improve and strengthen our control processes
                  and
                  procedures to fully remedy these deficiencies. Our management and
                  directors will continue to work with our auditors and other outside
                  advisors to ensure that our controls and procedures are adequate
                  and
                  effective.
 
 (b)
              Changes
                  in internal control over financial reporting. During the quarter
                  under
                  report, our CFO is overseeing the implementation of better controls
                  and
                  procedures over all aspects of revenue and expense recognition
                  and
                  improving supervision and training of our accounting staff. The
                  evaluation
                  of our disclosure controls included a review of whether there were
                  any
                  significant deficiencies in the design or operation of such controls
                  and
                  procedures, material weaknesses in such controls and procedures,
                  any
                  corrective actions taken with regard to such deficiencies and weaknesses
                  and any fraud involving management or other employees with a significant
                  role in such controls and
                  procedures.
  I-6
 *Table
            of Contents*
  PART
        II
 
 ITEM
                  1.
              LEGAL
                  PROCEEDINGS
 
 NONE.
 
 ITEM
                  2.
              UNREGISTERED
                  SALES OF EQUITY SECURITIES AND USE OF
                  PROCEEDS
 
 We
        issued
        unregistered securities in transactions summarized below.
 
 (1)
        In
        August 2006, we issued an option to purchase 150,000 shares of our common
        stock
        at an exercise price of $0.62 per share to a director of the company. The
        option
        had a market value of $92,701 on the date of grant, vests immediately and
        expires in August 2011. We expensed
        $92,701 during the quarter ended September 30, 2006 related to this option. This
        transaction was made in reliance upon exemptions from registration under
        Section
        4(2) of the Securities Act. Each certificate issued for unregistered securities
        contained a legend stating that the securities have not been registered under
        the Securities Act and setting forth the restrictions on the transferability
        and
        the sale of the securities.
 
 (2)
        In
        September 2006, we issued an option to purchase 264,250 shares of our common
        stock at an exercise price of $0.62 per share to a group of employees. The
        option had a market value of $237,192 on the date of grant, vests immediately
        and expires in September 2011. We expensed
        $237,192 during the quarter ended September 30, 2006 related to this
        option. This
        transaction was made in reliance upon exemptions from  registration
        under Section 4(2) of the Securities Act. Each certificate issued for
        unregistered securities contained a legend stating that the securities have
        not
        been registered under the Securities Act and setting forth the restrictions
        on
        the transferability and the sale of the securities.
 
 3)
        In
        September 2006, we issued an option to purchase 200,000 shares of our common
        stock at an exercise price of $0.71 per share to an employee. The option
        had a
        market value of $141,543 on the date of grant, vests through August 2008
        and
        expires in September 2011. We expensed
        $5,898 during the quarter ended September 30, 2006 related to this
        option. This
        transaction was made in reliance upon exemptions from  registration
        under Section 4(2) of the Securities Act. Each certificate issued for
        unregistered securities contained a legend stating that the securities have
        not
        been registered under the Securities Act and setting forth the restrictions
        on
        the transferability and the sale of the securities.
 
 4)
        In
        September 2006, we issued an option to purchase 50,000 shares of our common
        stock at an exercise price of $0.80 per share to an employee. The option
        had a
        market value of $39,871 on the date of grant, vests through August 2008 and
        expires in September 2011. We expensed
        $1,661 during the quarter ended September 30, 2006 related to this
        option. This
        transaction was made in reliance upon exemptions from  registration
        under Section 4(2) of the Securities Act. Each certificate issued for
        unregistered securities contained a legend stating that the securities have
        not
        been registered under the Securities Act and setting forth the restrictions
        on
        the transferability and the sale of the securities.
 
 (5)
        During the quarter ended September 30, 2006, we issued 990,000 shares of
        stock,
        warrants for 990,000 shares of our common stock at an exercise price of $0.75
        per share and warrants for 495,000 shares of our common stock at an exercise
        price of $1.00 per share, for cash consideration of $495,000 in connection
        with
        a private placement. This transaction was made in reliance upon exemptions
        from
        registration under Section 4(2) of the Securities Act. Each certificate issued
        for unregistered securities contained a legend stating that the securities
        have
        not been registered under the Securities Act and setting forth the restrictions
        on the transferability and the sale of the securities. This transaction did
        not
        involve a public offering. The investors were knowledgeable about our operations
        and financial condition. The investors were accredited investors as defined
        in
        Regulation D and had knowledge and experience in financial and business matters
        that allowed them to evaluate the merits and risk of receipt of these
        securities.
  II-1
 *Table
            of Contents*
  (6)
        On
        September 30, 2006, we issued 407,407 shares of stock as additional
        consideration for the purchase of Trilliant Corporation’s assets, at $0.74. As a
        result of this transaction, $29,819 was allocated to goodwill and $271,662
        was
        expensed during the quarter ended September 30, 2006. This transaction was
        made
        in reliance upon exemptions from registration under Section 4(2) of the
        Securities Act. Each certificate issued for unregistered securities contained
        a
        legend stating that the securities have not been registered under the Securities
        Act and setting forth the restrictions on the transferability and the sale
        of
        the securities. This transaction did not involve a public offering. The investor
        was knowledgeable about our operations and financial condition. The investor
        was
        an accredited investor as defined in Regulation D and had knowledge and
        experience in financial and business matters that allowed him to evaluate
        the
        merits and risk of receipt of these securities.
 
 (7)
        In
        October and November 2006, we issued 240,000 shares of stock, warrants for
        240,000 shares of our common stock at an exercise price of $0.75 per share
        and
        warrants for 120,000 shares of our common stock at an exercise price of $1.00
        per share, for cash consideration of $120,000 in connection with a private
        placement. This transaction was made in reliance upon exemptions from
        registration under Section 4(2) of the Securities Act. Each certificate issued
        for unregistered securities contained a legend stating that the securities
        have
        not been registered under the Securities Act and setting forth the restrictions
        on the transferability and the sale of the securities. This transaction did
        not
        involve a public offering. The investor was knowledgeable about our operations
        and financial condition. The investor was an accredited investor as defined
        in
        Regulation D and had knowledge and experience in financial and business matters
        that allowed them to evaluate the merits and risk of receipt of these
        securities.
 
 (8)
        In
        October 2006, we issued 180,000 shares of stock, warrants for 180,000 shares
        of
        our common stock at an exercise price of $0.75 per share and warrants for
        90,000
        shares of our common stock at an exercise price of $1.00 per share, for cash
        consideration of $90,000 in connection with a private placement. This
        transaction was made in reliance upon exemptions from registration under
        Section
        4(2) of the Securities Act. Each certificate issued for unregistered securities
        contained a legend stating that the securities have not been registered under
        the Securities Act and setting forth the restrictions on the transferability
        and
        the sale of the securities. We paid one broker-dealer a sales commission
        in this
        transaction. This transaction did not involve a public offering. The investor
        was knowledgeable about our operations and financial condition. The investor
        was
        an accredited investor as defined in Regulation D and had knowledge and
        experience in financial and business matters that allowed them to evaluate
        the
        merits and risk of receipt of these securities.
 
 (9)
        In
        October 2006, we issued warrants to purchase 12,000 shares of our common  stock
        at
        an exercise price of $0.75 per share and warrants to purchase 9,000 shares
        of
        our common stock at an exercise price of $1.00 per share to a vendor. The
        warrants had a market value of $18,841 on the date of grant and expire in
        September 2011. We expensed
        $18,841 during October 2006 related to these warrants. This
        transaction were made in reliance upon exemptions from registration under
        Section 4(2) of the Securities Act. Each certificate issued for unregistered
        securities contained a legend stating that the securities have not been
        registered under the Securities Act and setting forth the restrictions on
        the
        transferability and the sale of the securities.
 
 (10)
        In
        October 2006, we issued 66,000 shares of common stock for the conversion
        of a
        note payable plus accrued interest amounting to $33,000. This transaction
        was
        made in reliance upon exemptions from registration under Section 4(2) of
        the
        Securities Act. Each certificate issued for unregistered securities contained
        a
        legend stating that the securities have not been registered under the Securities
        Act and setting forth the restrictions on the transferability and the sale
        of
        the securities. This transaction did not involve a public offering. The investor
        was knowledgeable about our operations and financial condition. The investor
        was
        an accredited investor as defined in Regulation D and had knowledge and
        experience in financial and business matters that allowed them to evaluate
        the
        merits and risk of receipt of these securities.
  II-2
 *Table
            of Contents*
  ITEM
                  5.
              OTHER
                  INFORMATION
 
 (1)
        In
        August 2006, we issued an option to purchase 150,000 shares of our common
        stock
        at an exercise price of $0.62 per share to a director of the company. The
        option
        had a market value of $92,701 on the date of grant and expires in August
        2011.
        We expensed
        $92,701 during the quarter ended September 30, 2006 related to this option.
 
 (2)
        In
        September 2006 we issued an option to purchase 264,250 shares of our common
        stock at an exercise price of $0.62 per share to a group of employees. The
        option had a market value of $237,192 on the date of grant and expires in
        September 2011. We expensed
        $237,192 during the quarter ended September 30, 2006 related to this
        option.
 
 3)
        In
        September 2006 we issued an option to purchase 200,000 shares of our common
        stock at an exercise price of $0.71 per share to an employee. The option
        had a
        market value of $141,543 on the date of grant and expires in September 2011.
        We expensed
        $5,898 during the quarter ended September 30, 2006 related to this
        option.
 
 4)
        In
        September 2006 we issued an option to purchase 50,000 shares of our common
        stock
        at an exercise price of $0.80 per share to an employee. The option had a
        market
        value of $39,871 on the date of grant and expires in September 2011.
        We expensed
        $1,661 during the quarter ended September 30, 2006 related to this
        option.
 
 (5)
        During the quarter ended September 30, 2006 we issued 990,000 shares of stock,
        warrants for 990,000 shares of our common stock at an exercise price of $0.75
        per share and warrants for 495,000 shares of our common stock at an exercise
        price of $1.00 per share, for cash consideration of $495,000 in connection
        with
        a private placement.
 
 (6)
        Effective September 30, 2006, we issued 407,407 shares of stock as additional
        consideration for the purchase of Trilliant Corporation’s assets, at $0.74. As a
        result of this transaction, $29,819 was allocated to goodwill and $271,662
        was
        expensed during the quarter ended September 30, 2006.
 
 (7)
        In
        October and November 2006 we issued 420,000 shares of stock, warrants for
        420,000 shares of our common stock at an exercise price of $0.75 per share
        and
        warrants for 210,000 shares of our common stock at an exercise price of $1.00
        per share, for cash consideration of $210,000 in connection with a private
        placement.
 
 (8)
        In
        October 2006, we issued 66,000 shares of common stock for the conversion
        of a
        note payable plus accrued interest amounting to $33,000.
  
 ITEM
                  6.
              EXHIBITS
 
 ExhibitNumber
              Name10.1
              Stock
                  Option Agreement of Gilbert Gertner31.1
              Certification
                  pursuant to Section 13a-14 of CEO31.2
              Certification
                  pursuant to Section 13a-14 of CFO32.1
              Certification
                  pursuant to Section 1350 of CEO32.2
              Certification
                  pursuant to Section 1350 of CFO
  II-3
 *Table
            of Contents*
  SIGNATURES
 
 In
        accordance with the Exchange Act, the registrant caused this report to be
        signed
        on its behalf by the undersigned, thereunto duly authorized
 
 
 Bluegate
                  CorporationDate:November
                  3, 2006
              /s/
              Manfred
                  SternbergManfred
                  Sternberg,Chief
                  Executive OfficerBluegate
                  CorporationDate:November
                  3, 2006
              /s/
              Charles
                  E. LeiboldCharles
                  E. Leibold, CPA,Chief
                  Financial Officer
  II-4