10-Q 1 x10q-802.txt INTACTA TECHNOLOGIES INC. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- FORM 10-Q (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 ------------- OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________________ to ________________ Commission file number: 0-30467 -------------------- INTACTA TECHNOLOGIES INC. ----------------------------------------- (Exact name of registrant as specified in its charter) Nevada 58-2488071 --------------------------- -------------------------- (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 945 East Paces Ferry Road N.E. Suite 1445, Atlanta, Georgia 30326 ----------------------------------------------------------- ------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 404-880-9919 ---------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days. YES [X] NO [ ]. As of August 12, 2002, there were 20,345,924 shares of the registrant's Common Stock, par value $.0001, outstanding. TABLE OF CONTENTS PART I - FINANCIAL INFORMATION Page ---- Item 1. Consolidated Financial Statements Consolidated Balance Sheets as of June 30, 2002 (unaudited) and December 31, 2001 3 Consolidated Statements of Operations (unaudited) for the three and six months ended June 30, 2002 and 2001 5 Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2002 and 2001 6 Notes to Consolidated Financial Statements (unaudited) 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk 15 PART II - OTHER INFORMATION Item 6. Exhibits and Reports Filed on Form 8-K 18 Signatures 19 PART I. - FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS The consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. The consolidated balance sheet as of June 30, 2002; the consolidated statements of operations for the three and six months ended June 30, 2002 and June 30, 2001; and the consolidated statements of cash flows for the six months ended June 30, 2002 and June 30, 2001 have been prepared without audit. The consolidated balance sheet as of December 31, 2001 has been audited by independent certified public accountants. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures herein are adequate to make the information presented not misleading. It is suggested that these consolidated financial statements and related notes be read in conjunction with the consolidated financial statements and notes thereto, included in the Company's Annual Report on Form 10-K for the year ended December 31, 2001. In the opinion of the Company, the statements for the unaudited interim periods presented included all adjustments that were of a normal recurring nature necessary to present a fair statement of the financial condition and results of operations for such interim periods. The results of operations for the interim periods presented are not necessarily indicative of the results of operations for the entire year. INTACTA TECHNOLOGIES INC. CONSOLIDATED BALANCE SHEETS JUNE 30, 2002 December 31, 2001 (Unaudited) ================================================================================ ASSETS CURRENT Cash and cash equivalents $ 182,200 $ 679,000 Accounts receivable 26,800 7,200 Prepaid insurance and other 17,800 106,900 -------------------------------------------------------------------------------- Total current assets 226,800 793,100 PROPERTY AND EQUIPMENT, net 35,500 68,700 PATENTS, net 118,700 119,500 -------------------------------------------------------------------------------- $ 381,000 $ 981,300 ================================================================================ See accompanying notes to unaudited consolidated financial statements. 3 INTACTA TECHNOLOGIES INC. CONSOLIDATED BALANCE SHEETS

See accompanying notes to unaudited consolidated financial statements. 4 INTACTA TECHNOLOGIES INC. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001 (UNAUDITED)

See accompanying notes to unaudited consolidated financial statements. 5 INTACTA TECHNOLOGIES INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001 (UNAUDITED)

See accompanying notes to unaudited consolidated financial statements. 6 INTACTA TECHNOLOGIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS Intacta Technologies Inc. and its wholly-owned subsidiaries, Intacta Delaware, Inc., and Intacta Labs, Ltd, (collectively the "Company"), is a developer and marketer of software products based on its patented technology that, through its unique combination of compression, encoding and error correction processes, transforms any data format ranging from text, graphic, audio or video from a binary file into INTACTA.CODE(TM) which is language transparent and platform independent. The Company believes that its technology provides solutions and applications that enable enterprises to bridge their communications and management information systems across digital and non-digital media by providing the secure bi-directional transmission and subsequent recovery and storage of data. Intacta Labs Ltd., an Israeli corporation and wholly owned subsidiary (Intacta Labs), primarily conducts product research and development in the high tech area of Beer Sheba, Israel, and is currently conducting new research projects expected to produce significant time and cost savings through continued development of a medium for transmitting and storing data in secure formats. PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. SOFTWARE DEVELOPMENT COSTS In accordance with Statement of Financial Accounting Standards (SFAS) No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed", costs related to the research and development of new products and enhancements to existing products are expensed as incurred until technological feasibility of the product has been established, at which time such costs are capitalized, subject to expected recoverability. Therefore, the Company has not capitalized any software development costs related to its products, since the time period between technological feasibility and the general release of a market accepted product is not significant. LONG-LIVED ASSETS Long-lived assets, such as patents and property and equipment, are evaluated for impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through the estimated undiscounted future cash flows resulting from the use of these assets. When any such impairment exists, the related assets will be written down to fair value. The Company believes that the recoverability of its long-lived assets is likely whether or not the Company continues as a going concern or ceases operations. 7 INTACTA TECHNOLOGIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In October 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards, (SFAS 144), "Accounting for Impairment of Disposal of Long-Lived Assets." SFAS 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of," and addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement is effective for fiscal years beginning after December 15, 2001. The Company does not expect the adoption of SFAS 144 to have a material impact on its financial statements. In June 2001, the Financial Accounting Standards Board finalized Statements No. 141, "Business Combinations" (SFAS 141), and No. 142, "Goodwill and Other Intangible Assets" (SFAS 142). SFAS 141 requires the use of the purchase method of accounting and prohibits the use of the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001. SFAS 141 also requires that the Company recognize acquired intangible assets apart from goodwill if the acquired intangible assets meet certain criteria. SFAS 141 applies to all business combinations initiated after June 30, 2001 and for purchase business combinations completed on or after July 1, 2001. It also requires, upon adoption of SFAS 142, that the Company reclassify the carrying amounts of intangible assets and goodwill based on the criteria in SFAS 141. SFAS 142 requires, among other things, that companies no longer amortize goodwill, but instead test goodwill for impairment at least annually. In addition, SFAS 142 requires that the Company identify reporting units for the purposes of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets, and cease amortization of intangible assets with an indefinite useful life. An intangible asset with an indefinite useful life should be tested for impairment in accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in fiscal years beginning after December 15, 2001 to all goodwill and other intangible assets recognized at that date, regardless of when those assets were initially recognized. SFAS 142 requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is also required to reassess the useful lives of other intangible assets within the first interim quarter after adoption of SFAS 142. The adoption of SFAS No. 141 and SFAS No. 142 is not expected to have a material effect on the Company's financial position, results of operations and cash flows in 2002 and subsequent years. REVENUE RECOGNITION The Company's revenue recognition policies are in compliance with generally accepted accounting principles including Statement of Position (SOP 97-2), "Software Revenue Recognition." As such, the Company recognizes product revenue upon shipment if persuasive evidence of an arrangement exists, delivery has occurred, the fees are fixed and determinable and collectibility is probable. Revenues, if any, from arrangements to provide maintenance, bug fixing, support, upgrades and enhancements are recognized over the period in which such arrangements exist. While such arrangements were made available to some customers on a limited basis during the reporting periods presented, SOP 97-2 allows for full revenue recognition upon delivery if certain criteria are met. Such criteria include such factors as insignificant costs of providing such arrangements and minimal and infrequent upgrades and enhancements, among other things. The Company met the conditions of such criteria and, as a result, was not required to defer the recognition of revenue for arrangements described above. License revenues are recognized based on actual sales of licensed software by a customer/licensee and are not recognized by the company as revenue until the final sale is reported by the customer/licensee. This is the time at which the Company believes that revenue recognition in accordance with SOP 97-2, as described above, has occurred. Support revenue is not integral to the functionality of the licensed software and is billed and recognized as incurred. 8 INTACTA TECHNOLOGIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The Company believes that it is in compliance with Staff Accounting Bulletin No. 101, "Revenue Recognition", which outlines the basic criteria that must be met to recognize revenue and provides guidance for presentation of revenue and for disclosure related to revenue recognition policies in financial statements filed with the SEC. LOSS PER SHARE Basic loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Shares issued during the year are weighted for the portion of the year that they were outstanding. Diluted loss per share is computed in a manner consistent with that of basic loss per share while giving effect to all potentially dilutive common shares outstanding during the period. As a result of losses, all stock options and warrants outstanding for the periods presented were antidilutive and accordingly, were excluded from the computation of loss per share. 2. GOING CONCERN The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the consolidated financial statements, the Company has a cumulative deficit of $26,594,200 through June 30, 2002. The Company has incurred losses of $3,521,400, $4,551,200 and $3,617,600 for the years ended December 31, 2001, 2000 and 1999, and $850,400 for the six months ended June 30, 2002, respectively. These losses were primarily the result of the Company's transition in late 1997 from production and marketing of its facsimile-based products upon realization that the market potential for such products was diminished, and the significant costs required to support research, development and marketing efforts for the Company's INTACTA.CODE related technology, in advance of any significant generation of revenue. These conditions give rise to substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of assets or the amount and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company is continuing to incur significant losses from operations and is not generating sufficient revenue to meet its operating activities. The Company anticipates incurring continuing losses in the future as it continues the development and marketing of its software products and technology. Moreover, the Company estimates that cash and cash equivalents will be substantially depleted by the middle of the third quarter of fiscal 2002. The Company will therefore require third-party financing, either debt or equity, in the immediate future in order to continue operations. At this time the Company does not have any current arrangements with respect to other potential sources of additional financing and cannot assure you that additional financing will be available to it on commercially reasonable terms or at all. If such financing is not available to the Company in the near term, the Company may be required to curtail its operations significantly or cease operations altogether. If operations are curtailed, the Company will continue its efforts to generate revenues by (i) assisting current customers and business partners introducing their products and processes incorporating the Company's technology on a timely basis, and (ii) seeking to establish additional business alliances for the integration of its technology into firmware products in the area of secure data storage, transmission and retrieval, and obtaining additional revenue and financing from these business alliances. There is no assurance, however, that these efforts will result in an increase in revenues or the receipt of financing. 9 INTACTA TECHNOLOGIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 3. SEGMENT INFORMATION During 1999, the Company adopted SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information" which establishes standards for the way that public business enterprises report information about operating segments in their financial statements. The standard defines operating segments as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Based on these standards the Company has determined that it operates in a single operating segment: the development, marketing and licensing of software and sale of ancillary components. Geographic Segments: The following table represents revenues and other financial information at and for the periods designated below. Revenues attributable to geographic areas are based on the location of the customer.

4. SUBSEQUENT EVENTS On August 9, 2002 the Company accepted the resignations of two members of its Board of Directors, Charles Johnston and Bernard Girma. The Company has not appointed new Board members in their place as of the date hereof. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Private Securities Litigation Reform Act of 1995 provides a "safe-harbor" for forward-looking statements. Certain statements contained in this report that are not historical fact, including, but not limited to, those concerning its expectations of future sales revenues, gross profits, research and development, sales and marketing, and administrative expenses, product introductions and cash requirements are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause its actual results to differ from expectations including variations in the level of orders, general economic conditions in the markets served by its customers, international economic and political climates, timing of future product releases, difficulties or delays in product functionality of performance, its failure to respond adequately to changes in technology or customer preferences, changes in its pricing or that of its competitors and its inability to manage growth. All of the above factors constitute significant risks to its operations. There can be no assurance that the Company's results of operations will not be adversely affected by one or more of these factors. As a result, its actual results may vary materially from its expectations. The words "believe", "expect", "anticipate", "intend", and "plan" and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date the statement was made. GENERAL The Company is engaged in the development and marketing of software products based on its INTACTA.CODE technology which provides solutions and applications for the secure storage and bi-directional transmission of data in digital and non-digital media. The Company's revenues were $140,800 for fiscal 2001, and $532,800 for the six months ended June 30, 2002. Beginning in 1998, the Company commenced the transition of its business from the production and sale of facsimile storage and retrieval products to development of software products based upon its core technology. Through the second quarter of fiscal 2000, primarily as a result of its limited financial resources and personnel available for marketing activities, the Company made limited progress in establishing licensing arrangements for its technology. The majority of its revenues during this time were generated primarily from a consulting arrangement and the sale of discontinued hardware products. This consulting project was a one-time service performed for one of its clients and was completed during the second quarter of fiscal 2000. For fiscal 2000, its licensing revenues were $94,000. Although this represented an increase of approximately 28% from fiscal 1999, licensing revenues accounted for only approximately 12% of its total revenues in fiscal 2000. Sales of certain test platforms constructed principally from component parts from its discontinued facsimile business, the production and sale of which has since been discontinued, together with sales of other products from its inventory of discontinued facsimile business, accounted in the aggregate for approximately 46% of its total revenues for fiscal 2000. As a result of the Company's continuing shift in business strategy toward licensing of its technology and software applications combined with the depletion of the remaining inventory of hardware and other non-proprietary computer processing equipment from its discontinued facsimile business, its sales of products and components decreased to $94,400 for fiscal 2001, representing an approximate 74% decrease from the prior year. Further, as a consequence of its reduced marketing resources resulting in its inability to obtain additional customers for its Developer's Edition and Enterprise Edition SDK products, as well as extended sales cycles for implementation of its technology and related products to existing customers, royalties from licensing arrangements decreased to $46,400 for fiscal 2001, representing an approximate 51% decrease in such revenues from the prior year. In May 2002, the Company entered into a formal licensing agreement with Zixsys Inc., a newly formed joint venture between Sanyo Semiconductor Corporation and Imagis Technologies, Inc., an affiliated entity, relating to the licensing of its technology for integration by Zixsys in the development and manufacturing of advanced security based products and systems. Under the agreement, the Company received in June 2002, a non-refundable initial licensing fee of $469,000 and is entitled to receive subsequent royalty fees based upon revenues from sales of products by Zixsys incorporating the Company's technology. 11 The Company's independent auditors have included an explanatory paragraph in the report on its financial statements for each of the three years in the period ended December 31, 2001, stating that recurring losses from operations and an accumulated deficit at December 31, 2001 of $25,743,800 raise substantial doubt its ability to continue as a going concern. The Company's accumulated deficit as of June 30, 2002 is $26,594,200. RESULTS OF OPERATIONS Three months ended June 30, 2002 compared to three months ended June 30, 2001 Revenues. Revenues increased by $473,400 to $478,600 for the three months ended June 30, 2002, from $5,200 for the three months ended June 30, 2001. This increase was primarily attributable to the receipt of an initial license fee from Zixsys, Inc., of $469,000. Cost of products and components. There was no cost of products and components for the three months ended June 30, 2002, compared to $10,400 of such costs for the three months ended June 30, 2001. The decrease in such costs was attributable to the corresponding reduction in sales of discontinued products and components. Research and development expenses. Research and development expenses decreased by $179,600 or 57.9% to $130,800 for the three months ended June 30, 2002, from $310,400 for the three months ended June 30, 2001. The decrease was primarily attributable to the reduction in staff related to the Company's discontinued facsimile-based business. This decrease was also partially attributable to a decrease in non-cash charges to $0 for the second quarter of fiscal 2002 from $47,300 for the second quarter of fiscal 2001, to account for options previously granted below fair market value as compensation to employees and consultants. Sales and marketing expenses. Sales and marketing expenses decreased by $161,400 or 63.3%, to $93,600 for the three months ended June 30, 2002, from $255,000 for the three months ended June 30, 2001. The decrease was primarily attributable to (i) lowered salary costs and consulting fees from the reduction of personnel as well as consultants and other outside services and (ii) reduced expenses related to marketing materials, partially offset by a commission expense of approximately $42,000 related to Zixsys Inc. license fees. General and administrative expenses. General and administrative expenses increased by $26,400 or 6.1% to $460,200 for the three months ended June 30, 2002, from $433,800 for the three months ended June 30, 2001. This increase was attributable to legal costs associated with the Company's defense of a patent infringement claim, taxes of approximately $46,900 related to Zixsys, Inc. license fees, partially offset by lowered salary costs related to the reduction of its administrative staff, and third-party consulting and professional fees in connection with business strategy development and management and operation of its business. Interest income (expense), net. Net interest income was $200 for the three months ended June 30, 2002 compared to $26,700 of net interest income for the three months ended June 30, 2001. Net loss. As a result, net loss decreased by $764,600 or 78.3% to $212,300, or $(.01) per share, for the three months ended June 30, 2002, as compared to its net loss of $976,900, or $(.05) per share, for the three months ended June 30, 2001. Six months ended June 30, 2002 compared to six months ended June 30, 2001 Revenues. Revenues increased by $435,700 to $532,800 for the six months ended June 30, 2002, from $97,100 for the six months ended June 30, 2001. This increase was primarily attributable to the receipt of an initial license fee from Zixsys, Inc., of $469,000 during the second quarter 2002. Cost of products and components. There was no cost of products and components for the six months ended June 30, 2002, compared to $24,100 of such costs for the six months ended June 30, 2001. The decrease in such costs was attributable to the corresponding reduction in sales of discontinued products and components. 12 Research and development expenses. Research and development expenses decreased by $311,800 or 51.7% to $290,800 for the six months ended June 30, 2002, from $602,600 for the six months ended June 30, 2001. The decrease was primarily attributable to the reduction in staff related to the Company's discontinued facsimile-based business. This decrease was also partially attributable to a decrease in non-cash charges to $7,600 for the first half of fiscal 2002 from $94,600 for the first half of fiscal 2001, to account for options previously granted below fair market value as compensation to employees and consultants. Sales and marketing expenses. Sales and marketing expenses decreased by $344,900 or 67.5%, to $166,100 for the six months ended June 30, 2002, from $511,000 for the six months ended June 30, 2001. The decrease was primarily attributable to (i) lowered salary costs and consulting fees from the reduction of personnel as well as consultants and other outside services and (ii) reduced expenses related to marketing materials, partially offset by a commission expense of approximately $42,000 related to Zixsys Inc. license fees. General and administrative expenses. General and administrative expenses increased by $28,200 or 3.2% to $920,200 for the six months ended June 30, 2002, from $892,000 for the six months ended June 30, 2001. This increase was attributable to legal costs associated with the Company's defense of a patent infringement claim, taxes of approximately $46,900 related to Zixsys, Inc. license fees, partially offset by lowered salary costs related to the reduction of its administrative staff, and third-party consulting and professional fees in connection with business strategy development and management and operation of its business. Interest income (expense), net. Net interest income was $2,400 for the six months ended June 30, 2002 compared to $67,900 of net interest income for the six months ended June 30, 2001. Net loss. As a result, net loss decreased by $1,022,900 or 54.6 % to $850,400, or $(.04) per share, for the six months ended June 30, 2002, as compared to its net loss of $1,873,300, or $(.09) per share, for the six months ended June 30, 2001. LIQUIDITY AND CAPITAL RESOURCES Since inception, the Company has financed its operating costs and capital requirements primarily through: o the private sale of its capital stock to various parties; o non-interest-bearing loans from Valor Invest Limited, an affiliate of the Company's Chairman of the Board, substantially all of which was subsequently repaid or converted into equity; and o cash acquired in connection with the acquisition of its subsidiaries. At June 30, 2002 the Company had $182,200 in cash and cash equivalents, the majority of which represented the balance of proceeds remaining from its October 2000 private placement. At June 30, 2002, the Company had a working capital deficit of $409,500 as compared to working capital of $393,700 at December 31, 2001. Cash used in operating activities for the six months ended June 30, 2002 was $489,600, primarily consisting of net loss, partially offset by an increase of an aggregate of $237,000 in accounts payable, accrued expenses, and related party payables, and a decrease in other assets of $89,000. Cash in investing activities during the first half of 2002 was $7,200. As a result, the Company had a net decrease of $496,800 in cash and cash equivalents during the six months ended June 30, 2002. Cash used in operating activities for the six months ended June 30, 2001 was $1,715,000, primarily consisting of net loss and an increase of $47,100 in other current assets, partially offset by $110,100 of non-cash compensation expense and a decrease in accounts receivable of $56,600. Cash used in investing activities was $40,900. As a result, the Company had a net decrease of $1,755,900 in cash and cash equivalents during the six months ended June 30, 2001. 13 Other than the leases for its offices and research facilities in Atlanta, Georgia and Beer Sheba, Israel, and certain computer equipment relating to its research and development activities, the Company does not have any material capital obligations and the Company does not anticipate making any material capital expenditures in the immediate future. The Company's aggregate minimum commitments under its existing operating leases for fiscal 2002, 2003 and 2004 are $153,000, $153,300 and $144,500, respectively. Additionally, the Company does not carry any material short or long-term debt or other financing commitments. As a result, the majority of its business costs are the direct result of its operating costs including personnel expenses, such as payroll, and other facility maintenance and overhead expenses. In an effort to reduce its operating costs, the Company, beginning in September 2001, reduced its personnel by approximately 30%, and instituted a firm-wide reduction of salaries by 20%. In addition to its cost-reduction efforts, the Company has engaged in, or is currently engaging in, efforts to increase revenues and obtain financing to supplement its cash and cash equivalents in order to meet its operating costs in the near term. These efforts include: o Assisting current customers and business partners introducing their products and processes incorporating the Company's technology on a timely basis. o Seeking to establish additional business alliances for the integration of its technology into firmware products in the area of secure data storage, transmission and retrieval, and obtaining additional revenue and financing from these business alliances. There is no assurance, however, that these efforts will result in an increase in revenues or the receipt of financing. The Company is continuing to incur significant losses from operations and is not generating sufficient revenue to meet its operating activities. At June 30, 2002 the Company had an accumulated deficit of $26,594,200. Moreover, the Company estimates that cash and cash equivalents will be substantially depleted by the middle of the third quarter of fiscal 2002. The Company will therefore require third-party financing, either debt or equity, in the immediate future in order to continue operations. At this time the Company does not have any current arrangements with respect to other potential sources of additional financing and cannot assure you that additional financing will be available to the Company on commercially reasonable terms or at all. If such financing is not available to the Company in the near term, and the Company is unable to increase its revenue from existing sources to meet its operating expenses, the Company may be required to curtail its operations significantly or cease operations altogether. CRITICAL ACCOUNTING POLICIES The Company believes the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. Revenue Recognition. The Company's revenue recognition policies are in compliance with generally accepted accounting principles including Statement of Position (SOP) 97-2, Software Revenue Recognition. As such, the Company recognizes product revenue upon shipment if persuasive evidence of an arrangement exists, delivery has occurred, the fees are fixed and determinable and collectibility is probable. Revenues, if any, from arrangements to provide maintenance, bug fixing, support, upgrades and enhancements are recognized over the period in which such arrangements exist. While such arrangements were made available to some customers on a limited basis during the reporting periods presented, SOP 97-2 allows for full revenue recognition upon delivery if certain criteria are met. Such criteria include such factors as insignificant costs of providing such arrangements and minimal and infrequent upgrades and enhancements, among other things. The Company met the conditions of such criteria and, as a result, was not required to defer the recognition of revenue for arrangements described above. License revenues are recognized based on actual sales of licensed software by a customer/licensee and are not recognized by the company as revenue until the final sale is reported by the customer/licensee. This is the time at which 14 the Company believes that revenue recognition in accordance with SOP 97-2, as described above, has occurred. Support revenue is not integral to the functionality of the licensed software and is billed and recognized as incurred. The Company believes that we are in compliance with Staff Accounting Bulletin ("SAB") No. 101, Revenue Recognition, which outlines the basic criteria that must be met to recognize revenue and provides guidance for presentation of revenue and for disclosure related to revenue recognition policies in financial statements filed with the SEC. Valuation of Long-lived Assets. The Company evaluates long-lived assets, such as patents and property and equipment for impairment when events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable through the estimated undiscounted future cash flows resulting from the use of these assets. When any such impairment exists, the related assets are written down to fair value. Software Development Costs. In accordance with Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed", costs related to the research and development of new products and enhancements to existing products are expensed as incurred until technological feasibility of the product has been established, at which time such costs are capitalized, subject to expected recoverability. Therefore, the Company has not capitalized any software development costs related to its products, since the time period between technological feasibility and the general release of a market accepted product is not significant. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company does not engage in trading market risk sensitive instruments, nor does the Company purchase for investment, hedging or for purposes "other than trading", instruments that are likely to expose it to market risk, whether it be interest rate, foreign currency exchange, commodity price or equity price risk. Consequently, management believes that as of June 30, 2002, the Company does not have exposure to foreign currency exchange risk. RISK FACTORS Risks Related to the Company's Financial Condition THE COMPANY HAS INCURRED LOSSES SINCE INCEPTION AND IT EXPECTS TO INCUR LOSSES IN THE FUTURE. The Company has incurred significant net losses in each fiscal year since its inception and expects losses to continue. During the year ended December 31, 2000, the Company had a net loss of approximately $4.5 million, for the year ended December 31, 2001, it had a net loss of approximately $3.5 million, and for the six months ended June 30, 2002, it had a net loss of $850,400. The Company cannot assure you that its future operations will ever become profitable. THE COMPANY'S INDEPENDENT AUDITORS HAVE EXPRESSED SUBSTANTIAL DOUBT ABOUT ITS ABILITY TO CONTINUE AS A GOING CONCERN. Primarily as a result of the Company's recurring losses, its independent auditors qualified their opinion on the Company's 2001 financial statements and in the two preceding years to include an explanatory paragraph expressing substantial doubt about its ability to continue as a going concern. BECAUSE THE COMPANY'S OPERATIONS DO NOT GENERATE CASH FLOW, IF IT IS UNABLE TO OBTAIN FINANCING WHEN NEEDED, IT MAY BE REQUIRED TO CURTAIL OR CEASE OPERATIONS. The Company's operating requirements have been and will continue to be significant. Its operations do not currently generate positive cash flow. Based upon current estimates, the Company believes that it will be able to fund its operating activities and capital requirements only through the middle of the third fiscal quarter of 2002. The Company does not 15 have any current arrangements with respect to other potential sources of additional financing. The Company cannot assure you that additional financing will be available to it on commercially reasonable terms or at all. If the Company is unable to obtain financing when needed, it may be required to curtail or cease operations. Risks Related to the Company's Operations THE COMPANY MAY NOT BE ABLE TO ACHIEVE MARKET ACCEPTANCE FOR SOFTWARE PRODUCTS INCORPORATING ITS TECHNOLOGY. Because its technology and related software products have only recently been introduced and are marketed in a rapidly evolving industry, market acceptance of its technology is uncertain. Despite the expanding market for secure data transmission and storage solutions, the Company has not been able to increase its market acceptance and its revenues from software licensing has only slowly increased. The Company will be required to expend a substantial amount of funds on marketing efforts to inform end-users of the perceived benefits and advantages of its technology and to update and enhance its existing products and technology on a timely basis. The Company cannot assure you that it will have the funds or other resources necessary to achieve its marketing and product-enhancement objectives and successfully compete in its markets or that these increased efforts, if engaged in, will result in successful commercialization and market acceptance of its software products and technology. Moreover, potential customers may elect to utilize competitive products and services embodying new technologies that they believe to be more efficient and have other advantages over its technology. THE COMPANY'S FUTURE REVENUE GROWTH DEPENDS SUBSTANTIALLY ON ITS ABILITY TO SUCCESSFULLY IDENTIFY APPLICATIONS OR PRODUCTS FOR WHICH ITS TECHNOLOGY MAY BE DEVELOPED AND MARKETED. If the Company is unable to identify applications or products that will achieve widespread commercial acceptance or adapt or enhance its technology for these applications or products the Company will be unable to expand the market for its technology. Adapting and enhancing technology as complex as the Company's will be subject to risks of unanticipated technical or other problems and possible insufficiency of funds which could result in a delay of introduction or abandonment of the proposed application or product. The Company cannot assure you that it will be able to identify applications or products, adapt its technology for specific applications or products on a timely basis or be able to achieve significant market acceptance of its technology. THE COMPANY HAS LIMITED MARKETING CAPABILITIES AND IS DEPENDENT UPON ARRANGEMENTS WITH THIRD-PARTY SOLUTION PROVIDERS TO MARKET AND DISTRIBUTE ITS TECHNOLOGY. The Company has limited marketing experience, as well as limited financial, personnel and other resources, to undertake extensive marketing activities. As a result, the Company relies to a large extent on arrangements with third party solution providers for the marketing and distribution of its technology. The Company has only recently entered into marketing arrangements with a limited number of third-party solution providers and other strategic partners and, accordingly, has not developed any meaningful sales through any of these marketing arrangements. Its prospects will depend on its ability to develop and maintain strategic relationships with additional solution providers and upon the marketing and distribution efforts of these solution providers. Additionally, the time and resources devoted to these activities generally will be contributed to and controlled by these third parties and not by the Company. A decline in the financial prospects of a third-party solution provider or other strategic partner with whom the Company develop a significant marketing relationship could adversely affect its sales efforts. THE COMPANY FACES INTENSE COMPETITION IN THE MARKETS FOR ITS TECHNOLOGY, WHICH COULD RESULT IN PRICE REDUCTIONS, LOWER GROSS MARGINS OR LOSS OF ITS MARKET SHARE. The markets for its technology are characterized by rapidly changing technological and industry standards. As a result, to compete effectively, companies must be able to develop new products, technologies and applications to respond to these changes. Because the Company has limited resources, it may not be able to develop new products, technologies and applications or otherwise compete successfully. Many of the Company's competitors have substantially greater financial, technical, personnel, and other resources than it does and have established reputations for success in the development, licensing, and sale of their products and technology. Additionally, future technologies or products could 16 render its technology obsolete or less marketable. As a result of the Company's limited resources, significant competition and the nature of the markets for its technology, the Company may not be able to compete successfully. AS AN EARLY-STAGE COMPANY, THE COMPANY'S LIMITED OPERATING HISTORY IS NOT A RELIABLE PREDICTOR OF ITS FUTURE OPERATING RESULTS AND WE FACE MANY RISKS INCLUDING LIQUIDITY PROBLEMS, DELAYS AND UNCERTAINTIES. The Company was organized in October 1997 and did not commence active operations until May 1998. In addition, during 1998, the Company shifted the focus of its business from production and sale of facsimile-based products to the development of advanced products based upon its proprietary technology. More recently the Company has determined to focus on the commercial exploitation of its technology for applications and solutions in the area of data compression and transmission. Because its business has significantly changed and much of the Company's historical operating results do not reflect its current operations, the Company has a limited relevant operating history upon which you can evaluate its performance and prospects. Additionally, the Company face many of the risks, expenses, delays, problems and uncertainties encountered by early-stage companies in rapidly evolving markets, including generating and maintaining sufficient liquidity for operating and capital expenses as well as identifying, developing and marketing commercially viable products on a timely basis, which could materially adversely affect its business and results of operations. THE MAJORITY OF THE COMPANY'S RESEARCH AND DEVELOPMENT ACTIVITIES ARE CONDUCTED IN ISRAEL, WHICH MAY BE SUBJECT TO ECONOMIC, MILITARY AND POLITICAL INSTABILITY. The Company's principal research and development facility is located in Beer Sheba, Israel. The Company is, therefore, directly influenced by the economic, political and military conditions in Israel and the Middle East. Any major hostilities involving Israel, the interruption or curtailment of trade between Israel and its trading partners or a significant downturn in the economic or financial condition of Israel could have a material adverse effect on its operations. THE COMPANY IS THE SUBJECT OF A PATENT INFRINGEMENT CLAIM BY A THIRD PARTY. In November 2001, Datastrip International Limited, an Ireland company, filed a complaint in the United States District Court for the Northern District of Georgia against the Company alleging patent infringement. In addition to preliminary and permanent injunctions sought by Datastrip from further alleged infringement of its patent, Datastrip seeks an unstated amount of monetary damages equal to three times the amount the court would deem sufficient to compensate Datastrip for the alleged infringement. Since this lawsuit is in an early stage, the Company cannot predict the outcome and cannot assure you that it will be resolved in the Company's favor or that an outcome of any further litigation or settlement would not have a material adverse effect on its operations or financial condition. Risks Related to the Company's Securities MOST OF THE COMPANY'S SHARES OF COMMON STOCK ARE CURRENTLY ELIGIBLE FOR SALE AND COULD BE SOLD IN THE MARKET IN THE NEAR FUTURE, WHICH COULD DEPRESS ITS STOCK PRICE. The Company currently has 20,345,924 shares of common stock outstanding, 12,358,920 of which are currently freely tradable without restriction under the Securities Act of 1933. Of the remaining 7,987,004 shares outstanding, 6,412,004 shares have been registered for resale. The balance of shares outstanding are restricted securities, however, substantially all of these restricted securities have been held for more than two years and are available for resale pursuant to Rule 144 promulgated under the Securities Act. The sale of a significant number of shares of common stock could adversely affect the market price of the Company's common stock. Moreover, as these shares are sold, the market price could drop significantly if the holders of these restricted shares sell them or if the market perceives that the holders intend to sell these shares. 17 THE SIGNIFICANT NUMBER OF OUTSTANDING OPTIONS AND WARRANTS COULD DEPRESS THE MARKET PRICE OF THE COMPANY'S COMMON STOCK AND COULD INTERFERE WITH ITS ABILITY TO RAISE CAPITAL. The Company currently has outstanding options and warrants to purchase an aggregate of 5,599,474 shares of its common stock, at exercise prices ranging from $.75 to $3.50 per share. To the extent that the outstanding options and warrants are exercised, dilution to the percentage of ownership of its stockholders will occur and any sales in the public market of its common stock underlying those options and warrants may adversely affect prevailing market prices for its common stock. Moreover, the terms upon which the Company will be able to obtain additional equity capital may be adversely affected since the holders of outstanding options and warrants can be expected to exercise them when the Company would, in all likelihood, be able to obtain any needed capital on terms more favorable to us than those provided in the outstanding options and warrants. THE COMPANY'S COMMON STOCK IS SUBJECT TO THE SEC'S PENNY STOCK RULES WHICH CAN AFFECT THE MARKET LIQUIDITY AND THE ABILITY OF PURCHASERS TO SELL ITS COMMON STOCK. Because the Company's common stock is not listed on the Nasdaq National or SmallCap markets or a national securities exchange and the trading price of its common stock is below $5.00 per share, trading in the Company's common stock is subject to the SEC's penny stock rules, which severely limit the market liquidity of its common stock and the ability of purchasers to sell their shares. As a result, a purchaser of the Company's common stock could find it more difficult to dispose of, or obtain accurate quotations as to the market value of its common stock. PART II. - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS FILED ON FORM 8-K (a) Exhibits 99.1 Certification by Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification by Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K none 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: August 14, 2002 INTACTA TECHNOLOGIES INC. (Registrant) By: /s/ Noel R. Bambrough ---------------------- Noel R. Bambrough President and CEO By: /s/ Graham E. Argott ---------------------- Graham E. Argott Chief Financial Officer 19

INTACTA TECHNOLOGIES INC 10-Q