10QSB 1 zk62785.txt U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB (Mark One) [X] Quarterly report pursuant to Sections 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2006 [_] Transition report pursuant to Sections 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______________ to _______________ COMMISSION FILE NUMBER: 0-24431 INKSURE TECHNOLOGIES INC. (Exact Name of Small Business Issuer as Specified in Its Charter) DELAWARE 84-1417774 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 1770 N.W. 64TH STREET FORT LAUDERDALE, FL 33309 (Address of Principal Executive Offices, Including Zip Code) (954) 772-8507 (Issuer's Telephone Number, Including Area Code) -------------------------------------------- (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Check whether the Registrant (1) has filed all reports required to be filed by Section 123 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 filing requirements for the past ninety 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 [X] No [_] The number of shares outstanding of our Common Stock, $0.01 par value per share, as of August 3, 2006, was 15,589,296 shares. TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE): Yes [_] No [X] INKSURE TECHNOLOGIES INC. INDEX TO FORM 10-QSB PAGE PART I FINANCIAL INFORMATION 1 Item 1 Financial Statements 1 Condensed Consolidated Balance Sheet as of June 30, 2006 (unaudited) 2 Condensed Consolidated Statements of Operations (unaudited) for the Six and Three Months Ended June 30, 2006 and 2005 3 Statements of Stockholders' Equity as of June 30, 2006 (unaudited after December 31, 2005) 4 Condensed Consolidated Statements of Cash Flows (unaudited) for the Six and Three Months Ended June 30, 2006 and 2005 5 Notes to Consolidated Financial Statements 6 Item 2 Management's Discussion and Analysis or Plan of Operation 8 Item 3 Controls and Procedures 14 PART II OTHER INFORMATION 14 Item 1 Legal Proceedings 14 Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 15 Item 3 Defaults Upon Senior Securities 15 Item 4 Submission of Matters to a Vote of Security Holders 15 Item 5 Other Information 16 Item 6 Exhibits 16 SIGNATURES 17 - i - ITEM 1. FINANCIAL STATEMENTS -------------------------------------------------------------------------------- INKSURE TECHNOLOGIES INC. CONDENSED CONSOLIDATED BALANCE SHEET (U.S. DOLLARS IN THOUSANDS) JUNE 30, 2006 ------ UNAUDITED ------ ASSETS CURRENT ASSETS: Cash and cash equivalents $ 862 Short-term deposit 3,079 Trade receivables 316 Other accounts receivable and prepaid expenses 166 Inventories 634 ------ Total current assets 5,057 ------ PROPERTY AND EQUIPMENT, NET 356 ------ DEFERRED CHARGES 600 ------ GOODWILL 271 ------ Total assets $6,284 ====== The accompanying notes are an integral part of the consolidated financial statements. - 1 - INKSURE TECHNOLOGIES INC. CONDENSED CONSOLIDATED BALANCE SHEET (U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30, 2006 ------- UNAUDITED ------- LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Trade payables 363 Employees and payroll accruals 111 Deferred income 206 Accrued expenses 198 ------- Total current liabilities 878 ------- ACCRUED SEVERANCE PAY 18 ------- Convertible notes, net 5,820 Warrants to purchase Convertible notes 108 ------- Total amount related to Convertible notes 5,928 STOCKHOLDERS' EQUITY: Share capital: Preferred stock of $ 0.01 par value: Authorized: 10,000,000 stocks at June 30, 2006; Issued and outstanding: 0 stocks at June 30, 2006 Common Stock of $ 0.01 par value - Authorized: 35,000,000 stocks at June 30, 2006; Issued and outstanding: 15,589,296 stocks at June 30, 2006 156 Additional paid-in capital 12,803 Accumulated other comprehensive income 118 Accumulated deficit (13,617) ------- Total stockholders' equity (540) ------- Total liabilities and stockholders' equity 6,284 =======
The accompanying notes are an integral part of the consolidated financial statements. - 2 - INKSURE TECHNOLOGIES INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
SIX MONTHS ENDED THREE MONTHS ENDED JUNE 30, JUNE 30, ------------------------------ ------------------------------ 2006 2005 2006 2005 ------------ ------------ ------------ ------------ UNAUDITED UNAUDITED ------------------------------ ------------------------------ Revenues $ 977 $ 781 $ 439 $ 287 Cost of revenues 421 489 224 187 ------------ ------------ ------------ ------------ Gross profit 556 292 215 100 ------------ ------------ ------------ ------------ Operating expenses: Research and development 553 370 322 188 Selling and marketing 933 700 417 350 General and administrative 639 284 268 159 ------------ ------------ ------------ ------------ TOTAL operating expenses 2,125 1,354 1,007 697 ------------ ------------ ------------ ------------ Operating loss (1,569) (1,062) (792) (597) ------------ ------------ ------------ ------------ Financial income (expenses) (38) 17 (44) 6 Non cash financial expenses related to convertible notes, net (23) - (189) - ------------ ------------ ------------ ------------ Financial income (expenses), net (61) 17 (233) 6 Net loss $ (1,630) $ (1,045) $ (1,025) $ (591) ============ ============ ============ ============ Basic and diluted net loss per share $ (0.11) $ (0.07) $ (0.07) $ (0.04) ============ ============ ============ ============ Weighted average number of Common Stock used in computing basic and diluted net loss per share 15,308,704 15,011,579 15,381,742 15,011,579 ============ ============ ============ ============
The accompanying notes are an integral part of the consolidated financial statements. - 3 - INKSURE TECHNOLOGIES INC. STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY U.S. DOLLARS IN THOUSANDS
ACCUMULATED ADDITIONAL DEFERRED OTHER TOTAL SHARE PAID-IN STOCK-BASED COMPREHENSIVE ACCUMULATED STOCKHOLDERS' CAPITAL CAPITAL COMPENSATION INCOME DEFICIT EQUITY -------- -------- -------- -------- -------- -------- Balance as of January 1, 2004 $ 119 $ 9,683 - $ 118 $ (7,713) $ 2,207 Issuance of Common stock and warrants, net 31 2,348 - - - 2,379 Net loss - - - - (2,061) (2,061) -------- -------- -------- -------- -------- -------- Balance as of December 31, 2004 150 12,031 - 118 (9,774) 2,525 Grant of warrant 58 (58) - Amortization of deferred stock-based compensation 46 46 Conversion of 368,429 warrants into 223,278 ordinary shares 2 71 - - 73 Net loss - - - (2,213) (2,213) -------- -------- -------- -------- -------- -------- Balance as of December 31, 2005 152 12,160 (12) 118 (11,987) 431 Stock based compensation - 457 - - - 457 Amortization of deferred stock-based compensation - - 12 - - 12 Conversion of 380,723 warrants/options into 354,442 ordinary shares 4 186 - - 190 Net loss - - - - (1,630) (1,630) -------- -------- -------- -------- -------- -------- Balance as of June 30, 2006 $ 156 $ 12,803 - $ 118 $(13,617) $ (540) ======== ======== ======== ======== ======== ========
The accompanying notes are an integral part of the consolidated financial statements. - 4 - INKSURE TECHNOLOGIES INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS U.S. DOLLARS IN THOUSANDS
SIX MONTHS ENDED THREE MONTHS ENDED JUNE 30, JUNE 30, --------------------- --------------------- 2006 2005 2006 2005 ------- ------- ------- ------- UNAUDITED UNAUDITED --------------------- --------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(1,630) $(1,045) $(1,025) $ (591) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 513 47 159 22 Accrued severance pay, net (1) - (2) - Decrease (increase) in trade receivables 44 35 104 (10) Non cash financial (income) expenses related to convertible notes, net (49) - 153 - Increase in other accounts receivable and prepaid expenses 26 (15) 53 34 Decrease (increase) in inventories (39) 39 31 (45) Increase (decrease) in trade payables (131) (109) (32) (132) Increase (decrease) in employees and payroll accruals 7 (8) (3) (7) Increase (decrease) in other payables (15) 277 7 253 ------- ------- ------- ------- Net cash used in operating activities (1,275) (779) (555) (476) ------- ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (63) (11) (15) (7) Proceeds from short-term bank deposits 1,278 - 826 - ------- ------- ------- ------- Net cash provided by (used in) investing activities 1,215 (11) 811 (7) ------- ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Exercise of options 190 - 190 - Issuance of common stock, net - 18 - 18 ------- ------- ------- ------- Net cash provided by (used in) financing activities 190 18 190 18 ------- ------- ------- ------- Increase (decrease) in cash and cash equivalents 130 (772) 446 (465) Cash and cash equivalents at the beginning of the period 732 1,648 416 1,341 ------- ------- ------- ------- Cash and cash equivalents at the end of the period $ 862 $ 876 $ 862 $ 876 ======= ======= ======= =======
The accompanying notes are an integral part of the consolidated financial statements. - 5 - INKSURE TECHNOLOGIES INC. NOTES TO THE CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS NOTE 1 - BASIS OF PRESENTATION The accompanying condensed unaudited interim consolidated financial statements have been prepared by INKSURE TECHNOLOGIES INC. (the "Company") in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-QSB and Article 10 of Regulation S-X. These financial statements reflect all adjustments, consisting of normal recurring adjustments and accruals, which are, in the opinion of management, necessary for a fair presentation of the financial position of the Company as of June 30, 2006 and the results of operations and cash flows for the interim periods indicated in conformity with generally accepted accounting principles applicable to interim periods. Accordingly, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These financial statements should be read in conjunction with the audited financial statements and notes thereto of the Company for the year ended December 31, 2005 that are included in the Company's Form 10-KSB filed with the Securities and Exchange Commission on March 30, 2006 (the "2005 10-KSB"). The results of operations presented are not necessarily indicative of the results to be expected for future quarters or for the year ending December 31, 2006. NOTE 2: - STOCK-BASED COMPENSATION In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment." SFAS No. 123(R) which requires the Company to measure all employee stock-based compensation awards using a fair value method and record such expense in its consolidated financial statements. In March 2005, the SEC issued Staff Accounting Bulletin (SAB) 107, which provides the Staff's views regarding interactions between SFAS No. 123(R) and certain SEC rules and regulations and provides interpretations of the valuation of share-based payments for public companies. The adoption of SFAS No. 123(R) requires additional accounting related to the income tax effects and additional disclosure regarding the cash flow effects resulting from share-based payment arrangements. The adoption of SFAS No. 123(R) in the fiscal quarter ended March 30, 2006, had a material impact on the Company's consolidated results of operations, financial position and statement of cash flows. InkSure adopted the provisions of SFAS No. 123(R), "Share-Based Payment". SFAS No. 123(R) establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the employee requisite service period. The Company previously applied Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations and provided the required pro forma disclosures of SFAS No. 123, "Accounting for Stock-Based Compensation". Prior to the adoption of SFAS No. 123(R), the Company provided the disclosures required under SFAS No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosures." - 6 - The pro-forma information for the six months and three months periods ended June 30, 2005 was as follows: SIX MONTHS THREE MONTHS ENDED ENDED JUNE 30, JUNE 30, ------- ------- 2005 2005 ------- ------- UNAUDITED UNAUDITED ------- ------- Net loss, as reported $(1,045) $ (591) Deduct: Total stock-based compensation expense determined under fair value method for all awards (160) (84) ------- ------- Pro forma net loss $(1,205) $ (675) ======= ======= Basic and diluted net loss per share, as reported $ (0.07) $ (0.04) ======= ======= Basic and diluted net loss per share, pro forma $ (0.08) $ (0.04) ======= ======= - 7 - ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION In this section, "Management's Discussion and Analysis or Plan of Operation," references to "we," "us," "our," and "ours" refer to InkSure Technologies Inc. and its consolidated subsidiaries. This Quarterly Report on Form 10-QSB contains statements that may constitute "forward-looking statements" within the meaning, and made pursuant to the Safe Harbor provisions, of the Private Securities Litigation Reform Act of 1995. Such statements are based on management's current expectations and are subject to a number of risks and uncertainties, including, but not limited to, the difficulty inherent in operating an early-stage company in a new and rapidly evolving market, market and economic conditions, the impact of competitive products, product demand and market acceptance risks, changes in product mix, costs and availability of raw materials, fluctuations in operating results, delays in development of highly complex products, risk of customer contract or sales order cancellations and other risks detailed from time to time in our filings with the Securities and Exchange Commission. These risks and uncertainties could cause our actual results to differ materially from those described in the forward-looking statements. Any forward-looking statement represents our expectations or forecasts only as of the date it was made and should not be relied upon as representing its expectations or forecasts as of any subsequent date. Except as required by law, we undertake no obligation to correct or update any forward-looking statement, whether as a result of new information, future events or otherwise, even if our expectations or forecasts change. The following discussion and analysis should be read in conjunction with the financial statements, related notes and other information included in this Quarterly Report on Form 10-QSB. OVERVIEW We specialize in comprehensive security solutions, designed to protect branded products and documents of value from counterfeiting, fraud, and diversion. By creating "Smart Protection" systems from proprietary machine-readable authentication technologies, we help companies and organizations worldwide regain control over their most valuable assets, their products, their reputation and their revenues. We employ a team of experts in the fields of material science, electro-optics and software. We utilize cross-disciplinary technological innovations to implement customized and cost efficient security systems for data and asset integrity within the customer's existing infrastructure and environment. Our SmartInkTM solutions enable authentication and tracking of documents and products by adding special chemical markers to standard inks and coatings. The combination of markers, inks and materials produce electro-optic "signatures", unique codes that are seamlessly incorporated into the printed media used by the customer. Proprietary computerized readers, available in hand-held, stationary and modular kit configurations, quickly verify these codes by manual or automatic operation. By focusing on customer driven solutions, we are able to offer added value through enhanced reader functionality, including high-speed automatic sorting, one-to-many code matching, first and second level track and trace, code activation at the point of distribution and detrimental authentication for debit applications. The inherent flexibility of our technology also enables overlaying the machine-readable codes onto holograms and other overt features, resulting in multi-layered security that is both effective and economical. - 8 - FACTORS AFFECTING FUTURE RESULTS INDUSTRY AND ECONOMIC FACTORS: Our operations and earnings are affected by local, regional and global events or conditions that affect supply and demand for products and services. These events or conditions are generally not predictable and include, among other things, general economic growth rates and the occurrence of economic recessions; the development of new supply sources; supply disruptions; technological advances, including advances in security technology and advances in technology relating to security usage; changes in demographics, including population growth rates and consumer preferences; and the competitiveness of alternative security sources or product substitutes. COMPETITIVE FACTORS: The brand and document protection industry is competitive. There is competition with the traditional document protection suppliers (mainly protection for bank notes) and also with other emergent "next generation" technology providers. We compete with other firms in the sale and purchase of various products and services in many national and international markets and employ all methods of competition, which are lawful and appropriate for such purposes. We believe that a key component of our competitive position is our technology. POLITICAL FACTORS: Our operations and earnings have been, and may in the future be, affected from time to time in varying degrees by political instability and by other political developments and laws and regulations, such as forced divestiture of assets; restrictions on production; imports and exports; war or other international conflicts; civil unrest and local security concerns that threaten the safe operation of our facilities, particularly those that are located in Israel; price controls; expropriation of property; and the cancellation of contract rights. Both the likelihood of such occurrences and their overall effect upon us vary greatly from country to country and are not predictable. PROJECT FACTORS: In addition to the factors cited above, the advancement, cost and results of particular projects depend on the outcome of negotiations with potential partners, governments, suppliers, customers or other third parties; changes in operating conditions or costs; and the occurrence of unforeseen technical difficulties. REVENUES We are currently concentrating on entering into and implementing large-scale projects. These potential contracts are subject into to a long sales cycle and the timetable is lengthy for entering into and implementing such projects. These projects involve high volume sales through multiple-year sales contracts. We have completed several successful field trials during the last year related to these projects. Our revenues in the second quarter of 2006 consisted of revenues from (i) our sales agreements for brand protection with two North American customers; and (ii) ink sales related to projects in Turkey (iii) initial sales to new customers. In the second quarter of 2006 approximately 72% of our revenues were earned from customers located in the United States. COSTS AND OPERATING EXPENSES Costs and operating expenses consist of cost of revenues, research and development expenses, selling and marketing expenses, general and administrative expenses and depreciation. Our cost of revenues consists primarily of materials, including taggants and electronic and optical parts, payments to sub-contractors and compensation costs for our operations staff. Our research and development expenses consist primarily of costs associated with the development of new generic products and the development of new products related to customer projects. These expenses may fluctuate as a percentage of revenue depending on the projects undertaken during the reporting period. Since our inception, we have expensed all research and development costs in each of the periods in which they were incurred. - 9 - Our selling and marketing expenses consist primarily of costs associated with our direct sales force that have been incurred to attract potential business customers, professional advisors and commissions. We anticipate that, as we add new customers, we will be able to spread these costs over a larger revenue base and, accordingly, improve our operating margins. Our general and administrative expenses consist primarily of costs related to compensation and employees benefits of our management (including the costs of directors' and officers' insurance), legal and accounting fees, as well as the expenses associated with being a publicly traded company. We have not recorded any income tax benefit for net losses and credits incurred for any period from inception to June 30, 2006. The utilization of these losses and credits depends on our ability to generate taxable income in the future. Because of the uncertainty of our generating taxable income, we have recorded a full valuation allowance with respect to these deferred assets. CRITICAL ACCOUNTING POLICIES Our financial statements are prepared in accordance with US GAAP. The significant accounting policies followed in the preparation of the financial statements, applied on a consistent basis and which have been prepared in accordance with the historical cost convention, are set forth in Note 2 to the Consolidated Financial Statements as of December 31, 2005. Of these significant accounting policies, certain policies may be considered critical because they are most important to the portrayal of our financial condition and results, and they require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. REVENUE RECOGNITION. Revenues from product sales are recognized in accordance with Staff Accounting Bulletin No. 104, "Revenue Recognition in Financial Statements", or SAB No. 104, when delivery has occurred, persuasive evidence of an agreement exists, the vendor's fee is fixed or determinable, no further obligation exists and collectability is probable. Delivery is considered to have occurred upon shipment of products. When a right of return exists, we defer revenues until the right of return expires. We do not grant a right of return to our customers. Revenues from certain arrangements may include multiple elements within a single contract. Our accounting policy complies with the provisions of Emerging Issues Task Force Issue 00-21, "Revenue Arrangements with Multiple Deliverables" ("EITF 00-21"), relating to the separation of multiple deliverables into individual accounting units with determinable fair value. In cases where we have partial delivery at the cut off dates and no fair value exist for the undelivered elements revenues are being deferred and recognized only at the point where the entire arrangement has been delivered. INVENTORIES. Inventories are stated at the lower of cost or net realizable value. Cost is determined by calculating raw materials, work in process and finished products using the "first in, first out" method. OTHER ACCRUED EXPENSES. We also maintain other accrued expenses. These accruals are based on a variety of factors including past experience and various actuarial assumptions and, in many cases, require estimates of events not yet reported to us. If future experience differs from these estimates, operating results in future periods would be impacted. - 10 - THREE MONTHS ENDED JUNE 30, 2006 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2005 REVENUES. Revenues consist of gross sales of products less discounts. We are currently concentrating on entering and implementing large-scale projects. In the three months ended June 30, 2006, we had revenue of $439,000, compared to $287,000 in the three months ended June 30, 2005. Revenues increased by $152,000, or 53.0%, in the three months ended June 30, 2006 compared to the three months ended June 30, 2005. The increase is mainly related to higher sales in regard to brand protection project with one of our North American customers and higher sales to one project in Turkey. COST OF REVENUE. Our cost of revenue consists of materials, sub-contractors and compensation costs. Cost of revenues increased by $37,000, or 19.8%, to $224,000 in the three months ended June 30, 2006 from $187,000 in the three months ended June 30, 2005. Cost of revenues as a percentage of sales was 51.0% in the three months ended June 30, 2006, compared with 65.1% in the three months ended June 30, 2005. The decrease in cost of revenues is mainly related to higher sales with higher gross margin. Cost of revenue included a non cash expenses of $4,000 related to the implementation of SFAS No. 123(R). RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses consist primarily of compensation costs attributable to employees engaged in ongoing research and development activities, development-related raw materials and sub-contractors and other related costs. Research and development expenses increased by $134,000, or 71.3%, to $322,000 in the three months ended June 30, 2006 from $188,000 in the three months ended June 30, 2005. This increase in research and development expenses is primarily related to non-cash expenses of $8,000 as a result of the implementation of SFAS No. 123(R), a one time charge of $65,000 as a result of settlement agreement in an action relating to a real property lease and higher research and development expenses related to our RFID project. SELLING AND MARKETING EXPENSES. Selling and marketing expenses consist primarily of costs relating to compensation attributable to employees engaged in sales and marketing activities, promotion, advertising, trade shows and exhibitions, sales support, travel, commissions and related expenses. Selling and marketing expenses increased by $67,000, or 19.1%, to $417,000 in the three months ended June 30, 2006 from $350,000 in the three months ended June 30, 2005. This increase in selling and marketing expenses was primarily due to non-cash expenses of $22,000 as a result of the implementation of SFAS No. 123(R) and higher sales and marketing expenses related to the expansion of our marketing activates in the US. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist primarily of compensation costs for administration, finance and general management personnel, insurance, legal, accounting and administrative costs. General and administrative expenses increased by $109,000, or 68.6%, to $268,000 in the three months ended June 30, 2006 from $159,000 in the three months ended June 30, 2005. The increase was primarily related to non-cash expenses of $103,000 as a result of the implementation of SFAS No.123(R) and higher legal expenses. FINANCIAL EXPENSES, NET. Financial expenses, net, increased by $239,000 to $233,000 in the three months ended June 30, 2006 from income of $6,000 in the three months ended June 30, 2005. This increase is due to non-cash financial expenses of $189,000 related to the convertible notes and changes in the exchange rate between the United States Dollar, the Israeli New Shekel and the Great Britain Pound. - 11 - NET LOSS. We had a net loss of $1,025,000 in the three months ended June 30, 2006, compared with a net loss of $591,000 in the three months ended June 30, 2005. The 73.4% increase in net loss in the three months ended June 30, 2006 in comparison with the three months ended June 30, 2005 is attributable mainly to non-cash expenses of $137,000 as a result of the implementation of SFAS No. 123(R), non-cash expenses of $189,000 related to the convertible notes and various influences described above. SIX MONTHS ENDED JUNE 30, 2006 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2005 REVENUE. Revenue consists of gross sales of products less discounts. We are currently concentrating on entering and implementing large-scale projects. These potential contracts are subject to a long sales cycle and fluctuated timetable for entering and implementing such projects. Revenues increased by $196,000, or 25.1%, in the six months ended June 30, 2006 compared to the six months ended June 30, 2005. In the six months ended June 30, 2006, we had revenue of $977,000, compared to $781,000 in the six months ended June 30, 2005, primarily due to our new customers located in the United States. COST OF REVENUE. Our cost of revenue consists of materials, sub-contractors and compensation costs. Cost of revenue in the six months ended June 30, 2006 was $421,000, compared to $489,000 in the six months ended June 30, 2005. Cost of revenue as a percentage of sales was 43.1% in the six months ended June 30, 2006, compared with 62.6% in the six months ended June 30, 2005. The decrease in cost of revenue is mainly related to higher sales with higher gross margin. Cost of revenue included non-cash expenses of $5,000 related to the implementation of SFAS No. 123(R). RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses consist primarily of compensation costs attributable to employees engaged in ongoing research and development activities, development-related raw materials and sub-contractors, and other related costs. Research and development expenses increased by $183,000, or 49.4%, to $553,000 in the six months ended June 30, 2006 from $370,000 in the six months ended June 30, 2005. This increase in research and development expenses is primarily related to non-cash expenses of $41,000 as a result of the implementation of SFAS No. 123(R), one time charge of $65,000 as a result of a settlement agreement in regard to a lawsuit relating to a real property lease and higher research and development expenses related to our RFID project. SELLING AND MARKETING EXPENSES. Selling and marketing expenses consist primarily of costs relating to compensation attributable to employees engaged in sales and marketing activities, promotion, advertising, trade shows and exhibitions, sales support, travel, commissions and related expenses. Selling and marketing expenses increased by $233,000, or 33.3%, to $933,000 in the six months ended June 30, 2006 from $700,000 in the six months ended June 30, 2005. This increase in selling and marketing expenses was primarily due to non-cash expenses of $101,000 as a result of the implementation of SFAS No. 123(R) and higher sales and marketing expenses related to the expansion of our marketing activities in the US. We believe that the significant investment in pre-sales and marketing activities will contribute to our short-term and long-term sales levels. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist primarily of compensation costs for administration, finance and general management personnel, insurance, legal, accounting and administrative costs. General and administrative expenses increased by $355,000, or 125.0%, to $639,000 in the six months ended June 30, 2006 from $284,000 in the six months ended June 30, 2005. The increase was primarily related to non-cash expenses of $310,000 as a result of the implementation of SFAS No.123(R) and higher legal expenses. - 12 - FINANCIAL EXPENSES, NET. Financial expenses, net, increased by $78,000, to $61,000 in the six months ended June 2006 from income of $17,000 in the six months ended June 30, 2005. This increase is due to non-cash financial expenses of $23,000 related to the convertible notes and changes in the exchange rate between the United States Dollar, the Israeli New Shekel and the Great Britain Pound. NET LOSS. We had a net loss of $1,630,000 in the six months ended June 30, 2006, compared with a net loss of $1,045,000 in the six months ended June 30, 2005. The 56.0% increase in net loss in the six months ended June 30, 2006 in comparison with the six months ended June 30, 2005 is attributable to the various influences described in the immediately preceding paragraph. B. LIQUIDITY AND CAPITAL RESOURCES We have incurred substantial losses since our inception in May 2000. We had an accumulated deficit of approximately $13,617,000 at June 30, 2006, and had a working capital (current assets less current liabilities) of approximately $4,179,000 at June 30, 2006. Capital expenditures were approximately $15,000 in the three months ended June 30, 2006 and $7,000 in the three months ended June 30, 2005. Capital expenditures were approximately $63,000 in the six months ended June 30, 2006 and $11,000 in the six months ended June 30, 2005. We do not have any material commitments for capital expenditures for the year ending December 31, 2006. At June 30, 2005, we had cash, cash equivalents and short-term deposits of approximately $3,941,000, compared to $876,000 at June 30, 2005. The differences from June 30, 2006 to June 30, 2005 are due to the issuance of convertible notes with net proceeds of $5,304,000, as such amount is offset by our continuing investments in research and development and selling and marketing expenses. We generated negative cash flow from operating activities of approximately $555,000 in the three months ended June 30, 2006, compared to $476,000 in the three months ended June 30, 2005. We generated negative cash flow from operating activities of approximately $1,275,000 in the six months ended June 30, 2006 compared to $779,000 in the six months ended June 30, 2005. We believe that cash generated from operations will provide sufficient cash resources to finance our operations and the projected expansion of our marketing and research and development activities for at least the next twelve months. However, if our operations do not generate cash to the extent currently anticipated, or we grow more rapidly than currently anticipated, it is possible that we would require more funds than presently anticipated. C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES We believe that our future success will depend upon our ability to enhance our existing products and systems and introduce new commercially viable products and systems addressing the demands of the evolving markets for brand and document protection. As part of the product development process, we work closely with current and potential customers, distribution channels and leaders in certain industry segments to identify market needs and define appropriate product specifications. Our employees also participate in industry forums in order to stay informed about the latest industry developments. Our research and development expenses were approximately $322,000 in the three months ended June 30, 2006, compared to $188,000 in the three months ended June 30, 2005. Our research and development expenses were approximately $553,000 in the six months ended June 30, 2006, compared to $370,000 in the six months ended June 30, 2005. To date, all research and development expenses have been charged to operating expenses as incurred. - 13 - We currently hold one pending patent in the United States and we have been issued two patents in Israel relating to our technology of marking documents for the purpose of authentication. With respect to the RFID technology being developed by us, we have applied for four patents: we have been issued patents for our first application in each of the United States, France, Germany, Switzerland and the United Kingdom; we have been issued a patent in the United States and a European Patent for our second application; we have been issued a patent in the United States for our third application and we hold one pending patent before the European Patent Office; and we have only recently made an application before the United States Patent and Trademark Office with respect to our fourth patent application. D. CONTRACTUAL OBLIGATIONS AND COMMITMENTS Our contractual obligations and commitments at June 30, 2006 principally include obligations associated with operating lease obligations and the lease of several automobiles. Our total future obligation is approximately $120,000 until 2007. We expect to finance these contractual commitments from cash on hand and cash generated from operations. ITEM 3. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures. Our principal executive officer and principal financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-QSB, have concluded that, based on such evaluation, our disclosure controls and procedures were adequate and effective to ensure that material information relating to us, including our consolidated subsidiaries, was made known to them by others within those entities, particularly during the period in which this Quarterly Report on Form 10-QSB was being prepared. (b) Changes in Internal Controls. There were no changes in our internal control over financial reporting, identified in connection with the evaluation of such internal control that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On December 12, 1999, Secu-Systems filed a lawsuit with the District Court in Tel Aviv-Jaffa against Supercom Ltd. (InkSure Delaware's former parent company) and InkSure Ltd. seeking a permanent injunction and damages. The plaintiff asserted in its suit that the printing method applied to certain products that have been developed by InkSure Ltd. constitutes, INTER ALIA: (a) breach of a confidentiality agreement between the plaintiff and Supercom; (b) unjust enrichment of Supercom and InkSure Ltd.; (c) a breach of fiduciary duties owed to the plaintiff by Supercom and InkSure Ltd.; and (d) a tort of misappropriation of trade secret and damage to plaintiff's property. As part of its complaint, Secu-Systems sought, among other things, an injunction and a 50% share of profits from the printing method at issue. On March 15, 2006, the court rendered a decision (i) denying the claim for breach of contract; (ii) finding that there was a misappropriation of a trade secret, but not assessing any damages with respect thereto; (iii) requiring the defendants to cease all activity involving the use of any confidential information; and (iv) awarding the plaintiff reimbursement of the costs of the litigation in the amount of NIS 130,000, plus interest and VAT, which the defendants had split equally. - 14 - Both the plaintiff and the defendants have filed an appeal to the court's decision, and the parties are awaiting the court's decision. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held its Annual Meeting of Stockholders on June 15, 2006. The following matters were voted on at the Annual Meeting of Stockholders: Proposal 1: Election of a Board of Directors. NUMBER OF SHARES VOTED FOR AGAINST WITHHELD --- ------- -------- Elie Housman 12,022,381 0 80 Yaron Meerfeld 12,022,381 0 80 James Lineberger 12,022,381 0 80 Philip Getter 12,022,381 0 80 Michael Acks 12,022,381 0 80 Albert Attias 12,022,381 0 80 David Sass 12,022,381 0 80 Proposal 2: Ratification of the appointment of Brightman Almagor & Co., Certified Public Accountants, A member firm of Deloitte Touche Tohmatsu, as the independent auditors and accountants for the Company for the year ending December 31, 2006. There were a total of 12,022,461 votes cast in favor this proposal, with no votes withheld or cast against this proposal. - 15 - ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS The following exhibits are being filed with this Report: EXHIBIT NUMBER DESCRIPTION ------ ----------- 31.1* Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. 31.2* Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. 32.1* Certification of Principal Executive Officer and Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. * Filed herewith. - 16 - SIGNATURES In accordance with the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. INKSURE TECHNOLOGIES INC. Dated: As of August 3, 2006 By: /s/ Eyal Bigon -------------------- Eyal Bigon Chief Financial Officer, Secretary and Treasurer (Principal Financial and Accounting Officer) Dated: As of August 3, 2006 By: /s/ Elie Housman -------------------- Elie Housman Chief Executive Officer (Principal Executive Officer) - 17 -