Item 2.  Management’s Discussion and Analysis or Plan of Operations

FORWARD-LOOKING INFORMATION

We caution readers that certain important factors may affect our actual results and could cause such results to differ materially from any forward-looking statements that we make in this report.  For this purpose, any statements that are not statements of historical fact may be deemed to be forward-looking statements.  This report contains statements that constitute “forward-looking statements.”  These forward-looking statements can be identified by the use of predictive, future-tense or forward-looking terminology, such as “believes,” “anticipates,” “expects,” “estimates,” “plans,” “may,” or similar terms.  These statements appear in a number of places in this report and include statements regarding our intent, belief or current expectations with respect to many things, some of which are:

 trends affecting our financial condition or results of operations for our limited history;  

 our business and growth strategies;  

 our technology;  

 the Internet; and  

 our financing plans.  

We caution readers that any such forward-looking statements are not guarantees of future performance and involve significant risks and uncertainties.  In fact, actual results most likely will differ materially from those projected in the forward-looking statements as a result of various factors.  Some factors that could adversely affect actual results and performance include:

 our limited operating history;  

 our lack of sales to date;  

 our requirements for additional capital and operational funding;  

 the failure of our technology and products to perform as specified;  

 the discontinuance of growth in the use of the Internet;  

 the enactment of new adverse government regulations; and  

 the development of better technology and products by others.  

You should carefully consider and evaluate all of these factors.  In addition, we do not undertake to update forward-looking statements after we file this report with the SEC, even if new information, future events or other circumstances have made them incorrect or misleading.

CRITICAL ACCOUNTING POLICIES

We prepare our financial statements in accordance with generally accepted accounting principles in the United States of America.  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 and related disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  Significant accounting policies and methods used in preparation of the financial statements are described in note 2 to our 2018 Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2018.  We evaluate our estimates and assumptions on a regular basis, based on historical experience and other relevant factors.  Actual results could differ materially from these estimates and assumptions.  The following critical accounting policies are impacted by judgments, assumptions and estimates used in preparation of our June 30, 2019 Interim Consolidated Financial Statements.

Research and development expenses:

We expense all of our research and development expenses in the period in which they are incurred.  At such time as our product is determined to be commercially available, we will capitalize those development expenditures that are related to the maintenance of the commercial products, and amortize these capitalized expenditures over the estimated life of the commercial product.  The estimated life of the commercial product will be based on management’s estimates, including estimates of current and future industry conditions.  A significant change to these assumptions could impact the estimated useful life of our commercial product resulting in a change to amortization expense and impairment charges.

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Stock based compensation:

The Company accounts for its stock-based payments in accordance with FASB Accounting Standards Codification Topic 718 “Compensation – Stock Compensation”, which requires all share-based payments, including stock options granted by the Company to its employees, to be recognized as expenses, based on the fair value of the share-based payments at the date of grant.  For purposes of estimating the grant date fair value of stock-based compensation, the Company uses the Black Scholes option-pricing model, and has elected to treat awards with graded vesting as a single award.  The fair value of awards granted is recognized as compensation expense on a straight-line basis over the requisite service period, which in the Company’s circumstances is the stated vesting period of the award.

Financial instruments

We have issued convertible notes and convertible notes with common shares.  The fair value of the convertible notes is required to be estimated as well as the fair value of the convertible notes issued with common shares.  There are significant assumptions and management estimates used in determining these amounts.  A significant change to these assumptions could result in a significant change to the fair value of the convertible notes.

RESULTS OF OPERATIONS

The three months ended June 30, 2019 compared to the three months ended June 30, 2018

Revenue: We had no revenue during the three months ended June 30, 2019, nor during the three months ended June 30, 2018.  Since August 1999 we have directed all of our attention towards the completion, and sales and marketing of our software applications.  We believe that if we are successful in our development and sales and marketing efforts, we will generate a source of revenue in the future from sales and/or licensing of our software applications.

Selling, general and administrative expenses: Selling, general and administrative expenses consist primarily of personnel costs, professional fees, communication expenses, travel and other miscellaneous costs associated with supporting our research and development, sales and marketing and investor relations activities.  During the three months ended June 30, 2019, we incurred a total of $44,671, as compared to $69,731 during the three months ended June 30, 2018.  There was an overall decrease in selling, general and administrative expenses of $25,060 (36%) during the three months ended June 30, 2019 as compared to the three months ended June 30, 2018.

This decrease occurred primarily as a result of a decrease in the fair value of stock-based compensation recognized as expense during the three months ended June 30, 2019 as compared with the three months ended June 30, 2018, relating to the amortization of prepaid balances for service contracts.

We have made efforts to minimize selling, general and administrative expenses wherever possible, through measures such as reducing the number of personnel, postponing our Annual General Meeting, reducing the number of trade shows in which we participate, reducing travel costs, delaying production of new promotional material, and reducing our occupancy costs.  We will continue to carefully monitor our selling, general and administrative expenses as we work within current budgetary limits leading up to the full commercial release of our products.

Research and development expenses:   Research and development expenses consist primarily of personnel costs directly associated with the research and development of our technology and of the use of our technology in the proposed software applications of our prospective customers.  During the three months ended June 30, 2019, we incurred a total of $82,504, as compared to $22,089 during the three months ended June 30, 2018 on research and development activities. There was an overall increase in research and development expenses of $60,415 (274%) during the three months ended June 30, 2019 as compared to the three months ended June 30, 2018.

The increase in research and development expenses occurred as a result of an increase in fees paid to consultants during the three months ended June 30, 2019 as compared with the three months ended June 30, 2018.

During the three months ended June 30, 2019, the primary focus of our development activity was supporting customer and prospect technical reviews as well as development of the next versions of our ValidianProtect and Data Protection Module technology.

During the three months ended June 30, 2018, the primary focus of our development activity was research on securing web applications and browsers including design, architecture and testing.

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Interest and financing costs:  Interest and financing costs during the three months ended June 30, 2019 and during the three months ended June 30, 2018 consisted of costs associated with our 10% senior convertible notes, our promissory notes, and our convertible promissory notes. During the three months ended June 30, 2019, we incurred $48,898 in interest and financing costs, a decrease of $104,387 (68%) from the $153,285 in interest and financing costs incurred during the three months ended June 30, 2018.  

The $48,898 in interest and financing costs we incurred during the three months ended June 30, 2019 is comprised of $48,898 of interest paid and payable to the holders of our debt; $nil of accretion of our promissory notes; $nil of accretion of our convertible promissory notes; and $nil of amortized deferred finance fees and original issue discount relating to the promissory notes and convertible promissory notes.  The $153,285 in interest and financing costs we incurred during the three months ended June 30, 2018 is comprised of $41,144 of interest paid and payable to the holders of our debt; $nil of accretion of our promissory notes; $96,493 of accretion of our convertible promissory notes; and $15,648 of amortized deferred finance fees and original issue discount relating to the promissory notes and convertible promissory notes.

We failed to settle certain of our promissory notes and 10% senior convertible notes, and accrued interest thereon, when they became due on various dates between October 1, 2008, and June 30, 2019; a significant portion of these notes remain in default as at June 30, 2019.  In accordance with the default provision of the 10% senior convertible notes, and of the promissory notes outstanding at June 30, 2019, this has resulted in all of these notes becoming due and payable on demand as of the date of the default, or in the case of notes issued subsequent to the default, on the date of issuance, notwithstanding any other stated maturity date.  Consequently, the accretion relating to the equity components of these notes issued since the initial event of default, and the amortization of any finance charges incurred thereon, has occurred in the period of issuance.   

Accretion of our convertible promissory notes decreased by $96,493 (100%) due to no conversions made in the second quarter of 2019 versus conversions made in the second quarter of 2018 in excess of the value of convertible promissory notes historically issued.

Foreign exchange gain (loss):  Foreign exchange gain (loss) is comprised of realized gains and losses on foreign currency conversions, the majority of which relate to accounts payable and accrued liabilities denominated in Canadian dollars.  During the three months ended June 30, 2019, the Canadian dollar gained strength relative to the United States dollar, resulting in an overall loss on foreign currency transactions of $32,824. During the three months ended June 30, 2018 the United States dollar gained strength relative to the Canadian dollar, resulting in an overall gain on foreign currency transactions of $39,089.

Net loss: We incurred a loss of $208,897 (rounded to $0.00 per share) for the three months ended June 30, 2019, compared to a loss of $206,016 (rounded to $0.00 per share) for the three months ended June 30, 2018.  Our revenues and future profitability are substantially dependent on our ability to:

 raise additional capital to fund operations;  

 license software applications to a sufficient number of clients;  

 be cash-flow positive on an ongoing basis;  

 modify the successful software applications, over time, to provide enhanced benefits to then-existing users; and  

 successfully develop related software applications.  

The six months ended June 30, 2019 compared to the six months ended June 30, 2018

Revenue: We had no revenue during the six months ended June 30, 2019, nor during the three months ended June 30, 2018.  Since August 1999 we have directed all of our attention towards the completion, and sales and marketing of our software applications.  We believe that if we are successful in our development and sales and marketing efforts, we will generate a source of revenue in the future from sales and/or licensing of our software applications.

Selling, general and administrative expenses: Selling, general and administrative expenses consist primarily of personnel costs, professional fees, communication expenses, travel and other miscellaneous costs associated with supporting our research and development, sales and marketing and investor relations activities.  During the six months ended June 30, 2019, we incurred a total of $101,063, as compared to $140,980 during the six months ended June 30, 2018.  There was an overall decrease in selling, general and administrative expenses of $39,917 (28%) during the six months ended June 30, 2019 as compared to the six months ended June 30, 2018.

This decrease occurred primarily as a result of a decrease in the fair value of stock-based compensation recognized as expense during the six months ended June 30, 2019 as compared with the six months ended June 30, 2018, relating to the amortization of prepaid balances for service contracts.

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We have made efforts to minimize selling, general and administrative expenses wherever possible, through measures such as reducing the number of personnel, postponing our Annual General Meeting, reducing the number of trade shows in which we participate, reducing travel costs, delaying production of new promotional material, and reducing our occupancy costs.  We will continue to carefully monitor our selling, general and administrative expenses as we work within current budgetary limits leading up to the full commercial release of our products.

Research and development expenses:   Research and development expenses consist primarily of personnel costs directly associated with the research and development of our technology and of the use of our technology in the proposed software applications of our prospective customers.  During the six months ended June 30, 2019, we incurred a total of $87,170, as compared to $22,089 during the six months ended June 30, 2018 on research and development activities. There was an overall increase in research and development expenses of $65,081 (295%) during the six months ended June 30, 2019 as compared to the six months ended June 30, 2018.

The increase in research and development expenses occurred as a result of an increase in fees paid to consultants during the six months ended June 30, 2019 as compared with the six months ended June 30, 2018.

During the six months ended June 30, 2019, the primary focus of our development activity was supporting customer and prospect technical reviews as well as development of the next versions of our ValidianProtect and Data Protection Module technology.

During the six months ended June 30, 2018, the primary focus of our development activity was supporting analysis by our prospective customers of what cyber security risks that Validian's core technology could protect against in our prospective customers' technical environments; and research on securing web applications and browsers including design, architecture and testing.        

Interest and financing costs:  Interest and financing costs during the six months ended June 30, 2019 and during the six months ended June 30, 2018 consisted of costs associated with our 10% senior convertible notes, our promissory notes, and our convertible promissory notes.  During the six months ended June 30, 2019, we incurred $86,826 in interest and financing costs, a decrease of $185,341 (68%) from the $272,167 in interest and financing costs incurred during the six months ended June 30, 2018.  

The $86,826 in interest and financing costs we incurred during the six months ended June 30, 2019 is comprised of $86,826 of interest paid and payable to the holders of our debt; $nil of accretion of our promissory notes; $nil of accretion of our 10% senior convertible notes; $nil of accretion of our convertible promissory notes; and $nil of amortized deferred finance fees and original issue discount relating to the promissory notes and convertible promissory notes.  The $272,167 in interest and financing costs we incurred during the six months ended June 30, 2018 is comprised of $80,770 of interest paid and payable to the holders of our debt; $nil of accretion of our promissory notes; $nil of accretion of our 10% senior convertible notes; $170,981 of accretion of our convertible promissory notes; and $20,416 of amortized deferred finance fees and original issue discount relating to the promissory notes and convertible promissory notes.

We failed to settle certain of our promissory notes and 10% senior convertible notes, and accrued interest thereon, when they became due on various dates between October 1, 2008, and December 31, 2018; a significant portion of these notes remain in default as at June 30, 2019.  In accordance with the default provision of the 10% senior convertible notes, and of the promissory notes outstanding at June 30, 2019, this has resulted in all of these notes becoming due and payable on demand as of the date of the default, or in the case of notes issued subsequent to the default, on the date of issuance, notwithstanding any other stated maturity date.  Consequently, the accretion relating to the equity components of these notes issued since the initial event of default, and the amortization of any finance charges incurred thereon, has occurred in the period of issuance.   

Accretion of our convertible promissory notes decreased by $170,981 (100%) due to no conversions made during the six months ended June 30, 2019 versus conversions made during the six months ended June 30, 2018 in excess of the value of convertible promissory notes historically issued.

Foreign exchange gain:  Foreign exchange gain (loss) is comprised of realized gains and losses on foreign currency conversions, the majority of which relate to accounts payable and accrued liabilities denominated in Canadian dollars.  During the six months ended June 30, 2019, the Canadian dollar gained strength relative to the United States dollar, resulting in an overall loss on foreign currency transactions of $71,534. During the six months ended June 30, 2018 the United States dollar gained strength relative to the Canadian dollar, resulting in an overall gain on foreign currency transactions of $102,346.

Net loss: We incurred a loss of $346,593 (rounded to $0.00 per share) for the six months ended June 30, 2019, compared to a loss of $332,890 (rounded to $0.00 per share) for the six months ended June 30, 2018.  Our revenues and future profitability are substantially dependent on our ability to:

 raise additional capital to fund operations;  

 license software applications to a sufficient number of clients;  

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 be cash-flow positive on an ongoing basis;  

 modify the successful software applications, over time, to provide enhanced benefits to then-existing users; and  

 successfully develop related software applications.  

LIQUIDITY AND CAPITAL RESOURCES

General: Since inception, we have funded our operations from private placements of debt and equity securities.  In addition, until September 1999 we derived revenues from consulting contracts with affiliated parties, the proceeds of which were used to fund operations.  We have also received an aggregate of $791,650 in proceeds relating to “VAR” licensing agreements.  Until such time as we are able to generate adequate revenues from the licensing of our software applications, we cannot assure that we will be successful in raising additional capital, or that cash from the issuance of debt securities, the exercise of existing warrants and options, and the placements of additional equity securities, if any, will be sufficient to fund our long-term research and development and selling, general and administrative expenses.

Our cash increased by $184 during the six months ended June 30, 2019, from a bank indebtedness balance of $171 at December 31, 2018, to a cash balance of $13 at June 30, 2019.  This increase in cash occurred from net cash used in operations of $477,512 during the period being less than the $477,525 in net proceeds from financing activities and a reduction in the amount spent on research and development activities.

We added an explanatory paragraph to our interim consolidated financial statements for the six months ended June 30, 2019.  It states that our economic viability is dependent on our ability to finalize the development of our principal products, generate sales and finance operational expenses, and that these factors, together with our lack of revenues to date; our negative working capital; our loss for the year, as well as negative cash flow from operating activities in the same period; and our accumulated deficit, raise substantial doubt regarding our ability to continue as a going concern.  At June 30, 2019, we had negative working capital of $5,251,266 and an accumulated deficit of $55,619,817; for the six months then ended we had a net loss of $346,593, and negative cash flow from operations of $477,512.  Furthermore, the Company failed to settle certain of its 10% senior convertible notes and promissory notes, plus accrued interest thereon when they matured on various dates from October 1, 2008 to December 31, 2018.  A substantial amount of these notes remain unpaid as of June 30, 2019.  All of the 10% senior convertible notes, as well as the promissory notes, were in default at June 30, 2019 in accordance with the default provisions of the respective notes, and as a result are due and payable on demand.

We anticipate commercial sales during the third quarter of 2019, however we cannot be assured that this will be the case.  During the next three months we do not expect to hire additional personnel unless we are successful in raising significant funds through the issuance of our debt or equity securities.  We do not expect to make any material commitments for capital equipment expenditures during the next twelve months.

We have an immediate requirement for additional working capital in order to proceed with our business plan.  We review our cash needs and sources on a month-to-month basis and we are currently pursuing appropriate opportunities to raise additional capital to fund operations.  Additional sources of capital could involve issuing equity or debt securities.  We have engaged consultants to provide advice to us with respect to the raising of capital.  However, additional funding may not be available to us on reasonable terms, if at all.  The perceived risk associated with the possible sale of a large number of shares of our common stock could cause some of our stockholders to sell their stock, thus causing the price of our stock to decline.  In addition, actual or anticipated downward pressure on our stock price due to actual or anticipated issuance of stock could cause some institutions or individuals to engage in short sales of our common stock, which may itself cause the price of our stock to decline.  We may be unable to raise additional capital if our stock price is too low.  A sustained inability to raise capital could force us to limit or curtail our operations.

We expect the level of our future operating expenses to be driven by the needs of our research and development and marketing programs, offset by the availability of funds.  In addition, we have since inception taken steps to keep our expenses relatively low and conserve available cash until we begin generating sufficient operating cash flow.

Sources of Capital : Our principal sources of capital for funding our business activities have been the private placements of debt and equity securities.  During the six months ended June 30, 2019, we did not issue shares of our common stock.

Uses of Capital:  Over the past several years, we have scaled our development activities to the level of available cash resources.  Our plans with respect to future staffing will be dependent upon our ability to raise additional capital.  We have not entered into any off-balance sheet arrangements which would have resulted in our use of capital.

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