**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

** **

**(MarkOne)**

 

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

** **

**For the quarterly period ended March 31,2008**

 

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT

** **

**Forthe transition periodfrom         to         **

 

**Commissionfile number 001-15757**

 

**IMAGEWARE SYSTEMS, INC.**

(Exact Name ofRegistrant as Specified in Its Charter)

 

| **Delaware**                                      | ** ** | **33-0224167**                     |
|---------------------------------------------------|------------|------------------------------------|
| (State or Other  Jurisdiction of Incorporation or |       | (IRS Employer  Identification No.) |
| Organization)                                     |       |                               |

 

**10883Thornmint Road**

**SanDiego, CA 92127**

(Address ofPrincipal Executive Offices)

 

**(858)673-8600**

(Registrant’sTelephone Number, Including Area Code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company. See definitions of “large accelerated filer,”“accelerated filer,” and “smaller reporting company” in Rule 12b-2 of theExchange Act. (Check one):

 

| Large accelerated filer  o                     |   | Accelerated filer o          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer x                        |   | Smaller reporting  company o |
| (Do not check if a  smaller reporting company) |   |                              |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-12 ofthe Exchange Act).  Yes o  No x

 

The number of shares ofCommon Stock, with $0.01 par value, outstanding on May 12, 2008 was 18,075,639.

 

 

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**IMAGEWARESYSTEMS, INC. INDEX**

 
| PART I.  |   | FINANCIAL  INFORMATION |   |
|---------------|--------|------------------------|--------|
|          |   | ITEM 1.                |   | FINANCIAL  STATEMENTS |   |
|          |   |                   |   | Condensed Consolidated  Balance Sheets as of March 31, 2008 (unaudited) and December 31,  2007 |   |
|          |   |                   |   | Condensed Consolidated  Statements of Operations for the three months ended March 31, 2008 and  2007 (unaudited) |   |
|          |   |                   |   | Condensed Consolidated  Statements of Cash Flows for the three months ended March 31, 2008 and  2007 (unaudited) |   |
|          |   |                   |   | Condensed Consolidated  Statements of Comprehensive Loss for the three months ended March 31,  2008 and 2007 (unaudited) |   |
|          |   |                   |   | Notes  to unaudited Condensed Consolidated Financial Statements |   |
|          |   | ITEM 2.                |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|          |   | ITEM 3.                |   | Quantitative  and Qualitative Disclosures About Market Risk |   |
|          |   | ITEM 4.                |   | Controls and  Procedures |   |
|          |   |                   |   |   |   |
| PART II. |   | OTHER INFORMATION      |   |
|          |   | ITEM  1A.              |   | Risk  Factors |   |
|          |   | ITEM  6.               |   | Exhibits |   |
|          |   |                   |   |   |   |
| SIGNATURES    |   |

 

2

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**PART I**

 

**FINANCIAL INFORMATION**

 

**ITEM 1.FINANCIAL STATEMENTS**

 

**IMAGEWARE SYSTEMS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(In Thousands, except share and per share data)**

 
| ** **                                                                                                                                                                                                                                                                                                        | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                        | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                                        | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current Assets:                                                                                                                                                                                                                                                                                                   |       |                     |       |                        |       |
| Cash                                                                                                                                                                                                                                                                                                              |       | $                        | 301        |                        | $          | 1,044 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $0 (unaudited) and  $0 at March 31, 2008 and December 31, 2007, respectively                                                                                                                                                  |       | 633                      |       | 425                         |       |
| Inventory                                                                                                                                                                                                                                                                                                         |       | 225                      |       | 130                         |       |
| Other current  assets                                                                                                                                                                                                                                                                                             |       | 493                      |       | 441                         |       |
| Total Current  Assets                                                                                                                                                                                                                                                                                             |       | 1,652                    |       | 2,040                       |       |
|                                                                                                                                                                                                                                                                                                              |       |                     |       |                        |       |
| Property and  equipment, net                                                                                                                                                                                                                                                                                      |       | 259                      |       | 288                         |       |
| Other assets                                                                                                                                                                                                                                                                                                      |       | 24                       |       | 24                          |       |
| Pension assets                                                                                                                                                                                                                                                                                                    |       | 756                      |       | 694                         |       |
| Intangible  assets, net of accumulated amortization                                                                                                                                                                                                                                                               |       | 2,290                    |       | 2,437                       |       |
| Goodwill                                                                                                                                                                                                                                                                                                          |       | 3,416                    |       | 4,452                       |       |
| **Total  Assets**                                                                                                                                                                                                                                                                                                 | ** ** | **$**                    | **8,397**  | ** **                  | **$**      | **9,935** | ** ** |
|                                                                                                                                                                                                                                                                                                              |       |                     |       |                        |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                     | ** ** | ** **               | ** ** | ** **                  | ** ** |
|                                                                                                                                                                                                                                                                                                              |       |                     |       |                        |       |
| Current  Liabilities:                                                                                                                                                                                                                                                                                             |       |                     |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                                                                                  |       | $                        | 2,053      |                        | $          | 1,415 |   |
| Deferred revenue                                                                                                                                                                                                                                                                                                  |       | 1,362                    |       | 1,011                       |       |
| Accrued expenses                                                                                                                                                                                                                                                                                                  |       | 1,229                    |       | 1,341                       |       |
| Acquisition  related obligation                                                                                                                                                                                                                                                                                   |       | 1,116                    |       | 1,502                       |       |
| Total Current  Liabilities                                                                                                                                                                                                                                                                                        |       | 5,760                    |       | 5,269                       |       |
|                                                                                                                                                                                                                                                                                                              |       |                     |       |                        |       |
| Pension  obligation                                                                                                                                                                                                                                                                                               |       | 1,201                    |       | 1,139                       |       |
| Total  Liabilities                                                                                                                                                                                                                                                                                                |       | 6,961                    |       | 6,408                       |       |
|                                                                                                                                                                                                                                                                                                              |       |                     |       |                        |       |
| Shareholders’  equity:                                                                                                                                                                                                                                                                                       |       |                     |       |                        |       |
| Preferred stock,  authorized 4,000,000 shares:                                                                                                                                                                                                                                                                    |       |                     |       |                        |       |
| Series B  convertible redeemable preferred stock, $0.01 par value; designated 750,000  shares, 389,400 shares issued, and 239,400 shares outstanding at  March 31, 2008 and December 31, 2007; liquidation preference $599  at March 31, 2008 and December 31, 2007                      |       | 2                        |       | 2                           |       |
| Series C  convertible non-redeemable preferred stock, $0.01 par value; designated 3,500  shares, 2,500 shares issued, and 2,200 shares outstanding at March 31,  2008 and December 31, 2007; liquidation preference $2,200 at  March 31, 2008 and December 31, 2007                      |       | —                   |       | —                      |       |
| Series D  convertible non-redeemable preferred stock, $0.01 par value; designated 2,000  shares, 1,500 shares issued, and 1,388 shares outstanding at March 31,  2008 and December 31, 2007; liquidation preference $1,388 at  March 31, 2008 and December 31, 2007                      |       | —                   |       | —                      |       |
| Common stock,  $.01 par value, 50,000,000 shares authorized; 18,082,343 (unaudited) and  17,797,826 shares issued at March 31, 2008 and December 31, 2007,  respectively, and 18,075,639 (unaudited) and 17,791,122 shares outstanding at  March 31, 2008 and December 31, 2007, respectively |       | 180                      |       | 177                         |       |
| Additional paid  in capital                                                                                                                                                                                                                                                                                       |       | 80,937                   |       | 79,294                      |       |
| Treasury stock,  at cost - 6,704 shares                                                                                                                                                                                                                                                                           |       | (64                      | )          | (64                         | )          |
| Accumulated  other comprehensive income                                                                                                                                                                                                                                                                           |       | (32                      | )          | 7                           |       |
| Accumulated deficit                                                                                                                                                                                                                                                                                               |       | (79,587                  | )          | (75,889                     | )          |
| Total  Shareholders’ equity                                                                                                                                                                                                                                                                                  |       | 1,436                    |       | 3,527                       |       |
|                                                                                                                                                                                                                                                                                                              |       |                     |       |                        |       |
| **Total  Liabilities and Shareholders’ Equity**                                                                                                                                                                                                                                                              | ** ** | **$**                    | **8,397**  | ** **                  | **$**      | **9,935** | ** ** |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

3

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**IMAGEWARESYSTEMS, INC.**

 

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)(UNAUDITED)**

 
| ** **                                                  | ** ** | **THREE MONTHS ENDED  MARCH 31,** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                  | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| **Revenues:**                                               | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Product                                                     |       | $                                                | 777        |   | $ | 709 |   |
| Maintenance                                                 |       | 606                                              |       | 627 |   |
|                                                        |       | 1,383                                            |       | 1,336 |   |
| **Cost of  revenues:**                                      | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Product                                                     |       | 139                                              |       | 185 |   |
| Maintenance                                                 |       | 315                                              |       | 294 |   |
| Gross profit                                                |       | 929                                              |       | 857 |   |
|                                                        |       |                                             |       |   |   |
| **Operating  expenses:**                                    | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| General &  administrative                          |       | 1,101                                            |       | 1,143 |   |
| Sales and  marketing                                        |       | 667                                              |       | 694 |   |
| Research &  development                            |       | 897                                              |       | 1,186 |   |
| Depreciation and  amortization                              |       | 201                                              |       | 61 |   |
|                                                        |       | 2,866                                            |       | 3,084 |   |
| Loss from  operations                                       |       | (1,937                                           | )          | (2,227 | ) |
|                                                        |       |                                             |       |   |   |
| Interest expense  (income), net                             |       | (5                                               | )          | 243 |   |
|                                                        |       |                                             |       |   |   |
| Other income,  net                                          |       | (28                                              | )          | (38 | ) |
| Loss from  operations before income taxes                   |       | (1,904                                           | )          | (2,432 | ) |
|                                                        |       |                                             |       |   |   |
| Income tax  expense (benefit)                               |       | —                                           |       | — |   |
|                                                        |       |                                             |       |   |   |
| Net loss                                                    |       | $                                                | (1,904     | ) | $ | (2,432 | ) |
| Preferred  dividends                                        |       | (1,878                                           | )          | (433 | ) |
| Net loss  available to common shareholders                  |       | $                                                | (3,782     | ) | $ | (2,865 | ) |
|                                                        |       |                                             |       |   |   |
| Basic and  diluted loss per common share — see note 2: |       |                                             |       |   |   |
| Continuing  operations                                      |       | $                                                | (0.11      | ) | $ | (0.18 | ) |
| Preferred  Dividends                                        |       | (0.11                                            | )          | (0.03 | ) |
| Basic and  diluted loss per common share - see note 2       |       | $                                                | (0.22      | ) | $ | (0.21 | ) |
|                                                        |       |                                             |       |   |   |
| Weighted-average  shares outstanding (basic and diluted)    |       | 17,836,698                                       |       | 13,763,224 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

4

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**IMAGEWARESYSTEMS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(IN THOUSANDS)(UNAUDITED)**

 
| ** **                                                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| **Cash  flows from operating activities**                                    |       |                                             |       |   |   |
| Net loss                                                                     |       | $                                                | (1,904     | ) | $ | (2,432 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities  |       |                                             |       |   |   |
| Depreciation and amortization                                                |       | 201                                              |       | 61 |   |
| Reduction in  inventory obsolescence reserve                                 |       | —                                           |       | (33 | ) |
| Non cash  interest and amortization of debt discount and debt issuance costs |       | —                                           |       | 229 |   |
| Stock based  compensation                                                    |       | 92                                               |       | 202 |   |
| Provision for  losses on accounts receivable                                 |       | —                                           |       | 25 |   |
| Change in assets  and liabilities                                            |       |                                             |       |   |   |
| Accounts  receivable, net                                                    |       | (208                                             | )          | 699 |   |
| Inventory                                                                    |       | (95                                              | )          | 13 |   |
| Other current  assets                                                        |       | (53                                              | )          | (45 | ) |
| Pension assets                                                               |       | (63                                              | )          | (12 | ) |
| Accounts payable                                                             |       | 639                                              |       | 154 |   |
| Accrued expenses                                                             |       | (84                                              | )          | 385 |   |
| Deferred revenue                                                             |       | 352                                              |       | 137 |   |
| Pension  obligation                                                          |       | 62                                               |       | 20 |   |
| Total  adjustments                                                           |       | 843                                              |       | 1,835 |   |
| Net cash used in  operating activities                                       |       | (1,061                                           | )          | (597 | ) |
|                                                                         |       |                                             |       |   |   |
| **Cash  flows from investing activities**                                    |       |                                             |       |   |   |
| Purchase of  property and equipment                                          |       | (26                                              | )          | (15 | ) |
| Acquisition of  business, net of cash acquired                               |       | (159                                             | )          | — |   |
| Net cash used in  investing activities                                       |       | (185                                             | )          | (15 | ) |
|                                                                         |       |                                             |       |   |   |
| **Cash  flows from financing activities**                                    |       |                                             |       |   |   |
| Repayment of  notes payable                                                  |       | —                                           |       | (1,310 | ) |
| Proceeds from  issuance of preferred stock, net of issuance costs            |       | —                                           |       | 1,386 |   |
| Other financing  issuance costs                                              |       | —                                           |       | (55 | ) |
| Proceeds from  exercised stock purchase warrants                             |       | 542                                              |       | 1,105 |   |
|                                                                         |       |                                             |       |   |   |
| Net cash  provided by financing activities                                   |       | 542                                              |       | 1,126 |   |
| Effect of  exchange rate changes on cash                                     |       | (39                                              | )          | (10 | ) |
| Net increase  (decrease) in cash                                             |       | (743                                             | )          | 504 |   |
|                                                                         |       |                                             |       |   |   |
| Cash at  beginning of period                                                 |       | 1,044                                            |       | 939 |   |
|                                                                         |       |                                             |       |   |   |
| Cash at end of  period                                                       |       | $                                                | 301        |   | $ | 1,443 |   |
|                                                                         |       |                                             |       |   |   |
| Supplemental  disclosure of cash flow information:                           |       |                                             |       |   |   |
| Cash paid for  interest                                                      |       | $                                                | —     |   | $ | 46 |   |
| Summary of  non-cash investing and financing activities:                     |       |                                             |       |   |   |
| Beneficial  conversion feature of series C and D preferred stock             |       | $                                                | 1,794      |   | $ | 344 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

5

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**IMAGEWARE SYSTEMS, INC**

**CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVELOSS(IN THOUSANDS)(UNAUDITED)**

 
| ** **                               | ** ** | **THREE MONTHS ENDED  MARCH 31,** | ** ** |
|------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                               | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Net loss                                 |       | $                                                | (1,904     | ) | $ | (2,432 | ) |
| Other  comprehensive loss:               |       |                                             |       |   |   |
| Foreign currency  translation adjustment |       | (39                                              | )          | (10 | ) |
| Comprehensive  loss                      |       | $                                                | (1,943     | ) | $ | (2,442 | ) |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

6

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**IMAGEWARE SYSTEMS, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**NOTE1.  DESCRIPTION OF BUSINESS ANDOPERATIONS**

 

ImageWare Systems, Inc.(the “Company” or “ImageWare”) is a leader in the emerging market forsoftware-based identity management solutions, providing biometric, securecredential, law enforcement and enterprise authorization.  Our “flagship”product is the IWS Biometric Engine.  Scalable for small city business orworldwide deployment, our biometric engine is a multi-biometric platform thatis hardware and algorithm independent, enabling the enrollment and managementof unlimited population sizes.  Our identification products are used tomanage and issue secure credentials, including national IDs, passports, driverlicenses, smart cards and access control credentials. Our law enforcementproducts provide law enforcement with integrated mug shot, fingerprint LiveScanand investigative capabilities. We also provide comprehensive authenticationsecurity software, as well as real-time voice recognition, multilingual speechtranslation and voice analytics technologies.  Biometric technology is nowan integral part of all markets we address, and all of our products areintegrated into the Biometric Engine Platform.  Elements of the IWSBiometric Engine can be used as investigative tools for law enforcementutilizing multiple biometrics and forensic data elements, and to enhancesecurity and authenticity of public and private sector credentials.

 

Our biometric technologyis a core software component of an organization’s security infrastructure andincludes a multi-biometric identity management solution for enrolling,managing, identifying and verifying the identities of people by the physicalcharacteristics of the human body. We develop, sell and support variousidentity management capabilities within government (federal, state and local),law enforcement, commercial enterprises, and transportation and aviationmarkets for identification and verification purposes. Our IWS Biometric Engineis a biometric identity management platform for multi-biometric enrollment,management and authentication, managing population databases of virtuallyunlimited sizes. It is also offered as a Software Development Kit (SDK) basedsearch engine, enabling developers and system integrators to implement abiometric solution or integrate biometric capabilities into existingapplications without having to derive biometric functionality from pre-existingapplications.  The IWS Biometric Engine combined with our securecredential platform, IWS EPI Builder, provides a comprehensive, integratedbiometric and secure credential solution that can be leveraged for high-endapplications such as passports, driver licenses, national IDs, and other securedocuments. It can also be utilized within our law enforcement systems toincorporate any number of various multiple biometrics into one system.

 

We recently added nextgeneration voice recognition, multilingual speech translation and voiceanalytics capabilities to our suite of biometric identity management solutions,enabling users to facilitate and improve communication across major languagegroups globally. The ImageWare Mediator products are offered standalone orintegrated with our Biometric Engine platform providing an advancedmultilingual communications capability. Government, intelligence, defense,public safety and border control customers are able to realize languagetranslation and voice recognition capabilities whereby an English-speaking usercan understand and be understood in numerous languages including Spanish,German, French, Korean, Arabic and Polish, among others. ImageWare Mediatorproducts support speech to speech translation, multilingual collaboration,conversational environments, which are represented for both voice and text andinclude biometric functionality for speaker identification and voice analytics.

 

Our law enforcementsolutions enable agencies to quickly capture, archive, search, retrieve, andshare digital images, fingerprints and criminal history records on astand-alone, networked, wireless or Web-based platform. We develop, sell andsupport a suite of modular software products used by law enforcement and publicsafety agencies to create and manage criminal history records and to investigatecrime. Our IWS Law Enforcement solution consists of six software modules: aCapture and Investigative module, which provides a criminal booking system andrelated database; a Facial Recognition module, which uses biometric facialrecognition to identify suspects; a Suspect ID module, which facilitates thecreation of full-color, photo-realistic suspect composites; a wireless module,which provides access to centrally stored records over the Internet in aconnected or wireless fashion; a PDA add-on module, which enables access tocentrally stored records while in the field on a handheld Pocket PC compatibledevice combined with central repository services which allows for inter-agencydata sharing on a local, regional, and/or national level; and a LiveScan module,which incorporates LiveScan capabilities into IWS Law Enforcement providingintegrated fingerprint and palm print biometric management for civil and lawenforcement use.

 

Our Secure Credential IDsolutions empower customers to create secure and smart digital identificationdocuments with complete ID systems. We develop, sell and support software anddesign systems which utilize digital imaging in the production of photoidentification cards and credentials and identification systems. Our products inthis market consist of IWS EPI Suite, IWS EPI Builder (SDK), Identifier forWindows and ID Card Maker.  These products allow for the production ofdigital identification cards and related databases and records and can be usedby, among others, schools, airports, hospitals, corporations orgovernments.  We have recently added the ability to incorporate multiplebiometrics into the ID systems we offer with the addition of our new IWSBiometric Engine to our product line.

 

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Our enterpriseauthentication software includes the IWS Desktop Security product which is acomprehensive authentication management infrastructure solution providing addedlayers of security to workstations, networks and systems through advancedencryption and authentication technologies. IWS Desktop Security is optimizedto enhance network security and usability, and uses multi-factor authenticationmethods to protect access, verify identity and help secure the computingenvironment without sacrificing ease-of-use features such as quick login.Additionally, IWS Desktop Security provides an easy integration with varioussmart card-based credentials including the Common Access Card (CAC), HomelandSecurity Presidential Directive 12 (HSPD-12) Personal Identity Verification(PIV) credential, and Transportation Worker Identification Credential (TWIC)with an organization’s access control process. IWS Desktop Security providesthe crucial end-point component of a Logical Access Control System (LACS), andwhen combined with a Physical Access Control System (PACS), organizationsbenefit from a complete door to desktop access control and security model.

 

*Basis of Presentation*

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, the disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenue and expensesduring the reporting period. Actual results could differ from those estimates.

 

Theaccompanying condensed consolidated balance sheet as of December 31, 2007has been derived from the Company’s audited balance sheet included in the2007 Annual Report on Form 10-K and the condensed consolidated unauditedfinancial statements of ImageWare have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”) regarding interimfinancial reporting. Accordingly, they do not include all of the informationand footnotes required by generally accepted accounting principles for annualfinancial statements and should be read in conjunction with the consolidatedfinancial statements for the year ended December 31, 2007, and notesthereto included in the Company’s Annual Report on Form 10-K, filed withthe SEC on April 15, 2008, as amended on April 29, 2008. In theopinion of management, the accompanying condensed consolidated financialstatements contain all adjustments, consisting only of adjustments of a normalrecurring nature, necessary for a fair presentation of the Company’s financialposition as of March 31, 2008, and its results of operations for theperiods presented. These condensed consolidated unaudited financial statementsfor the period ended March 31, 2008 are not necessarily indicative of theresults to be expected for the entire year.

 

*Going Concern*

 

Asreflected in the accompanying condensed consolidated financial statements, theCompany has continuing losses, negative working capital and negative cash flowsfrom operations. These matters raise substantial doubt about the Company’sability to continue as a going concern.

 

Newfinancing will be required to fund working capital and operations should theCompany be unable to generate positive cash flow from operations in the nearfuture. The Company is exploring the possible sale of equity securities and/ordebt financing. However, there can be no assurance that additional financingwill be available. In the event financing is not available in the time framerequired, the Company will be forced to sell certain of its assets or licenseits technologies to others. These actions, while necessary for the continuanceof operations during a time of cash constraints and a shortage of workingcapital, could adversely affect the Company’s business.

 

On April 25, 2008, the Company received a letter from the American Stock Exchange (“AMEX”) advising that a Listing Qualifications Panel of the AMEX Committee on Securities (the “Panel”) had affirmed the determination of the staff of the Listing Qualifications Department of AMEX (the “Staff”) to delist the Company’s common stock from AMEX as a result of the Company’s failure to comply with:  (A) Section 1003(a)(ii) of the AMEX Company Guide (the “Company Guide”), because the Company has shareholders’ equity of less than $4 million and has sustained losses from continuing operations and net losses in three out of four of the Company’s most recent fiscal years; and (B) Section 1003(a)(iii) of the Company Guide, because the Company has shareholders’ equity of less than $6 million and has sustained losses from continuing operations and net losses in five of the Company’s most recent fiscal years.

 

On May 5, 2008 the Company’s common stock was delisted from AMEX.  The Company’s common stock is currently trading on the Over-The-Counter-Bulletin Board (“OTCBB”) under the ticker symbol “IWSY”.

 

8

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However, the delisting could adversely affect the public price of the Company’s common stock and limit the Company’s stockholders’ ability to dispose of, or to obtain accurate quotations as to the prices of, the Company’s common stock. Moreover, the Company’s ability to obtain financing on favorable terms, or at all, may be adversely affected by the delisting because certain institutional investors that have policies against investments in companies that are not traded on a national securities exchange and other investors may refrain from purchasing the Company’s common stock because of the delisting.  The Company’s ability to obtain financing may also be more limited in numerous states because the Company will no longer benefit from state exemptions from registration which are dependent upon the listing of the Company’s common stock on AMEX.

 

In view of the mattersdescribed in the preceding paragraphs, recoverability of a major portion of therecorded asset amounts shown in the accompanying condensed consolidated balancesheets is dependent upon continued operations of the Company, which, in turn,is dependent upon the Company’s ability to continue to raise capital andgenerate positive cash flows from operations. The condensed consolidatedfinancial statements do not include any adjustments relating to therecoverability and classification of recorded asset amounts or amounts andclassifications of liabilities that might be necessary should the Company beunable to continue its existence.

 

TheCompany operates in markets that are emerging and highly competitive. There isno assurance that the Company will operate at a profit in the future.

 

*Recently Issued Accounting Standards*

 

In September 2006,the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standards (“SFAS”) No. 157, *Fair Value Measurements*(SFAS No. 157).SFAS No. 157 replaces the different definitions of fair value in theaccounting literature with a single definition. It defines fair value as theprice that would be received to sell an asset or paid to transfer a liabilityin an orderly transaction between market participants at the measurement date.SFAS No. 157 is effective for fair-value measurements alreadyrequired or permitted by other standards for financial statements issued forfiscal years beginning after November 15, 2007 and interim periods withinthose fiscal years, with earlier adoption encouraged. The FASB has deferred theimplementation of SFAS 157 by one year for certain non-financial assetsand liabilities such as this will be effective for the fiscal years beginningafter November 15, 2008. We are currently in the process of determiningthe impact, if any, of adopting the provisions of SFAS No. 157 on ourresults of operations or financial position.

 

In February 2007,the FASB issued SFAS No. 159, *The FairValue Option for Financial Assets and Financial Liabilities—Including anamendment of FASB Statement No. 115*(“SFAS No. 159”). SFASNo. 159 provides companies with an option to report selected financialassets and liabilities at fair value. The objective of SFAS No. 159 is toreduce both the complexity in accounting for financial instruments and thevolatility in earnings caused by measuring related assets and liabilitiesdifferently. SFAS No. 159 also establishes presentation and disclosurerequirements designed to facilitate comparisons between companies that choosedifferent measurement attributes for similar types of assets and liabilities.SFAS No. 159 is effective for fiscal years beginning after November 15,2007, with earlier adoption permitted. We are currently in the process ofdetermining the impact of adopting the provisions of SFAS No. 159 on ourresults of operations or statement of financial position.

 

In December 2007,the FASB issued SFAS No. 141(R), “Business Combinations” and SFAS No. 160,“Non-controlling Interests in Consolidated Financial Statements”. The standardsare intended to improve, simplify, and converge internationally the accountingfor business combinations and the reporting of non-controlling interests inconsolidated financial statements. SFAS No. 141(R) requires theacquiring entity in a business combination to recognize all (and only) theassets acquired and liabilities assumed in the transaction; establishes theacquisition-date fair value as the measurement objective for all assetsacquired and liabilities assumed; and requires the acquirer to disclose toinvestors and other users all of the information they need to evaluate andunderstand the nature and financial effect of the business combination. SFAS No. 141(R) iseffective for fiscal years, and interim periods within those fiscal years,beginning on or after December 15, 2008. SFAS No. 141(R) appliesprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008. Earlier adoption is prohibited. The Company is currently evaluating theimpact of this standard on its consolidated financial statements.

 

SFAS No. 160is designed to improve the relevance, comparability, and transparency offinancial information provided to investors by requiring all entities to reportnon-controlling (minority) interests in subsidiaries in the same way–as equityin the consolidated financial statements. Moreover, SFAS No. 160eliminates the diversity that currently exists in 

 

9

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accounting for transactions between an entity and non-controllinginterests by requiring they be treated as equity transactions. SFAS No. 160is effective for fiscal years, and interim periods within those fiscal years,beginning on or after December 15, 2008. Earlier adoption is prohibited.In addition, SFAS No. 160 shall be applied prospectively as of thebeginning of the fiscal year in which it is initially applied, except for thepresentation and disclosure requirements. The presentation and disclosurerequirements shall be applied retrospectively for all periods presented. We donot have an outstanding non-controlling interest in one or more subsidiariesand therefore, SFAS No. 160 is not applicable to us at this time.

 

In December 2007, the FASB ratified the consensusreached by the EITF on Issue No. 07-1 (“EITF 07-1”), *Accounting for Collaborative Arrangements*.EITF 07-1 is effective for the Company beginning January 1, 2009 and willbe applied retrospectively to all prior periods presented for all collaborativearrangements existing as of the effective date. EITF 07-1 defines collaborativearrangements and establishes reporting requirements for transactions betweenparticipants in a collaborative arrangement and between participants in thearrangement and third parties. The Company is assessing the impact of adoptionof EITF 07-1 on its financial position and results of operations.

 

In March 2008, the FASB issued Statement No. 161,*Disclosures about Derivative Instruments andHedging Activities*(“FAS 161”), which is effective January 1,2009. FAS 161 requires enhanced disclosures about derivative instruments andhedging activities to allow for a better understanding of their effects on anentity’s financial position, financial performance, and cash flows. Among otherthings, FAS 161 requires disclosure of the fair values of derivativeinstruments and associated gains and losses in a tabular format. Since FAS 161requires only additional disclosures about the Company’s derivatives andhedging activities, the adoption of FAS 161 will not affect the Company’sfinancial position or results of operations.

 

In May 2008, the FASB issued FASB Statement No. 162,*The Hierarchy of Generally AcceptedAccounting Principles.* The new standard is intended to improvefinancial reporting by identifying a consistent framework, or hierarchy, forselecting accounting principles to be used in preparing financial statementsthat are presented in conformity with U.S. generally accepted accountingprinciples (GAAP) for nongovernmental entities.

 

In May 2008, the FASB issued FASB Staff Position(FSP) No. APB 14-1, *Accounting for ConvertibleDebt Instruments That May Be Settled in Cash upon Conversion (IncludingPartial Cash Settlement)*(“FSP APB 14-1”*)*.  FSP APB 14-1 clarifies that convertible debtinstruments that may be settled in cash upon conversion (including partial cashsettlement) are not addressed by paragraph 12 of APB Opinion No. 14, *Accounting for Convertible Debt and Debt Issued withStock Purchase Warrants*. Additionally, this FSP specifies thatissuers of such instruments should separately account for the liability and equitycomponents in a manner that will reflect the entity’s nonconvertible debtborrowing rate when interest cost is recognized in subsequent periods. This FSPis effective for financial statements issued for fiscal years beginning after December 15,2008, and interim periods within those fiscal years. Early adoption is notpermitted. We do not have an outstanding convertible debt instruments thereforeFSP No. APB 14-1 is not applicable to us at this time.

 

*Reclassifications*

 

Certainreclassifications have been made to the prior period balances in order toconform to the current period presentation.

 

**NOTE2.  NET LOSS PER COMMON SHARE**

 

Basicloss per common share is calculated by dividing net loss available to commonshareholders for the period by the weighted-average number of common sharesoutstanding during the period. Diluted earnings per common share is calculatedby dividing net loss available to common shareholders for the period by theweighted-average number of common shares outstanding during the period,adjusted to include, if dilutive, potential dilutive shares consisting ofconvertible preferred stock, stock options and warrants, calculated using thetreasury stock method. During the periods ended March 31, 2008 and 2007,the Company has excluded the following securities from the calculation ofdiluted loss per share, as their effect would have been antidilutive due to theCompany’s net loss:

 
| **Potential Dilutive Securities:** | ** ** | **Number of  Common Shares  Convertible into at  March 31, 2008** | ** ** | **Number of  Common Shares  Convertible into at  March 31, 2007** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|
|                                         |       |                                                                                            |       |                                                                                            |       |
| Convertible  preferred stock                 |       | 3,633,384                                                                                       |       | 2,501,523                                                                                       |       |
| Stock options                                |       | 2,127,954                                                                                       |       | 1,566,882                                                                                       |       |
| Warrants                                     |       | 6,721,385                                                                                       |       | 4,982,360                                                                                       |       |

 

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The table below presentsthe computation of basic and diluted earnings (loss) per share:

 
| ** **                                                                                       | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Numerator for  basic and diluted earnings per share:                                             |       |                                             |       |   |   |
| Net loss from  operations                                                                        |       | $                                                | (1,904     | ) | $ | (2,432 | )  |
| Preferred  dividends                                                                             |       | (1,878                                           | )          | (433 | ) |
| Net loss from  operations available to common shareholders                                       |       | $                                                | (3,782     | ) | $ | (2,865 | ) |
|                                                                                             |       |                                             |       |   |   |
| Denominator for  basic and diluted earnings per share — weighted-average shares outstanding |       | 17,836,698                                       |       | 13,763,224 |   |
|                                                                                             |       |                                             |       |   |   |
| Basic and  diluted income (loss) per share:                                                      |       |                                             |       |   |   |
| Loss from  operations                                                                            |       | $                                                | (0.11      | ) | $ | (0.18 | ) |
| Preferred  dividends                                                                             |       | (0.11                                            | )          | (0.03 | ) |
| Net loss  available to common shareholders                                                       |       | $                                                | (0.22      | ) | $ | (0.21 | ) |

 

Asmore fully explained in Note 6 to these condensed consolidated financialstatements, preferred stock dividends for the three months ended March 31,2008 contains approximately $1,794,000 in preferred dividends attributable toan embedded beneficial conversion feature recognized in conjunction with theissuance of common stock pursuant to the Company’s warrant financingtransaction consummated in March 2008. Preferred dividends for the threemonths ended March 31, 2007 contains approximately $344,000 in preferredstock dividends attributable to an embedded beneficial conversion featurerecognized in conjunction with the March 2007 issuance of the Company’s Series DPreferred Stock.

 

**NOTE 3.INVENTORY**

 

Inventoriesat March 31, 2008 were comprised of work in process of $86,000 representingdirect labor costs on in-process projects and finished goods $139,000 net ofreserves for obsolete and slow-moving items of $16,000.  Inventories at December 31, 2007 werecomprised of work in process of $29,000 representing direct labor costs onin-process projects and finished goods of $101,000 net of reserves for obsoleteand slow-moving items of $16,000. Appropriate consideration is given to obsolescence, excessive levels,deterioration, and other factors in evaluating net realizable value andrequired reserve levels.

 

**NOTE 4.ACQUISITION**

** **

In December 2007, the Company entered into anagreement for the purchase of certain assets of Sol Logic, Inc. (“SolLogic”) pursuant to an Asset Purchase Agreement (the “Asset Purchase Agreement”). The assets acquired include certain customer contracts, software licenses andintellectual property (collectively, the “Acquired Assets”).  As a resultof this asset acquisition, the Company expects to integrate real-time voicerecognition, multiple language translation and voice analytic capabilities intoits biometric offerings. The Asset Purchase Agreement contains customaryrepresentations and warranties on behalf of Sol Logic.

 

In consideration for the acquisition of the AcquiredAssets, the Company: (1) issued to Sol Logic on December 19, 2007(the “Closing”) 935,089 shares of restricted common stock of the Company (the “InitialShares”), and (2) on June 19, 2008 (the “Additional Issuance Date”)will issue to Sol Logic that number of shares of restricted common stock (the “AdditionalShares” and collectively with the Initial Shares, the “Shares”) equal to thequotient obtained by dividing $1,502,000 by the greater of (A) $1.633 and (B) thevolume weighted average closing price of the Company’s common stock over the 20trading-day period ending on June 18, 2008, as reported on theOver-the-Counter Bullet Board (“OTCBB”).  Fifty percent of the InitialShares and ten percent of the Additional Shares will be held in escrow untilthe one-year anniversary of the Closing. The Company recorded the obligation toissue the required number of shares on the Additional Issuance Date as acurrent liability in the accompanying Condensed Consolidated Balance Sheet asof December 31, 2007 under the caption “Acquisition related obligation”.

 

On March 28, 2008, the Company entered intoAmendment No. 1 to Asset Purchase Agreement (the “Purchase AgreementAmendment”) to amend the Purchase Agreement.  The Purchase AgreementAmendment provides that in consideration for the Acquired Assets, the Companyshall issue to Sol Logic an aggregate of 677,940 shares of restricted CommonStock (the “Initial Shares”). Of these shares, 467,545 were issued to Sol Logicon December 19, 2007, the date of the Purchase Agreement. The remaining210,395 shares were issued to Sol Logic upon execution of the PurchaseAgreement Amendment.  In conjunction with these issuances, the Companysimultaneously rescinded the issuance of 257,149 common shares originallyplaced into escrow on December 19, 2007.

 

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In the event the Company’s revenues on certainspecified products set forth in the Purchase Agreement Amendment either equalor exceed $3,000,000 for the six-month period commencing on March 6, 2008and ending on September 6, 2008 or equal or exceed $5,000,000 for theeighteen-month period commencing on March 6, 2008 and ending on September 6,2009, the Company will be obligated to issue that number of additional sharesof Common Stock (the “Additional Shares” and together with the Initial Shares,the “Shares”) obtained by dividing $1,921,924 by the greater of $1.10 or thevolume weighted average closing price of the Company’s common stock over the 20trading-day period immediately prior to the date the Additional Shares areissued, subject to the terms of the escrow described below.  Pursuant tothe Purchase Agreement Amendment, the maximum number of Additional Shares thatmay be issued are 1,747,204.

 

Concurrently with the execution of the PurchaseAgreement Amendment, the Company entered into Amendment No. 1 toRegistration Rights Agreement (the “Rights Agreement Amendment”) to amend theRights Agreement.  Under the terms of the Rights Agreement Amendment, theCompany will register an additional 371,755 of the Initial Shares, for a totalof 677,940 shares of Common Stock, for resale by Sol Logic.

 

In the event any Additional Shares become issuablepursuant to the Purchase Agreement Amendment, approximately 47.5% of theseshares will be deposited by the Company into an escrow account to satisfy anyindemnification and reimbursement claims of the Company and the remainingshares will be issued directly to Sol Logic.

 

As a result of recording the terms of the PurchaseAgreement Amendment, the aggregate purchase price, not including direct transactioncosts of approximately $246,000 was approximately $1,019,000. The value of the677,940 common shares issued was determined based on the average market priceof the Company’s common stock over the 2-day period before and after the termsof the Purchase Agreement Amendment were consummated on March 6, 2008 inaccordance with EITF 99-12, “Determination of the Measurement Date for theMarket Price of Acquirer Securities Issued in a Purchase Business Combination’.As of March 31, 2008, the Company also incurred approximately $131,000related to the issuance and registration of the Company’s equity securitiesissued pursuant to the Sol Logic asset purchase. Such issuance and registrationcosts have been recognized as a reduction of the fair value of the Company’scommon stock in accordance with FASB Statement of Financial AccountingStandards No 141, Business Combinations” (“FAS 141”).

 

In connection the Purchase Agreement Amendment, theCompany has agreed to pay additional consideration in future periods, basedupon the attainment of certain revenue levels on certain specified products.FAS 141 requires, in situations involving a contingent consideration agreementthat might result in the recognition of an additional element of cost when thecontingency is resolved, the recognition of a purchase accounting liability inan amount equal to the lesser of the maximum amount of contingent considerationor the excess (the amount by which the amounts assigned to the assets acquiredexceeds the cost of the acquired entity). Accordingly, the Company has recordeda purchase accounting liability of approximately $1,087,000 as a currentliability in the accompanying Condensed Consolidated Balance Sheet as of March 31,2008 under the caption “Acquisition related obligation”. When the contingencyis resolved and the consideration is issued or becomes issuable, any excess ofthe fair value of the contingent consideration issued or issuable over theamount that was recognized as a liability shall be recognized as an additionalcost of the acquisition. Any such additional cost would result in increases ingoodwill. If the amount initially recognized as a liability exceeds the fairvalue of the consideration issued or issuable, that excess shall be allocatedas a pro rata reduction of the amounts assigned to the acquired assets. As of March 31,2008, no additional consideration was due pursuant to the terms of the PurchaseAgreement Amendment.

 

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Thefollowing table presents the allocation of the acquisition cost, includingprofessional fees and other related acquisition costs, to the assets acquiredand liabilities assumed, based on their fair values:

 
| ** **                                           | ** ** | **As recorded  per Dec. 19 2007  Asset Purchase  Agreement** | ** ** | **As recorded  per Mar. 6, 2008  Purchase  Agreement  Amendment** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
|                                                 |       |                                                              |       |                                                                        |       |
| Fixed assets,  net                                   |       | $                                                                 | 41,805     |                                                                        | $          | 41,805 |   |
| Covenant not to  compete                             |       | 199,760                                                           |       | 199,760                                                                     |       |
| Customer base                                        |       | 93,000                                                            |       | 93,000                                                                      |       |
| Developed  technology                                |       | 2,018,242                                                         |       | 2,018,242                                                                   |       |
| Goodwill                                             |       | 1,036,396                                                         |       | —                                                                      |       |
| Total assets acquired                                |       | $                                                                 | 3,389,203  |                                                                        | $          | 2,352,807 |   |
|                                                 |       |                                                              |       |                                                                        |       |
| Cash and direct  transaction costs                   |       | $                                                                 | (409,762   | )                                                                           | $          | (438,262 | ) |
| Acquisition  liability                               |       | (1,502,000                                                        | )          | (1,087,459                                                                  | )          |
| common stock                                         |       | (9,351                                                            | )          | (6,779                                                                      | )          |
| apic                                                 |       | (1,468,090                                                        | )          | (820,307                                                                    | )          |
| Total  consideration issued and liabilities incurred |       | $                                                                 | (3,389,203 | )                                                                           | $          | (2,352,807 | ) |
|                                                 |       |                                                              |       |                                                                        |       |
| Number of shares  issued                             |       | 935,089                                                           |       | 677,940                                                                     |       |

 

Thefollowing (unaudited) pro forma consolidated results of operations have beenprepared as if the acquisition of Sol Logic, Inc. had occurred at January 1,2007:

 
| **($ in thousands)**                       | ** ** | **March 31, 2007** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|
| ** **                                           | ** ** | **(unaudited)**              | ** ** |
| Sales                                                |       | $                            | 1,446      |   |
| Net loss  available to common shareholders           |       | $                            | (3,141     | ) |
| Net loss per  share available to common shareholders |       | $                            | (0.22      | ) |

 

The pro forma information is presented for informationalpurposes only and is not necessarily indicative of the results of operationsthat actually would have been achieved had the acquisition been consummated asof that time, nor is it intended to be a projection of future results.

 

**NOTE5. COMMON STOCK AND WARRANTS**

 

On March 12,2008, the Company received $541,666 from the exercise of 541,666 warrantsto purchase shares of the Company’s common stock, par value $0.01 per share(the “Warrant Financing”). The warrants were originally issued in connection witha private placement of Common Stock to certain accredited investors (the “Investors”).The Financing was previously reported in a Current Report on Form 8-Kfiled on September 26, 2007. The Company agreed to reprice all warrantsissued in the Financing, which originally had an exercise price of $1.67 pershare, to an exercise price of $1.00 per share, in consideration for theirimmediate exercise (the “Warrant Repricing”) by the Investors who participatedin the Warrant Repricing or their transferees, as applicable (the “ParticipatingInvestors”).

 

Inconnection with the Warrant Repricing, the Company also issued to theParticipating Investors new warrants (the “Warrants”) to purchase up to anaggregate of 270,833 shares of Common Stock with an exercise price of $1.20 pershare. The Warrants may be exercised at any time from March 12, 2008 untilMarch 12, 2013. In addition, if the shares of Common Stock issuable uponexercise of the Warrants are not registered for resale with the Securities andExchange Commission on or before the later of September 12, 2008 or theend of the applicable holding period for resales of securities bynon-affiliates under Rule 144 of the Securities Act, but in any event nolater than March 12, 2009, the Warrants may be exercised by theParticipating Investors by “cashless” exercise.

 

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Theissuance of common stock and warrants pursuant to the Warrant Financingtriggered certain antidilution and exercise price reduction clauses in existingwarrant agreements. As a result of these modifications, the Company wasrequired to issue an additional 1,036,388 warrants and reduce the exerciseprice of certain previously issued warrants. As these warrants were classifiedas permanent equity, and the adjustment was related to antidilution featureswithin these financial instruments, this increase in warrants and reduction ofexercise price resulted in no adjustment to the financial statements.

 

Asmore fully disclosed in Note 4 to these condensed consolidated financialstatements, in March 2008 the Company amended the Asset Purchase Agreementrelating to the purchase of certain assets of Sol Logic, Inc. As a resultof amending the Asset Purchase Agreement, the Company rescinded the issuance of257,149 shares of common stock originally issued to Sol Logic and placed intoescrow on December 19, 2007.

 

**NOTE6. PREFERRED STOCK**

 

The issuance of commonstock and warrants pursuant to the Warrant Financing triggered certainantidilution clauses in the Company’s Series C and Series D PreferredStock agreements. As a result of these antidilution clauses, the Company wasrequired to adjust the conversion price of the Series C and Series DPreferred Stock from $1.50 per share to $1.00 per share. This antidilutionfeature will cause an additional 733,335 common shares to be issued uponconversion of the Series C Preferred Stock into common stock and anadditional 462,669 common shares to be issued upon conversion of the Series DPreferred Stock into common stock. In accordance with EITF Issue 00-27, “Applicationof Issue No. 98-5 to Certain Convertible Instruments”, this antidilutionfeature resulted in the additional recognition of a discount attributable to anembedded beneficial conversion feature of approximately $1,100,000 related to Series CPreferred Stock and $694,000 related to Series D Preferred Stock. Thisdiscount was amortized over the minimum period from the date of the conversionprice adjustment to the date at which the preferred shareholders are permittedto convert as a dividend to the Series C and Series D Preferred Stockshareholders.

 

At March 31, 2008,the Company had cumulative undeclared dividends relating to Series B, Cand D Preferred Stock of approximately $21,000, $271,000 and $125,000 respectively.

 

**NOTE7. REGISTRATION PAYMENT ARRANGEMENTS**

 

On September 25,2007, the Company sold to certain accredited investors a total of 2,016,666shares of the Company’s common stock, par value $0.01 per share, at apurchase price of $1.50 per share for aggregate gross proceeds of $3,025,003(the “Common Stock Financing”). As part of the Common Stock Financing, theCompany entered into a Registration Payment Arrangement as defined by FASBStaff Position No. EITF 00-19-2, “Accounting for Registration PaymentArrangements” (“EITF 00-19-2”). EITF 00-19-2 specifies that the contingentobligation to make future payments or otherwise transfer consideration under aregistration payment arrangement should be separately recognized and measuredin accordance with SFAS No. 5 “Accounting for Contingencies” (“SFAS No. 5”).EITF 00-19-2 is effective for registration payment arrangements entered intoafter December 21, 2006 or for the fiscal year beginning after December 15,2006. The Company determined that no loss contingency related to the CommonStock Financing registration payment arrangement was required to be recorded asof March 31, 2008.

 

As part of the September 25,2007 Common Stock registration payment arrangement, the Company agreed toregister the shares of common stock issued in the financing and the shares ofcommon stock underlying the warrants issued to the investors in the CommonStock Financing with the SEC within certain contractually specified timeperiods. The Company also agreed to use its best efforts to keep theregistration statement continuously effective until the earlier of either thesecond year after the date the registration statement is declared effective bythe SEC or the date when all the common stock, including the common stock underlyingthe warrants have been sold or may be sold without volume limitations. If theCompany is unable to register the shares of common stock with the SEC or keepthe registration statement continuously effective in accordance with theSecurities Purchase Agreement dated September 25, 2007, between theCompany and certain accredited investors, the Company is subject to aliquidated damages penalty equal to 1% of the aggregate purchase price paid foreach month the registration statement is not effective, provided that suchliquidated damages shall not exceed 12% of the aggregate purchase price. Themaximum exposure at March 31, 2008 is approximately $363,000. The Companyhas met the requirements of the Common Stock Financing registration paymentarrangement by filing the required registration statement with the SEC withinthe time frame specified by the agreement. Company management believes that itwill be able to maintain current filing status with the SEC over the prescribedperiod.

 

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On March 9, 2007,the Company entered into a Securities Purchase Agreement with certainaccredited investors pursuant to which the Company sold to the investors anaggregate of 1,500 shares of the Company’s Series D 8% ConvertiblePreferred Stock (the “Series D Preferred Stock”) at a stated value of$1,000 per share for aggregate gross proceeds of $1,500,000 and issued to theinvestors warrants to purchase up to an aggregate of 59,207 shares of commonstock of the Company. As part of the Series D Preferred Stock financing,the Company entered into a Registration Payment Arrangement as defined by FSP No. EITF00-19-2. The Company determined that no loss contingency related to the Series DPreferred Stock registration payment arrangement was required to be recorded asof March 31, 2008.

 

As part of the Series DPreferred Stock registration payment arrangement, the Company agreed toregister the shares of common stock the Series D Preferred Stock isconvertible into and the shares of common stock underlying the warrants issuedto the investors in the Series D Preferred Stock financing with the SECwithin certain contractually specified time periods. The Company also agreed touse its best efforts to keep the registration statement continuously effectiveuntil the earlier of either the fifth year after the date the registrationstatement is declared effective by the SEC or the date when all the commonstock, including the common stock underlying the warrants have been sold. Ifthe Company is unable to register the shares of common stock with the SEC orkeep the registration statement continuously effective in accordance with theSecurities Purchase Agreement dated March 9, 2007, between the Company andcertain accredited investors, the Company is subject to a liquidated damagespenalty equal to 1% of the aggregate purchase price paid for each month theregistration statement is not effective, provided that such liquidated damagesshall not exceed 12% of the aggregate purchase price. The maximum exposure at March 31,2008 is approximately $180,000. The Company has met the requirements of the Series DPreferred Stock registration payment arrangement by filing the requiredregistration statement with the SEC within the time frame specified by theagreement. Company management believes that it will be able to maintain currentfiling status with the SEC over the prescribed period.

 

In November and December of2006, the Company entered into a Securities Purchase Agreement with certainaccredited investors to which the Company sold to the investors an aggregate of2,500 shares of the Company’s Series C 8% Convertible Preferred Stock (the“Series C Preferred Stock”) at a stated value of $1,000 per share foraggregate gross proceeds of $2,500,000 and issued to the investors warrants topurchase up to an aggregate of 125,000 shares of the Company’s common stock. Aspart of the Series C Preferred Stock financing consummated in November andDecember of 2006, the Company entered into a Registration Payment Arrangementas defined by EITF 00-19-2. EITF 00-19-2 is effective for registration paymentarrangements entered into after December 21, 2006 or for the fiscal yearbeginning after December 15, 2006, however early adoption is permitted forinterim or annual periods for which financial statements have not been issued. TheCompany adopted the provisions of FSP EITF 00-19-2 for the annual period endingDecember 31, 2006. The Company determined that no loss contingency relatedto the Series C Preferred Stock registration payment arrangement wasrequired to be recorded as of March 31, 2008.

 

As part of the Series CPreferred Stock registration payment arrangement, the Company agreed toregister the shares of common stock the Series C Preferred Stock isconvertible into and the shares of common stock underlying the warrants issuedto the Series C investors with the SEC within certain contractuallyspecified time periods. The Company also agreed to use its best efforts to keepthe registration statement continuously effective until the earlier of eitherthe fifth year after the date the registration statement is declared effectiveby the SEC or the date when all the common stock, including the common stockunderlying the warrants have been sold. If the Company is unable to registerthe shares of common stock with the SEC or keep the registration statementcontinuously effective in accordance with the Securities Purchase Agreementdated November 14, 2006, between the Company and certain accreditedinvestors,  the Company is subject to aliquidated damages penalty equal to 1% of the aggregate purchase price paid foreach month the registration statement is not effective, provided that suchliquidated damages shall not exceed 12% of the aggregate purchase price. Themaximum exposure at March 31, 2008 is approximately $300,000. The Companyhas met the requirements of the Series C Preferred Stock registrationpayment arrangement by registering the shares of common stock with the SECwithin the time frame specified by the agreement and has kept the registrationcontinuously effective thereafter. Company management believes that it will beable to maintain current filing status with the SEC over the prescribed period.

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

** **

ThisQuarterly Report on Form 10-Q contains forward-looking statements withinthe meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended. All forward-lookingstatements included in this report are based on information available to us asof the date hereof and we assume no obligation to update any forward-lookingstatements. Forward-looking statements involve known or unknown risks,uncertainties and other factors, which may cause our actual results,performance or achievements, or industry results to be materially differentfrom any future results, performance or achievements expressed or implied bysuch forward-looking statements. Factors that could cause or contribute to suchdifferences include but are not limited to those items discussed under “RiskFactors” beginning on page 23 and elsewhere in this Quarterly Report.

 

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Thefollowing discussion of the financial condition and results of operationsshould be read in conjunction with the condensed consolidated financialstatements included elsewhere within this Quarterly Report. Fluctuations inannual and quarterly results may occur as a result of factors affecting demandfor our products such as the timing of new product introductions by us and byour competitors and our customers’ political and budgetary constraints. Due tosuch fluctuations, historical results and percentage relationships are notnecessarily indicative of the operating results for any future period.

 

**OVERVIEW**

 

ImageWare Systems, Inc.is a leader in the emerging market for software-based identity managementsolutions, providing biometric, secure credential and law enforcement technologies.Our “flagship” product is the IWS Biometric EngineTM. Scalable for small citybusiness or worldwide deployment, our biometric engine is a multi-biometricplatform that is hardware and algorithm independent, enabling the enrollmentand management of unlimited population sizes. Our identification products areused to manage and issue secure credentials including national IDs, passports,driver licenses, smart cards and access control credentials. Our lawenforcement products provide law enforcement with integrated mug shot,fingerprint Livescan and investigative capabilities. The biometric technologyis now an integral part of all markets we address, and all of our products areintegrated into the Biometric Engine Platform.  Elements of the biometric engine canbe used as investigative tools to law enforcement potentially utilizingmultiple biometrics and forensic data elements, and to enhance security andauthenticity of public and private sector credentials.

 

CRITICALACCOUNTING ESTIMATES

 

Thediscussion and analysis of our financial condition and results of operationsare based on our consolidated financial statements, which have been prepared inaccordance with accounting principals generally accepted in the United Statesof America, or U.S. GAAP. The preparation of these financial statements inaccordance with U.S. GAAP requires us to utilize accounting policies and makecertain estimates and assumptions that affect the reported amounts of assetsand liabilities, the disclosure of contingencies as of the date of thefinancial statements and the reported amounts of revenue and expenses during afiscal period. The SEC considers an accounting policy to be critical if it isimportant to a company’s financial condition and results of operations, and ifit requires significant judgment and estimates on the part of managementin its application. Although we believe that our judgments and estimates areappropriate and correct, actual results may differ from those estimates.

 

Thefollowing are our critical accounting policies because we believe they are bothimportant to the portrayal of our financial condition and results of operationsand require critical management judgments and estimates about matters that areuncertain. If actual results or events differ materially from thosecontemplated by us in making these estimates, our reported financial conditionand results of operations for future periods could be materially affected.

 

***Revenue Recognition***

 

Ourrevenue recognition policy is significant because our revenue is a keycomponent of our consolidated results of operations. We recognize revenue fromthe following major revenue sources:

 
| · | Long-term  fixed-price contracts involving significant customization |
|--------|----------------------------------------------------------------------|
|   |                                                                 |
| · | Fixed-price  contracts involving minimal customization               |
|   |                                                                 |
| · | Software  licensing                                                  |
|   |                                                                 |
| · | Sales of  computer hardware and identification media                 |
|   |                                                                 |
| · | Postcontract  customer support (PCS)                                 |

 

TheCompany’s revenue recognition policies are consistent with U. S. GAAP includingStatements of Position 97-2 “Software Revenue Recognition” and 98-9 “Modificationof SOP 97-2, Software Revenue Recognition With Respect to Certain Transactions”,Securities and Exchange Commission Staff Accounting Bulletin 104 , EmergingIssues Task Force 

 

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Issue 00-21 “RevenueArrangements with Multiple Deliverables”, and Emerging Issues Task Force Issue03-05 “Applicability of AICPA Statement of Position 97-2 to Non-SoftwareDeliverables in an Arrangement Containing More-Than-Incidental Software”.Accordingly, the Company recognizes revenue when all of the following criteriaare met: persuasive evidence of an arrangement exists, delivery has occurred orservices have been rendered, the fee is fixed or determinable, andcollectibility is reasonably assured.

 

Werecognize revenue and profit as work progresses on long-term, fixed-pricecontracts involving significant amounts of hardware and software customizationusing the percentage of completion method based on costs incurred to datecompared to total estimated costs at completion. Revenue from contracts forwhich we cannot reliably estimate total costs or which do not involvesignificant amounts of customization are recognized upon completion.Determining when a contract should be accounted for using the percentage ofcompletion method involves judgment. Critical items that are considered in thisprocess are the degree of customization and related labor hours necessary tocomplete the required work as well as ongoing estimates of the future laborhours needed to complete the contract. We also generate non-recurring revenuefrom the licensing of our software. Software license revenue is recognized uponthe execution of a license agreement, upon deliverance, fees are fixed anddeterminable, collectibility is probable and when all other significantobligations have been fulfilled. We also generate revenue from the sale ofcomputer hardware and identification media. Revenue for these items isrecognized upon delivery of these products to the customer. Our revenue fromperiodic maintenance agreements is generally recognized ratably over therespective maintenance periods provided no significant obligations remain andcollectibility of the related receivable is probable.

 

***Allowance for Doubtful Accounts***

 

Ourmanagement must make estimates of the uncollectibility of our accountsreceivable. Management specifically analyzes accounts receivable and analyzeshistorical bad debts, customer concentrations, customer creditworthiness,current economic trends, the age of the accounts receivable balances, andchanges in our customer payment terms when evaluating the adequacy of theallowance for doubtful accounts. Our accounts receivable balance wasapproximately $633,000 and our allowance for doubtful accounts wasapproximately $0 as of March 31, 2008.

 

***Valuation Of Goodwill And Other Intangible Assets***

 

Weassess impairment of goodwill and identifiable intangible assets wheneverevents or changes in circumstances indicate that the carrying value may not berecoverable. Factors we consider important which could trigger an impairmentreview include the following:

 
| · |   | Significant  underperformance relative to historical or expected future operating results;                     |
|--------|--------|----------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                           |
| · |   | Significant  changes in the manner of our use of the acquired assets or the strategy of  our overall business; |
|   |   |                                                                                                           |
| · |   | Significant  negative industry or economic trends;                                                             |

 

Whenwe determine that the carrying value of goodwill and other intangible assetsmay not be recoverable based upon the existence of one or more of the aboveindicators of impairment, we measure any impairment based upon fair valuemethodologies. Goodwill and other net intangible assets amounted toapproximately $5,706,000 for as of March 31, 2008. During the three monthsended March 31, 2008 we amended the purchase agreement for the acquisitionof substantially all the assets of Sol Logic, Inc. originally consummated December 19,2007. As a result of this amendment, which reduced the purchase price of theSol Logic assets, we reversed previously recorded goodwill from thisacquisition of approximately $1,036,000.

 

In2002, Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwilland Other Intangible Assets” became effective, and as a result we ceased toamortize goodwill. In lieu of amortization, we performed an initial impairmentreview of our goodwill in June, 2002 and will perform an annual impairmentreview thereafter in the fourth quarter of our fiscal year.

 

Withthe sale of our Digital Photography component in 2006, we reassessed thecomposition of our operating segments and determined that we no longer operatein separate, distinct market segments but rather operate in one market segment,such segment being identity management. The Company’s determination was basedon fundamental changes in the Company’s business structure due to theconsolidation of operations, restructuring of the Company’s operations andmanagement team, and the integration of what where previously distinct,mutually exclusive technologies. This has resulted in changes in the manner bywhich the Company’s chief decision maker assesses performance and makesdecisions 

 

17

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concerning resourceallocation. As a result of our operation in one market segment, such segmentbeing identity management, our 2006 and 2007 goodwill impairment reviewconsisted of the comparison of the fair value of our identity managementsegment as determined by the quoted market prices of our common stock to thecarrying amount of the segment. As the fair value exceeded the carrying valueby a substantial margin, we determined that our goodwill was not impaired. Usingthe same methodologies, we determined that as of March 31, 2008 there wereno indicators of potential impairment.

 

Thereare many management assumptions and estimates underlying the determination ofan impairment loss, and estimates using different, but reasonable, assumptionscould produce significantly different results. Significant assumptions includeestimates of future levels of revenues and operating expenses. Therefore, thetiming and recognition of impairment losses by us in the future, if any, may behighly dependent upon our estimates and assumptions. There can be no assurancethat goodwill impairment will not occur in the future.

 

Weaccount for long-lived assets in accordance with the provisions of SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets.”  This statement requires that long-livedassets and certain identifiable intangible assets be reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Recoverability of assets to be held andused is measured by a comparison of the carrying amount of an asset to futurenet undiscounted cash flows expected to be generated by the asset. If suchassets are considered to be impaired, the impairment to be recognized ismeasured by the amount which the carrying amount of the assets exceeds the fairvalue of the assets. Fair value is determined based on discounted cash flows orappraised values, depending upon the nature of the asset. Assets to be disposedof are reported at the lower of the carrying amount of fair value less costs tosell. During the twelve months ended December 31, 2007 we completed theacquisition of substantially all the assets of Sol Logic, Inc. In March 2008,we amended the purchase price of this asset acquisition. Pursuant to thisacquisition, we recorded approximately $2,311,000 in identifiable intangibleassets. The assets acquired were a covenant not to compete valued atapproximately $200,000, customer base valued at approximately $93,000 anddeveloped technology valued at approximately $2,018,000. The allocation of thepurchase price was based on fair value methodologies employed by an independentvaluation firm.

 

Wedetermined that as of March 31, 2008 there were no indicators of potentialimpairment and accordingly we recorded no impairment losses for long-lived orintangible assets during the three months ended March 31, 2008. There aremany management assumptions and estimates underlying the determination of animpairment loss, and estimates using different, but reasonable, assumptionscould produce significantly different results. Significant assumptions includeestimates of future levels of revenues and operating expenses. Therefore, thetiming and recognition of impairment losses by us in the future, if any, may behighly dependent upon our estimates and assumptions. There can be no assurancethat intangible asset impairment will not occur in the future.

 

***Stock-Based Compensation***

 

Uponadoption of SFAS 123R on January 1, 2006, we began estimating the value ofemployee stock options on the date of grant using the Black-Scholes model.Prior to the adoption of SFAS 123R, the value of each employee stock option wasestimated on the date of grant using the Black-Scholes model for the purpose ofthe pro forma financial disclosure in accordance with SFAS 123. Thedetermination of fair value of stock-based payment awards on the date of grantusing an option-pricing model is affected by our stock price as well asassumptions regarding a number of highly complex and subjective variables.These variables include, but are not limited to the expected stock pricevolatility over the term of the awards and the actual and projected employeestock option exercise behaviors. The expected term of options granted isderived from historical data on employee exercises and post-vesting employmenttermination behavior. We calculated our expected volatility assumption requiredin the Black-Scholes model based on the historical volatility of our stock. Inaddition to the key assumptions used in the Black-Scholes model, the estimatedforfeiture rate at the time of valuation is a critical assumption. The Companyhas estimated an annualized forfeiture rate of 10% for corporate officers, 4%for members of the Company’s Board of Directors and 24% for all other employees.The Company reviews the expected forfeiture rate annually to determine if thatpercent is still reasonable based on historical experience.

 

As of January 1,2006 we have adopted the modified prospective transition method and its effectis included in our Condensed Consolidated Statements of Operations for thethree months ended March 31, 2008 and 2007.

 

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**RESULTSOF OPERATIONS**

 

Resultsas presented do not contain the results of our Digital Photography component asthis component is classified as a discontinued operation due to the sale of theDigital Photography product line in November 2006.

 

***THREE MONTHS ENDED MARCH 31, 2008 AND 2007.***

 
| ** **                               | ** ** | **THREE MONTHS   ENDED  MARCH 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|------------------------------------------|------------|----------------------------------------------------|------------|------------|------------|-------------------|------------|
| **Net Product Revenues**       | ** ** | **2008**                                           | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| **(dollars in thousands)**     | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
|                                     |       |                                               |       |       |       |              |       |   |   |
| Software and  royalties                  |       | $                                                  | 659        |       | $          | 614               |       | $ | 45 |   | 7 | % |
| Percentage of  total net product revenue |       | 85                                                 | %          | 87         | %          |              |       |   |   |
| Hardware and  consumables                |       | $                                                  | 21         |       | $          | 73                |       | $ | (52 | ) | (71 | )% |
| Percentage of  total net product revenue |       | 3                                                  | %          | 10         | %          |              |       |   |   |
| Services                                 |       | $                                                  | 97         |       | $          | 22                |       | $ | 75 |   | 341 | % |
| Percentage of  total net product revenue |       | 12                                                 | %          | 3          | %          |              |       |   |   |
| Total net  product revenues              |       | $                                                  | 777        |       | $          | 709               |       | $ | 68 |   | 10 | % |

 

Softwareand royalty revenues increased 7% or $45,000 during the three months ended March 31,2008 as compared to the corresponding period in 2007. The increase is due tohigher sales of our biometric engine of approximately $300,000 offset by lowerproject-oriented revenues of our Law Enforcement software solutions ofapproximately $39,000 combined with lower royalties and license revenues ofapproximately $146,000. Sales of boxed identity management software through ourdistribution channel decreased approximately $70,000.

 

Revenuesfrom the sale of hardware and consumables decreased 71% or approximately$52,000 during the three months ended March 31, 2008 as compared to thecorresponding period in 2007. The decrease reflects the lower revenues fromproject solutions containing hardware and consumable components.

 

Servicesrevenues are comprised primarily of software integration services, systeminstallation services and customer training. Such revenues increasedapproximately $75,000 during the three months ended March 31, 2008 ascompared to the corresponding period in 2007 due primarily to a higherpercentage of overall revenues being generated from project work and a decreasein our sales of boxed products which do not typically require integration orinstallation services. We expect service revenues to increase in the remainderof 2008 through increased implementations of large-scale high-end solutions.

 

Webelieve that the increase in identity management software revenue inproject-oriented solutions is largely due to increases in governmentprocurement with respect to the various programs we are pursuing. Based onmanagement’s current visibility into the timing of potential governmentprocurements, we believe that we will see a significant increase in governmentprocurement and implementations with respect to identity management initiativesduring the remainder to 2008 and continuing into 2009.

 

Wefeel that we are well positioned for participation in one or more large-scaledomestic or international projects which will enable our company to achievesignificant product revenue growth. In the past eighteen months we have continuouslyretooled our identity management suite of products to meet changing governmentspecifications and to enable customization for large project applications. Additionally,we reoriented our sales organization to direct our resources and efforts towardestablishing partnerships with large systems integrators as we believe theseintegrators will be the ultimate choice for awards of large-scale secureidentification solutions.

 

19

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Ourbacklog of product orders as of March 31, 2008 was approximately$3,115,000. At March 31, 2008, we also had maintenance and support backlogof approximately $1,235,000 under existing maintenance agreements. Productrevenue is typically recognized within a three to six month time perioddepending upon the required degree of customization, if any and customerimplementation schedules. Historically, we have experienced a very minimal riskof order cancellation. Our revenue from maintenance agreements is generallyrecognized ratably over the respective maintenance periods provided nosignificant obligations remain and collectibility of the related receivable isprobable.

 
| ** **                           | ** ** | **THREE MONTHS  ENDED  MARCH 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------|------------|----------------------------------------------|------------|------------|------------|-------------------|------------|
| **Maintenance Revenues**        | ** ** | **2008**                                     | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| **(dollars in thousands)** | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
|                                 |       |                                         |       |       |       |              |       |   |   |
| Maintenance  revenues                |       | $                                            | 606        |       | $          | 627               |       | $ | (21 | ) | (3 | )% |
|                                      |            |                                              |            |            |            |                   |            |  |  |  |  |  |

 

Thedecrease in maintenance revenues reflects lower maintenance revenues generatedfrom our Desktop Security product due to the expiration of certain maintenancecontracts related to this product. We expect maintenance revenues to increaseduring the remainder of 2008 due to the expansion of our installed baseresulting from the completion of significant project-oriented work during the2008 year.

 

Weanticipate the growth of our maintenance revenues through the retention ofexisting customers combined with the expansion of installed base combinedresulting from the completion of project-oriented work, however, we cannotpredict the timing of this anticipated growth.

 
| ** **                                              | ** ** | **THREE MONTHS  ENDED  MARCH 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------|------------|------------|------------|-------------------|------------|
| **Cost of Product Revenues:**            | ** ** | **2008**                                     | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| **(dollars in thousands)**                    | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
|                                                    |       |                                         |       |       |       |              |       |   |   |
| Software and  royalties                                 |       | $                                            | 106        |       | $          | 98                |       | $ | 8 |   | 8 | % |
| Percentage of  software and royalty product revenue     |       | 16                                           | %          | 16         | %          |              |       |   |   |
| Hardware and  consumables                               |       | $                                            | 25         |       | $          | 85                |       | $ | (60 | ) | (71 | )% |
| Percentage of  hardware and consumables product revenue |       | 119                                          | %          | 116        | %          |              |       |   |   |
| Services                                                |       | $                                            | 8          |       | $          | 2                 |       | $ | 6 |   | 300 | % |
| Percentage of  services product revenue                 |       | 8                                            | %          | 9          | %          |              |       |   |   |
| Total product  cost of revenues                         |       | $                                            | 139        |       | $          | 185               |       | $ | (46 | ) | (25 | )% |
| Percentage of  total product revenues                   |       | 18                                           | %          | 26         | %          |              |       |   |   |

 

Thecost of software and royalty product revenue increased 8% or $8,000 during thethree months ended March 31, 2008 as compared to the corresponding periodin 2007 due to higher third-party software content in solutions provided duringthe three months ended March 31, 2008 as compared to the correspondingperiod in 2007. Costs of products can vary as a percentage of product revenuefrom period to period depending upon level of software customization and thirdparty software license content included in product sales during a given period.

 

Thedecrease in the cost of product revenues for our hardware and consumable salesof $60,000 for the three months ended March 31, 2008 as compared to thecorresponding period in 2007 reflects the decrease in hardware and consumablerevenues for the three months ended March 31, 2008 as compared to thecomparable period in 2007.

 

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| ** **                                      | ** ** | **THREE MONTHS  ENDED  MARCH 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|-------------------------------------------------|------------|----------------------------------------------|------------|------------|------------|-------------------|------------|
| **Maintenance cost of revenues** | ** ** | **2008**                                     | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** |
| **(dollars in thousands)**            | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Total  maintenance cost of revenues             |       | $                                            | 315        |       | $          | 294               |       | $ | 21 |   | 7 | % |
| Percentage of  total maintenance revenues       |       | 52                                           | %          | 47         | %          |              |       |   |   |
|                                                 |            |                                              |            |            |            |                   |            |  |  |  |  |  |

 

Costof maintenance revenues as a percentage of maintenance revenues increased to52% during the three months ended March 31, 2008 from 47% for thecorresponding period in 2007 due primarily to slightly lower maintenancerevenues to absorb fixed maintenance costs. The dollar increase of $21,000 or7% during the three months ended March 31, 2008 as compared to thecorresponding period in 2007 reflects higher costs needed to service ourexpanding installed base.

 
| ** **                                              | ** ** | **THREE MONTHS  ENDED  MARCH 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------|------------|------------|------------|-------------------|------------|
| **Product gross profit**                      | ** ** | **2008**                                     | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| **(dollars in thousands)**                    | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                                              | ** ** | ** **                                   | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| Software and  royalties                                 |       | $                                            | 553        |       | $          | 516               |       | $ | 37 |   | 7 | % |
| Percentage of  software and royalty product revenue     |       | 84                                           | %          | 84         | %          |              |       |   |   |
| Hardware and  consumables                               |       | $                                            | (4         | )          | $          | (12               | )          | $ | 8 |   | 67 | % |
| Percentage of  hardware and consumables product revenue |       | (19                                          | )%         | (16        | )%         |              |       |   |   |
| Services                                                |       | $                                            | 89         |       | $          | 20                |       | $ | 69 |   | 345 | % |
| Percentage of  services product revenue                 |       | 92                                           | %          | 91         | %          |              |       |   |   |
| Total product  gross profit                             |       | $                                            | 638        |       | $          | 524               |       | $ | 114 |   | 22 | % |
| Percentage of  total product revenues                   |       | 82                                           | %          | 74         | %          |              |       |   |   |

 

Totalproduct gross profit increased due to higher product revenues during the threemonths ended March 31, 2008 as compared to the corresponding period in2008.

 

Softwareand royalty gross profit increased by 7% or approximately $37,000 for the threemonths ended March 31, 2008 from the corresponding period in 2007 as the2008 period contained higher software and royalty revenues. Costs of softwareproducts can vary as a percentage of product revenue from quarter to quarterdepending upon product mix and third party software licenses included insoftware solutions.

 

Servicesgross profit increased due to higher services revenues generated throughproject sales for the three month period ending March 31, 2008 as comparedto the corresponding period in 2007.

 

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| ** **                                | ** ** | **THREE MONTHS   ENDED  MARCH 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|-------------------------------------------|------------|-----------------------------------------------|------------|------------|------------|-------------------|------------|
| **Maintenance gross profit**    | ** ** | **2008**                                      | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| **(dollars in thousands)**      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
|                                      |       |                                          |       |       |       |              |       |   |   |
| Total  maintenance gross profit           |       | $                                             | 291        |       | $          | 333               |       | $ | (42 | ) | (13 | )% |
| Percentage of  total maintenance revenues |       | 48                                            | %          | 53         | %          |              |       |   |   |
|                                           |            |                                               |            |            |            |                   |            |  |  |  |  |  |

 

Grossmargins related to maintenance revenues decreased due primarily to lowermaintenance revenues to absorb fixed maintenance costs combined with highercosts incurred to service our expanding installed base.

 
| ** **                           | ** ** | **THREE MONTHS ENDED  MARCH 31,** | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|------------|------------|-------------------|------------|
| **Operating expenses**          | ** ** | **2008**                                    | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| **(dollars in thousands)** | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| ** **                           | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** **        | ** ** | ** ** | ** ** |
| General &  administrative   |       | $                                           | 1,101      |       | $          | 1,143             |       | $ | (42 | ) | (4 | )% |
| Percentage of  total net revenue     |       | 80                                          | %          | 86         | %          |              |       |   |   |
| Sales and  marketing                 |       | $                                           | 667        |       | $          | 694               |       | $ | (27 | ) | (4 | )% |
| Percentage of  total net revenue     |       | 48                                          | %          | 52         | %          |              |       |   |   |
| Research &  development     |       | $                                           | 897        |       | $          | 1,186             |       | $ | (289 | ) | (24 | )% |
| Percentage of  total net revenue     |       | 65                                          | %          | 89         | %          |              |       |   |   |
| Depreciation and  amortization       |       | $                                           | 201        |       | $          | 61                |       | $ | 140 |   | 230 | % |
| Percentage of  total net revenue     |       | 15                                          | %          | 5          | %          |              |       |   |   |

 

*GENERAL AND ADMINISTRATIVE EXPENSES.*Generaland administrative expenses are comprised primarily of salaries and otheremployee-related costs for executive, financial, and other infrastructurepersonnel. General legal, accounting and consulting services, insurance,occupancy and communication costs are also included with general andadministrative expenses. The decrease in such expenses, as a percentage oftotal net revenues, is reflective of higher net revenues during the threemonths ended March 30, 2008 as compared to the corresponding period in2007. The dollar decrease of $42,000 is primarily comprised of the followingmajor components:

 
| · | Decrease in  stock-based compensation expense of approximately $74,000 due to the  expiration of certain restricted stock grants combined with lower expenses  recorded pursuant to SFAS 123(R) due to the expiration of vesting  periods for certain prior year share-based payment issuances. |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                 |
| · | Decrease in bad  debt expense of $25,000                                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                 |
| · | Decrease in  office related expenses of approximately $13,000                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                 |
| · | Increase in  professional services of approximately $52,000                                                                                                                                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                 |
| · | Increase in  travel related expenses of approximately $18,000                                                                                                                                                                                                                                        |

 

We arecontinuing to focus our efforts on achieving additional future operatingefficiencies by reviewing and improving upon existing business processes andevaluating our cost structure. We believe these efforts will allow us togradually decrease our level of general and administrative expenses expressedas a percentage of total revenues.

 

*SALES AND MARKETING.*Sales and marketingexpenses consist primarily of the salaries, commissions, other incentivecompensation, employee benefits and travel expenses of our sales, marketing,business development and product management functions. The decrease in suchexpenses as a percentage of net revenues to 48% for the three months ended March 31,2008 from 52% for the corresponding period in 2007 is due to the higherrevenues. The dollar decrease of $27,000 during the three months ended March 31,2008 as compared to the corresponding period in 2007 reflects headcountreductions due to the elimination and consolidation of various sales positions.

 

*RESEARCH AND DEVELOPMENT.*Research anddevelopment expenses consist primarily of salaries, employee benefits andoutside contractors for new product development, product enhancements andcustom integration work. Such expenses decreased 24% or approximately $289,000for the three months ended March 31, 2008 as compared to the correspondingperiod in 2007. The decrease reflects reductions in contract programmingexpenditures of approximately $237,000 and reductions in salaries and employeebenefits of approximately $63,000 offset by slightly higher travel and other 

 

22

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expenses of approximately$11,000. The reduction in contract programming reflects the absorption of themajority of these functions by internal engineering resources. The reduction insalaries and employee benefits is due primarily to the three month periodending March 31, 2007 containing approximately $94,000 in accruedtermination costs for certain employees. Our level of expenditures in researchand development reflects our belief that to maintain our competitive positionin markets characterized by rapid rates of technological advancement, we mustcontinue to invest significant resources in new systems and software as well ascontinue to enhance existing products.

 

*DEPRECIATION AND AMORTIZATION.*During thethree months ended March, 31, 2008, depreciation and amortization expenseincreased 230% or $140,000 as compared to the corresponding period in 2007. Theincrease in depreciation and amortization expense reflects higher amortizationof approximately $143,000 for certain definite long-lived intangible assetsacquired in the Company’s December 2007 purchase of certain assets of SolLogic, Inc.

 

*INTEREST EXPENSE (INCOME), NET.*For thethree months ended March 31, 2008, we recognized interest income of $5,000and interest expense of $0. For the three months ended March 31, 2007, werecognized interest income of $8,000 and interest expense of $251,000. Interestexpense for the three months ended March 31, 2007 contains threecomponents approximating $248,000 related to our secured notes payable issuedin March 2006: $19,000 of coupon interest, $213,000 in note discountamortization and $16,000 in deferred financing fee amortization classified asinterest expense.

 

*LIQUIDITYAND CAPITAL RESOURCES*

 

As of March 31,2008, we had total current assets of $1,652,000 and total current liabilitiesof $5,760,000, or negative working capital of $4,108,000. At March 31, 2008,we had available cash of $301,000 and $132,000 in restricted cash securing ourperformance on certain software implementation contracts.

 

Netcash used in operating activities was $1,061,000 for the three month periodended March 31, 2008 as compared to $597,000 for the corresponding periodin 2007. We used cash to fund net losses of $1,611,000, excluding non-cashexpenses (depreciation, amortization, and stock-based compensation ) of$293,000 for the three months ended March 31, 2008. We used cash to fundnet losses of $1,948,000, excluding non-cash expenses (depreciation,amortization, debt issuance costs, debt discount, stock-based compensation andprovision for losses on accounts receivable less reductions in enventoryobsolescence reserves) of $484,000 for the three months ended March 31,2007. For the three months ended March 31, 2008, we used cash of $419,000to fund increases in current assets and generated cash of $969,000 throughincreases in current liabilities and deferred revenues, excluding debt. For thethree months ended March 31, 2007, we generated cash of $655,000 throughreductions in current assets and generated cash of $696,000 through increasesin current liabilities and deferred revenues, excluding debt.

 

Netcash used in investing activities was $185,000 for the three months ended March 31,2008. Net cash used in investing activities was $15,000 for the three monthsended March 31, 2007. For the three months ended March 31, 2008, weused cash to fund capital expenditures of computer equipment, software andfurniture and fixtures of approximately $26,000. This level of equipmentpurchases resulted primarily from the replacement of older equipment. We alsoused cash of approximately $159,000 for our acquisition of Sol Logic, Inc.For the three months ended March 31, 2007, we used cash to fund capitalexpenditures of computer equipment and software, furniture and fixtures andleasehold improvements of approximately $15,000.

 

Netcash provided by financing activities was $542,000 for the three month periodended March 31, 2008 as compared to $1,126,000 for the correspondingperiod in 2007. For the three months ended March 31, 2008, we generatedcash of $542,000 from our issuance of common stock pursuant to warrantexercises. For the three months ended March 31, 2007, we generated cash of$1,386,000 from our issuance of preferred stock in a private placement net ofdirect transaction costs of $114,000. We also generated cash of $1,105,000 fromour issuance of common stock pursuant to warrant exercises. For the threemonths ended March 31, 2007, we used cash of $1,310,000 for the repaymentof our secured notes payable and used cash of $55,000 from the incurrence offinancing related expenses.

 

Weconduct operations in leased facilities under operating leases expiring atvarious dates through 2009. As collateral for performance on certain softwareinstallation and implementation contracts, we are contingently liable under anirrevocable standby letter of credit in an amount of approximately $132,000.This letter of credit expires on December 26, 2008. As a condition to thisletter of credit, the bank requires the Company to invest an equal amount inthe form of certificate of deposit. As of March 31, 2008, there wereno drawings against the outstanding balance. This certificate of deposit isincluded as a component of other current assets in the Company’s CondensedConsolidated Balance Sheets at March 31, 2008 and December 31, 2007.

 

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The report of our independent accountants included with our Annual Report on Form 10-K as filed with the Commission on April 15, 2008, contained an explanatory paragraph regarding the substantial doubt of our ability to continue as a going concern. We are seeking additional financing that we believe is necessary to fund our working capital requirements for at least the next twelve months in conjunction with the successful implementation of our business plan. Our business plan includes, among other things, the monitoring and controlling of operating expenses, collection of significant trade and other accounts receivable, and controlling of capital expenditures. We may seek to sell equity or debt securities, secure a bank line of credit, or consider strategic alliances. The sale of equity or equity-related securities could result in additional dilution to our shareholders. There can be no assurance that additional financing, in any form, will be available at all or, if available, will be on terms acceptable to us. On May 5, 2008 the Company’s common stock was delisted from AMEX. The Company’s common stock is currently trading on the Over-The-Counter-Bulletin Board (“OTCBB”) under the ticker symbol “IWSY”. The delisting could adversely affect the public price of our common stock and limit the Company’s stockholders’ ability to dispose of, or to obtain accurate quotations as to the prices of the Company’s common stock. Moreover, the Company’s ability to obtain financing on favorable terms, or at all, may be adversely affected by the delisting because certain institutional investors that have policies against investments in companies that are not traded on a national securities exchange and other investors may refrain from purchasing the Company’s common stock because of the delisting. The Company’s ability to obtain financing may also be more limited in numerous states because the Company will no longer benefit from state exemptions from registration which are dependent upon the listing of the Company’s common stock on AMEX. Insufficient funds will require us to sell certain of our assets or license or technologies to others and if we are unable to obtain additional funding there is substantial doubt about our ability to continue as a going concern.

 

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** **

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

** **

*ForeignCurrency Exchange Risk*

 

Marketrisk is the potential loss arising from adverse changes in market rates andprices, such as interest rates and foreign currency exchange rates. Changes inforeign currency exchange rates have an impact on our results of operations.Our exposure to adverse movements in foreign currency exchange rates isprimarily related to our subsidiaries operating expense, primarily in Canada, denominatedin the respective local currency. We currently do not enter into forwardexchange contracts to hedge exposures denominated in foreign currencies and donot use derivative financial instruments for trading or speculative purposes.The effect of an immediate 10% change in foreign currency exchange rates shouldnot have a material effect on our future operating results or cash flows;however, a long term change in foreign currency rates would likely result inincreased technical support and engineering expenses. The vast majority of oursales are transacted in U. S. dollars.

 

**ITEM 4T. CONTROLS AND PROCEDURES**

** **

***Conclusions Regarding the Effectiveness of Disclosure Controls andProcedures.***Under the supervision and with theparticipation of our management, including our principal executive officer andprincipal financial officer, we conducted an evaluation of our disclosurecontrols and procedures as such term is defined under Rule 13a-15(e) promulgatedunder the Securities Exchange Act of 1934, as amended. Based on thisevaluation, our principal executive officer and principal financial officerhave concluded, based upon their evaluation as of the end of the period coveredby this report, that our disclosure controls and procedures are effective inensuring that information required to be disclosed in the reports that we fileor submit under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms.

 

***Changes in Internal Control Over Financial Reporting*.**There has been no change in our internal control over financial reportingduring the fiscal quarter ended March 31, 2008, that has materiallyaffected, or is reasonably likely to materially affect, our internal control overfinancial reporting.

 

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**PART II**

 

**ITEM 1A. RISKFACTORS**

 

Our results of operationsand financial condition are subject to numerous risks and uncertaintiesdescribed in our Annual Report on Form 10-K for our fiscal year ended December 31,2007, filed on April 15, 2008 and as amended on April 30, 2008 andincorporated herein by reference. You should carefully consider these riskfactors in conjunction with the other information contained in this report. Shouldany of these risks materialize, our business, financial condition and futureprospects could be negatively impacted. As of March 31, 2008, there havebeen no material changes to the disclosures made on the above-referenced Form 10-K,as amended, except as follows:

 

**AMEX**HAS DELISTEDTHE COMPANY’S COMMON STOCK FROM LISTING AND REGISTRATION ON THE EXCHANGE.**

 

On May 5, 2008 the Company’s common stock was delisted from AMEX. The Company’s common stock is currently trading on the Over-The-Counter-Bulletin Board (“OTCBB”) under the ticker symbol “IWSY”.

 

The delisting could adversely affect the public price of our common stock and limit our stockholders’ ability to dispose of, or to obtain accurate quotations as to the prices of, our common stock. Moreover, our ability to obtain financing on favorable terms, or at all, may be adversely affected by the delisting because certain institutional investors that have policies against investments in companies that are not traded on a national securities exchange and other investors may refrain from purchasing our common stock because of the delisting. Our ability to obtain financing may also be more limited in numerous states because we will no longer benefit from state exemptions from registration which are dependent upon the listing of our common stock on AMEX.

 

**WEHAVE A HISTORY OF SIGNIFICANT RECURRING LOSSES TOTALING APPROXIMATELY $79.6MILLION, AND THESE LOSSES MAY CONTINUE IN THE FUTURE.**

 

As of March 31,2008, we had an accumulated deficit of $79.6 million, and these lossesmay continue in the future. We will need to raise capital to coverthese losses, and financing may not be available to us on favorable terms.In the event financing is not available, in the time frame required, we will beforced to sell certain of our assets or license our technologies to others. Weexpect to continue to incur significant sales and marketing, research anddevelopment, and general and administrative expenses. As a result, we will needto generate significant revenues to achieve profitability and we may neverachieve profitability.

 

**THEHOLDERS OF OUR PREFERRED STOCK HAVE CERTAIN RIGHTS AND PRIVILEGES THAT ARESENIOR TO THE COMMON STOCK, AND WE MAY ISSUE ADDITIONAL SHARES OFPREFERRED STOCK WITHOUT SHAREHOLDER APPROVAL THAT COULD HAVE A MATERIAL ADVERSEEFFECT ON THE MARKET VALUE OF THE COMMON STOCK.**

 

OurBoard of Directors has the authority to issue a total of up to 4,000,000 sharesof preferred stock and to fix the rights, preferences, privileges, andrestrictions, including voting rights, of the preferred stock, which typicallyare senior to the rights of the common stockholders, without any further voteor action by the common stockholders. The rights of our common shareholderswill be subject to, and may be adversely affected by, the rights of the holdersof the preferred stock that have been issued, or might be issued in the future.Preferred stock also could have the effect of making it more difficult for athird party to acquire a majority of the outstanding voting stock of ImageWare.This could delay, defer, or prevent a change in control. Furthermore, holdersof preferred stock may have other rights, including economic rights, senior tothe common stock. As a result, their existence and issuance could have amaterial adverse effect on the market value of the common stock. We have in thepast issued and may from time to time in the future issue, preferred stock forfinancing or other purposes with rights, preferences, or privileges senior tothe common stock. At March 31, 2008 we had three series of preferred stockoutstanding, Series B preferred stock, Series C 8% convertiblepreferred stock and Series D 8% convertible preferred stock.

 

Theprovisions of our Series B Preferred Stock prohibit the payment ofdividends on the common stock unless the dividends on those preferred sharesare first paid. In addition, upon a liquidation, dissolution or sale ofImageWare’s business, the holders of the Series B Preferred Stock will beentitled to receive, in preference to any distribution to the holders of commonstock, initial distributions of $2.50 per share, plus all accrued but unpaiddividends.  Pursuant to the terms of our Series B Preferred Stock weare obligated to pay cumulative cash dividends on shares of Series BPreferred Stock from legally available funds at the annual rate of $0.2125 pershare, payable in two semi-annual installments of $0.10625 each, whichcumulative dividends must be paid prior to payment of any dividend on ourcommon stock. As of March 31, 2008, the Company had cumulative undeclareddividends on the Series B Preferred Stock of approximately $21,000.

 

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The Series CPreferred Stock has a liquidation preference equal to its stated value, plusany accrued and unpaid dividends thereon and any other fees or liquidateddamages owing thereon. The Series C Preferred Stock accrues cumulativedividends at the rate of 8.0% of the stated value per share per annum.  Atthe option of the Company, the dividend payment may be made in the form ofcash, after the payment of cash dividends to the holders of Series BPreferred Stock, or common stock issuable upon conversion of the Series CPreferred Stock.  Each share of Series C Preferred Stock isconvertible at any time at the option of the holder into a number of shares ofcommon stock equal to the stated value (initially $1,000 per share, subject toadjustment), plus any accrued and unpaid dividends, divided by the conversionprice (initially $1.50 per share, subject to adjustment). Subject to certainlimitations, the conversion price per share shall be adjusted in the event ofcertain subsequent stock dividends, splits, reclassifications, dilutiveissuances, rights offerings, and reclassifications.  The Series CPreferred Stock generally does not have voting rights except as required bylaw, however, certain activities may not be undertaken by the Company withoutthe affirmative vote of a majority of the holders of the outstanding shares of Series CPreferred Stock. As of March 31, 2008, the Company had cumulativeundeclared dividends on the Series C Preferred Stock of approximately$271,000.

 

The Series DPreferred Stock has a liquidation preference equal to its stated value, plusany accrued and unpaid dividends thereon and any other fees or liquidateddamages owing thereon. The Series D Preferred Stock accrues cumulativedividends at the rate of 8.0% of the stated value per share per annum.  Atthe option of the Company, the dividend payment may be made in the form ofcash, after the payment of cash dividends to the holders of Series B and Series CPreferred Stock, or common stock issuable upon conversion of the Series DPreferred Stock.  Each share of Series D Preferred Stock isconvertible at any time at the option of the holder into a number of shares ofcommon stock equal to the stated value (initially $1,000 per share, subject toadjustment), plus any accrued and unpaid dividends, divided by the conversionprice (initially $1.90 per share, subject to adjustment). Subject to certainlimitations, the conversion price per share shall be adjusted in the event ofcertain subsequent stock dividends, splits, reclassifications, dilutiveissuances, rights offerings, and reclassifications.  The Series DPreferred Stock generally does not have voting rights except as required bylaw, however, certain activities may not be undertaken by the Company withoutthe affirmative vote of a majority of the holders of the outstanding shares of Series CPreferred Stock. As of March 31, 2008, the Company had cumulativeundeclared dividends on the Series D Preferred Stock of approximately$125,000.

 

**ITEM 6. EXHIBITS**

 
| **(a)** | ** ** | **EXHIBITS**                                                                                                                                                                                                                                                                                             |
|---------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |       |                                                                                                                                                                                                                                                                                                     |
| 4.1     |       | Amendment  No. 1 to Registration Rights Agreement, dated March 28, 2008, by  and among the Company, Sol Logic and the Representative (incorporated by  reference to Exhibit 4.1 to the Company’s Current Report on  Form 8-K/A, Amendment No. 3 filed April 1, 2008). |
| 10.1    |       | Form of  Warrant to Purchase Common Stock dated March 12, 2008 (incorporated by  reference to Exhibit 10.1 to the Company’s Current Report on  Form 8-K, filed March 18, 2008.)                                                                                            |
| 10.2    |       | Amendment No 1  to Asset Purchase Agreement, dated March 28, 2008, by and between the  Company and the Representative (incorporated by reference to  Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed  April 1, 2008.)                                           |
| 31.1    |       | Certification of  the Principal Executive Officer pursuant to Rule 13a-14(a) and  15d-14(a)                                                                                                                                                                                                    |
| 31.2    |       | Certification of  the Principal Financial and Accounting Officer pursuant to  Rule 13a-14(a) and 15d-14(a)                                                                                                                                                                                     |
| 32.1    |       | Certification by  the Principal Executive Officer and Principal Financial and Accounting  Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                                                                                                  |

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|   |              | IMAGEWARE SYSTEMS, INC. |
|--------|-------------------|-------------------------|
|   |              |                    |
|   |              |                    |
| Date:  | May 20, 2008 |                    | By: |   | /s/ Wayne  Wetherell |   |   |
|   |              |                    |   | Wayne Wetherell,  Chief Financial |   |
|   |              |                    |   | Officer |   |
|   |              |                    |   | (on behalf of  the Registrant and as Registrant’s Principal Financial and Accounting  Officer) |   |
|        |                   |                         |  |  |  |  |  |

 

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