UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549







FORM 10-K




(Mark
One)


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




For
the fiscal year ended December 31, 2008.


or





o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934




For
the transition period from 
to.





Commission
File Number 001-33353




INNOVATIVE CARD
TECHNOLOGIES, INC.


(Exact
name of registrant as specified in its charter)





Delaware
            
            90-0249676State
      or other jurisdiction of
              incorporation
      or organization
            
            (I.R.S.
      Employer
              Identification
      No.)633
      West Fifth Street, Suite 2600
              Los
      Angeles, CA
            
            90071(Address
      of principal executive offices)
            
            (Zip
      Code)




Registrant’s
telephone number, including area code(310)
312-0700





Securities
registered pursuant to Section 12(b) of the Act:





Title
      of each class
            
            Name
      of each exchange on which registeredCommon
      Stock, $0.0001 par value
            
            Over-the-Counter
      Bulletin Board(1)




(1) On
February 20, 2009, the registrant’s Common Stock was delisted from trading on
the NASDAQ Capital Market




Securities
registered pursuant to Section 12(g) of the Act:




None




Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act o


Yes   
xNo





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.    oYes     xNo





Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.  x  Yes oNo





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files).       ̈   Yes
 ̈   No




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. o




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.




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




Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act).  oYes  x
 No





The
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
last sold as of the last business day of the registrant’s most recently
completed second fiscal quarter based upon the closing price of the common stock
as reported by NASDAQ Capital Market on such date, was approximately
$28,258,837.





The
number of shares outstanding of Registrant’s common stock, $0.001 par value at
April 20, 2009 was 28,495,256.





DOCUMENTS
INCORPORATED BY REFERENCE





None.




SUBSEQUENT
EVENTS





None.










INNOVATIVE
CARD TECHNOLOGIES, INC




FORM 10-K




FOR
THE YEAR ENDED DECEMBER 31, 2008




INDEX




PagePART IItem
      1.
            
            Business
            
            1Item
      1A.
            
            Risk
      Factors
            
            4Item
      2.
            
            Properties
            
            11Item
      3.
            
            Legal
      Proceedings
            
            11Item
      4.
            
            Submission
      of Matters to a Vote of Security Holders
            
            11PART IIItem
      5.
            
            Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
            
            11Item
      6.
            
            Selected
      Financial Data
            
            13Item
      7.
            
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            
            13Item
      7A.
            
            Quantitative
      and Qualitative Disclosures About Market Risk
            
            19Item
      8.
            
            Financial
      Statements and Supplementary Data
            
            20Item
      9.
            
            Changes
      in and Disagreements With Accountants on Accounting and Financial
      Disclosure
            
            20Item
      9A.
            
            Controls
      and Procedures
            
            20PART IIIItem
      10.
            
            Directors,
      Executive Officers and Corporate Governance
            
            21Item
      11.
            
            Executive
      Compensation
            
            24Item
      12.
            
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            
            25Item
      13.
            
            Certain
      Relationships and Related Transactions, and Director
      Independence
            
            26Item
      14.
            
            Principal
      Accounting Fees and Services
            
            27PART IVItem
      15.
            
            Exhibits,
      Financial Statement Schedules
            
            28




i




PART I




We
urge you to read this entire Annual Report on Form 10-K, including the” Risk
Factors” section the financial statements and related notes included
herein.  As used in this Annual Report, unless context otherwise
requires, the words “we,” “us,”“our,” “the Company,” “Innovative Card” “InCard”
and “Registrant” refer to Innovative Card Technologies, Inc.  and its
wholly owned subsidiary PSA Co. Also, any reference to “common shares,” “Common
Stock,” “common stock” or “Common Shares” refers to our $.001 par value common
stock.




SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS





Certain
statements contained in this Annual Report on Form 10-K constitute
“forward-looking statements” within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. All statements included in this Annual Report, including those related to
our cash, liquidity, resources and our anticipated cash expenditures, as well as
any statements other than statements of historical fact, regarding our strategy,
future operations, financial position, projected costs, prospects, plans and
objectives are forward-looking statements.  These forward-looking
statements are derived, in part, from various assumptions and analyses we have
made in the context of our current business plan and information currently
available to us and in light of our experience and perceptions of historical
trends, current conditions and expected future developments and other factors we
believe are appropriate in the circumstances. You can generally identify forward
looking statements through words and phrases such as“believe”, “expect”, “seek”,
“estimate”, “anticipate”, “intend”, “plan”, “budget”, “project”, “may likely
result”, “may be”, “may continue”  and other similar
expressions, although not all forward-looking statements contain these
identifying words. We cannot guarantee future results, levels of activity,
performance or achievements, and you should not place undue reliance on our
forward-looking statements.





Our
actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including the risks
described in Part I, Item 1A, “Risk Factors” and elsewhere
in this Annual Report. Our forward-looking statements do not reflect the
potential impact of any future acquisitions, mergers, dispositions, joint
ventures or strategic investments. In addition, any forward-looking statement
represents our expectation only as of the day this Annual Report was first filed
with the Securities and Exchange Commission (“SEC”) and should not be relied on
as representing our expectations as of any subsequent date. While we may elect
to update forward-looking statements at some point in the future, we
specifically disclaim any obligation to do so, even if our expectations
change.





When
reading any forward-looking statement, you should remain mindful that actual
results or developments may vary substantially from those expressed in or
implied by such statement for a number of reasons or factors.  Each
forward-looking statement should be read in context with and in understanding of
the various other disclosures concerning our company and our business made
elsewhere in this Annual Report as well as our public filings with the SEC. You
should not place undue reliance on any forward-looking statement. We are not
obligated to update or revise any forward-looking statements contained in this
Annual Report or any other filing to reflect new events or circumstances unless
and to the extent required by applicable law.





ITEM
      1.
            BUSINESS




Our
Business





We
develop and market secure powered cards for payment, identification, physical
and logical access applications. Our main product, the ICT DisplayCard,
integrates the security of a one-time password token directly into a card the
size of a standard credit or debit card. A token is a portable physical device,
typically in a key-fob form factor, that generates the one-time password (also
referred to as a one-time passcode). At the push of a button on the back of the
ICT DisplayCard, a one-time passcode (OTP) is shown on the card’s integrated
display. During a transaction, this number is entered into a user interface with
other information (such as the user’s static PIN and login name). This
information is relayed to a backend system for multi-factor authentication.
InCard does not provide the backend authentication server, but rather will
integrate the ICT DisplayCard into authentication systems provided by other
companies including distributors and other resellers of the ICT DisplayCard. The
ICT DisplayCard’s OTP authentication works like tokens issued by VASCO, RSA, and
ActivIdentity, but in a more convenient, wallet-sized card form
factor.





Our
products can be used for both the enterprise and the on-line banking markets.
The enterprise market, which is served by authentication companies such as
VASCO, ActivIdentity, Verisign, and RSA, will be able to offer the ICT
DisplayCard as an alternative for end users to replace existing tokens. We also
offer the ICT DisplayCard to financial institutions to increase the security of
on-line banking transactions. In addition to the security authentication
function, our ICT DisplayCard can be specified to have payment functionality,
enabling credit and debit card issuers to enhance anti-fraud
protection.





Our
primary focus is and will continue to be the further development, sale and
marketing of the ICT DisplayCard. The ICT DisplayCard will generate a
one-time passcode or other numeric information after the user’s push of a button
located on the rear surface of the card. Our proprietary power inlay technology
consists of a battery, integrated circuit, printed wiring boards and switch that
can power applications on credit cards and other information-bearing plastic
cards. We have devoted our efforts to marketing  this product. We
believe that our power inlay technology, and our software and firmware
technology can provide an operating platform for new business opportunities for
both the enterprise market and on-line banking market.




1





During
the fiscal year ended December 31, 2008, we continued to further develop the ICT
DisplayCard and expand our sales and marketing efforts.  During 2008,
we achieved the following significant milestones:





·
            Commenced
      volume manufacturing of our one time programmable
    DisplayCard.





·
            Began
      development work on a next generation, time-based DisplayCard, which will
      be introduced in 2009.





·
            Booked
      a single order valued at over 3.7 million dollars, the largest order ever
      booked in this market segment.





·
            Ended
      the fiscal year with a shippable backlog of almost $4.5
      million.





·
            Began
      planning the expansion of our supply
chain




Industry Background





The
growth in electronic banking and electronic commerce, and the increasing use and
reliance by business, government and educational institutions upon proprietary
or confidential information that is remotely accessible by many users over
different networks, has made information security a paramount concern.
Enterprises are seeking solutions that will continue to allow them to expand
access to data and financial assets while maintaining network security, and
firms such as VASCO, RSA, VeriSign, and ActivIdentity are providing solutions
for these enterprises. We believe that the tokens provided to end users by these
and other network security firms are generally inconvenient as these tokens have
to be carried outside of a wallet or placed on a keychain or in a pocket. Our
ICT DisplayCard offers the same functionality as a token, but in a form factor
that can be carried in a wallet. We believe the increased convenience offered by
our device will provide the end user with a better experience and greater
convenience.





Internet
and Enterprise Security – With the advent of personal computers and
distributed information systems in the form of wide area networks, intranets,
local area networks and the Internet, as well as other direct electronic links,
many organizations have implemented applications to enable their work force and
third parties, including vendors, suppliers and customers, to access and
exchange data and perform electronic transactions. As a result of the increased
number of users having direct and remote access to such enterprise applications,
data and financial assets have become increasingly vulnerable to unauthorized
access and misuse.





Individual
User Security – In addition to the need for enterprise-wide security, the
proliferation of personal computers, personal digital assistants and mobile
telephones in both the home and office settings, combined with widespread access
to the Internet, have created significant opportunities for electronic commerce
by individual users such as electronic bill payment, home banking and home
shopping.





Fueled by
well-publicized incidents, including misappropriation of credit card information
and theft of sensitive personal data, there is a growing perception among many
consumers of risks involved in transmitting information via the Internet. These
incidents and this perception may hamper the development of consumer-based
electronic commerce. Because of these factors, data security firms such as
VASCO, RSA, VeriSign, and ActivIdentity, have seen increasing demand for their
security solutions. Electronic commerce will benefit from the implementation of
improved security measures that accurately identify users and reliably encrypt
data transmissions over the Internet. To address these security concerns, in
2005 many banks in European countries began to issue EMV-compliant smart cards
(credit cards with a micro-chip).





Although
security solution providers have and, we expect, will continue to have growth in
their businesses, we believe that a barrier to further widespread adoption of
multi-factor authentication is the end user’s experience using the tokens
provided to them by the security solution providers. Our product, the ICT
DisplayCard, is more portable and user friendly as it can be kept in a wallet,
carried along with other credit card form factor cards.





Manufacturing& Production





The ICT
DisplayCard has been available for issuance on a limited quantity basis since
December 2006.  Although we continue to develop our own
manufacturing process, we currently outsource a majority of our
manufacturing.  We rely on OEMs, and the ability to produce the ICT
DisplayCard is limited by our supply chain partners and  the component
parts we are able to procure.





The
electronics and the EPS display of the ICT DisplayCard is presently being
manufactured in Taiwan by a single supplier, SmartDisplayer,
LTD.  A  European company, NagraID laminates the finished
polymer surfaces including the artwork and other printing that provide the
card’s cosmetic finish. The battery, presently available from only one supplier,
Solicore, Inc.powers the card’s circuitry and display.InCard performs final
testing and quality assurance testing on the finished cards prior to shipping to
our customers.





We
estimate that with our current suppliers and increased, minimal investment in
the company’s manufacturing infrastructure , we have the capacity to produce
more than three million ICT DisplayCards per month.  We believe that
our present capacity will meet our anticipated demand well into 2010. In the
event that we receive greater interest or orders than our projections, our OEMs
and new supply chain partners have indicated to us that they will be able to
significantly increase capacity.





2





Our
Power Inlay Technology And Products





Our power
inlay technology integrates a battery, circuit, switch and output device into
financial cards or other information-bearing plastic cards that comply with the
various requirements set forth by the International Organization for
Standardization (ISO) for credit/debit cards. Our technology is designed to be
used as an operating system to add different applications that require power
into credit card sized cards to run complex integrated circuitry. Our power
inlay technology can be used to power display screens, a one-time-passcode
generator, and other anti-fraud measures. We have developed a process for
imbedding our power inlay technology into a payment card and into credit card
sized cards that meet ISO standards.





Our
Strategy And Sales Cycle





We
anticipate selling our product through resellers and distributors who provide
security technology such as tokens for enterprise security and on-line banking
applications. Our ICT DisplayCard, which we believe provides the end user with
OTP security in a more user-friendly form factor, will assist our resellers and
distributors in further differentiating themselves within their market
segments.





Presently,
our sales cycle takes several months and generally requires negotiation and
completion of a pilot program before any order for our cards. We are now
entering into pilot programs and completing pilot programs for the ICT
DisplayCard through several large commercial entities. If these pilot programs
are successful, with the users in the pilot program having a good experience
with the ICT DisplayCard and the entity hosting the pilot wanting to order
larger quantities of cards, we anticipate that the resellers will order
commercial quantities of cards in greater quantities. Depending upon the size of
the purchaser, there may be several pilot programs involving their employees or
customers prior to a larger sales order being received.





Sales
& Marketing





We
anticipate that the majority of our revenues will come from the sale of ICT
DisplayCards. We intend to sell these cards through resellers. However, these
resellers are not obligated to sell our product and in fact the degree of
success of these resellers will depend on our ability to develop interest in the
ICT DisplayCard with end-users and with companies that need or provide security
solutions.





The
resellers for our ICT DisplayCard include Actividentity, Entrust, Gemalto,
InfoSERVER, Inteligensa, Inex Americana, Verisign, Innet and IDENTIPHI. These
companies sell a complete security solution, either by themselves or with other
providers. Although some of these resellers are required to make a deposit for
the ICT DisplayCard, none of these resellers are required by these agreements to
order our products. The extent to which these resellers market and sell our
products will depend on the reseller’s customer experience with the ICT
DisplayCard and our ability to provide a quality product, to deliver quantities
as needed by the reseller, and to offer competitive pricing.




Research
& Development





We
conduct research and development activities both in-house and at outside
laboratories.  We have purchased materials and components for our
products under development from a number of technology companies.




We have
spent $467,887 and $1,352,413 for research and development for the fiscal years
ended December 31, 2008 and 2007, respectively.





Intellectual
Property





We rely
on a combination of patent, trademark and trade secret laws as well as
confidentiality procedures and contractual provisions to protect our proprietary
technology. We currently own eleven U.S. patents and twenty five foreign patents
most of which relates to our prior products and not to the ICT DisplayCard which
is now the focus of our efforts. We also have fifteen foreign patent
applications pending. The duration of the U.S. patents generally is 20 years
from the date the original application was filed. At this time,
we  have limited patent protection on our ICT DisplayCard
technology.





We
currently have trademarks registered for InCard Technologies and the LensCard in
the United States. We also have additional marks for which registration is
pending.





From time
to time, we may encounter disputes over rights and obligations concerning
intellectual property. Also, the efforts we have taken to protect our
proprietary rights may not be sufficient or effective. Any significant
impairment of our intellectual property rights could harm our business, our
reputation, or our ability to compete. Also, protecting our intellectual
property rights could be costly and time consuming.





Competition





We are
aware of products that are being mass produced in the same form factor as our
ISO-compliant CR80 form factor that incorporates the token technology. There are
companies creating tokens and random number generators for use in dual-factor
authentication (as an item separate from the transaction card). For example,
RSA, Vasco, and VeriSign token devices may be cost competitive to our technology
but are not in a credit card form factor. Smart Card, biometrics, and software
programs can provide multi-factor authentication competitive to our ICT
DisplayCard.





We
believe that the principal competitive factors that affect the market for tokens
include convenience, price, quality/reliability, ease of use,
and  cost. Although we believe that our ICT DisplayCard will be able
to compete favorably with respect to some of these factors, there can be no
assurances that we will be able to maintain our competitive position against
current and potential competitors, especially those with significant marketing,
service, support, technical and other competitive resources.




3





Some of
our present and potential competitors have significantly greater financial,
technical, marketing, purchasing and other resources than we do, and as a
result, may be able to respond more quickly to new or emerging technologies and
changes in customer requirements, or to devote greater resources to the
development, promotion and sale of products, or to deliver competitive products
at a lower end-user price. Current and potential competitors have established or
may establish cooperative relationships among themselves or with third parties
to increase the ability of their products to address the needs of our
prospective customers. It is possible that new competitors or alliances may
emerge and rapidly acquire significant market share. Accordingly, we continue to
pursue our technological advantage and effective relationships to develop,
manufacture and sell our ICT DisplayCard to the market.





Governmental
Regulation





The
development of our products is generally not subject to government regulation.
However, because we intend to market our products in countries other than the
United States, importation and exportation regulations may impact our
activities. A breach of these laws or regulations may result in the imposition
of penalties or fines, suspension or revocation of licenses. We are not
currently involved in any such judicial or administrative proceedings and
believe that we are in compliance with all applicable regulations.





Although
it is impossible to predict the effect that additional import and export
requirements and other regulations may have on future earnings and operations,
we are presently unaware of any future regulations that may have a material
effect on our financial position, but cannot rule out the
possibility.





Employees





We have 5
full time employees including our officers.  We also have 2 part time
employees and utilize the services of 2 outside consultants on a full time
basis.





Where
to Find More Information




We make
our public filings with the SEC, including our Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all
exhibits and amendments to these reports.  Also our executive
officers, directors and holders of more than 10% of our common stock, file
reports with the SEC on Forms 3, 4 and 5 regarding their ownership of our
securities. These materials are available on the SEC’s web site,http://www.sec.gov.
You may also read or copy any materials we file with the SEC at the SEC’s Public
Reference Room at 100 F Street, N.E., Washington, DC 20549. You
may obtain information on the operation of the Public Reference Room by calling
the SEC at 1-800-SEC-0330.




ITEM
      1A.
            RISK
      FACTORS





We
have described below a number of uncertainties and risks which, in addition to
uncertainties and risks presented elsewhere in this Annual Report, may adversely
affect our business, operating results and financial condition.  The
uncertainties and risks enumerated below as well as those presented elsewhere in
this Annual Report should be considered carefully in evaluating our company and
our business and the value of our securities. The following important factors,
among others, could cause our actual business, financial condition and future
results to differ materially from those contained in forward-looking statements
made in this Annual Report or presented elsewhere by management from time to
time.





We
are in default of our 8% Senior Secured Debentures.





We are in
default of our debt agreements entered into in January 2008 and
April 2008 in connection with the sale of our 8% Senior Secured
Debentures.  In September 2008, we agreed to defer a portion of the
interest payments due October 1, 2008 and January 1, 2009. Such deferral
resulted in those payments, plus a ten percent (10%) deferral charge being added
to the principal balance of those debentures. In February 2009, we were delisted
from the NASDAQ National Market, constituting a default on the entire debenture
balance. We are currently negotiating waivers for this
default.  However, as a result of the default,  investors
can call the debentures and demand immediate repayment.  Our inability
to repay the outstanding balance can result in our debenture holders exercising
their remedies under the accompanying security agreements and foreclosing on
substantially all of our assets.  In such instance, we could be forced
to seek bankruptcy protection or the debenture holders could take our assets as
satisfaction of their indebtedness.  In either instance, this will
result in a total loss of our common shareholders’ investment.





Our
independent registered public accounting firm has raised concerns about our
ability to continue as a going concern.





Our
auditors have added an explanatory paragraph to their opinion on our financial
statements for the year ended December 31, 2008 because of concerns about
our ability to continue as a going concern. These concerns arise from the fact
that we have not yet established an ongoing source of revenues sufficient to
cover our operating costs and we must raise additional capital in order to
continue to operate our business. If we fail to generate positive cash flows or
obtain additional financing when required, we may have to modify, delay or
abandon some or all of our business and expansion plans.




4





The
Company has a history of recurring losses from operations and has an accumulated
deficit of $36,996,720 as of December 31, 2008. Sales of the InCard
DisplayCard, the Company’s main product, are not expected to generate positive
cash flow until the fourth quarter of 2009. As a result, there is substantial
doubt about the Company’s ability to continue as a going concern.





Management’s
plan regarding these matters is to raise additional debt and/or equity financing
to allow it the ability to cover its current cash flow requirements and meet its
obligations as they become due.





There can
be no assurances that funds will be available to the Company when needed or, if
available, that such funds would be available under favorable terms. In the
event that the Company is unable to generate adequate revenues to cover expenses
and cannot obtain additional funds in the near future, the Company may seek
protection under bankruptcy laws.





Our
common shares were delisted from the NASDAQ Capital Market.





On
February 20, 2009, our common shares were delisted from the NASDAQ Capital
Market.  As a result of the delisting, our shares now trade on the
Over-the-Counter Bulletin Board and on the Pinksheets.  Historically,
the volume and liquidity of these two markets has been significantly less than
on the NASDAQ Capital Market.  Addition, shares listed these markets
are unlikely to be followed by any market analysts, and there may be few
institutions acting as market makers for our common stock. Either of these
factors could adversely affect the liquidity and trading price of our common
stock and could result in large fluctuations or market price.





Our
common stock is subject to the pennystock regulations and restrictions which may create a lack of
liquidity and make trading difficult or impossible.




The
trading of our securities, if any, will be in the OTCBB as maintained by FINRA.
As a result, an investor may find it difficult to dispose of, or to obtain
accurate quotations as to the price of our common stock.




Rule
3a51-1 of the Securities Exchange Act of 1934 establishes the definition of a "pennystock," for purposes relevant to
us, as any equity security that has a minimum bid price of less than $5.00 per
share or with an exercise price of less than $5.00 per share, subject to a
limited number of exceptions which are not available to us. It is likely that
our shares will be considered to be penny stocks for the immediately foreseeable
future. This classification severely and adversely affects any market liquidity
for our common stock.




For any
transaction involving a pennystock,
unless exempt, thepennystock
rules require that a broker or dealer approve a person's account for
transactions in penny stocks and the broker or dealer receive from the investor
a written agreement to the transaction setting forth the identity and quantity
of thepennystock to be
purchased.  In order to approve a person's account for transactions in
penny stocks, the broker or dealer must obtain financial information and
investment experience and objectives of the person and make a reasonable
determination that the transactions in penny stocks are suitable for that person
and that that person has sufficient knowledge and experience in financial
matters to be capable of evaluating the risks of transactions in penny
stocks.




The
broker or dealer must also deliver, prior to any transaction in a pennystock, a disclosure schedule
prepared by the SEC relating to thepennystock market, which, in highlight form, sets
forth:


·
              the
      basis on which the broker or dealer made the suitability determination,
      and
 
 ·
              that
      the broker or dealer received a signed, written agreement from the
      investor prior to the
transaction.


Disclosure also has to be
made about the risks of investing in penny stocks in both public offerings and
in secondary trading and commissions’ payable to both the broker-dealer and the
registered representative, current quotations for the securities and the rights
and remedies available to an investor in cases of fraud in pennystock transactions. Finally,
monthly statements have to be sent disclosing recent price information for thepennystock held in the account
and information on the limited market in penny stocks.




Because
of these regulations, broker-dealers may not wish to engage in the
above-referenced necessary paperwork and disclosures and/or may encounter
difficulties in their attempt to sell shares of our common stock, which may
affect the ability of selling shareholders or other holders to sell
their shares in any secondary market and have the effect of reducing the
level of trading activity in any secondary market. These additional sales
practice and disclosure requirements could impede the sale of our common stock,
if and when our common stock becomes publicly traded. In addition, the liquidity
for our common stock may decrease, with a corresponding decrease in the price of
our common stock. Our shares, in all probability, will be subject to such pennystock rules for the foreseeable
future and our shareholders will, in all likelihood, find it difficult to sell
their common stock.




5




The
market for penny stocks has experienced numerous frauds and abuses which could
adversely impact investors perception of our stock.




We
believe that the market for penny stocks has suffered from patterns of fraud and
abuse. Such patterns include:


·
                Control
      of the market for the security by one or a few broker-dealers that are
      often related to the promoter or
  issuer;
 
 ·
                Manipulation
      of prices through prearranged matching of purchases and sales and false
      and misleading press
releases;
 ·
                  “Boiler
      room" practices involving high pressure sales tactics and unrealistic
      price projections by inexperienced sales
    persons;
 
 ·
                  Excessive
      and undisclosed bid-ask differentials and markups by selling
      broker-dealers; and
 ·
                    Wholesale
      dumping of the same securities by promoters and broker-dealers after
      prices have been manipulated to a desired level, along with the inevitable
      collapse of those prices with consequent investor
      losses.




As a
result, investors may have the perception that penny stock are too risky which
will make developing an active market for our common shares more
difficult.





We
are an early stage company with an unproven business strategy. Our limited
history of operations makes evaluation of our business and prospects
difficult.





Our
business prospects are difficult to predict because of our limited operating
history, early stage of development and unproven business strategy. Since our
incorporation, we have primarily been and continue to be involved in development
of products using our power inlay technology and marketing these products to
industry partners. In 1998, our founder commenced commercialization of our first
product, the LensCard, and entered into license agreements with banks and credit
card issuers, most of which have terminated. After discovering the possibility
of placing power into an International Organization of Standards (ISO) compliant
card, we began to focus our efforts on the development of our power inlay
technology and not on the marketing of the LensCard. For these reasons, we
expect that future orders for the LensCard will be insignificant. We closed our
first commercial sale of our InCard DisplayCard, which uses our power inlay
technology, in the fourth quarter of 2007. Although we believe that our power
inlay technology and products under development have significant profit
potential, we may not attain profitable operations and may not succeed in
realizing our business objectives.




We
may currently be operating in the “zone of insolvency” and as a result our
directors’ fiduciary duty may be to creditors and shareholders.





Generally,
a corporation’s directors owe a fiduciary duty to the corporation’s shareholders
and not to its creditors. The duties of the directors to creditors do not expand
beyond the relevant contractual terms. However, when a corporation is operating
in the “zone of insolvency,” some courts have concluded that the fiduciary duty
of directors shifts to include creditors. Delaware courts have taken the
position that directors of a corporation operating in the zone of insolvency
continue to owe a fiduciary duty to the corporation’ shareholders but also to
its creditors. Accordingly, management and the directors are required to
consider their duties with regard to both shareholders and creditors in their
decision making process.





We have an accumulated deficit of$36,996,720
asof December 31, 2008 and we may
never achieve profitability





We have
incurred significant net losses every year since our inception, including net
losses of $8,929,537 and $14,333,622 for the fiscal years ending
December 31, 2008 and 2007, respectively. As of December 31, 2008, we had
an accumulated deficit of $36,996,720. These losses have resulted principally
from expenses incurred in our research and development programs and general and
administrative expenses. To date we have not generated significant revenues. We
have sustained operations through the issuance of our securities.  We
anticipate that we will continue to incur substantial operating losses based on
projected sales revenues less manufacturing, general and administrative and
other operating costs for an indefinite period of time.  We cannot
assure you that we will ever be profitable and accordingly, will be completely
dependent on raising additional capital through the sale of our securities, if
possible.




To
be successful we may require additional capital, which we may be unable to
obtain.





We
believe that our current cash, combined with anticipated revenue collections,
will be enough to fund our operations through the end of this year.  We
currently do not have any binding commitments for, or readily available sources
of additional financing, and we cannot assure you that such funding will be
available at all or available on terms acceptable to us. If we are unable to
raise additional capital we may be forced to file for bankruptcy.





We depend on a
limited number of suppliers, and we will be unable to manufacture or deliver our
products if shipments from these suppliers stop, are late or are otherwise
interrupted .





We obtain
the battery, a key component for our power inlay technology, from a single
source on a purchase order basis from Solicore, Inc. In the event of a
disruption or discontinuation in supply, we could may not be able
to  obtain replacement batteries on a timely basis, which would
disrupt our operations, delay production  and impair our ability to
manufacture and sell our products.





We obtain
the display, a key component for the InCard DisplayCard, from a single source,
SmartDisplayer, under a written agreement. In the event of a disruption or
discontinuation in supply, we  may not be able to obtain replacement
displays on a timely basis, which would disrupt our operations, delay
production  and impair our ability to manufacture and sell our InCard
DisplayCard.




6




Our
dependence upon outside suppliers exposes us to risks,
including:




·
            the
      possibility that our suppliers will experience major disruptions in
      production, which is exacerbated by the fact that we are a major customer
      of our suppliers;





·
            the
      solvency of our suppliers and the potential that our suppliers will be
      solely dependent upon us;


·
              the
      potential inability of our suppliers to obtain required components or
      products;
 
 ·
              reduced
      control over pricing, quality and timely delivery, due to the difficulties
      in switching to alternative
suppliers;


·
              the
      potential delays and expense of seeking alternative sources of suppliers;
      and
 
 ·
              increases
      in prices of key components.


If
we are not able to devote adequate resources to product development and
commercialization, we may not be able to develop our products.





Our
business strategy is to develop and market new products using our power inlay
technology that can enhance payment and other information-bearing plastic cards.
We believe that our revenue growth and profitability, if any, will substantially
depend upon our ability to:


·
              mass
      produce the InCard DisplayCard at significantly lower
      cost;
 
 ·
              continue
      to fund research and development
  endeavors;
 ·
                complete
      development of new products;
and
 
 ·
                successfully
      introduce and commercialize new
  products.


If we do
not devote adequate resources to our product development efforts, we may be
unable to develop our products, which would adversely affect our revenue growth
and profitability.





If
we or our suppliers fail to adequately protect our proprietary rights, third
parties could use our technology, or very similar technology, and could reduce
our ability to compete in the market, and any proprietary rights litigation
could be time-consuming and expensive to prosecute and defend.





Establishment
of patents and other proprietary rights by us and our suppliers is important to
our success and our competitive position. Performance in the payment card
industry can depend, among other factors, on patent protection. Our policy is to
identify patentable inventions developed by our company, and to seek to acquire
patent rights for such inventions. We mainly develop and patent technology in
the fields of card enhancements and methods of card manufacturing. We seek to
obtain a reasonably broad territorial protection for our patented technologies.
We usually file initial patent applications in the United States, and
subsequently file corresponding applications in   foreign countries
depending on the relevant circumstances. We may elect to forego patent
protection for some of our proprietary technologies   and treat such
technologies as trade secrets. Despite our efforts to establish and protect our
patents, trade secrets or other proprietary rights, unauthorized parties may
attempt to copy aspects of our technology or to obtain and use information that
we regard as proprietary. In addition, the laws of some foreign countries do not
protect our proprietary rights as much as the laws of the United States protect
them. Our means of establishing and protecting our proprietary rights may not be
adequate, and our competitors may independently develop similar technology,
duplicate our products or design around our patents or our other proprietary
rights.  We  have limited patent protection for our InCard
DisplayCard.





Due to
the importance of proprietary technology in the payment card industry, our
business involves a risk of overlap with third party patents and subsequent
litigation with competitors or patent-holders. Any claims, with or without
merit, could be time-consuming, result in costly litigation, or cause us to
enter into licensing agreements




7





We
depend on key personnel in a competitive market for skilled employees, and
failure to retain and attract qualified personnel could substantially harm our
business.





We rely
to a substantial extent on the management, marketing and product development
skills of our key employees and consultants, particularly Richard Nathan, our
President and Chief Executive Officer, Craig Nelson, who supervises the
manufacturing and testing of the InCard DisplayCard, and Mark Poidomani, our
chief technology officer, to formulate and implement our business plan,
including the development of our power inlay technology. Our success depends to
a significant extent upon our ability to retain and attract key personnel.
Competition for employees can be intense in the payment card industry, and the
process of locating key personnel with the right combination of skills is often
lengthy. The loss of the services of our key personnel may significantly delay
or prevent the achievement of product development and could have a material
adverse effect on us.




If
our future products do not achieve a significant level of market acceptance, it
is highly unlikely that we ever will become profitable.





The
commercial success of our future products will depend upon the adoption of our
power inlay technology as a preferred method of applying card enhancements to
payment cards. In order to be successful, our future products must meet the
technical and cost requirements for card enhancements within the payment card
industry. Market acceptance will depend on many factors, including:


·
                our
      ability to convince prospective strategic partners and customers to adopt
      our products;
 
 ·
                the
      willingness and ability of prospective strategic partners and customers to
      adopt our products; and
 ·
                  our
      ability to sell and service sufficient quantities of our
      products.


Because
of these and other factors, our products may not achieve market acceptance. If
our products do not achieve a significant level of market acceptance, demand for
our future products will not develop as expected and it is highly unlikely that
we ever will become profitable.





We
have granted third parties substantial marketing rights to certain of our
products and products under development. If the third parties are not successful
in marketing our products, we may not be able to commercialize our
products.





Some of
our agreements with our corporate marketing partners contain no minimum purchase
requirements in order for them to maintain their exclusive marketing rights. In
the future, third-party marketing assistance may not be available on reasonable
terms, if at all. If marketing partners do not order adequate quantities of our
products or if we are unable to procure third-party marketing assistance on
reasonable terms, we may not be able to commercialize our products, which could
negatively impact our results of operations or substantially limit our ability
to execute our business strategy.





We
may experience customer concentration in the enterprise and on-line banking
marketplace, which may expose us to all of the risks faced by our potential
material customers.





Until and
unless we secure multiple customer relationships in the enterprise and on-line
banking marketplaces, we may experience periods during which we will be highly
dependent on one or a limited number of customers. Dependence on a single or a
few customers will make it difficult to satisfactorily negotiate attractive
prices for our products and will expose us to the risk of substantial losses if
a single dominant customer stops conducting business with us. Moreover, to the
extent that we may be dependent on any single customer, we could be subject to
the risks faced by that customer to the extent that such risks impede the
customer’s ability to stay in business and make timely payments to
us.





Failure to
manufacture in mass production may have a material negative effect on our
business strategy and operations.





Our power
inlay technology has only been produced in limited production quantities. We are
applying our own resources and working in cooperation with other companies that
have specialized technical expertise related to the power inlay technology for
thin, flexible non-payment cards. Failure to secure or maintain exclusive rights
or failure to successfully transition to full scale production, without the use
of proprietary technology of others, may have a material negative effect on our
business strategy and operations.





We
rely substantially on third-party manufacturers. The loss of any third-party
manufacturer could limit our ability to launch our products in a timely manner,
or at all.





To be
successful, we must manufacture, or contract for the manufacture of, our future
products in compliance with industry standards and on a timely basis, while
maintaining product quality and acceptable manufacturing costs. As discussed in
the risk factor above, we are working in cooperation with other companies that
have specialized technical expertise related to the manufacturing process of our
power inlay technology for the InCard DisplayCard. We also currently use a
limited number of sources for most of the supplies and services that we use in
the manufacturing of our power inlay technology and prototypes. Our
manufacturing strategy presents the following risks:





·
            delays
      in the quantities needed for product development could delay
      commercialization of our products in
  development;





·
            if
      we need to change to other commercial manufacturers, any new manufacturer
      would have to be educated in, or develop substantially equivalent
      processes necessary for, the production of our
  products;




8




·
            if
      market demand for our products increases suddenly, our current
      manufacturers might not be able to fulfill our commercial needs, which
      would require us to seek new manufacturing arrangements and may result in
      substantial delays in meeting market demand;
and





·
            we
      may not have intellectual property rights, or may have to share
      intellectual property rights, to any improvements in the manufacturing
      processes or new manufacturing processes for our
  products.





Any of
these factors could delay commercialization of our products under development,
entail higher costs and result in our being unable to effectively sell our
products.





Some
of our competitors have significantly greater resources than we do and may be
able to respond more quickly to new or emerging technologies and changes in
customer requirements, which could adversely affect our ability to generate or
maintain revenues and be profitable.





We
believe that the principal competitive factors that affect the market for tokens
include convenience, price, quality/reliability, ease of use, and distribution
cost. We cannot assure you that we will be able to maintain our competitive
position against current and potential competitors, especially those with
significant marketing, service, support, technical and other competitive
resources.





Some of
our present and potential competitors have significantly greater financial,
technical, marketing, purchasing and other resources than we do, and as a
result, may be able to respond more quickly to new or emerging technologies and
changes in customer requirements, or to devote greater resources to the
development, promotion and sale of products, or to deliver competitive products
at a lower end-user price. Current and potential competitors have established or
may establish cooperative relationships among themselves or with third parties
to increase the ability of their products to address the needs of our
prospective customers. It is possible that new competitors or alliances may
emerge and rapidly acquire significant market share. We cannot guarantee that we
will be able to compete successfully against present or future competitors or
that competitive pressures will not materially and adversely affect our
business, financial condition and results of operations.





Risks
Related to our Securities





We
do not anticipate paying any cash dividends in the foreseeable future, which may
reduce your return on an investment in our common stock.





We plan
to use all of our earnings, to the extent we have earnings, to fund our
operations. We do not plan to pay any cash dividends in the foreseeable future.
We cannot guarantee that we will, at any time, generate sufficient surplus cash
that would be available for distribution as a dividend to the holders of our
common stock. Therefore, any return on your investment would derive from an
increase in the price of our stock, which may or may not occur.





Substantial
future sales of our common stock in the public market may depress our stock
price, which could result in significant losses to you and could limit our
ability to raise capital.





As of
December 31, 2008, we had 28,495,256 shares of common stock outstanding. All of
these shares can be traded pursuant to a prospectus or via a transaction
pursuant to Rule 144 under the Securities Act of 1933. On a fully diluted
basis, including shares issuable upon exercise of warrants and stock options, we
have 40,180,853 shares.





If our
stockholders sell substantial amounts of common stock in the public market, or
the market perceives that such sales may occur, the market price of our common
stock could fall, which could result in a significant loss on any investment you
make in our common stock. The sale of a large number of shares could impair our
ability to raise needed capital by depressing the price at which we could sell
our common stock.





We
may be subject to securities litigation as the price of our common stock has
drastically decreased over the past nine months.





During
the past nine months, the price of our common stock has decreased from $1.27 on
June 30, 2008 to $0.12 as of March 31, 2009.  Although management
feels that at all times it has acted in the best interest of the company’s
shareholders, such declines in stock price have historically increased the
probability of becoming the subject of a securities class action law
suit.  If we were to become the target of such litigation, we will
have to spend considerable time and resources in defending such
litigation.  This would result in management diverting its focus from
the development and sale of our products.  Additionally, such
litigation can also be extremely costly and deplete our assets.





We
may raise additional capital through a securities offering that could dilute
your ownership interest and voting rights.





Our
certificate of incorporation currently authorizes our board of directors to
issue up to 75,000,000 shares of common stock and 5,000,000 shares of preferred
stock. As of December 31, 2008, after taking into consideration our outstanding
common and preferred shares, our board of directors will be entitled to issue up
to 46,504,744 additional common shares and 5,000,000 preferred shares. The power
of the board of directors to issue these shares of common stock, preferred stock
or warrants or options to purchase shares of our stock is generally not subject
to stockholder approval.




9




We may
require additional working capital to fund our business. If we raise additional
funds through the issuance of equity, equity-related or convertible debt
securities, these securities may have rights, preferences or privileges senior
to those of the holders of our common stock. The issuance of additional common
stock or securities convertible into common stock by our board of directors will
also have the effect of diluting the proportionate equity interest and voting
power of holders of our common stock.  We cannot assure you that we will be
able to raise additional capital on terms that are acceptable to us, or at
all.





Our
incorporation documents and Delaware law may inhibit a takeover that
stockholders consider favorable and could also limit the market price of your
stock, which may inhibit an attempt by our stockholders to change our direction
or management.





Our
amended and restated certificate of incorporation and bylaws contain provisions
that could delay or prevent a change in control of our company. Some of these
provisions:





·
            authorize
      our board of directors to determine the rights, preferences, privileges
      and restrictions granted to, or imposed upon, the preferred stock and
      to fix the number of shares constituting any series and the designation of
      such series without further action by our stockholders;·
            prohibit
      stockholders from calling special
meetings;




·
            prohibit
      cumulative voting in the election of directors, which would otherwise
      allow less than a majority of stockholders to elect director
      candidates;





·
            establish
      advance notice requirements for submitting nominations for election to the
      board of directors and for proposing matters that can be acted upon by
      stockholders at a meeting; and





·
            prohibit
      stockholder action by written consent, requiring all stockholder actions
      to be taken at a meeting of our
stockholders.




In
addition, we are governed by the provisions of Section 203 of the Delaware
General Corporate Law. These provisions may prohibit large stockholders, in
particular those owning 15% or more of our outstanding voting stock, from
merging or combining with us, which may prevent or frustrate any attempt by our
stockholders to change our management or the direction in which we are heading.
These and other provisions in our amended and restated certificate of
incorporation and bylaws and under Delaware law could reduce the price that
investors might be willing to pay for shares of our common stock in the future
and result in the market price being lower than it would be without these
provisions.





New
rules, including those contained in and issued under the Sarbanes-Oxley Act of
2002, may make it difficult for us to retain or attract qualified officers and
directors, which could adversely affect the management of our business and our
ability to obtain or retain listing of our common stock.





We may be
unable to attract and retain qualified officers, directors and members of board
committees required to provide for our effective management as a result of the
recent and currently proposed changes in the rules and regulations that
govern publicly held companies, including, but not limited to, certifications
from executive officers and requirements for financial experts on the board of
directors. The perceived increased personal risk associated with these recent
changes may deter qualified individuals from accepting these roles. The
enactment of the Sarbanes-Oxley Act of 2002 has resulted in the issuance of a
series of new rules and regulations and the strengthening of existing
rules and regulations by the Securities and Exchange Commission (the
“SEC”). Further, certain of these recent and proposed changes heighten the
requirements for board or committee membership, particularly with respect to an
individual’s independence from the corporation and level of experience in
finance and accounting matters. We may have difficulty attracting and retaining
directors with the requisite qualifications. If we are unable to attract and
retain qualified officers and directors, the management of our business could be
adversely affected.





Our
management has concluded that, as of December 31, 2008, our disclosure
controls and procedures were not effective.





Our
management, with the participation of our Chief Executive Officer (“CEO”) and
Chief Financial Officer (“CFO”), has evaluated the effectiveness of the
Company’s disclosure controls and procedures (as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as amended (the “Exchange Act”)) as of December 31, 2008. Based on
such evaluation which disclosed numerous material weaknesses, our CEO and CFO
have concluded that, as of December 31, 2008, the Company’s disclosure
controls and procedures were not effective in recording, processing, summarizing
and reporting, on a timely basis, information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act and were
not effective in ensuring that information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act is
accumulated and communicated to the Company’s management, including the
Company’s CEO and CFO, as appropriate to allow timely decisions regarding
required disclosure. If we fail to implement new or improved disclosure
controls, investors could lose confidence in the reliability of our financial
statements, which could result in a decrease in the value of our common
stock.




10




We
have identified numerous material weaknesses in our internal control over
financial reporting.





As
directed by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adopted
rules requiring public companies to include a report of management on
internal control over financial reporting in their Annual Reports on
Form 10-K. This report is required to contain an assessment by management
of the effectiveness of a company’s internal control over financial reporting.
Our non-affiliated market capitalization qualified us as a “Smaller Reporting
Company” effective in 2009. As a result, we are required to include our
management’s report on internal control over financial reporting in this Annual
Report but are not required to include our auditors’ attestation report on our
internal control over financial reporting.   As discussed in Item
9A to this Annual Report, we have concluded that, as of December 31, 2008,
our internal control over financial reporting was not effective and have
identified a number of material weaknesses in our internal control over
financial reporting. While we intend to remedy these weaknesses during the
current fiscal year, we may be unable to do so. If we fail to implement required
new or improved controls there may be an adverse reaction in the financial
markets due to a loss of confidence in the reliability of our financial
statements, which could cause the market price of our common stock to
decline.




ITEM
      2.
            PROPERTIES




We
currently lease our executive offices which are located at 633 West Fifth
Street, Suite 2600, Los Angeles, CA 90071.  Our lease consists of
approximately 175 square feet and we pay $1,200 per month. Our lease is on a
month-to-month basis. In addition, several of our employees work from
satellite or home offices.  We do not pay for these
facilities.   There is no affiliation between us or any of our
principals or agents and our landlord or any of their principals or agents.




ITEM
      3.
            LEGAL
      PROCEEDINGS





As of the date of this Annual Report, there are no material
pending legal or governmental proceedings relating to our company or properties
to which we are a party, and to our knowledge there are no material proceedings
to which any of our directors, executive officers or affiliates are a party
adverse to us or which have a material interest adverse to us.





ITEM
      4.
            SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY
HOLDERS




None.





PART
II





ITEM
      5.
              MARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY
SECURITIES





Market
Information





Until
February 20, 2009, our common stock was traded on the NASDAQ Capital Market
under the symbol "INVC" at which time our shares were delisted.  After
February 20, 2009, our common shares have been traded on the Over-the-Counter
Bulletin Board and Pink Sheets under the ticker symbol INVC.OB.  The
following table sets forth, for the periods indicated, the high and low intraday
sale prices for our common stock on the NASDAQ Capital Market.




High
              
              
              Low2007First
      Quarter
              
              $
              6.20
              
              
              $
              4.26Second
      Quarter(1)
              
              $
              6.24
              
              
              $
              4.00Third
      Quarter
              
              $
              4.90
              
              
              $
              1.93Fourth
      Quarter
              
              $
              3.80
              
              
              $
              1.692008First
      Quarter
              
              $
              2.55
              
              
              $
              1.69Second
      Quarter
              
              $
              2.55
              
              
              $
              1.01Third
      Quarter
              
              $
              1.35
              
              
              $
              0.40Fourth
      Quarter
              
              $
              0.44
              
              
              $
              0.06




Our
transfer agent is American Stock Transfer & Trust Company
www.amstock.com.




11





Holders





As of
April 20, 2009 our common stock was held by approximately 25 record
holders.  We believe our actual number of shareholders may be
significantly higher as 28,086,660 shares are currently being held in street
name.





Dividends





We have
not paid any cash dividends to date and have no plans to do so in the immediate
future.





Equity
Compensation Plan Information





The
following table sets forth information with respect to our 2004 and 2007
Stock Plans as of December 31, 2008.




(a)
              
              
              (b)
              
              
              (c)Number
      of
                Securities
                to
      be Issued
                upon
      Exercise
                ofOutstanding
                Options,
      Warrants
                and
      Rights
              
              
              Weighted-Average
                Exercise
      Price of
                Outstanding
                Options,
                Warrants
      and
                Rights
              
              
              Number
      of Securities
                Remaining
      Available for
                Future
      Issuance under
                (Excluding
      Securities
                Reflected
      in Column (a))Equity
      compensation plans approved by security holders2004
      Stock Incentive Plan, as amended
              
              
              454,500
              
              
              $
              2.41
              
              
              
              -2007
      Equity Incentive Plan
              
              
              3,478,177
              
              
              
              1.23
              
              
              
              521,823Equity
      compensation plans not approved by security holders
              
              
              N/A
              
              
              
              N/A
              
              
              
              N/ATotal
              
              
              3,932,677
              
              
              $
              1.37
              
              
              
              521,823




Recent
Sale of Unregistered Securities





During
the period covered by this Annual Report we have not sold any unregistered
securities that were not registered under the Securities Act or included in a
Quarterly Report on Form 10-Q or in a Current Report on Form 8-K.





·
            On
      January 4, 2008, we issued a common stock purchase warrant to
      purchase 60,000 of our common shares at $2.49 per share to one of our
      consultants. The warrant has a ten year exercise
  period.





·
            On
      January 8, 2008, we sold $3.5 million of our 8% Senior Secured
      Convertible Debentures. As part of the transaction, we issued the
      purchasers common stock purchase warrants to purchase 700,000 of our
      common shares. For a more detailed description of the transaction, refer
      to Note 12 of our financials contained in this report. We incorporate by
      reference the disclosure of the transaction and accompanying documents as
      contained in our Current Report on Form 8-K filed with the SEC on
      January 9, 2008.





·
            On
      February 25, 2008, pursuant to our 2007 Equity Incentive Plan, we
      issued one of our directors an option to purchase 63,333 common shares at
      $1.95 per share as compensation for serving on the board and any relevant
      committees thereof. The option has a vesting period of three years
      (vesting 1/3 per year), and a duration of 10 years. In the event the
      director resigns or is removed, the holder has 90 days to exercise of the
      option.





·
            On
      February 25, 2008, pursuant to our 2007 Equity Incentive Plan, we
      issued one of our directors an option to purchase 63,333 common shares at
      $1.95 per share as compensation for serving on the board and any relevant
      committees thereof. The option has a vesting period of three years
      (vesting 1/3 per year), and a duration of 10 years. In the event the
      director resigns or is removed, the holder has 90 days to exercise of the
      option.





·
            On
      March 27, 2008, pursuant to our 2007 Equity Incentive Plan, we issued
      to our CEO an option to purchase 1,000,000 common shares at $2.25 per
      share. The option vests over a period of approximately 36 months upon the
      occurrence of certain milestones and has duration of 10 years. For a more
      detailed description of the option and the vesting conditions, please
      refer to our Current Report filed with the SEC on Form 8-K on
      April 2, 2008.





·
            On
      March 27, 2008, pursuant to our 2007 Equity Incentive Plan, we issued
      to our CFO an option to purchase 200,000 common shares at $2.25 per share.
      The option vests over a period of approximately 36 months upon the
      occurrence of certain milestones and has duration of 10 years. For a more
      detailed description of the option and the vesting conditions, please
      refer to our Current Report filed with the SEC on Form 8-K on
      April 2, 2008.





·
            On
      April 15, 2008, we sold $5 million of our 8% Senior Secured
      Convertible Debentures. As part of the transaction, we issued the
      purchaser common stock purchase warrant to purchase 1,008,064 of our
      common shares. For a more detailed description of the transaction, refer
      to Note 12 of our financials contained in this report. We incorporate by
      reference the disclosure of the transaction and accompanying documents as
      contained in our Current Report on Form 8-K filed with the SEC on
      April 16, 2008.





·
            On
      May 5, 2008, pursuant to our 2007 Equity Incentive Plan, we granted one of
      our employees an option to purchase 225,000 common shares at an exercise
      price of $1.95 per share.  The option vests over five years and
      expires if not exercised in 10 years from the grant
  date.




12




·
            On
      May 22, 2008, pursuant to our 2007 Equity Incentive Plan, we granted one
      of our employees an option to purchase 350,000 common shares at an
      exercise price of $1.67 per share.  The option vests over four
      years and expires if not exercised in 10 years from the grant
      date.





·
            On
      June 16, 2008, we issued a common stock purchase warrant to purchase
      350,000 of our common shares at $2.48 per share to one of our consultants.
      The warrant has a five year exercise
period.





·
            On
      June 16, 2008, pursuant to our 2007 Equity Incentive Plan, we granted one
      of our employees an option to purchase 5,000 common shares at an exercise
      price of $1.67 per share.  The option vests over five years and
      expires if not exercised in 10 years from the grant
  date.





·
            On
      November 11, 2008, pursuant to our 2007 Equity Incentive Plan, we agreed
      to grant Richard Nathan, or Chief Executive Officer, an option to purchase
      1,000,000 common shares at an exercise price of $0.10 per
      share.  The granting of the option was contingent on Mr. Nathan
      and us reaching an agreement on the terms of his employment contract and
      board approval.  Both these conditions were met in early
      2009.  The option vests quarterly over two (2) years and expires
      if not exercised on November 11,
2009.





·
            On
      December 19, 2009, pursuant to our 2007 Equity Incentive Plan, we granted
      6 employees an aggregate of 408,000 options to purchase common stock at an
      exercise price per share of $0.07.  The options vest over three
      years and expire on December 19, 2018 if not
  exercised.





·
            On
      December 19, 2008, pursuant to our 2007 Equity Incentive Plan, we granted
      one of our directors an option to purchase 100,000 common shares at an
      exercise price of $0.07.  The option vests over three years and
      expires on December 19, 2018 if not
exercised.




ITEM
      6.
            SELECTED
      FINANCIAL DATA





We are
not required to provide the information as to selected financial data as we are
considered a smaller reporting company.





ITEM
      7.
              MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS





Our
Management’s Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) is provided in addition to the accompanying consolidated
financial statements and notes to assist readers in understanding our results of
operations, financial condition, and cash flows. MD&A is organized as
follows:





·
            Overview. Discussion
      of our business and overall analysis of financial and other highlights
      affecting the company in order to provide context for the remainder of
      MD&A.·
            Critical AccountingPolicies. Accounting
      policies that we believe are important to understanding the assumptions
      and judgments incorporated in our reported financial results and
      forecasts.·
            Results of
      Operations. Analysis of our financial results comparing 2008
      to 2007.·
            Liquidity and Capital
      Resources. An analysis of changes in our balance sheets and
      cash flows, and discussion of our financial condition including the credit
      quality of our investment portfolio and potential sources of
      liquidity.




The
various sections of this MD&A contain a number of forward-looking
statements. Words such as “expects,” “goals,” “plans,” “believes,” “continues,”
“may,” and variations of such words and similar expressions are intended to
identify such forward-looking statements. In addition, any statements that refer
to projections of our future financial performance, our anticipated growth and
trends in our businesses, and other characterizations of future events or
circumstances are forward-looking statements. Such statements are based on our
current expectations and could be affected by the uncertainties and risk factors
described throughout this filing and particularly in the “Overview” section (see
also “Risk Factors” in Part I, Item 1A of this Form 10-K). Our actual results
may differ materially.




Overview





Since
2002, we have continued to develop our power inlay technology that is designed
to bring power-based applications to the enterprise market and on-line banking
market. Our present focus is the InCard DisplayCard power inlay technology which
consists of a battery, circuit, and switch that can power applications on credit
card sized cards and other information-bearing plastic cards. We have devoted a
majority of our efforts to completing the development of our power inlay
technology, initiating marketing and raising the financing required to do so and
fund our expenses. We have generated limited revenues. Prior to the fourth
quarter of 2007 these revenues derived primarily from licensing agreements of
our LensCard product, most of which have terminated. At this time, we have no
plans to renew the LensCard licensing agreements or to further market or sell
the LensCard, unless requested by a customer.




13





On
February 20, 2009, as a result of our common shares being delisted from the
NASDAQ Capital Market, we defaulted on our debt agreements entered into in
January 2008 and April 2008 in connection with the sale of our 8%
Senior Secured Debentures.  Accordingly investors can call the
debentures and demand immediate repayment.  Our inability to repay the
outstanding balance can result in our debenture holders exercising their
remedies under the accompanying security agreements and foreclosing on
substantially all of our assets.  In such instance, we could be forced
to seek bankruptcy protection or the debenture holders could take our assets as
satisfaction of their indebtedness.  In either instance, this will
result in a total loss of our common shareholders’ investment.  At
present, we are attempting to modify the terms of our 8% Senior Secured
Debentures in order to present the holders foreclosure on our
assets.  There can be no assurance that we will be able to modify the
terms of such debentures or that if we do, that such modification will allow us
to continue operating.





Since
inception, we have been unprofitable. We incurred net losses of $8,929,537 and
$14,333,622 for the twelve months ending December 31, 2008 and 2007,
respectively. As of December 31, 2008, we had an accumulated deficit of
$36,996,720. Our continued existence is dependent upon our ability to generate
sales of the InCard DisplayCard or, if we are unable to do so in sufficient
quantity to cover our expenses, to obtain additional financing. In 2008, we made
our first significant sale of InCard DisplayCards; however we anticipate that we
will continue to incur net losses due to our costs exceeding our
revenues.  Management cannot yet predict when we will achieve an
operating profit or net income.  Our capital requirements for the next
12 months consist of the acquisition of inventory, retention and hiring of key
personnel, implementation of a sales force for our products, and further
research and development relating to the production of our power inlay
technology.  These expenditures are anticipated to be
significant.   In addition, our gross margin is greatly impacted
by production volume. At low levels of production our gross margin is in the
single digits and may be negative. At the higher volume levels our gross margin
rises. To date, our operations have been funded primarily through equity and
debt financings.





We
believe that our current cash, combined with anticipated revenue collections,
will be adequate to fund our operations through the third quarter of 2009. If we
are unable to raise additional financing by that date, we may be forced to
curtail our operations or seek bankruptcy protection. We anticipate that we will
not be able to generate sales of the InCard DisplayCard in quantities that will
sustain a positive cash flow until the fourth quarter of 2009. At such time, our
cash needs since the breakeven volume is higher than originally
anticipated.





Our
backlog, which consists of orders received but not yet shipped, totals $4.45
million at December 31, 2008, most of which we expect to deliver in
2009.





We raised
$3,500,000 of operating capital in January 2008 and $5,000,000 in
April 2008 (see Equity and Debt Financings and Accounts Payable in this
Item 2) but may be unable to raise additional operating capital on terms
satisfactory to us, if at all. There can be no assurances that we will be able
to raise operating capital on satisfactory terms, or that sufficient revenues
will be generated from the sales of our product in order to sustain our
operations. Should our cash and liquidity position become severe, we would need
to limit our operations which would harm the value of your investment in the
Company.





Critical
Accounting Policies





Our
discussion and analysis of our financial condition and results of operations are
based on our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the U.S. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses for each period. The following represents a summary of our critical
accounting policies, defined as those policies that we believe are the most
important to the portrayal of our financial condition and results of operations
and that require management’s most difficult, subjective or complex judgments,
often as a result of the need to make estimates about the effects of matters
that are inherently uncertain.





Revenue
recognition.





We
recognize revenues in accordance with SEC Staff Accounting Bulletin No. 104
(“SAB 104”). Revenues are recognized when persuasive evidence of an arrangement
exists, delivery has occurred or services have been rendered, the price is fixed
and determinable and collectability is reasonably assured. Revenue is not
recognized on product sales transacted on a test or pilot basis. Instead,
receipts from these types of transactions offset marketing expenses. Revenue
from royalties is recognized with the passage of time in accordance with the
underlying agreement. We recognize certain long-term contracts using the
completed-contract method in accordance with SOP 81-1, “Accounting for
Performance of Construction-Type and Certain Production-Type of
Contracts.”





We have
generated revenue from three sources: sale of the InCard DisplayCard, licensing
of the LensCard to various credit card issuers and selling the LightCard to a
credit card issuer. The LensCard is composed of a credit card with a small
magnifying lens embedded into the card. The LightCard is composed of a credit
card that when a button is pressed a small LED light is activated. We sell
time-based licenses to various credit card issuers for the LensCard. We
recognize royalties attributable to these time-based licenses as they are sold
to the credit card issuers’ customers. Royalty revenue is recognized when each
LensCard is sold by an issuer in accordance with SAB 104.




14





We
anticipate that the majority of our revenues in the coming year will come from
the InCard DisplayCard. We intend to sell these cards through resellers. We do
not recognize revenue when we sell the InCard DisplayCard in small quantities
under a test or pilot program. Cash receipts from these transactions are used to
offset marketing expenses.





The
revenue generated from the LensCard and LightCard is negligible, and we expect
that the sales of these products will have no impact on our results of
operations.





Deferred
revenue is recorded when the payments from a reseller are received by us prior
to the sale of an InCard DisplayCard to the resellers’ customer.





Accounts
receivable allowances.





Our sales
to date have been to large credit card issuers and we have been successful in
collecting for products and services. We perform a regular review of our
customer activity and associated credit risks and do not require collateral from
our customers. At December 31, 2008, based on our review of customer activity,
we recorded an allowance for doubtful accounts of $60,000.





Warranty
expense.





We
estimate the cost associated with meeting our warranty obligations for the sale
of our products. The initial estimate and changes to the estimate are charged to
cost of goods sold at the time of sale of the product.





Inventory.





Our
inventories are valued at the lower of cost or market. We use estimates and
judgments regarding the valuation of inventory to properly value inventory.
Inventory adjustments are made for the difference between the cost of the
inventory and the estimated market value and charged to cost of goods sold in
the period in which the facts that give rise to the adjustments become
known.





Research
and Development.





Costs of
research and development, principally the design and development of hardware and
software prior to the determination of technological feasibility, are expensed
as incurred.





Valuation
of Intangible Assets and Long-Lived Assets.





We assess
the impairment of identifiable intangibles and long-lived assets whenever events
or changes in circumstances indicate that the carrying value may not be
recoverable. Factors considered important that could trigger an impairment
review include, but are not limited to, the following: a significant
underperformance to expected historical or projected future operating results, a
significant change in the manner of the use of the acquired asset or the
strategy for the overall business, or a significant negative industry or
economic trend. We assess the carrying value of long-lived assets in accordance
with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived
Assets.”





Stock
Based Compensation.





On
January 1, 2006, we adopted SFAS No. 123 (R), “Share Based
Payment,” which establishes standards for the accounting of transactions in
which an entity exchanges its equity instruments for goods or services,
primarily focusing on accounting for transactions where an entity obtains
employee services in share-based payment transactions. SFAS
No.123(R) requires a public entity to measure the cost of employee services
received in exchange for an award of equity instruments, including stock
options, based on the grant-date fair value of the award and to recognize it as
compensation expense over the period the employee is required to provide service
in exchange for the award, usually the vesting period. SFAS
No.123(R) supersedes the Company’s previous accounting under Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees for periods beginning in fiscal year 2006. In March 2005, the SEC
issued Staff Accounting Bulletin (“SAB”) No. 107 relating to SFAS
No. 123(R). We have applied the provisions of SAB No.107 in our adoption of
SFAS No. 123(R).




Results
of Operations




Our
results of operations have varied significantly from year to year and quarter to
quarter and may vary significantly in the future due to the occurrence of
material recurring and nonrecurring events.




15





Revenue





Revenue
totaled $2,828,581 in 2008 and $445,000 in 2007.


Change
      in2008
                Versus
      20072008
              
              
              2007
              
              
              $
              
              
              %Revenue
              
              $
              2,828,581
              
              
              $
              445,000
              
              
              $
              2,383,581
              
              
              
              536
              %




The
increase in revenue in 2008 as compared to 2007 was attributable to sales of the
InCard DisplayCard and the clamshell.  In 2007 revenue consisted of
royalties from LensCard.  We believe that future revenue will be
primarily from the sales of the InCard DisplayCard, while revenue from LensCard
royalties is expected to be negligible. The increase in revenue in 2008 was
attributed to an improvement in our supply chain, allowing us to ship more
quality products. Specifically, we made advances in the card’s electronics,
including the battery and display module. By improving the quality, more
customers were interested in the product and we had a lower return
rate.





Cost
of Goods Sold





Cost of
goods sold totaled $4,350,975 in 2008 and $851,637 in 2007.


Change
      in2008
                  Versus
      20072008
                
                
                2007
                
                
                $
                
                
                %Cost
      of Goods Sold
                
                $
                4,350,975
                
                
                $
                851,637
                
                
                $
                3,499,338
                
                
                
                411
                %


The
increase of cost of goods sold in 2008 compared to 2007 was attributed to
increased sales of the InCard DisplayCard.  Cost of goods sold
consists of costs to manufacture in the amount of $2.4 million, inventory
write-offs and reserve adjustments in the amount of $1.7 million and warranty
expense of $227,024. The improvement in our gross margin percentage was
attributable to the advances we made in the supply chain, resulting in fewer
rejects. The primary reason for this was an improvement in the firmware used in
producing the product.





Operating
Expenses




Operating
expense totaled $8,727,651 in 2008 and $14,088,503 in 2007.




Change
      in2008
              Versus
      20072008
            
            
            2007
            
            
            $
            
            
            %Operating
      ExpensesAdministrative
            
            $
            5,461,782
            
            
            $
            8,389,987
            
            
            $
            (2,928,205
            )
            
            
            -35
            %Consulting
      Fees
            
            
            612,414
            
            
            
            641,884
            
            
            
            (29,470
            )
            
            
            -5
            %Impairment
            
            
            1,450,888
            
            
            
            1,000,010
            
            
            
            450,878
            
            
            
            45
            %Unrecoverable
      payment to suppliers
            
            
            -
            
            
            
            1,546,428
            
            
            
            (1,546,428
            )
            
            
            -100
            %Professional
      Fees
            
            
            734,680
            
            
            
            1,157,781
            
            
            
            (423,101
            )
            
            
            -37
            %Research
      and development
            
            
            467,887
            
            
            
            1,352,413
            
            
            
            (884,526
            )
            
            
            -65
            %Total
      expense
            
            $
            8,727,651
            
            
            $
            14,088,503
            
            
            $
            (5,360,852
            )
            
            
            -38
            %




Administrative
Expenses




Administrative
expenses totaled $5,461,782 in 2008 compared with $8,389,987 in
2007.  The decrease of $2,928,205 or 35% from 2007 to 2008 was
attributed to a conscious cutback in expenses of the Company. Specifically,
there was a significant staff reduction in June, and again in November. Overall,
we believe administrative spending was excessive in 2007 and during the first
half of 2008. Prospectively we are actively monitoring our spending and avoiding
all unnecessary spending.  Administrative expenses consist of travel,
marketing, compensation, administrative fees, and depreciation and amortization
expense.




16




Consulting
Fees





Consulting
fees expense totaled $612,414 in 2008, as compared to $641,884 in
2007.  The decrease of $29,470, or 5%, from 2007 to 2008 was primarily
attributable to a reduction in the value of warrants granted to contractors. As
our stock price decreased in the second half of 2008, the warrants we had
granted to contractors became less valuable and this non-cash expense was
reduced. Consulting fee expense consists of payments made to independent
contractors that provided services to us.





Impairment





Impairment
expense totaled $1,450,888 in 2008, as compared to $1,000,010 in
2007.  Impairment expense consists of certain impaired acquired
intangible assets.  Refer to Note 6 to the financial
statements.





Unrecoverable
Payments to Suppliers





Unrecoverable
payments to suppliers expense totaled $1,546,428 in 2007. Unrecoverable payments
to suppliers consist of payments made to third party suppliers for deposits that
we no longer expect to utilize, purchase orders that we do not expect to fulfill
and accrued expenses to satisfy irrevocable purchase orders.  There
was no equivalent expense in 2008.





Professional
Fees





Professional
fees expense totaled $734,680 in 2008, as compared to $1,157,781 in
2007.  The decrease of $423,101, or 37%, from 2007 to 2008 was
primarily attributable to a reduction in legal fees.  Professional
fees expense primarily consists of amounts related to services provided by our
outside counsel, auditors and other similar providers





Research
and Development Expense




Research
and development expense totaled $467,887 in 2008, as compared to $1,352,413 in
2007.  The decrease of $884,526, or 65%, from 2007 to 2008 was
primarily attributable to staff reductions and cutbacks in the second half of
2008.  Research and development expense consists of costs relating to
further development of the InCard DisplayCard.





Other
Income (Expense)




Other incometotaled$1,321,308in 2008, compared with $162,318in 2007.




Change
      in2008
              Versus
      20072008
            
            
            2007
            
            
            $
            
            
            %Other
      income (expense):Change
      in fair value of warrant liability and other expense
            
            $
            3,068,251
            
            
            $
            -
            
            
            $
            3,068,251
            
            
            
            100
            %Interest
      income
            
            
            26,857
            
            
            
            183,793
            
            
            
            (156,936
            )
            
            
            -85
            %Interest
      expense
            
            
            (1,644,005
            )
            
            
            (21,475
            )
            
            
            (1,622,530
            )
            
            
            7555
            %Other
      expense
            
            
            (129,795
            )
            
            
            -
            
            
            
            (129,795
            )
            
            NATotal
      other income (expense)
            
            $
            1,321,308
            
            
            $
            162,318
            
            
            $
            1,158,990
            
            
            
            714
            %




Change
in fair value of warrant liability and other expense




During
2008, due to the decline in our stock price, the value of our warrant liability
has decreased since our initial valuation.  We had no warrant
liability at December 31, 2007.  Refer to Note 12 to the financial
statements for further discussion on our warrant liability  and the
related 8% senior secured convertible debentures.




Interest
Income




Interest
income totaled $26,857 in 2008 compared to $183,793 in 2007. The decrease in
2008 as compared to 2007 of $156,936 was attributed to lower cash balances
maintained in 2008 along with lower interest rates on the cash we had on
deposit.




17




Interest
Expense




Interest
expense totaled $1,644,005 in 2008 and $21,475 in 2007. The increase in 2008 as
compared to 2007 was attributable to the amortization of the debt discounts
related to our 8% senior secured convertible debenture transactions during
2008.  Refer to Note 12 to the financial statements.





Other
Expense





Other
expense in 2008 represents a loss on a lease that did not occur in
2007.





Liquidity
and Capital Resources





Our
principal sources of operating capital since our inception through
December 31, 2008 have been equity and debt financings totaling
$30,303,691, and to a lesser degree our revenues.  Since our
inception, we have incurred significant losses, and as of December 31, 2008
we had an accumulated deficit of $36,996,720. Our cash and cash equivalents
balance at December 31, 2008 was $76,645, a decrease from $339,600 at
December 31, 2007.




2007
            
            
            Change
      in2008
              Versus
      20072008
            
            
            (as
      restated)
            
            
            $
            
            
            %At
      December 31:Cash
      & Cash Equivalents
            
            $
            76,645
            
            
            $
            339,600
            
            
            $
            (262,955
            )
            
            
            -77
            %Year
      ended December 31:Net
      cash used in operating activities
            
            $
            (8,216,304
            )
            
            $
            (7,949,145
            )
            
            $
            (267,159
            )
            
            
            3
            %Net
      cash used in investing activities
            
            $
            (69,151
            )
            
            $
            (21,351
            )
            
            $
            (47,800
            )
            
            
            224
            %Net
      cash provided by financing activities
            
            $
            8,022,500
            
            
            $
            40,000
            
            
            $
            7,982,500
            
            
            
            19956
            %




The
decrease in our cash and cash equivalents balance was attributed to (1) losses
from operations and the reduction of accounts payable that exceeded (2) our
ability to raise adequate debt and equity capital to support these
activities.





Net
Cash Used in Operating Activities




In our
operating activities we used $8,216,304 in cash in 2008 and $7,949,145 in cash
in 2007. The increase of $267,159 in cash used in operating activities in 2008
as compared to 2007 was primarily attributable to an increased use of working
capital primarily to reduce accounts payable to a more current
level.





Net
Cash Used in Investing Activities




In our
investment activities we used $69,151 in cash in 2008 and $21,351 in cash in
2007.  The increase of $47,800 in cash used in investing
activities in 2008 as compared to 2007 was due to increased purchases of
production and testing equipment





Net
Cash Provided by Financing Activities




Net cash
provided by financing activities was $8,022,500 in 2008 as compared to $40,000
in 2007.  The increase from 2007 to 2008 was attributed to our January
and April 8% Senior Convertible Debenture financings.




Listed
below are key financing transactions entered into by us in the last three
years:





·
            On
      May 30, 2006, we issued 3,785,500 shares of common stock at a price
      of $3.00 per share to accredited investors pursuant to a private placement
      for total gross proceeds of $11,356,500. In connection with the
      transaction, T.R. Winston & Company served as placement agent for
      the securities sold and received a net commission of 5% of the total gross
      proceeds and a warrant to purchase 113,565 shares of our common stock at
      an exercise price of $3.30 per share that expire on May 30, 2011. The
      warrant issued to T.R. Winston & Company has full ratchet
      anti-dilution protection, for so long as it is outstanding, in the event
      we issue common shares or common share equivalents for a price less than
      $3.00 per share. No adjustment is required in the event of certain exempt
      issuances as more fully contained in the warrant. The warrant exercise
      price was reset following the April 15, 2008 financing described
      below.





·
            On
      September 28, 2006, we purchased rights relating to the InCard
      DisplayCard from nCryptone for 4,500,000 shares of our common stock and
      acquired a license to use a patent for $1,000,010 that was due by
      September 27, 2007. We have paid $400,000 towards the cost of the
      patent through March 31, 2008. The remainder is due in
      January 2009.




18




·
            On
      January 8, 2008, we entered into a securities purchase agreement with
      13 institutional and accredited investors. Pursuant to the terms of the
      agreement, we sold $3.5 million of our 8% Senior Secured Convertible
      Debenture. The debentures: (i) bear interest at 8% per year, paid
      quarterly in cash or registered common stock, at our discretion;
      (ii) have a maturity of January 8, 2011, (iii) are
      convertible at the holder’s option into shares of our common stock at
      $2.50 per share, (iv) are secured by all of our and our subsidiary’s
      assets including inventory, receivables, unencumbered equipment and
      intellectual property, and (v) have a forced conversion feature which
      allows us to force the conversion of the debentures if our common stock
      trades above $5.00 for 20 consecutive trading days and certain other
      conditions are met. In connection with the sale of the debentures, we also
      issued the purchasers five-year common stock purchase warrants to purchase
      an aggregate of 700,000 shares of our common stock at an exercise price of
      $2.75 per share. We used the net proceeds of the financing for our working
      capital requirements and to pay down certain obligations. Both the
      conversion price of the debentures and the warrants’ exercise price were
      reset following the April 15, 2008 financing discussed
      below.





·
            On April 15, 2008, sold an
      additional $5 million of our 8% Senior Secured Convertible Debenture to
      EMC Corporation.   As a result of market conditions, the
      conversion price of the debenture is $2.48 per share.  This
      resulted in a re-pricing of our January 8, 2008
      debentures.   In connection with the sale of the additional
      debentures, we issued EMC a five-year common stock purchase warrant to
      purchase 1,008,064 shares of our common stock at an exercise price of
      $2.728 per share. Similar to the conversion of the debentures, this
      resulted in a re-pricing of the January 8, 2008 warrant exercise price to
      $2.7828 per share.We used the net proceeds of the
      financing for our working capital requirements and to pay down certain
      obligations.




Default
of 8% Senior Secured Debentures





In
September 2008, we agreed with certain Debenture holders to defer a portion of
the interest payments due October 1, 2008 and January 1, 2009. Such deferral
resulted in those payments, plus a ten percent (10%) deferral charge being added
to the principal balance of those debentures. On February 20, 2009, as a result
of our common shares being delisted from the NASDAQ Capital Market, we defaulted
on our debt agreements entered into in January 2008 and April 2008 in
connection with the sale of our 8% Senior Secured
Debentures.  Accordingly investors can call the debentures and demand
immediate repayment.  Our inability to repay the outstanding balance
can result in our debenture holders exercising their remedies under the
accompanying security agreements and foreclosing on substantially all of our
assets.  In such instance, we could be forced to seek bankruptcy
protection or the debenture holders could take our assets as satisfaction of
their indebtedness.  In either instance, this will result in a total
loss of our common shareholders’ investment.  At present, we are
attempting to modify the terms of our 8% Senior Secured Debentures in order to
prevent the holders’ foreclosure on our assets.  There can be no
assurance that we will be able to modify the terms of such debentures or that if
we do, that such modification will allow us to continue
operating.





Future
Needs





Through
the date of this report, our operations have been funded primarily through
equity and debt financings totaling $30,303,691,  We have engaged an
investment advisor to explore capital raising opportunities but there can be no
assurance that capital will be available to us on terms that are acceptable, or
at all.





We
believe that our current cash of $125,000 as of May 8, 2009, combined with
anticipated revenue collections, will provide us with sufficient resources to
fund our operations through the third quarter of 2009 provided our 8% Senior
Secured Debenture holders do not exercise their rights under their debentures
and foreclose on our assets.





If we are
able to successfully sell the InCard DisplayCard in substantial quantities
during the second and third quarters of 2009 we may be able to continue
operations through the third quarter of 2009.  If we need additional
capital, we do not have any binding commitments for, or readily available
sources of, additional financing. Additional financing, whether through public
or private equity or debt financing, arrangements with stockholders or other
sources to fund operations, may not be available, or if available, may be on
terms unacceptable to us. If we issue additional equity securities to raise
funds, the ownership percentage of our existing stockholders would be reduced.
New investors may demand rights, preferences or privileges senior to those of
existing holders of our common stock. Debt incurred by us would be senior to
equity in the ability of debt holders to make claims on our assets. The terms of
any debt issued could impose restrictions on our operations. If adequate funds
are not available to satisfy our capital requirements, our operations and
liquidity could be materially adversely affected.





Going
Concern





Our
independent registered public accountants have included a going concern
explanatory paragraph in their unqualified opinion of our 2008 financial
statements.








ITEM
      7A.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURE ABOUT MARKET
  RISK





We are
not required to provide the information as to selected financial data as we are
considered a smaller reporting company.




19




ITEM
      8.
            FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA





Our
consolidated financial statements and related financial information required to
be filed hereunder are indexed under Item 15 of this report and are incorporated
herein by reference.




ITEM
      9.
              CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE




Not
applicable.





ITEM
      9A.
            CONTROLS
      AND PROCEDURES





Evaluation
of Disclosure Controls and Procedures




Our
management, with the participation of our Chief Executive Officer (“CEO”), has
evaluated the effectiveness of the Company’s disclosure controls and procedures
(as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the
period covered by this report (December 31, 2008). Based on such evaluation
which disclosed numerous material weaknesses as noted below, our CEO has
concluded that, as of the end of such period, the Company’s disclosure controls
and procedures were not effective in recording, processing, summarizing and
reporting, on a timely basis, information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act and are
not effective in ensuring that information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act is
accumulated and communicated to the Company’s management, including the
Company’s CEO, as appropriate to allow timely decisions regarding required
disclosure.




Management
Report on Internal Control Over Financial Reporting




Management
of Innovative Card Technologies, Inc. is responsible for establishing and
maintaining adequate internal control over financial reporting, as defined in
Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934.
Internal control over financial reporting is a process designed by, or under the
supervision of, the Company’s principal executive and principal financial
officers to provide reasonable assurance to the Company’s management and board
of directors regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. Internal control over financial
reporting includes those policies and procedures that:




·
            pertain
      to the maintenance of records that in reasonable detail accurately and
      fairly reflect the transactions and dispositions of the assets of the
      Company;




·
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the Company
      are being made only in accordance with authorizations of management and
      directors of the Company; and




·
            provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of the Company’s assets that
      could have a material effect on the financial
  statements.




Because
of inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Projections of any evaluation of effectiveness
to future periods are subject to the risks that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate. A control system, no matter how well
designed and operated, can provide only reasonable, but not absolute, assurance
that the control system’s objectives will be met. The design of a control system
must reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs.




Management
assessed the effectiveness of the Company’s internal control over financial
reporting as of December 31, 2008. In making this assessment, management
used the criteria set forth inInternal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (“COSO”)  Based on our assessment at
December 31, 2008, management believes that our internal control over
financial reporting was not effective based on criteria set forth by the COSO.
The following material weaknesses were identified in our internal control over
financial reporting at December 31, 2008:


·
              We performed a financial close on
      a quarterly basis through March 2008 (effective April 2008 we began a
      monthly close process). The analysis of actual to budgeted results was
      either done marginally or not at all and there was no mechanism in place
      to evaluate variances, investigate unusual activity or communicate
      findings to senior management or the board of
      directors.
  ·
              During the quarterly financial
      close we did not utilize a financial closing checklist or prepare other
      documentation to ensure that all items had been considered for inclusion
      in the three quarterly filings of Forms
  10-Q.
  20
  ·
              We are unable to maintain the
      proper segregation of various accounting and finance duties because of our
      small size and limited resources. At risk areas include cash receipts and
      payments, processing of journal entries and account
      reconciliations.
 ·
                We did not maintain a standard
      listing of recurring journal entries through March 2008 (effective April
      2008 we began this monthly
  process).
  ·
                Much of the financial closing
      process is done off-line on electronic spreadsheets that are maintained on
      individual computers, unable to be shared by accounting personnel and not
      backed up.
  ·
                We have not performed a physical
      inventory of fixed assets. As a result, we failed to identify idle fixed
      assets that were not in our possession until late in the closing process
      necessitating an adjustment to our
  results.


·
              Through April 2008, we did not
      consistently utilize purchase orders when purchasing inventory, which
      could lead to uncertainty regarding our quarter end commitments. Effective
      May 2008 we began this
  process.
 ·
                Formal job descriptions do not
      exist and annual reviews are not
    performed.
  ·
                During the fourth quarter of 2008
      our CEO and CFO resigned. This caused us to have limited oversight of
      operations and less review of
  activity.
  ·
                Due
      to the deficiencies discussed above, we were not able to complete our
      December 31, 2008 annual close in a timely manner which lead to filing our
      Form 10-K late.


We intend
to remediate these material weaknesses during 2009. As concerns the material
weakness relating to segregation of duties, we are re-examining our procedures
to include compensating controls and minimize the risk associated with having
limited resources in the accounting department.





Notwithstanding
these material weaknesses, we believe that our financial condition, results of
operations and cash flows presented in this report of Form 10-K are fairly
presented in all material respects. We base our conclusion on our ability to
substantiate, with a high degree of confidence, the small number of significant
general ledger accounts that comprise our financial statements.





Changes
in Internal Control Over Financial Reporting





During
the year ended December 31, 2008 we made the following changes in internal
control over financial reporting:


·
                Beginning in April 2008 we
      instituted a monthly financial closing process. A formal report, including
      balance sheet, results of operations and analyses of key accounts, is
      prepared by the accounting manager, reviewed and signed off by the CFO and
      distributed to the CEO and the board of
      directors.
 ·
                  Beginning in April 2008 we
      established a standard listing of recurring journal entries that are
      reviewed and signed off by the CFO as part of the monthly closing
      process.
  ·
                  We instituted a formal purchasing
      policy in May 2008 that requires the use of purchase orders for all
      inventory
purchases.
  ·
                  We established with certainty the
      Section 382 limitation on our loss
      carryforwards.


PART III





ITEM
      10.
            DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE





Directors





Our board
of directors consists of five members.  The following sets forth our
current directors, the positions they have had with us, information concerning
their ages and background.








Name
            
            Positions
      with Company
            
            Age
            
            Director
              SinceDonald
      Joyce
            
            Director
      and Chairman of the Board
            
            57
            
            2003W.
      Robert Ramsdell
            
            Director
            
            67
            
            2007Richard
      Nathan
            
            Director,
      Chief Executive Officer and Principal Financial Officer
            
            67
            
            *Scott
      V. Ogilvie
            
            Director
            
            54
            
            2006Harry
      L. Tredennick, III
            
            Director
            
            62
            
            2007







*    
Please refer to Mr. Nathan’s bio for term of directorship.




21





Dr. Donald
Joyce has served as a director since November 2003 and our Chairman
since September 2007. Dr. Joyce serves as the Washington
representative for the University of Chicago Argonne National Laboratory
beginning February 2008. Previously, since April 2001, he served as Deputy
Director of the University of Chicago Argonne National Laboratory. From
June 6, 2000 to February 2001, Dr. Joyce served as Chief
Technology Officer for Technology Connect, a technology consulting firm in
Massachusetts. From May 1999 to June 2000, he served as Senior Vice
President of JDH Technologies, LLC, a software company. Prior to May 1999,
Dr. Joyce served as President of Muhlbauer Inc., an equipment supplier to
the semiconductor, circuit board assembly and smart card industries.
Dr. Joyce received a Ph.D. in Physics from the College of William and Mary
and a B.A. in Physics from the University of Colorado.





W. Robert
Ramsdell has served as a director since June 2007. Mr. Ramsdell
has been engaged in private investments in micro cap companies since 1990. 
From 1973 until his retirement in 1990, Mr. Ramsdell was senior partner,
director of research and office manager of Cantor Fitzgerald & Co. in
Los Angeles, engaged in the institutional equity business.





Richard J.
Nathan has served as a director since December 2007.  During
this period, Mr. Nathan resigned from the board from September to November
2008.  Mr. Nathan has served as our Chief Executive Officer and
Principal Financial Officer since November 17, 2008.   Mr. Nathan
founded JigSaw tek, Inc. in May 2001, where he served as the Chief
Executive Officer until 2005. The company marketed high-end, integrated circuit
packaging solutions using proprietary, patent-pending embedded silicon
technology. Since that time, Mr. Nathan has pursued personal and
professional interests and investments in various technology industries.
Mr. Nathan attended Denver University and majored in physics. He also
attended Adelphi University and completed numerous graduate and
undergraduate courses in various science and business disciplines. He has
authored or co-authored eight U.S. patents.




Scott V.
Ogilvie has served as a director since
December 2006.   Mr. Ogilvie is President andCEO of Gulf Enterprises
International, Ltd, (“Gulf”) a company that brings strategic partners, expertise
and investment capital to the Middle East and North Africa. He has held this
position since August of 2006. Mr. Ogilvie also serves as Chief Operating
Officer of CIC Group, Inc., an investment manager, a position he has held for
the last five years. He began his career as a corporate and securities lawyer
with Hill, Farrer & Burrill, and has extensive public and private corporate
board experience in finance, real estate, and technology companies. Mr. Ogilvie
currently serves on the board of directors of Neuralstem, Inc. (NYSE AMEX:CUR),
Innovative Card Technologies, Inc. (OTCBB:INVC) and Preferred Voice Inc,
(OTCBB:PRFV).




Harry L.
Tredennick III has served as a director since December 2007. Mr.
Tredennick serves as a technology analyst for Gilder Publishing. His area of
expertise is leading-edge components and he writes and speaks on topics related
to microprocessors, programmable logic, reconfigurable systems, and MEMS
(microelectromechanical systems). He has held this position since
August 2000. He has held engineering and research positions at Motorola and
IBM and was once Chief Scientist at Altera. Dr. Tredennick was named a
Fellow of the IEEE for his contributions to microprocessor design. He received
his Ph.D. in Electrical Engineering from the University of Texas, Austin. He
received his MSEE and BSEE in Electrical Engineering from
Texas Tech University, where he has been named a Distinguished
Engineering Graduate.




Executive
Officers and Significant Employees





The
following sets forth our current executive officers and information concerning
their age and background:





Name
            
            Positions
            
            Age
            
            Position
              SinceRichard
      Nathan
            
            Chief
      Executive Officer, Principal Financial Officer, Director
            
            67
            
            2008




Richard
Nathan – See Bio in the “Directors”
section





Family
Relationships





There are
no family relationships between any director, executive officer, or person
nominated or chosen by the registrant to become a director or executive
officer.




22





Compliance
with Section 16(a) of the Exchange Act





Section
16(a) of the Exchange Act requires our officers, directors, and stockholders
owning more than ten percent of our common stock, to file reports of ownership
and changes in ownership with the SEC and to furnish us with copies of such
reports. Based solely on our review of Form 3, 4 and 5’s, the following table
provides information regarding any of the reports which were filed late during
the fiscal year ended December 31, 2008:





Name
      of Reporting Person
            
            Type
      of Report Filed Late
            
            No.
      of Transactions
              Reported
      LateRichard
      Nathan
            
            Form
      3
            
            1Harry
      L. Tredennick III
            
            Form
      3
            
            1Steven
      Delcarson
            
            Form
      4
            
            1Charles
      Caporale
            
            Form
      4
            
            1Harry
      L. Tredennick III
            
            Form
      4
            
            1Richard
      Nathan
            
            Form
      4
            
            1




Code
of Ethics





We have
adopted a Code of Business Conduct and Ethics for all of our employees,
including our Chief Executive Officer, Chief Financial Officer and Principal
Accounting Officer. The purpose of the code is to ensure that our business is
conducted in a consistently legal and ethical matter. A copy of our code can be
viewed on our website at www.incardtech.com.




We intend
to disclose future amendments to our code, or waivers of such provisions on our
web site within four business days following the date of such amendment or
waiver.





Committees





We have
established 3 corporate governance committees comprising of the: (i) Audit
Committee; (ii) Compensation Committee; and (iii) Nomination and Corporate
Governance Committee.  Each of our committees has adopted a formal
charter.  A copy of each committee’s charter may be found on our
website at www.incard.com.




Audit
Committee




We have a
designated audit committee in accordance with section 3(a)(58)(A) of the
Exchange Act.  The committee oversees our financial reporting process
on behalf of the Board of Directors. The committee operates under a written
charter approved by the Board, a copy of which may be found on our website,
http://www.incardtech.com .  The committee meets at least quarterly
with our management and independent accountants to, among other things, review
the results of the annual audit and quarterly reviews and discuss the financial
statements, select and engage the independent accountants, assess the adequacy
of our staff, management performance and procedures in connection with financial
controls and receive and consider the accountants’ comments on our internal
controls.  The board has determined that Mr. Ogilvie is an “audit
committee financial expert” within the meaning of Item 407(d)(5) of SEC
Regulation S-K.





The
current members of the Audit Committee are Scott V. Ogilvie (Chairman), W.
Robert Ramsdell and Harry L. Tredennick.





Our board
of directors has determined that Mr. Ogilvie is an “audit committee financial
expert” within the meaning of Item 407(d)(5) of SEC Regulation S-K. An audit
committee financial expert is a person who can demonstrate the following
attributes:  (1) an understanding of generally accepted
accounting principles and financial statements; (2) the ability to assess
the general application of such principles in connection with the accounting for
estimates, accruals and reserves; (3) experience preparing, auditing,
analyzing or evaluating financial statements that present a breadth and level of
complexity of accounting issues that are generally comparable to the breadth and
complexity of issues that can reasonably be expected to be raised by the
company’s financial statements, or experience actively supervising one or more
persons engaged in such activities; (4) an understanding of internal
controls and procedures for financial reporting; and (5) an understanding
of audit committee functions.





Compensation
Committee




The
Compensation Committee makes determinations concerning salaries and incentive
compensation and otherwise determines compensation levels for the Company’s
executive officers, directors and other key employees and performs such other
functions regarding compensation as the board may delegate.





The
current members of the Compensation Committee are W. Robert Ramsdell (Chairman),
Scott V. Ogilvie and Harry L. Tredennick III.




Nomination
and Corporate Governance Committee




The
Nominating and Corporate Governance Committee reviews and evaluates the
effectiveness of the Company’s executive development and succession planning
processes, as well as providing active leadership and oversight of these
processes, and oversight of the Company’s corporate governance policies. The
Nominating and Corporate Governance Committee also evaluates and recommends
nominees for membership on the Company’s board of directors and its
committees.




23





The
current members of the Nominating and Corporate Governance Committee are Donald
Joyce (Chairman) and Scott V. Ogilvie.





There has
been no change material change to the procedures by which security holders may
recommend nominees to our board of directors since we last provided such
disclosure in our definitive proxy statement filed with the SEC in connection
with our 2008 annual meeting.




Independent
Directors




Our board
of directors has determined that Messrs Joyce, Ramsdell, Ogilvie and Tredennick
are each “independent” as that term is defined by the NASDAQ
rules.





ITEM
      11.
            EXECUTIVE
      COMPENSATION





Executive
Compensation





Summary
Compensation





The
following table sets forth information for our most recently completed fiscal
year concerning the compensation of (i) the Principal Executive Officer
(“PEO”); and (ii) the one most highly compensated individuals who earned
over $100,000 in salary and bonus during the last most recently completed fiscal
year ended December 31, 2008 (together the “Named Executive Officers”).





Name
      and principal position (a)
              
              Year
      (b)
              
              Salary
                ($)
      (c)
              
              Bonus
                ($)
      (d)
              
              Stock
      Awards
                ($)
      (e)
              
              Option
      Award
                ($)
      (f)(1)
              
              Nonequity
      Incentive Plan compensation
                ($)
      (g)
              
              Non-
      deferred compensation earning
                ($)
      (h)
              
              All
      other Compensat
                ($)
      (i)
              
              Total
                ($)
      (j)Richard
      Nathan
              
              2008
              
              $
              30,000
              
              
              
              
              
              $
              37,277
              
              
              
              
              
              
              
              $
              67,277Chief
      Executive
              
              2007
              
              $
              -
              
              
              
              
              
              $
              -
              
              
              
              
              
              
              
              $
              -President
      (“PEO”)(2)Steven
      Delcarson
              
              2008
              
              $
              407,102
              
              
              
              
              
              $
              211,286
              
              
              
              
              
              
              
              $
              618,388Former
      Chief Executive Officer
              
              2007
              
              $
              87,500
              
              
              
              
              
              $
              -
              
              
              
              
              
              
              
              $
              87,500Charles
      Caporale
              
              2008
              
              $
              204,167
              
              
              
              
              
              $
              102,079
              
              
              
              
              
              
              
              $
              306,246Former
      Chief Financial Officer
              
              2007
              
              $
              32,077
              
              
              
              
              
              $
              -
              
              
              
              
              
              
              
              $
              32,077Nick
      Leung
              
              2008
              
              $
              158,032
              
              
              
              
              
              $
              18,750
              
              
              
              
              
              
              
              $
              176,782Former
      Product Manager
              
              2007
              
              $
              75,000
              
              
              
              
              
              $
              25,000
              
              
              
              
              
              
              
              $
              100,000





(1)
            For
      additional information regarding the valuation of Option Awards, refer to
      Note 9 of our financial statements in the section captioned “Stock
      Options.”





(2)
            Mr.
      Nathan was appointed Chief Executive Officer on November 17, 2008 when Mr.
      Delcarson’s employment contract
terminated.




Employment
Agreements and Arrangements and Change-In-Control Arrangements





Employment
Agreement with Richard Nathan





On
February 20, 2009, we entered in into a written employment agreement with
Richard Nathan.  Pursuant to the terms of the agreement, Mr. Nathan
annual compensation is $240,000.  Also, as part of the agreement, we
granted Mr. Nathan a stock option to purchase 1,000,000 common shares at $0.10
per share.  The option has a term of five years.  The
agreement also provides for a bonus equal to: (i) 3% of increase in market
capitalization occurring during first year of employment; and (ii) 2% of
increase in market capitalization year after year for all periods
thereafter.  Mr. Nathan’s employment under the agreement is
“At-Will.”




24





Outstanding
Equity Awards at Fiscal Year-End





The
following table provides information concerning unexercised options; stock that
has not vested; equity incentive; and awards for each Named Executive Officer
outstanding as of the end of the last completed fiscal year.




Option
      Awards
            
            Stock
      AwardsName
                (a)
            
            Number of
              securities
              underlying
              unexercised
              options(#)
              exercisable
              (b)
            
            Number of
                securities
                underlying
                unexercised
                options(#)
                unexercisable
                (c)
            
            Equity
                plan
      awards:
                Number of
                securities
                underlying
                unexercised
                unearned
                options(#)
                (d)
            
            Option
              exercise
              price($)
              (e)
            
            Option
              expiration
              date(f)
            
            Number
              of shares
              or units
              of stock
              that have
              not
      vested
              (#)
              (g)
            
            Market
              value of
              shares of
              units of
              stock that
              have not
              vested($)
              (h)
            
            Equity
              incentive
              plan
      award:
              Number
      of
              un-earned
              shares,
      units
              or
      other
              rights that
              have not
              vested(#)
              (i)
            
            Equity
              incentive
              plan
      awards:
              Market or
              payout
      value
              of
      unearned
              shares,
      units
              or
      other
              rights that
              have not
              vested($)
              (j)Richard
      Nathan
            
            
            17,930
            
            -
            
            1,045,403
            
            $
            0.21
            
            2018
            
            
            -
            
            -
            
            
            -
            
            -Chief
      Executive OfficerSteven
      Delcarson
            
            
            100,000
            
            -
            
            -
            
            $
            2.25
            
            2009
            
            
            -
            
            -
            
            
            -
            
            -Previous
      Chief Executive OfficerCharles
      Caporale
            
            
            50,000
            
            -
            
            -
            
            $
            2.25
            
            2009
            
            
            -
            
            -
            
            
            -
            
            -Previous
      Chief Financial OfficerNick
      Leung
            
            
            150,000
            
            -
            
            -
            
            $
            1.00
            
            2009
            
            
            -
            
            -
            
            
            -
            
            -Previous
      ProductManager




Director
Compensation





The
following table summarizes the compensation for our board of directors for the
fiscal year ended December 31, 2008:




Name
                (a)
              
              Fees Earned or
                Paid in
                Cash($)
                (b)
              
              Stock
                Awards ($)
                (c)
              
              Option
                Awards ($)
                (d)
              
              Non-Equity
                Incentive
                Plan
                Compensation($)
                (e)
              
              Nonqualified
                Deferred
                Compensation
                Earnings($)
                (f)
              
              All Other Compensation
                ($)(g)
              
              Total($)
                (h)Donald
      Joyce
              
              
              
              
              
              $
              75,200
              
              
              
              
              
              
              
              $
              75,200W.
      Robert Ramsdell
              
              
              
              
              
              $
              87,778
              
              
              
              
              
              
              
              $
              87,778Richard
      Nathan
              
              
              
              
              
              $
              37,277
              
              
              
              
              
              
              
              $
              37,277Scott
      Ogilvie
              
              
              
              
              
              $
              97,800
              
              
              
              
              
              
              
              $
              97,800Harry
      L. Tredennick
              
              
              
              
              
              $
              31,822
              
              
              
              
              
              
              
              $
              31,822




Director
Compensation Plan





Our
Compensation Committee has adopted a formal outsider director compensation plan
to assist us in attracting and retaining qualified directors.  Under
our plan, incoming directors receive options to purchase 60,000 common
shares.  The options vest in equal installments on the anniversary of
the option grant.  The option grant date is the day the incoming
director is elected or accepts his appointment to the board.





ITEM
      12.
              SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS





Securities
Authorized for Issuance Under Equity Compensation Plans





Information
regarding shares authorized for issuance under equity compensation plans
approved and not approved by stockholders required by this Item are incorporated
by reference from Item 5 of this Annual Report from the section entitled
“Equity Compensation Plan
Information.”




25





Security
Ownership of Certain Beneficial Owners and Management





The
following table sets forth, as of April 20, 2009, information regarding
beneficial ownership of our capital stock by:





·
            each
      person, or group of affiliated persons, known by us to be the beneficial
      owner of 5% or more of any class of our voting
  securities;





·
            each
      of our current directors and
nominees;





·
            each
      of our current named executive officers;
and





·
            all
      current directors and named executive officers as a
  group.




Beneficial
ownership is determined according to the rules of the SEC. Beneficial ownership
means that a person has or shares voting or investment power of a security and
includes any securities that person or group has the right to acquire within 60
days after the measurement date. This table is based on information supplied by
officers, directors and principal stockholders. Except as otherwise indicated,
we believe that each of the beneficial owners of the common stock listed below,
based on the information such beneficial owner has given to us, has sole
investment and voting power with respect to such beneficial owner’s shares,
except where community property laws may apply.


Common
      StockName
      and Address of Beneficial Owner(1)
              
              Shares
              
              
              Shares
      Underlying Convertible Securities(2)
              
              
              Total
              
              
              Percent
      of Class(2)Directors
      and named executive officersDonald
      Joyce
              
              
              
              
              
              78,166
              
              
              
              78,166
              
              
              
              *
              %W.
      Robert Ramsdell
              
              
              337,500
              
              
              
              28,511
              
              
              
              366,011
              
              
              
              1.3
              %Richard
      Nathan
              
              
              
              
              
              
              267,930
              
              
              
              267,930
              
              
              
              0.9
              %Scott
      Ogilvie
              
              
              
              
              
              
              43,000
              
              
              
              43,000
              
              
              
              *
              %Harry
      L. Tredennick
              
              
              
              
              
              
              19,026
              
              
              
              19,026
              
              
              
              *
              %Nick
      Leung
              
              
              
              
              
              
              150,000
              
              
              
              150,000
              
              
              
              *
              %All
      directors and executive officers asa
      group (5 persons)
              
              
              337,500
              
              
              
              586,633
              
              
              
              924,133
              
              
              
              3.2
              %Beneficial
      Owners of 5% or moreNone
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              -
              %







*
            Less
      than one percent.(1)
            Except
      as otherwise indicated, the persons named in this table have sole voting
      and investment power with respect to all shares of common stock shown as
      beneficially owned by them, subject to community property laws where
      applicable and to the information contained in the footnotes to this
      table. Unless otherwise indicated, the address of the beneficial owner is
      c/o Innovative Card Technologies, Inc., 633 West Fifth Street,
      Suite 2600, Los Angeles, CA 90071.(2)
            Pursuant
      to Rules 13d-3 and 13d-5 of the Exchange Act, beneficial ownership
      includes any shares as to which a shareholder has sole or shared voting
      power or investment power, and also any shares which the shareholder has
      the right to acquire within 60 days, including upon exercise of common
      shares purchase options or warrant. There are 28,495,256 shares of common
      stock issued and outstanding as of April 20,
  2009.




ITEM
      13.
            CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE





Transactions
with Related Persons, Promoters and Certain Control Persons





The
following lists all transaction since the beginning of our last two fiscal
years, or any currently proposed transaction, in which the we are or are to be a
participant and the amount involved exceeds the lesser of $120,000 or one
percent of our average total assets at year end for the last two completed
fiscal years, and in which any related person had or will have a direct or
indirect material interest.





Information
regarding disclosure of an employment relationship or transaction involving an
executive officer and any related the lesser of $120,000 or one percent of the
average of the smaller reporting company's total assets at year end for the last
two completed fiscal years resulting from that employment relationship or
transaction is incorporated by reference from Item 11 of this Annual
Report.




26





Information
regarding disclosure of compensation to a director is incorporated by reference
from Item 11 of this Annual Report.





Employment
Agreements with Prior Employees.





On March
27, 2008 we entered into an employment agreement with Mr. Delcarson which
provided for a one year term.  Pursuant to the terms of the agreement, Mr.
Delcarson received annual base compensation of $300,000, which was increased to
$335,000 effective January 1, 2008.  Pursuant to the agreement, Mr.
Delcarson was also eligible to receive an annual bonus of up to the amount of
his base compensation based on the achievement of certain performance
criteria.  Also, pursuant to the agreement, Mr. Delcarson was issued
an option to purchase 1,000,000 common shares at a price per share of
$2.25.  The option vests upon the achievement of certain performance
milestones.  Mr. Delcarson’s employment terminated on November 13,
2008.  For a further description of the terms of Mr. Declarson’s
employment agreement, please refer to Exhibit 10.18 incorprated by reference in
this Annual Report entitled Executive Employment Agreement of Steven
Delcarson.




On
March 27, 2008, we entered into an employment agreement with
Mr. Caporale which provided for a one year term.  Pursuant to the
terms of the agreement, Mr. Caporale received annual base compensation of
$180,000 which was increased on March 1, 2008 to $200,000 per year,
retroactive to January 1, 2008.  Mr. Caporal was also eligible to
receive an annual bonus of up to the amount of his base compensation based on
the achievement of certain performance criteria.   Also, pursuant
to the agreement, Mr. Caporale was issued an option to purchase 200,000 common
shares stock at a price per share of $2.25.  The option vests upon the
achievement of certain performance milestones.   Mr. Caporale
resigned as our CFO effective October 31, 2008.  For a further
description of the terms of Mr. Caporale’s employment agreement, please refer to
Exhibit 10.19 incorprated by reference in this Annual Report entitled Executive
Employment Agreement of Charles Caporale.





Consulting
Services




We paid
Forest Finkelstein $85,000 in 2007 for services rendered to us. Forest
Finkelstein is the son of Alan Finkelstein, one of our former directors. Our
arrangement with Forest Finkelstein terminated in
December 2007.




Legal
Services




The law
firm of Blakely Sokoloff Taylor & Zafman, LLP (BSTZ) acted as our
outside legal counsel on intellectual property matters. George Hoover, a former
director of InCard, serves as a partner of BSTZ. Aggregate fees billed to us by
BSTZ for legal services rendered during fiscal years 2008 and 2007 were $0 and
$49,003, respectively. This amount is included in our Accounts Payable related
parties on December 31, 2008. The balance payable to BSTZ is non-interest
bearing and is payable on demand.





Director
Independence





Information
regarding director independence required by this Item is incorporated by
reference from Item. 10 of this Annual Report from the section entitled “Director
Independence.”





ITEM
      14.
            PRINCIPAL
      ACCOUNTING FEES AND SERVICES





The
following table summarizes the approximate aggregate fees billed to us or
expected to be billed to us by our independent auditors for our 2008 and 2007
fiscal years:





Type
      of Fees
            
            2008
            
            
            2007Audit
      Fees
            
            $
            98,269
            
            
            $
            246,461Audit
      Related Fees
            
            
            122,010
            
            
            
            45,012Tax
      Fees
            
            
            3,500
            
            
            
            15,506All
      Other Fees
            
            
            14,665
            
            
            
            9,899Total
      Fees
            
            $
            238,444
            
            
            $
            316,878




Pre-Approval
of Independent Auditor Services and Fees




Our audit
committee reviewed and pre-approved all audit and non-audit fees for services
provided by SingerLewak LLP (“Singer Lewak”) and has determined that the
provision of such services to us during fiscal 2008 and in connection with the
audit of our 2008 fiscal year financials is compatible with and did not impair
independence. It is the practice of the audit committee to consider and approve
in advance all auditing and non-auditing services provided to us by our
independent auditors in accordance with the applicable requirements of the
SEC.   Singer Lewak did not provide us with any services, other
than those listed above.





27




PART IV





ITEM
      15.
            EXHIBITS,
      FINANCIAL STATEMENT SCHEDULES





1.
            The
      Financial Statements and Financial Statement Schedules listed on page F-1
      of this document are filed as part of this
  Form 10-K.







2.
            Exhibits:
      The exhibits listed in the accompanying index to exhibits are filed or
      incorporated by reference as part of this
  Form 10-K.







Certain
of the agreements filed as exhibits to this Form 10-K contain
representations and warranties by the parties to the agreements that have been
made solely for the benefit of the parties to the agreement. These
representations and warranties:





·
            may
      have been qualified by disclosures that were made to the other parties in
      connection with the negotiation of the agreements, which disclosures are
      not necessarily reflected in the
agreements;





·
            may
      apply standards of materiality that differ from those of a reasonable
      investor; and





·
            were
      made only as of specified dates contained in the agreements and are
      subject to later developments.





Accordingly,
these representations and warranties may not describe the actual state of
affairs as of the date they were made or at any other time, and investors should
not rely on them as statements of fact.





SIGNATURES




In
accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.




INNOVATIVE
      CARD TECHNOLOGIES, INCDated:
      May 15, 2009
              By:
              /s/
      Richard NathanRichard
      NathanChief
      Executive Officer




Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
following capacities and on the dates indicated.




Name
                  
                  Title
                  
                  Date/s/
      Richard Nathan
                  
                  Chief
      Executive Officer, Chief
                  
                  May
      15, 2009Richard
      Nathan
                  
                  Financial
      Officer and Director/s/
      Donald Joyce
                  
                  Director
      and Chairman of the Board
                  
                  May
      15, 2009Donald
      Joyce/s/
      W. Robert Ramsdell
                  
                  Director
                  
                  May
      15, 2009W.
      Robert Ramsdell/s/
      Scott V. Ogilvie
                  
                  Director
                  
                  May
      15, 2009Scott
      V. Ogilvie/s/
      Harry L. Tredennick III
                  
                  Director
                  
                  May
      15, 2009Harry
      L. Tredennick III




28




INDEX
TO EXHIBITS




Incorporated by
  ReferenceExhibit
              
              
              
              Filed
              
              
              
              Exhibit
              
              
              
              FilingNo.
              
              Description
              
              Herewith
              
              Form
              
              No.
              
              File
      No.
              
              Date3.01(i)
              
              Amended
      and Restated Certificate of Incorporation of
              
              *Innovative
      Card Technologies, Inc. filed on 5/11/053.02(i)
              
              Certificate
      of Amendment to Certificate of Incorporation
              
              
              
              8-K
              
              3.1
              
              001-33353
              
              1/2/08of
      Innovative Card Technologies, Inc. filed on 12/21/073.03(ii)
              
              Amended
      and Restated Bylaws of Innovative Card
              
              *Technologies,
      Inc. adopted on May 5, 200510.01**
              
              2004
      Stock Incentive Plan as amended
              
              
              
              S-8
              
              10.1
              
              333-137033
              
              3/25/0810.02
              
              Form
      of Warrant pursuant to private placement dated
              
              
              
              8-K
              
              4.1
              
              000-51260
              
              10/25/05October
      19, 200510.03
              
              Form
      of Warrant issued to TR Winston & Company, LLC
              
              
              
              8-K
              
              4.1
              
              000-51260
              
              5/31/06dated
      May 30, 200610.04
              
              Form
      of Securities Purchase Agreement dated May 30,
              
              
              
              8-K
              
              10.1
              
              000-51260
              
              5/31/06200610.05
              
              Form
      of Registration Rights Agreement dated May 30,
              
              
              
              8-K
              
              10.2
              
              000-51260
              
              5/31/06200610.06
              
              Licensing
      Agreement dated September 26, 2006 by and
              
              
              
              SB-2
              
              10.35
              
              333-135715
              
              7/12/06between
      Innovative Card Technologies, Inc. andNCryptone,
      SA as license10.07
              
              Licensing
      Agreement dated September 26, 2006 by and
              
              
              
              SB-2
              
              10.36
              
              333-135715
              
              7/12/06betweenNCryptone,
      SA as licensor and Innovative Cardas
      license10.08
              
              Form
      of Indemnification Agreement for ExecutiveOfficers
      and Directors of Innovative Card Technologies,
              
              
              
              8-K
              
              10.1
              
              001-33353
              
              3/23/07Inc.10.09**
              
              2007
      Equity Incentive Plan
              
              
              
              10-QSB
              
              10.44
              
              001-33353
              
              11/19/0710.10
              
              Form
      of Indemnification Agreement entered into between
              
              
              
              8-K
              
              10.1
              
              001-33353
              
              11/29/07the
      Company and Messrs. Delcarson and Caporale10.11
              
              Form
      of Securities Purchase Agreement Dated January 8,
              
              
              
              8-K
              
              10.1
              
              001-33353
              
              1/9/07200810.12
              
              Form
      of 8% Senior Secured Convertible Debenture issued
              
              
              
              8-K
              
              10.2
              
              001-33353
              
              1/9/07January
      8, 2008




29




10.13
              
              Form
      of Common Stock Purchase Warranted issued
              
              
              
              8-K
              
              10.3
              
              001-33353
              
              1/9/07January
      8, 200810.14
              
              Form
      of Registration Rights Agreement dated January 8,
              
              
              
              8-K
              
              10.4
              
              001-33353
              
              1/9/07200810.15
              
              Form
      of Security Agreement dated January 8, 2008
              
              
              
              8-K
              
              10.5
              
              001-33353
              
              1/9/0710.16
              
              Form
      of Subsidiary Guarantee dated January 8, 2008
              
              
              
              8-K
              
              10.6
              
              001-33353
              
              1/9/0710.17**
              
              Form
      of Lock-Up Agreement dated January 8, 2008
              
              
              
              8-K
              
              10.7
              
              001-33353
              
              1/9/0710.18**
              
              Executive
      Employment Agreement of Steven Delcarson
              
              
              
              8-K
              
              10.1
              
              001-33353
              
              4/2/0810.19**
              
              Executive
      Employment Agreement of Charles Caporale
              
              
              
              8-K
              
              10.2
              
              001-33353
              
              4/2/0810.20
              
              Form
      of Securities Purchase Agreement Dated April 15,
              
              
              
              8-K
              
              10.1
              
              001-33353
              
              4/16/08200810.21
              
              Form
      of 8% Senior Secured Convertible Debenture issued
              
              
              
              8-K
              
              10.2
              
              001-33353
              
              4/16/08April
      15, 200810.22
              
              Form
      of Common Stock Purchase Warranted issued April
              
              
              
              8-K
              
              10.3
              
              001-33353
              
              4/16/0815,
      200810.23
              
              Form
      of Registration Rights Agreement dated April 15,
              
              
              
              8-K
              
              10.4
              
              001-33353
              
              4/16/08200810.24
              
              Form
      of Security Agreement dated April 15, 2008
              
              
              
              8-K
              
              10.5
              
              001-33353
              
              4/16/0810.25
              
              Form
      of Subsidiary Guarantee dated April 15, 2008
              
              
              
              8-K
              
              10.6
              
              001-33353
              
              4/16/0810.26
              
              Form
      of Lock-Up Agreement dated April 15, 2008
              
              
              
              8-K
              
              10.7
              
              001-33353
              
              4/16/0810.27**
              
              Form
      of Executive Employment Agreement of Vincent M.
              
              
              
              8-K
              
              10.1
              
              001-33353
              
              5/27/08




30




10.28**
              
              Employment
      Agreement of Mr. Richard Nathan dated
              
              
              
              8-K
              
              10.01
              
              001-33353
              
              2/24/09February
      20, 200914.01
              
              Code
      of Ethics
              
              
              
              10-KSB
              
              14.0
              
              000-51260
              
              3/20/0621.1
              
              List
      of Subsidiaries
              
              
              
              SB-2
              
              21.1
              
              333-119814
              
              10/19/0423
              
              Consent
      of Independent Registered Public Accounting Firm
              
              *31.1
              
              Certification
      of the Principal Executive Officer Pursuant
              
              *to
      Section 302 of the Sarbanes-Oxley Act of 200231.1
              
              Certification
      of the Principal Financial Officer Pursuant to
              
              *Section
      302 of the Sarbanes-Oxley Act of 200232.1
              
              Certification
      of Principal Executive Officer Pursuant to 18
              
              *U.S.C.
      § 135032.1
              
              Certification
      of Principal Financial Officer Pursuant to 18
              
              *U.S.C.
      § 1350







**
            Management
      contracts or compensation plans or arrangements in which directors or
      executive officers are eligible to
participate.




31




INNOVATIVE
CARD TECHNOLOGIES, INC.





Index
to Financial Statements





PageFinancial
      StatementsREPORT
      OF INDEPENDENT REGISTERED PUBLICACCOUNTING
      FIRM
              
              
              F-2CONSOLIDATED
      FINANCIAL STATEMENTSConsolidated
      Balance Sheets as of December 31, 2008 and 2007
              
              
              F-3Consolidated
      Statements of Operations for the Years EndedDecember 31, 2008
      and 2007
              
              
              F-4Consolidated
      Statements of Shareholders’ Equity for the Years EndedDecember 31, 2008
      and 2007
              
              
              F-5Consolidated
      Statements of Cash Flows for the Years EndedDecember 31, 2008
      and 2007
              
              
              F-6Notes
      to Consolidated Financial Statements
              
              
              F-7
      - F-20




Financial
Statement Schedules
 
 All
financial statement schedules are omitted because they are not applicable, not
required, or the information is shown in the Financial Statements or Notes
thereto.
  F-1





REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors and Shareholders


Innovative
Card Technologies, Inc





We have
audited the accompanying consolidated balance sheets of Innovative Card
Technologies, Inc and subsidiaries (collectively, the “Company”) as of December
31, 2008 and 2007, and the related consolidated statements of operations,
shareholder’s equity and cash flows for the years then ended.  These
financial statements are the responsibility of the Company's
management.  Our responsibility is to express an opinion on these
financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement.  An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements.  An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation.  We
believe that our audits provide a reasonable basis for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Innovative Card
Technologies, Inc and subsidiaries as of December 31, 2008 and 2007, and the
results of their operations and their cash flows for the years then ended,
in conformity with U.S. generally accepted accounting principles.





The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern.  As discussed in Note 1
to the consolidated financial statements, the Company has suffered recurring
losses from operations. This raises substantial doubt about the Company's
ability to continue as a going concern.  Management's plans in regard
to these matters are also described in Note 1.  The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.





We were
not engaged to examine management’s assessment of the effectiveness of
Innovative Card Technologies, Inc and subsidiaries’ internal control over
financial reporting as of December 31, 2008, included in the accompanying
management’s annual report on internal control over financial reporting and,
accordingly, we do not express an opinion thereon.




/s/
SingerLewak LLP





SingerLewak,
LLP


Los
Angeles, California


May 15,
2009




F-2


INNOVATIVE
CARD TECHNOLOGIES, INC.
 CONSOLIDATED
BALANCE SHEETS
 
 December
      31,
                  2008
                
                
                December
      31,
                  2007ASSETSCURRENT
      ASSETSCash
      and cash equivalents
                
                $
                76,645
                
                
                
                339,600Accounts
      receivable, net of allowance of $60,000 and zero,
    respectively
                
                
                190,767
                
                
                
                13,077Prepaids
      and other current assets
                
                
                174,178
                
                
                
                54,127Deposits
      on raw materials held for production
                
                
                268,318
                
                
                
                605,662Raw
      materials held for production
                
                
                347,529
                
                
                
                1,315,960Work
      in progress inventory, net
                
                
                1,454,940
                
                
                
                886,259Total
      current assets
                
                
                2,512,377
                
                
                
                3,214,685Property
      and equipment
                
                
                171,722
                
                
                
                193,185Deferred
      debt issuance cost
                
                
                449,052
                
                
                
                -Deposits
                
                
                62,971
                
                
                
                177,747Intangible
      assets, net of $0 and $954,047 accumulated amortization
                
                
                -
                
                
                
                2,075,953Total
      assets
                
                $
                3,196,122
                
                
                $
                5,661,570LIABILITIES
      AND STOCKHOLDERS’ EQUITY (DEFICIT)CURRENT
      LIABILITIESAccounts
      payable and accrued expenses
                
                $
                1,281,602
                
                
                
                3,660,044Accounts
      payable - related parties
                
                
                600,010
                
                
                
                657,254Accrued
      interest
                
                
                31,689
                
                
                
                -Warranty
      reserve
                
                
                198,854
                
                
                
                27,816Deferred
      rent
                
                
                56,929
                
                
                
                -Deferred
      revenue
                
                
                1,169,957
                
                
                
                898,585Total
      current liabilities
                
                
                3,339,041
                
                
                
                5,243,6998%
      convertible debentures, net of $4,432,928 discount (Note
    12)
                
                
                3,425,111
                
                
                
                -Warrant
      liability
                
                
                19,055
                
                
                
                -Total
      liabilities
                
                
                6,783,207
                
                
                
                5,243,699Commitments
      and Contingencies (Note 8)STOCKHOLDERS’
      EQUITY (DEFICIT)Preferred
      stock $0.001 par value, 5,000,000 shares authorized, 0 and 0 shares issued
      and outstanding
                
                
                -
                
                
                
                -Common
      stock $0.001 par value, 75,000,000 shares authorized, 28,495,256 and
      28,433,116 shares issued and outstanding
                
                
                28,495
                
                
                
                28,433Additional
      paid-in capital
                
                
                33,381,140
                
                
                
                28,456,621Accumulated
      deficit
                
                
                (36,996,720
                )
                
                
                (28,067,183
                )Total
      stockholders’ equity (deficit)
                
                
                (3,587,085
                )
                
                
                417,871Total
      liabilities and stockholders’ equity (deficit)
                
                $
                3,196,122
                
                
                $
                5,661,570
  The
accompanying notes are an integral part of these consolidated financial
statements
 
 F-3
  INNOVATIVE
CARD TECHNOLOGIES, INC.
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 
 Year
      Ended December 31,2008
                  
                  
                  2007Revenues
                  
                  $
                  2,828,581
                  
                  
                  $
                  445,000Cost
      of Goods Sold
                  
                  
                  (4,350,975
                  )
                  
                  
                  (851,637
                  )Gross
      Margin
                  
                  
                  (1,522,394
                  )
                  
                  
                  (406,637
                  )Operating
      expensesAdministrative
                  
                  
                  5,461,782
                  
                  
                  
                  8,389,987Consulting
      Fees
                  
                  
                  612,414
                  
                  
                  
                  641,884Impairment
                  
                  
                  1,450,888
                  
                  
                  
                  1,000,010Unrecoverable
      payments to suppliers
                  
                  
                  -
                  
                  
                  
                  1,546,428Professional
      Fees
                  
                  
                  734,680
                  
                  
                  
                  1,157,781Research
      and development
                  
                  
                  467,887
                  
                  
                  
                  1,352,413Total
      operating expenses
                  
                  
                  8,727,651
                  
                  
                  
                  14,088,503Loss
      from operations
                  
                  
                  (10,250,045
                  )
                  
                  
                  (14,495,140
                  )Other
      income (expense)Change
      in fair value of warrant liability and other expense
                  
                  
                  3,068,251
                  
                  
                  
                  -Interest
      income
                  
                  
                  26,857
                  
                  
                  
                  183,793Interest
      expense
                  
                  
                  (1,644,005
                  )
                  
                  
                  (21,475
                  )Other
      expense
                  
                  
                  (129,795
                  )
                  
                  
                  -Total
      other income (expense)
                  
                  
                  1,321,308
                  
                  
                  
                  162,318Loss
      before provision for income taxes
                  
                  
                  (8,928,737
                  )
                  
                  
                  (14,332,822
                  )Provision
      for income taxes
                  
                  
                  (800
                  )
                  
                  
                  (800
                  )Net
      loss
                  
                  $
                  (8,929,537
                  )
                  
                  $
                  (14,333,622
                  )Basic
      and diluted loss per share
                  
                  $
                  (0.31
                  )
                  
                  $
                  (0.50
                  )Weighted-average
      common shares outstanding
                  
                  
                  28,477,607
                  
                  
                  
                  28,420,141
  The
accompanying notes are an integral part of these consolidated financial
statements
 
 F-4
  INNOVATIVE
CARD TECHNOLOGIES, INC.
 CONSOLIDATED
STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)
  Series
      A Preferred Stock
                  
                  
                  Common
      Stock
                  
                  
                  Additional
      Paid-in
                  
                  
                  AccumulatedShares
                  
                  
                  Amount
                  
                  
                  Shares
                  
                  
                  Amount
                  
                  
                  Capital
                  
                  
                  Deficit
                  
                  
                  TotalBalance,
      December 31, 2006
                  
                  
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  28,372,308
                  
                  
                  $
                  28,372
                  
                  
                  $
                  26,298,606
                  
                  
                  $
                  (13,733,561
                  )
                  
                  $
                  12,593,417Exercise
      of warrants
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  32,000
                  
                  
                  
                  32
                  
                  
                  
                  39,968
                  
                  
                  
                  -
                  
                  
                  
                  40,000Cashless
      exercise of options
                  
                  
                  
                  
                  
                  
                  -
                  
                  
                  
                  28,808
                  
                  
                  
                  29
                  
                  
                  
                  (3,704
                  )
                  
                  
                  -
                  
                  
                  
                  (3,675
                  )Share-based
      compensation expense
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,121,751
                  
                  
                  
                  -
                  
                  
                  
                  2,121,751Net
      loss
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (14,333,622
                  )
                  
                  
                  (14,333,622
                  )Balance,
      December 31, 2007
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  28,433,116
                  
                  
                  
                  28,433
                  
                  
                  
                  28,456,621
                  
                  
                  
                  (28,067,183
                  )
                  
                  
                  417,871Value
      of warrants issued with 8% debentures (Note 12)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  3,237,954
                  
                  
                  
                  -
                  
                  
                  
                  3,237,954Warrants
      issued to consultants
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  413,350
                  
                  
                  
                  -
                  
                  
                  
                  413,350Cashless
      exercise of warrants
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  12,140
                  
                  
                  
                  12
                  
                  
                  
                  (12
                  )
                  
                  
                  -
                  
                  
                  
                  -Exercise
      of options
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  50,000
                  
                  
                  
                  50
                  
                  
                  
                  49,950
                  
                  
                  
                  -
                  
                  
                  
                  50,000Share-based
      compensation expense
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,223,277
                  
                  
                  
                  -
                  
                  
                  
                  1,223,277Net
      loss
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (8,929,537
                  )
                  
                  
                  (8,929,537
                  )Balance,
      December 31, 2008
                  
                  
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  28,495,256
                  
                  
                  $
                  28,495
                  
                  
                  $
                  33,381,140
                  
                  
                  $
                  (36,996,720
                  )
                  
                  $
                  (3,587,085
                  )
  The
accompanying notes are an integral part of these consolidated financial
statements
 
 F-5
  INNOVATIVE
CARD TECHNOLOGIES, INC.
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 
 Year
      Ended December 31,2008
                
                
                2007Cash
      flows from operating activitiesNet
      loss
                
                $
                (8,929,537
                )
                
                $
                (14,333,622
                )Adjustments
      to reconcile net loss to net cash used in operating
    activitiesDepreciation
      and amortization
                
                
                715,679
                
                
                
                779,466Change
      in fair value of warrant liability
                
                
                (3,068,251
                )
                
                
                -Amortization
      of debt discount
                
                
                941,206
                
                
                
                -Amortization
      of deferred debt issuance cost
                
                
                78,448
                
                
                
                -Deferred
      interest and deferral fees
                
                
                309,165
                
                
                
                -Stock
      compensation expense
                
                
                1,223,277
                
                
                
                2,121,751Warrant
      compensation expense
                
                
                413,350
                
                
                
                -Inventory
      writeoff
                
                
                923,065
                
                
                
                -Change
      in provision for obsolete inventory
                
                
                15,724
                
                
                
                -Impairment
      charge
                
                
                1,450,888
                
                
                
                1,000,010(Increase)
      decrease in Accounts receivable
                
                
                (177,690
                )
                
                
                1,759(Increase)
      decrease in Prepaid expenses and other current assets
                
                
                (120,051
                )
                
                
                (11,469
                )(Increase)
      decrease in Deposits on raw materials held for production
                
                
                337,344
                
                
                
                593,791(Increase)
      decrease in Raw materials held for production
                
                
                29,642
                
                
                
                (1,315,960
                )(Increase)
      decrease in Work in Progress Inventory
                
                
                (568,681
                )
                
                
                212,294(Increase)
      decrease in Deposit
                
                
                114,776
                
                
                
                (106,503
                )Increase
      (decrease) in Accounts payable and accrued expenses
                
                
                (2,378,442
                )
                
                
                3,187,852Increase
      (decrease) in Accounts payable - related parties
                
                
                (57,244
                )
                
                
                (664,905
                )Increase
      (decrease) in Accrued interest - 8% convertible debentures
                
                
                31,689
                
                
                
                -Increase
      (decrease) in warranty reserve
                
                
                171,038
                
                
                
                -Increase
      (decrease) in Deferred Rent
                
                
                56,929
                
                
                
                27,816Increase
      (decrease) in Deferred revenue
                
                
                271,372
                
                
                
                558,575Net
      cash used in operating activities
                
                
                (8,216,304
                )
                
                
                (7,949,145
                )Cash
      flows from investing activitiesPurchase
      of Property and Equipment
                
                
                (69,151
                )
                
                
                (21,351
                )Net
      cash used in investing activities
                
                
                (69,151
                )
                
                
                (21,351
                )Cash
      flows from financing activitiesGross
      proceeds from issuance of 8% convertible debentures
                
                
                8,500,000
                
                
                
                -Offering
      costs
                
                
                (527,500
                )
                
                
                -Proceeds
      from exercise of options / warrants
                
                
                50,000
                
                
                
                40,000Net
      cash provided by financing activities
                
                
                8,022,500
                
                
                
                40,000Net
      increase (decrease) in cash and cash equivalents
                
                
                (262,955
                )
                
                
                (7,930,496
                )Cash
      and cash equivalents, beginning of year
                
                
                339,600
                
                
                
                8,270,096Cash
      and cash equivalents, end of period
                
                $
                76,645
                
                
                $
                339,600Supplemental
      disclosures of cash flowInterest
      paid
                
                $
                253,356
                
                
                $
                21,475Income
      tax paid
                
                $
                800
                
                
                $
                800Supplemental
      schedule of non-cash investing and financing activitiesDebt
      discount attributable to beneficial conversion feature
                
                $
                3,237,954
                
                
                $
                -Debt
      discount attributable to warrants
                
                $
                3,087,307
                
                
                $
                -April
      2008 cashless exercise of warrants resulting in the issuance of 12,140
      shares of common stock
                
                $
                -
                
                
                $
                -January
      2007 cashless exercise of stock options resulting in the issuance of
      28,808 shares of common stock
                
                $
                -
                
                
                $
                (3,675
                )
 
 The
accompanying notes are an integral part of these financial
statements


F-6




NOTE
1 - ORGANIZATION AND LINE OF BUSINESS





COMPANY
OVERVIEW





The
Company develops and markets secure powered cards for payment, identification,
physical and logical access applications. Our main product, the ICT DisplayCard,
integrates the security of a one-time password token directly into a card the
size of a standard credit or debit card. A token is a portable physical device,
typically in a key-fob form factor, that generates the one-time password (also
referred to as a one-time passcode). At the push of a button on the back of the
ICT DisplayCard, a one-time passcode (OTP) is shown on the card’s integrated
display. During a transaction, this number is entered into a user interface with
other information (such as the user’s static PIN and login name). This
information is relayed to a backend system for multi-factor authentication.
InCard does not provide the backend authentication server, but rather will
integrate the ICT DisplayCard into authentication systems provided by other
companies including distributors and other resellers of the ICT DisplayCard. The
ICT DisplayCard’s OTP authentication works like tokens issued by VASCO, RSA, and
ActivIdentity, but in a more convenient, wallet-sized card form
factor.





BASIS
OF PRESENTATION AND GOING CONCERN





The
accompanying consolidated financial statements of Innovative Card
Technologies, Inc. (“ICTI”) include the amounts of its wholly-owned
subsidiary, PSA Co. (“PSAC”) which was incorporated in the State of Delaware on
August 27, 2003.




The Company has a history of
recurring losses from operations and has an accumulated deficit of $36,996,720
as of December 31, 2008. Sales of the InCard DisplayCard, the Company’s
main product, are not expected to generate positive cash flow until the second
half of 2009. As a result, there is substantial doubt about the Company’s
ability to continue as a going concern.





Management’s
plan regarding these matters is to increase sales, resulting in reduced losses
and raise additional debt and/or equity financing to cover operating costs as
well as its obligations as they become due.





There can
be no assurances that funds will be available to the Company when needed or, if
available, that such funds would be available under favorable terms. In the
event that the Company is unable to generate adequate revenues to cover expenses
and cannot obtain additional funds in the near future, the Company may seek
protection under bankruptcy laws.





The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. This basis of accounting
contemplates the recovery of the Company’s assets and the satisfaction of
liabilities in the normal course of business and does not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
might be necessary should the Company be unable to continue as a going
concern.




As of May
8, 2009 the Company has $125,000 in cash. Combined with anticipated revenue
collections and planned expense reductions, the Company believes this amount
will last through the third quarter of 2009.





NOTE 2 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES





PRINCIPLES
OF CONSOLIDATION





The
consolidated financial statements include the accounts of Innovative Card
Technologies and its wholly owned subsidiary, PSA Co. All significant
inter-company accounts and transactions are eliminated in
consolidation.





REVENUE
RECOGNITION





The
Company recognizes revenue in accordance with SEC Staff Accounting Bulletin
No. 104, or SAB 104. Revenue is recognized when persuasive evidence of an
arrangement exists, delivery has occurred or services have been rendered, the
price is fixed and determinable and collectibility is reasonably assured.
Revenue is not recognized on product sales transacted on a test or pilot basis.
Instead, receipts from these types of transactions offset marketing expenses.
Revenue from royalties is recognized with the passage of time in accordance with
the underlying agreement.





COMPREHENSIVE
INCOME





The
Company utilizes Statement of Financial Accounting Standards (“SFAS”)
No. 130, “Reporting Comprehensive Income.” This statement establishes
standards for reporting comprehensive income and its components in a financial
statement. Comprehensive income as defined includes all changes in equity (net
assets) during a period from non-owner sources. Examples of items to be included
in comprehensive income, which are excluded from net income, include foreign
currency translation adjustments, minimum pension liability adjustments, and
unrealized gains and losses on available-for-sale securities. Comprehensive
income is not presented in the Company’s consolidated financial statements since
the Company did not have any changes in equity from non-owner
sources.





ACCOUNTS
RECEIVABLE





Our sales
to date have been to large credit card issuers and we have been successful in
collecting for products and services. We perform a regular review of our
customer activity and associated credit risks and do not require collateral from
our customers. At December 31, 2008, based on our review of customer activity,
we recorded an allowance for doubtful accounts of $60,000.





F-7





INVENTORY





The
Company values its inventory at the lower of cost (first-in, first-out) or
market. The Company uses estimates and judgments regarding the valuation of
inventory to properly value inventory. Inventory adjustments are made for the
difference between the cost of the inventory and the estimated market value and
charged to cost of goods sold in the period in which the facts that give rise to
the adjustments become known.





INTANGIBLE
ASSETS AND LONG-LIVED ASSETS





The cost
incurred to acquire intangible assets, which are active and relate to products
with a definitive life cycle, are amortized over the estimated useful life of
three to five years. The Company assesses the carrying value of long-lived
assets in accordance with SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets.” The Company assesses the impairment of
identifiable intangibles and long-lived assets whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. Factors
considered important that could trigger an impairment review include, but are
not limited to, the following: a significant underperformance to expected
historical or projected future operating results, a significant change in the
manner of the use of the acquired asset or the strategy for the overall
business, or a significant negative industry or economic trend.





Based on
anticipated future income and cash flows and other factors relevant in the
opinion of the Company’s management, certain intangibles were determined to be
completely impaired during the two years ended December 31,
2008.  See Note 6 – Intangible Assets.





CASH
AND CASH EQUIVALENTS





For the
purpose of the statements of cash flows, the Company considers all highly liquid
investments purchased with original maturities of three months or less to be
cash equivalents.





MAJOR
SUPPLIERS





The
Company obtains the battery, a key component for the Company’s power inlay
technology, from a single source, Solicore, Inc., on a purchase order
basis. The Company believes that alternative sources for this component in the
event of a disruption or discontinuation in supply would not be available on a
timely basis, which could disrupt Company operations, delay production for up to
twelve months and impair the Company’s ability to manufacture and sell
products.





The
Company obtains the display, a key component for the Company’s ICT DisplayCard,
from a single source, SmartDisplayer, pursuant to the Company’s agreement with
SmartDisplayer. On November 10, 2007, the Company was required to make a deposit
on a purchase order to maintain its exclusivity. The Company was unable to make
the deposit and therefore does not have exclusivity with SmartDisplayer. The
Company believes that alternative sources for this component in the event of a
disruption or discontinuation in supply would not be available on a timely
basis, which could disrupt Company operations relating to the ICT DisplayCard,
delay production of the ICT DisplayCard for up to twelve months and impair the
Company’s ability to manufacture and sell the ICT DisplayCard.





The
Company assembles its ICT DisplayCard using a single source, NagraID, pursuant
to a written agreement. The Company believes that alternative sources for this
component in the event of a disruption or discontinuation in supply would not be
available on a timely basis, which could disrupt Company operations relating to
the ICT DisplayCard, delay production of the ICT DisplayCard for up to twelve
months and impair the Company’s ability to manufacture and sell the ICT
DisplayCard.





MAJOR
CUSTOMERS





Two
customers accounted for 77% of the Company’s revenues in 2008 and one customer
accounted for all of the Company’s revenue in 2007.





PROPERTY
AND EQUIPMENT





Property
and equipment are stated at cost. The Company provides for depreciation and
amortization using the double-declining method over estimated useful lives of
five to seven years. Expenditures for maintenance and repairs are charged to
operations as incurred while renewals and betterments are capitalized. Gains or
losses on the sale of property and equipment are reflected in the statements of
operations.




FAIR
VALUE OF FINANCIAL INSTRUMENTS





In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements,
which defines fair value, establishes a framework for consistently measuring
fair value under generally accepted accounting principles, and expands
disclosures about fair value measurements. SFAS 157 does not require any new
fair value measurements, but provides guidance on how to measure fair value by
providing a fair value hierarchy used to classify the source of the
information.  In February 2008, the FASB deferred the effective date
of SFAS 157 by one year for certain nonfinancial assets and liabilities, except
those that are recognized or disclosed at fair value in the financial statements
on a recurring basis (at least annually).  On November 1, 2008, the
Company adopted the provisions of SFAS 157, except as it applies to those
nonfinancial assets and liabilities for which the effective date has been
delayed by one year.




F-8


The fair
value hierarchy described by the standard is based on three levels of inputs, of
which the first two are considered observable and the last unobservable, that
may be used to measure fair value and include the following:




Level 1 –
Quoted prices in active markets for identical assets or
liabilities.




Level 2 –
Inputs other than Level 1 that are observable, either directly or indirectly,
such as quoted prices for similar assets or liabilities; quoted prices in
markets that are not active; or other inputs that are observable or can be
corroborated by observable market data for substantially the full term of the
assets or liabilities.




Level 3 –
Unobservable inputs that are supported by little or no market activity and that
are significant to the fair value of the assets or liabilities.




In
accordance with SFAS 157, the following table represents the Company’s fair
value hierarchy for its financial assets (cash equivalents and investments)
measured at fair value on a recurring basis as of December 31,
2008:




Level
      1
              
              
              Level
      2
              
              Level
      3
              
              TotalCash
      and cash equivalents
              
              
              76,645
              
              
              
              
              
              
              
              76,645Accounts
      receivable
              
              
              190,767
              
              
              
              
              
              
              
              190,767Accounts
      payable and accrued expenses
              
              
              1,281,602
              
              
              
              
              
              
              
              1,281,602Accounts
      payable - related parties
              
              
              600,010
              
              
              
              
              
              
              
              600,010Accrued
      interest
              
              
              
              
              
              
              31,689
              
              
              
              
              31,6898%
      convertible debentures
              
              
              
              
              
              
              8,809,165
              
              
              
              
              8,809,165





RESEARCH
AND DEVELOPMENT





Research
and development costs are charged to operations as incurred.





LOSS
PER SHARE





The
Company utilizes SFAS No. 128, “Earnings per Share.” Basic loss per share
is computed by dividing loss available to common shareholders by the
weighted-average number of common shares outstanding. Diluted loss per share is
computed similar to basic loss per share except that the denominator is
increased to include the number of additional common shares that would have been
outstanding if the potential common shares had been issued and if the additional
common shares were dilutive. Common equivalent shares are excluded from the
computation if their effect is anti-dilutive.




Since
their effect would have been anti-dilutive, common stock equivalents of
6,707,662 warrants and 3,977,935 stock options were excluded from the
calculation of diluted loss per share for the year ended December 31, 2008.
Since their effect would have been anti-dilutive, common stock equivalents of
4,614,598 warrants and 2,253,009 stock options were excluded from the
calculation of diluted loss per share for the year ended December 31,
2007.





INCOME
TAXES





The
Company utilizes SFAS No. 109, “Accounting for Income Taxes,” which
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been included in the financial
statements or tax returns. Under this method, deferred income taxes are
recognized for the tax consequences in future years of differences between the
tax bases of assets and liabilities and their financial reporting amounts at
each year-end based on enacted tax laws and statutory tax rates applicable to
the periods in which the differences are expected to affect taxable
income.





The
Company adopted the provisions of the Financial Accounting Standards Board
(“FASB”) Interpretation No.48, “Accounting for Uncertainty in Income Taxes-an
Interpretation of FASB Statement No. 109” (“FIN 48”), effective January 1, 2007.
As a result of the implementation of FIN 48, the Company made a comprehensive
review of its portfolio of uncertain tax positions in accordance with
recognition standards established by FIN 48. As a result of this review, the
Company concluded that at this time there are no uncertain tax positions that
would result in tax liability to the Company. As a result of applying the
provisions of FIN 48, there was no cumulative effect on retained
earnings.





F-9


STOCK
INCENTIVE PLAN





The
Company accounts for its stock incentive plan under SFAS No. 123R,
“Share-Based Payments”, which it adopted in 2006, using the fair value based
method. Under this method, compensation cost is measured at the grant date based
on the value of the award and is recognized over the service period, which is
usually the vesting period.  This Statement establishes standards for
the accounting for transactions in which an entity exchanges it equity
instruments for goods or services. It also addresses transactions in which an
entity incurs liabilities in exchange for goods or services that are based on
the fair value of the entity’s equity instruments or that may be settled by the
issuance of those equity instruments.





USE
OF ESTIMATES





The
preparation of financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.




CONCENTRATIONS
OF CREDIT RISK





Financial
instruments which potentially subject the Company to concentrations of credit
risk consist of cash and cash equivalents. The Company places its cash and cash
equivalents with high credit, quality financial institutions. At times, such
cash and cash equivalents may be in excess of the Federal Deposit Insurance
Corporation insurance limits.





RECLASSIFICATION





Certain
amounts included in the prior year financial statements have been reclassified
to conform with the current year presentation. Such reclassification did not
have any effect on the reported net loss.





RECENTLY
ISSUED ACCOUNTING PRONOUNCEMENTS





In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.
SFAS No. 157 clarifies the principle that fair value should be based on the
assumptions market participants would use when pricing an asset or liability and
establishes a fair value hierarchy that prioritizes the information used to
develop those assumptions. Under the standard, fair value measurements would be
separately disclosed by level within the fair value hierarchy. SFAS No. 157
is effective for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years, with
early adoption permitted. In February 2008, FASB Staff Position (FSP)
FAS 157-2, “Effective Date of FASB Statement No. 157”, which delays
the effective date of SFAS 157 to fiscal years and interim periods within
those fiscal years beginning after November 15, 2008 for non-financial
assets and non-financial liabilities, except for items that are recognized or
disclosed at fair value in the financial statements on a recurring basis (at
least annually). We elected to defer the adoption of the Standard for these
non-financial assets and liabilities, and are currently evaluating the impact,
if any, that the deferred provisions of the Standard will have on our
consolidated financial statements. The adoption of SFAS 157 for our financial
assets and liabilities did not have an impact on our financial position or
operating results.





In
February 2007, the FASB issued Statement of Financial Accounting Standard
No. 159, “The Fair Value Option for Financial Assets and Financial
Liabilities” (“SFAS 159”). SFAS 159 permits entities to choose to measure many
financial instruments and certain other items at fair value. Unrealized gains
and losses on items for which the fair value option has been elected are
reported in earnings. SFAS 159 is effective for fiscal years beginning after
November 15, 2007. The adoption of SFAS 159 did not have an impact on the
Company’s financial position, results of operations or cash flows.




In
December 2007 the FASB issued SFAS 160 “Non-controlling Interests in
Consolidated Financial Statements—an amendment of ARB No. 51”. This Statement
amends ARB 51 to establish accounting and reporting standards for the
non-controlling interest in a subsidiary and for the deconsolidation of a
subsidiary. It clarifies that a non-controlling interest in a subsidiary is an
ownership interest in the consolidated entity that should be reported as equity
in the consolidated financial statements. This Statement changes the way the
consolidated income statement is presented. It requires consolidated net income
to be reported at amounts that include the amounts attributable to both the
parent and the non-controlling interest. It also requires disclosure, on the
face of the consolidated statement of income, of the amounts of consolidated net
income attributable to the parent and to the non-controlling interest. This
Statement establishes disclosure requirements in the consolidated financial
statements, which will enable users to clearly distinguish between the interests
of the parent’s owners and the interests of the non-controlling owners of a
subsidiary. SFAS 160 is effective for fiscal years, and interim periods within
those fiscal years, beginning on or after December 15, 2008; earlier adoption is
prohibited. Management anticipates that the adoption of this standard will have
no impact to the Company’s financial position, results of operations, or cash
flows.





In
December 2007, the FASB issued No. 141 (revised 2007), “Business Combinations”,
which replaces SFAS No. 141. SFAS 141R establishes principles and requirements
for how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired and the liabilities assumed, any non-controlling
interest in the acquiree and the goodwill acquired. This Statement also
establishes disclosure requirements which will enable users to evaluate the
nature and financial effects of the business combination. This Statement is
effective for business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. Management anticipates that the adoption of this statement
will have no impact to the Company’s financial position, results of operations,
or cash flows.





F-10


In March
2008 the FASB issued SFAS 161 “Disclosures about Derivative Instruments and
Hedging Activities—an amendment of FASB Statement No. 133”. This Statement
changes the disclosure requirements for derivative instruments and hedging
activities. Entities are required to provide enhanced disclosures about (a) how
and why an entity uses derivative instruments, (b) how derivative instruments
and related hedged items are accounted for under Statement 133 and its related
interpretations, and (c) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash flows.
This Statement is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008; earlier adoption is
encouraged. Management has not yet determined what impact the adoption of this
statement will have on the Company’s financial position, results of operations,
or cash flows.





In April
2008, the FASB issued FSP FAS 142-3,“Determination of the
Useful Life of Intangible Assets”.  FSP 142-3 amends the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under SFAS No.
142,Goodwill and Other
Intangible Assets. This change is intended to improve the consistency
between the useful life of a recognized intangible asset under SFAS No. 142 and
the period of expected cash flows used to measure the fair value of the asset
under SFAS No. 141R and other GAAP. FSP 142-3 is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. The requirement for determining
useful lives must be applied prospectively to intangible assets acquired after
the effective date and the disclosure requirements must be applied prospectively
to all intangible assets recognized as of, and subsequent to, the effective
date. We do not expect the adoption of this statement to have a material impact
on our consolidated results of operations, financial position or cash
flows.





In
October 2008, FASB Staff Position (FSP) on FAS 157-3 was issued, which clarifies
the application of SFAS 157 in an inactive market and provides an example to
demonstrate how the fair value of a financial asset is determined when the
market for that financial asset is inactive. FSP FAS 157-3 was effective upon
issuance, including prior periods for which financial statements had not been
issued. The adoption of this standard as of September 30, 2008 did not have
an impact on our financial position, results of operations or cash
flows.





In
December 2008, the FASB issued FSP FAS 140-4 and FASB Interpretation No. (FIN)
46R-8,“Disclosures by Public
Entities (Enterprises) about Transfers of Financial Assets and Interests in
Variable Interest Entities”. This FSP amends FASB Statement No. 140“Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”
to require public entities to provide additional disclosures about transfers of
financial assets. It also amends FIN 46,“Consolidation of
Variable Interest Entities” as revised to require public enterprises to provide
additional disclosures about their involvement with VIEs. FSP FAS 140-4 and FIN
46(R)-8 are effective for the Company's fiscal year ending December 31,
2008.  The adoption of FSP FAS 140-4 did not have an impact on our
financial position, results of operations or cash flows.





NOTE
3 - DEPOSITS FOR RAW MATERIALS HELD FOR PRODUCTION




December 31,
                2008
              
              
              December 31,
                2007Deposits
      on raw materials held for production (display & manufacturing
      component)
              
              $
              268,318
              
              
              $
              605,662TOTAL
              
              $
              268,318
              
              
              $
              605,662





These
deposits for raw materials are held by certain vendors, are not refundable and
are made pursuant to agreements as discussed in Note 2 under Major
Suppliers.





NOTE
4 - RAW MATERIALS AND WORK IN PROGRESS INVENTORY HELD FOR
PRODUCTION





Raw
materials and work in progress inventory held for production at
December 31, 2008 and 2007 consisted of the following and are stated at the
lower cost or market, net of inventory reserves of $115,059 and $99,335,
respectively:




2008
              
              
              2007Raw
      materials held for production
              
              $
              347,529
              
              
              $
              1,315,960Work
      in progress inventory
              
              
              1,454,940
              
              
              
              886,259TOTAL
              
              $
              1,802,469
              
              
              $
              2,202,219
  F-11




NOTE
5 - PROPERTY AND EQUIPMENT





Property
and equipment at December 31, 2008 and 2007 consisted of the
following:




2008
              
              
              2007Computer
      equipment
              
              $
              75,431
              
              
              $
              96,451Office
      equipment
              
              
              -
              
              
              
              8,168Furniture
      and fixtures
              
              
              1,608
              
              
              
              24,386Leasehold
      improvements
              
              
              -
              
              
              
              5,608Production
      equipment
              
              
              339,888
              
              
              
              277,474416,927
              
              
              
              412,087Less
      accumulated depreciation and amortization
              
              
              (245,205
              )
              
              
              (218,902
              )TOTAL
              
              $
              171,722
              
              
              $
              193,185


Depreciation
expense was $81,053 and $189,085 for the years ended December 31, 2008 and
2007, respectively.





NOTE
6 - INTANGIBLE ASSETS





The
Company’s management valued the intangible assets acquired from nCryptone in
2006 at $3,030,000. The Company also acquired a patent license fee for
$1,000,010 from nCryptone. The $1,000,010 patent license fee, which was being
amortized over the remaining life of the patent (12 years through
November 2018), was fully impaired during the year ended December 31,
2007.  Additionally, as of December 31, 2008 the remaining intangible
assets acquired from nCryptone were determined to be fully
impaired.  Accordingly, $3,030,000, including $2,900,000 of developed
technologies and a $130,000 non-compete agreement, net of accumulated
amortization, has been expensed resulting in an impairment charge of $1,450,888
for the year ended December 31, 2008.





Amortization
expense was $625,065 (prior to the impairment charge discussed above) and
$590,380 for the years ended December 31, 2008 and 2007,
respectively.





NOTE
7 - PROVISION FOR INCOME TAXES





Income
taxes are accounted for using an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of temporary differences between the financial statement and the
tax bases of assets and liabilities at the applicable tax rates. A valuation
allowance is provided when it is more likely than not that some portion or all
of the deferred tax assets will not be realized.





The
provision for income taxes consisted of the following:




Year Ended December 31,2008
              
              
              2007Current
      provision:Federal
              
              $
              -
              
              
              $
              -State
              
              
              800
              
              
              
              800Total
      Current Provision
              
              
              800
              
              
              
              800Deferred
      provision (benefit)Federal
              
              
              -
              
              
              
              -State
              
              
              -
              
              
              
              -Total
      deferred portion (benefit)
              
              
              -
              
              
              
              -Total
      provision for income taxes
              
              $
              800
              
              
              $
              800





F-12




Reconciliations
between the statutory federal income tax rate and the Company’s effective income
tax rate were as follows:




Year Ended December 31,2008
              
              
              2007
              
              
              2006Federal
      income tax at statutory rates
              
              
              34
              %
              
              
              34
              %
              
              
              34
              %Change
      in fair value of warrants
              
              
              12
              %
              
              
              -Section
      382 limitation
              
              
              (12
              )
      %
              
              
              -Return
      to provision
              
              
              (2
              )
      %
              
              
              -Current
      year tax credit
              
              
              2
              %
              
              
              -State
      income taxes, net of federal benefit
              
              
              7
              %
              
              
              6
              %
              
              
              6
              %Change
      in valuation allowance
              
              
              (37
              )
      %
              
              
              (43
              )
      %
              
              
              (40
              )
      %Other
              
              
              (4
              )
      %
              
              
              3
              %
              
              
              0
              %Effective
      income tax rate
              
              
              0
              %
              
              
              0
              %
              
              
              0
              %





Deferred
tax assets and liabilities are measured based on the difference between the
financial statement and tax bases of assets and liabilities at the applicable
tax rates. The significant components of the Company’s net deferred tax assets
and (liabilities) consisted of the following:




December 31,2008
              
              
              2007
              
              
              2006Benefits
      from NOL carryforwards
              
              $
              10,103,826
              
              
              $
              7,699,234
              
              
              $
              3,472,511Tax
      credit carryforward
              
              
              268,133
              
              
              
              170,422
              
              
              
              61,788Differences
      in financial statement and tax accounting for:Stock
      compensation
              
              
              1,471,870
              
              
              
              1,457,994
              
              
              
              549,037Accruals
              
              
              168,201
              
              
              
              285,149
              
              
              
              10,358Inventory
              
              
              49,291
              
              
              
              42,555
              
              
              
              260,140Deferred
      revenue
              
              
              501,210
              
              
              
              384,954
              
              
              
              145,660Beneficial
      conversion feature
              
              
              (1,180,481
              )Depreciation
      and amortization
              
              
              1,564,649
              
              
              
              844,056
              
              
              
              237,830State
      income tax
              
              
              (909,192
              )
              
              
              (741,259
              )
              
              
              (331,068
              )Other
              
              
              -
              
              
              
              -Total
      Deferred tax assets (gross)
              
              
              12,037,507
              
              
              
              10,143,105
              
              
              
              4,406,256Less
      Valuation allowance
              
              
              (12,037,507
              )
              
              
              (10,143,105
              )
              
              
              (4,406,256
              )Total
      Deferred Tax assets, net
              
              $
              -
              
              
              $
              -
              
              
              $
              -





A
valuation allowance has been established due to the uncertainty of realizing
certain net operating loss (“NOL”) carryforwards and the other deferred tax
assets. The Company had net operating loss (“NOL”) carryforwards at
December 31, 2008 and 2007 of approximately $23.8 million and $18.6
million, respectively, for federal income tax purposes and an aggregate of $22.7
million and $18.6 million, respectively, for state income tax purposes. The
Company also has Federal research tax credit carryforwards of $130,680 and
$138,536 for the years ended December 31, 2008 and 2007, respectively, and
State research tax credit carryforwards of $137,453and $114,124 for the years
ended December 31, 2008 and 2007, respectively. The Company’s Federal and
State NOL carryforwards will be available to offset taxes through
December 31, 2020 and 2025, respectively.





The
Company adopted the provisions of the Financial Accounting Standards Board
(“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income
Taxes-an Interpretation of FASB Statement No. 109” (“FIN 48”), effective
January 1, 2007. As part of the implementation of FIN 48, the Company made
a comprehensive review of its portfolio of uncertain tax positions in accordance
with recognition standards established by FIN 48. As a result of applying the
provisions of FIN 48, there was no cumulative effect on retained
earnings.





For the
year ended December 31, 2008, the cumulative unrecognized tax benefit was
$114,915 which was netted against deferred tax assets with a full valuation
allowance, and if recognized there will be no effect on the Company’s
effective tax rate. Following is a reconciliation of the beginning to ending
cumulative unrecognized tax benefits.




December 31,2008
              
              
              2007Beginning
      unrecognized tax benefits
              
              $
              -
              
              
              $
              -Increase
      for tax positions in prior years
              
              
              66,788
              
              
              
              -Increase
      in tax positions for current year
              
              
              48,127
              
              
              
              -Ending
      unrecognized tax benefits
              
              $
              114,915
              
              
              $
              -




F-13





During
2008, it was determined that, in accordance with Section 382 of the Internal
Revenue Code of 1986, as amended (the “Code”) the Company experienced an
ownership change and would be unable to utilize Federal and State operating
losses, resulting in a reduction of its deferred tax asset of $1.1 million. In
general, an “ownership change” as defined by Section 382 of the Code,
results from a transaction or series of transactions over a three-year period
resulting in an ownership change of more than 50 percentage points of the
outstanding stock of a company by certain stockholders or public
groups





The
impact of this limitation resulted in a reduction of the Company’s deferred tax
assets and a corresponding reduction in its valuation allowance.





Any
additional ownership changes in the future, and any future change at its current
market capitalization would severely limit the annual use of these NOLs going
forward. Such limitation could also result in expiration of a portion of the
NOLs before utilization. Due to the existence of the valuation allowance, future
changes in the Company’s unrecognized benefits will not impact its effective tax
rate.





The
Company’s practice is to recognize interest and/or penalties related to income
tax matters in income tax expense. During the year ended December 31, 2008,
the Company did not recognize any interest or penalties. Upon adoption of FIN 48
on January 1, 2007, the Company did not record any interest or
penalties.





NOTE
8 - COMMITMENTS AND CONTINGENCIES





LEASE





On
September 14, 2006, the Company entered into a sublease for 6,500 square
feet of office space with Bergman & Dacey, Inc. which commenced on
October 1, 2006 and expires on July 31, 2009. The Company paid a
security deposit of $71,244. The lease requires monthly payments of $16,789 plus
32.5% of triple net costs charged to Bergman & Dacey, such as common
area operating expenses, taxes and insurance. The rent increases 3% on
October 1st of each year. Total minimum lease payments will be $160,051 in
calendar year 2009. The Company also leases additional office space on a
month-to-month basis.





Rent
expense was $161,499 and $252,530 for the years ended December 31, 2008 and
2007, respectively.





PATENT
AND TRADEMARK LICENSE AGREEMENTS





The
Company has entered into various Patent and Trademark License Agreements with
financial institutions granting a limited, non-exclusive right and license to
make, distribute, market, sell, and use credit cards or debit cards containing a
magnifying lens (the “Licensed Products”).





An
agreement dated January 16, 2002 and expiring on March 31, 2004,
providing for royalties to the Company at the rate of $1.50 per LensCard issued
to a customer. Royalties were due and payable quarterly within 30 days after the
last day of each calendar quarter. The Company receives sales reports within
thirty days following the end of a calendar quarter from this customer. On
April 1, 2004, the agreement was extended requiring a $12,500 payment by
the customer with the Company receiving a royalty of $0.25 per Licensed Product
and $0.50 for each additional LensCard sold thereafter.





LITIGATION





To date,
the Company has never been a party to and has never been involved with any
litigation. However, in the future, the Company, like any other business or
individual, may become subject to litigation some of which the Company can
control and other litigation that the Company cannot control. If the Company
were to become involved in any litigation, management would have to assess
whether or not such litigation would likely have a material adverse effect on
the Company’s consolidated financial condition or results of
operations.





EMPLOYMENT
AGREEMENT





On
February 20, 2009, we entered in into a written employment agreement with
Richard Nathan.  The agreement provides for a bonus equal to: (i) 3%
of increase in market capitalization occurring during first year of employment;
and (ii) 2% of increase in market capitalization year after year for all periods
thereafter.  Mr. Nathan’s employment under the agreement is
“At-Will.”





F-14





NOTE
9 - STOCKHOLDER’S EQUITY





PREFERRED
STOCK





The
Company has 5,000,000 authorized shares of $0.001 par value preferred stock. The
preferred stock may be issued in series, from time to time, with such
designations, rights, preferences, and limitations as the Board of Directors may
determine by resolution.





COMMON
STOCK





The
Company has 75,000,000 authorized shares of $0.001 par value common
stock.





WARRANTS





The
following summarizes the warrant transactions:




Warrants
      Outstanding
              
              
              Weighted-Average
      Exercise PriceOutstanding,
      December 31, 2006
              
              
              4,646,598
              
              
              $
              1.43Granted
              
              
              -
              
              
              
              -Exercised
              
              
              (32,000
              )
              
              $
              1.25Outstanding,
      December 31, 2007
              
              
              4,614,598
              
              
              $
              1.43Granted
              
              
              2,118,064
              
              
              $
              2.68Expired
              
              
              (12,860
              )
              
              $
              1.25Exercised
              
              
              (12,140
              )
              
              $
              1.25Outstanding,
      December 31, 2008
              
              
              6,707,662
              
              
              $
              1.83Exercisable,
      December 31, 2008
              
              
              6,707,662
              
              
              $
              1.83





During
2008, the Company issued 1,708,604 warrants in connection with its 8% Senior
Secured Debentures (see Note 12).





Additionally,
during 2008, the Company issued 410,000 warrants in payment for services. In
accordance with EITF No. 96-18 “Accounting for Equity Instruments That Are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services,” and EITF No. 00-18, “Accounting Recognition for Certain
Transactions involving Equity Instruments Granted to Other Than Employees,” the
compensation cost associated with these warrants of $413,350 was recognized
during 2008.





No
warrants were granted during the year ended December 31, 2007. The
weighted-average remaining contractual life of the 6,707,662 warrants
outstanding as of December 31, 2008 is 31 months.





2004
STOCK INCENTIVE PLAN





The
Company’s Board of Directors and stockholders approved the 2004 Stock Incentive
Plan in August 2004. The 2004 Stock Incentive Plan provides for the grant
of incentive stock options to the Company’s employees, and for the grant of
non-statutory stock options, restricted stock, stock appreciation rights and
performance shares to the Company’s employees, directors and
consultants.





The
Company reserved a total of 2,351,000 shares of its common stock for issuance
pursuant to the 2004 Stock Incentive Plan. The board of directors, or a
committee of the board, administers the 2004 Stock Incentive Plan. Stock options
are generally granted with terms of up to ten years and vest over a period of
five years under the 2004 Stock Incentive Plan. The administrator determines the
exercise price of options granted under the 2004 Stock Incentive Plan, but the
exercise price must not be less than 85% of the fair market value of the
Company’s common stock on the date of grant. In the event the participant owns
10% or more of the voting power of all classes of the Company’s stock, the
exercise price must not be less than 110% of the fair market value per share of
the Company’s common stock on the date of grant. With respect to all incentive
stock options, the exercise price must at least be equal to the fair market
value of the Company’s common stock on the date of grant. The term of an
incentive stock option may not exceed 10 years, except that with respect to any
participant who owns 10% of the voting power of all classes of the Company’s
outstanding stock or the outstanding stock of any parent or subsidiary of the
Company, the term must not exceed five years and the exercise price must equal
at least 110% of the fair market value on the grant date. The administrator
determines the term of all other options; however, no option will have a term in
excess of 10 years from the date of grant.




F-15





Certain
of these options were issued to non-employees, and accordingly the Company
accounts for these options in accordance with EITF No. 96-18 “Accounting for
Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services,” and EITF No. 00-18, “Accounting
Recognition for Certain Transactions involving Equity Instruments Granted to
Other Than Employees.” Compensation cost associated with these options of
$275,680 was recognized during 2008.





The 2004
Stock Incentive Plan was terminated concurrent with the approval of the 2007
Equity Incentive Plan in December 2007. No further grants will be made from
the 2004 Stock Incentive Plan. The termination does not affect the rights of
holders of options previously granted and outstanding under the 2004 Stock
Incentive Plan.





A summary
of stock option activity and weighted average exercise prices for the years
ended December 31, 2008 and 2007 is as follows:


2008
              
              
              2007ALL
      OPTIONS
              
              
              
              
              WEIGHTED
                AVERAGE
                EXERCISE PRICE
              
              
              
              
              
              WEIGHTED
                AVERAGE
                EXERCISE PRICEOutstanding
      at beginning of period
              
              
              2,184,498
              
              
              $
              1.97
              
              
              
              2,351,000
              
              
              $
              2.10Options
      granted
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Options
      forfeited
              
              
              (589,740
              )
              
              $
              3.10
              
              
              
              (131,500
              )
              
              $
              4.60Options
      expired
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Options
      exercised
              
              
              (50,000
              )
              
              $
              1.00
              
              
              
              (35,002
              )
              
              $
              1.00Outstanding
      at end of period
              
              
              1,544,758
              
              
              $
              1.52
              
              
              
              2,184,498
              
              
              $
              1.97Exercisable
      at end of period
              
              
              366,280
              
              
              $
              1.40
              
              
              
              1,557,349
              
              
              $
              1.34
  2008
              
              
              2007NON
      VESTED OPTIONS
              
              
              
              
              WEIGHTED
                AVERAGE
                EXERCISE
                PRICE
              
              
              
              
              
              WEIGHTED
                AVERAGE
                EXERCISE
                PRICENon-
      vested at beginning of period
              
              
              627,149
              
              
              $
              3.25
              
              
              
              1,516,000
              
              
              $
              2.68Options
      granted
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Options
      forfeited
              
              
              (404,482
              )
              
              $
              2.98
              
              
              
              (119,049
              )
              
              $
              4.90Options
      expired
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Options
      vested
              
              
              (129,333
              )
              
              $
              4.00
              
              
              
              (769,802
              )
              
              $
              1.63Non-
      vested at end of period
              
              
              93,334
              
              
              $
              3.39
              
              
              
              627,149
              
              
              $
              3.55


No
options were granted under the 2004 Stock Incentive Plan during the years ended
December 31, 2007 or 2008.





In the
fourth quarter of 2007, as part of the separation agreements with three former
officers and directors, the Company modified existing option grants by vesting
all of the options that at the date of termination were unvested and would
normally be forfeited at termination. In addition, the Company extended the
exercise period beyond 90 days (the standard exercise period for terminated
officers/directors). In accordance with SFAS No. 123(R), “Share-Based Payment,”
the modifications resulted in a charge of $727,670 in the 2007 income statement.
The amount was calculated using the stock price of the Company’s common stock on
the date of modification, a risk-free interest rate of 4.55% and volatility of
118%. The expected lives used for this calculation were the remaining lives of
each option.





The
weighted average remaining contractual lives of the options outstanding and
options exercisable were as follows:





Options
              outstanding
            
            Options
              exercisableDecember 31,
      2007
            
            7.05
      years
            
            6.66
      yearsDecember 31,
      2008
            
            6.26
      years
            
            6.01
      years




F-16




2007
EQUITY INCENTIVE PLAN





The
Company’s Board of Directors approved the 2007 Equity Incentive Plan in
September 2007 and stockholders approved the 2007 Equity Incentive Plan in
December 2007. The 2007 Equity Incentive Plan provides for the grant of
incentive stock options to the Company’s employees, and for the grant of
non-statutory stock options, restricted stock, stock appreciation rights,
performance units and performance shares to the Company’s employees, directors
and consultants.





The
Company reserved a total of 4,000,000 shares of its common stock for issuance
pursuant to the 2007 Equity Incentive Plan. A committee of the board of
directors administers the 2007 Equity Incentive Plan. Stock options are
generally granted with terms of up to ten years and vest over a period of five
years under the 2007 Equity Incentive Plan. The administrator determines the
exercise price of options granted under the 2007 Equity Incentive Plan, but the
exercise price must not be less than 85% of the fair market value of the
Company’s common stock on the date of grant. In the event the participant owns
10% or more of the voting power of all classes of the Company’s stock, the
exercise price must not be less than 110% of the fair market value per share of
the Company’s common stock on the date of grant. With respect to all incentive
stock options, the exercise price must at least be equal to the fair market
value of the Company’s common stock on the date of grant. The term of an
incentive stock option may not exceed 10 years, except that with respect to any
participant who owns 10% of the voting power of all classes of the Company’s
outstanding stock or the outstanding stock of any parent or subsidiary of the
Company, the term must not exceed five years and the exercise price must equal
at least 110% of the fair market value on the grant date. The administrator
determines the term of all other options; however, no option will have a term in
excess of 10 years from the date of grant.





Without
further stockholder approval, the 2007 Equity Incentive Plan may not issue
incentive stock options after September 2017.





A summary
of stock option activity and weighted average exercise prices for the years
ended December 31, 2008 and 2007 is as follows:




2008
              
              
              2007ALL
      OPTIONS
              
              
              
              
              WEIGHTED
                AVERAGE
                EXERCISE
                PRICE
              
              
              
              
              
              WEIGHTED
                AVERAGE
                EXERCISE
                PRICEOutstanding
      at beginning of period
              
              
              68,511
              
              
              $
              2.76
              
              
              
              -
              
              
              
              -Options
      granted
              
              
              3,414,666
              
              
              $
              1.20
              
              
              
              68,511
              
              
              $
              2.76Options
      forfeited
              
              
              (1,050,000
              )
              
              
              2.25
              
              
              
              -
              
              
              
              -Options
      expired
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Options
      exercised
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Outstanding
      at end of period
              
              
              2,433,177
              
              
              $
              0.80
              
              
              
              68,511
              
              
              $
              2.76Exercisable
      at end of period
              
              
              364,719
              
              
              $
              1.77
              
              
              
              -
              
              
              
              -
 
 2008
              
              
              2007NON
      VESTED OPTIONS
              
              
              
              
              WEIGHTED
                AVERAGE
                EXERCISE
                PRICE
              
              
              
              
              
              WEIGHTED
                AVERAGE
                EXERCISE
                PRICENon-
      vested at beginning of period
              
              
              68,511
              
              
              $
              2.76
              
              
              
              -
              
              
              
              -Options
      granted
              
              
              3,414,666
              
              
              $
              1.20
              
              
              
              68,511
              
              
              $
              2.76Options
      forfeited
              
              
              (1,050,000
              )
              
              
              2.25
              
              
              
              -
              
              
              
              -Options
      expired
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Options
      vested
              
              
              (364,719
              )
              
              $
              1.77
              
              
              
              -
              
              
              
              -Non-
      vested at end of period
              
              
              2,068,458
              
              
              $
              0.63
              
              
              
              68,511
              
              
              $
              2.76
  F-17
  The
weighted average remaining contractual lives of the options outstanding and
options exercisable, which had exercise prices ranging from $0.07 to $4.90, were
as follows:





Options
              outstanding
            
            Options
              exercisableDecember 31,
      2007
            
            9.83
      years
            
            —December 31,
      2008
            
            9.54
      years
            
            9.24
      years




The
Company recorded $947,597 and $2,121,751 of compensation expense for employee
stock options during the years ending December 31, 2008 and 2007,
respectively, which is included in the administrative expense category. At
December 31, 2008 and 2007, there was a total of $1,520,380 and $4,650,764,
respectively, of unrecognized compensation costs related to the non-vested
share-based compensation arrangements under the 2004 and 2007 Plans. The cost is
expected to be recognized over a weighted average period of 3.0 years. The
weighted average grant date fair value per share for options granted in 2008 was
$1.09.  The total fair value of options vested during the years ended
December 31, 2008 and 2007 was $947,597 and $1,255,092 respectively. The
intrinsic value of total outstanding options and total exercisable options were
$0 as of December 31, 2008.





Since
January 1, 2006, the Company is recognizing the cost of all employee stock
options on a straight-line attribution basis over their respective vesting
periods, net of estimated forfeitures. The Company has selected the modified
prospective method of transition; accordingly, prior periods have not been
restated. Prior to the adoptions of SFAS No. 123(R), the Company applied
APB Opinion No. 25 and related Interpretations in accounting for its
stock-based compensation plans; all employee stock options were granted at or
above the grant date market price; and accordingly, no compensation cost was
recognized for fixed stock option grants in prior periods. The Black
Scholes assumptions used are listed below:





2008
              
              2007Risk
      free interest rate
              
              1.35
      % - 3.73 %
              
              4.55
      %Dividends
              
              -
              
              -Volatility
      factor
              
              102
      %
              
              200
      %Expected
      life
              
              10
      years
              
              10
      yearsAnnual
      forfeiture rate
              
              10
      %
              
              0
      %


NOTE
10 - RELATED PARTY TRANSACTIONS





ACCOUNTS
PAYABLE - RELATED PARTIES





Accounts
payable – related parties at December 31, 2008 was comprised of $600,000
due to nCryptone in January 2009.   At December 31, 2007 the
accounts payable to related parties was comprised of $657,254 due to nCryptone,
SA, $600,000 of which is due in January 2009, and $14,521 due to Blakely,
Sokoloff, Taylor & Zafman, LLP (BSTZ), a law firm in which former
director George Hoover is a partner, for legal services related to our
intellectual property.





CONSULTING
AGREEMENTS





In
connection with his resignation as Chief Financial Officer in October 2007,
Bennet Tchaikovsky and the Company entered into three separate agreements: an
Indemnification Agreement, a Consulting Agreement, and a Separation Agreement.
Beginning October 29, 2007 and ending on June 29, 2008,
Mr. Tchaikovsky was paid $12,270 per month plus certain other
reimbursements for assisting us with transitioning our new Chief Financial
Officer. As part of the Separation Agreement, Mr. Tchaikovsky fully
released the Company in consideration for Mr. Tchaikovsky becoming vested
in his remaining 60,000 unvested options and extending the exercise period for
all of his options.





The
Company was a party to a Consulting Agreement with Forest Finkelstein, the son
of Alan Finklestein during the year ended December 31, 2007. The agreement
was cancelled in December 2007. The Company paid Mr. Finklestein $85,000
during the year ended December 31, 2007.  Forest Finkelstein is
not a related party as of December 31, 2008.





LEGAL
SERVICES





The
Company receives legal services from Blakely, Sokoloff, Taylor and Zafman, LLP,
a law firm that George Hoover, a former director of the Company, is a partner.
During the year ended December 31, 2007, the Company paid $95,654, to this
entity for legal services rendered.  Blakely, Sokoloff, Taylor and
Zafman, LLP is not a related party as of December 31, 2008.





NOTE
11 - CONCENTRATION OF SUPPLIERS AND SIGNIFICANT CUSTOMERS





The
Company currently relies on a limited number of suppliers to manufacture its
products, and does not have a long-term contract with any of these suppliers.
The Company also does not have internal manufacturing capabilities. Management
believes that in the event of an interruption of service production of the
DisplayCard would be delayed for up to one year.





Two
customers accounted for 77% of the Company’s revenue in 2008 and one customer
accounted for all of the Company’s revenue in 2007




F-18





NOTE
12 - 8% SENIOR SECURED CONVERTIBLE DEBENTURES





On
January 8, 2008, the Company entered into a Securities Purchase Agreement
(the “Purchase Agreement”) with 13 institutional and accredited investors (the
“Purchasers”). Pursuant to the terms of the Purchase Agreement, the Purchasers
purchased $3.5 million of the Company’s 8% Senior Secured Convertible Debenture
(“Debenture”). The Debenture: (i) bears interest at 8% per year, paid
quarterly in cash or registered common stock, at the Company’s discretion;
(ii) has a maturity of January 8, 2011, (iii) is convertible at
the holder’s option into shares of common stock at $2.50 per share, (iv) is
secured by all of the Company’s and its subsidiary’s assets including inventory,
receivables, unencumbered equipment and intellectual property under the terms of
a Security Agreement, and (v) has a forced conversion feature which allows
the Company to force the conversion of the Debenture if the Company’s common
stock trades above $5.00 for 20 consecutive trading days and certain other
conditions are met. The Company also issued to the Purchasers five-year common
stock purchase warrants to purchase 700,000 shares of common stock at an
exercise price of $2.75 per share (the “Warrants”). The Company used the net
proceeds of the financing for working capital requirements and to pay down
certain obligations. The Debenture also contains customary events of default
provisions. As part of the transaction, the Company agreed to: (i) cut its
monthly burn rate to $600,000 (ii) be compliant with NASDAQ listing
requirements; and (iii) obtain shareholder approval prior to effectuating a
reverse stock split.





Both the
conversion price under the Debenture and the exercise price of the Warrants are
subject to “full-ratchet” price protection in the event of stock issuances below
their respective conversion or exercise prices and have been reset to $2.48 and
$2.728 respectively as a result of the April financing discussed below. The
“full-ratchet” price protection does not apply to issuances of stock options and
stock issuances to officers, directors, employees and consultants. Both the
conversion price of the Debenture and the Warrant strike price were reset
following the April 15, 2008 financing described below.





Upon
review of EITF 00-19, “Accounting for Derivative Financial Instruments Indexed
to, and Potentially Settled in, a Company’s Own Stock”, paragraphs 12-32, the
Company concluded that all applicable requirements for equity treatment on the
conversion feature were met. The intrinsic value of the conversion feature
amounting to $1,534,460 was calculated in accordance with EITF 00-27 and
recorded as additional paid-in capital and a corresponding reduction of the
carrying value of the Debenture,





The
Company is accounting for the Warrants, issued in connection with the Debenture,
as derivative liabilities in accordance with SFAS 133, “Accounting for
Derivative Instruments and Hedging Activities” and EITF 00-19. The warrant
liability was valued at $1,464,459 at warrant issuance date. In accordance with
EITF 00-19, the value of Warrants has been recorded as liability subject to
marked-to-market revaluation at each period end. At December 31, 2008, the
warrant liability was valued at $86,617. The Company recorded a gain on the
change in fair value of warrant liability of $1,377,842. The Company uses the
Black Scholes model to value the liability. The assumptions used at
January 8, 2008 and December 31, 2008 included expected volatility of 118%
and 88%, a risk free interest rate of 3.16% and 2.98% and expected life of 5 and
4.3 years, respectively.





The
discount attributable to the issuance date intrinsic value of the conversion
feature and fair value of Warrants totaling $2,998,918 is being amortized using
the effective interest method over the term of the Debenture. During the year
ended December 31, 2008, $302,813 of this discount was amortized to interest
expense.





In
connection with this Debenture, the Company incurred financing cost of $290,000.
This financing cost was capitalized and amortized over the life of the Debenture
using the effective interest method. During the year ended December 31, 2008,
$29,282 of the capitalized financing cost was amortized to interest
expense.





As part
of the transaction, the Company granted the investors registration rights with
regard to: (i) the common shares issuable upon conversion of the
Debentures; (ii) the common shares underlying the Warrants; and
(iii) the common shares issuable as interest payments pursuant to the
Debentures. Pursuant to the registration rights agreement, the Company was
required to use its best efforts to file a registration statement by
June 7, 2008 and have it be declared effective by August 7, 2008. The
registration statement covering the registrable shares was timely filed and
declared effective on July 3, 2008. The Company has a continuing obligation
to use its best efforts to maintain the registration statement effective until
such time as all the registrable securities are eligible for resale without
volume or manner-of-sale restrictions and without current public information
pursuant to Rule 144.





On
April 15, 2008, the Company entered into a Securities Purchase Agreement
with EMC Corporation (“EMC”). Pursuant to the terms of the agreement, EMC
purchased $5 million of the Company’s 8% Senior Secured Convertible Debenture
(“Debenture”). The Debenture: (i) bears interest at 8% per year, paid
quarterly in cash or, subject to certain conditions, registered shares of the
Company’s common stock; (ii) has a maturity of April 15, 2011,
(iii) is convertible at EMC’s option into shares of the Company’s common
stock at $2.48 per share, (iv) is secured by all of the Company’s assets,
including inventory, receivables, unencumbered equipment and intellectual
property, and (v) has a forced conversion feature which allows the Company
to force the conversion of the Debenture if the Company’s common stock trades
above $5.00 for 20 consecutive trading days. Such a forced conversion may be
limited by contractual restrictions on the amount of the Company’s common stock
which EMC may own and certain other conditions. The Company also agreed to issue
EMC five-year Common Stock Purchase Warrants to purchase 1,008,064 shares of the
Company’s common stock at an exercise price of $2.728 per share. The Company is
using the net proceeds of the financing for working capital requirements and to
pay down certain obligations. The Debenture also contains customary events of
default provisions. As part of the transaction, the Company agreed to:
(i) maintain monthly burn rate at $600,000 or below, (ii) be compliant
with NASDAQ listing requirements; and (iii) obtain shareholder approval
prior to effectuating a reverse stock split and for the issuance of additional
shares of the Company’s common stock. Both the conversion price of the Debenture
and the exercise price of the Warrants are subject to “full-ratchet” price
protection in the event of stock issuances below their respective conversion or
exercise prices, except for specified exempted issuances including grants of
stock options and stock issuances to officers, directors, employees and
consultants. The Company agreed to grant registration rights to EMC, by filing a
registration statement covering the shares of common stock issuable upon the
conversion of the Senior Secured Convertible Debenture, exercise of the Common
Stock Purchase Warrant, and issuable by the Company as interest payments by
June 7, 2008, and to obtain effectiveness of that registration statement by
August 7, 2008. The Company’s officers, directors, and 10% shareholders
also executed agreements prohibiting the sales of the Company’s common stock by
them until October 31, 2008. In connection with the transaction, the
Company also secured voting agreements from its officers, directors and 10%
shareholders approving the transaction in the event that the Company is required
to seek such approval pursuant to the rules of the NASDAQ.




F-19




Both the
conversion price under the Debenture and the exercise price under the Warrants
are subject to “full-ratchet” price protection in the event of stock issuances
below their respective conversion or exercise prices, except for specified
exempted issuances including grants of stock options and stock issuances to
officers, directors, employees and consultants.





Upon
review of EITF 00-19, “Accounting for Derivative Financial Instruments Indexed
to, and Potentially Settled in, a Company’s Own Stock”, paragraphs 12-32, the
Company concluded that all applicable requirements for equity treatment on the
conversion feature were met. The intrinsic value of the conversion feature
amounting to $1,703,494 was calculated in accordance with EITF 00-27 and
recorded as additional paid-in capital and a corresponding reduction of the
carrying value of the Debenture.





The
Company is accounting for the Warrants, issued in connection with the Debenture,
as derivative liabilities in accordance with SFAS 133, “Accounting for
Derivative Instruments and Hedging Activities” and EITF 00-19. The warrant
liability was valued at $1,622,848 at warrant issuance date. In accordance with
EITF 00-19, the value of Warrants has been recorded as liability subject to
marked-to-market revaluation at each period end. At December 31, 2008, the
warrant liability was valued at $19,055. The Company recorded a gain on the
change in fair value of warrant liability of $3,068,251. The Company uses the
Black-Scholes model to value the liability. The assumptions used at
April 15, 2008 and December 31, 2008 included expected volatility of 80%
and 88%, a risk free interest rate of 2.68% and 2.98% and expected life of 5 and
4.5 years, respectively.





The
discount attributable to the issuance date intrinsic value of the conversion
feature and fair value of Warrants totaling $3,326,342 is being amortized using
the effective interest method over the term of the Debenture. During the year
ended December 31, 2008, $306,710 of this discount was amortized to interest
expense.





In
connection with this Debenture, the Company incurred financing cost of $237,500.
This financing cost was capitalized and amortized over the life of the Debenture
using the effective interest method. During the nine months ended
September 30, 2008, $21,899 of the capitalized financing cost was amortized
to interest expense.





As part
of the transaction, the Company granted the investors registration rights with
regard to: (i) the common shares issuable upon conversion of the
Debentures; (ii) the common shares underlying the Warrants; and
(iii) the common shares issuable as interest payments pursuant to the
Debentures. Pursuant to the registration rights agreement, the Company was
required to use its best efforts to file a registration statement by
June 7, 2008 and have it be declared effective by August 7, 2008. The
registration statement covering the registrable shares was timely filed and
declared effective on July 3, 2008. The Company has a continuing obligation
to use its best efforts to maintain the registration statement effective until
such time as all the registrable securities are eligible for resale without
volume or manner-of-sale restrictions and without current public information
pursuant to Rule 144.





In
September 2008, the Company reached agreements with holders of debentures
totaling $6,950,000 such that in lieu of cash, the holders received their
interest payments due October 1, 2008 and January 1, 2009 in the form of an
increase in the principal amount of the debentures. Included in the increase to
the principal amount was a deferral fee equal to ten percent (10%) of the
deferred interest. The total increases to the principal balance during 2008
amounted to $309,165.





NOTE
13 - SUBSEQUENT EVENTS





On
February 20, 2009, we entered in into a written employment agreement with
Richard Nathan as our Chief Executive Officer.  Pursuant to the terms
of the agreement, Mr. Nathan’s annual compensation is $240,000.  Also,
as part of the agreement, we granted Mr. Nathan a stock option to purchase
1,000,000 common shares at $0.10 per share.  The option has a term of
five years.  The agreement also provides for a bonus equal to: (i) 3%
of increase in market capitalization occurring during first year of employment;
and (ii) 2% of increase in market capitalization year after year for all periods
thereafter.  Mr. Nathan’s employment under the agreement is
“At-Will.”





On
February 20, 2009, the Company’s stock was delisted from the NASDAQ National
Market System due to a failure to maintain adequate share pricing. As a result,
the Company defaulted on its 8% Senior Secured Convertible
Debentures.  Such default results in acceleration of the debentures, a
thirty percent (30%) increase in the principal amount of the debentures, and an
increase in the interest rate on the debentures from eight percent (8%) to
eighteen percent (18%). As of the date of this filing, we are negotiating a
waiver of this default.





F-20