Table of Contents

 

 

 

**UNITEDSTATES****SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

 

**FORM 10-Q/ A**

 

**Mark One**

 

| **x** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**For The Quarterly Period Ended June 30,2008**

 

**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 000-51260**

 

**INNOVATIVECARD TECHNOLOGIES, INC.**(Exact name of registrant as specified in its charter)

 

| **DELAWARE**                                                     | ** ** | **90-0249676**                       |
|------------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of  incorporation  or organization) |       | (IRS Employer Identification Number) |
|                                                             |       |                                 |
| **633 West Fifth Street, Suite 2600**                       | ** ** | ** **                           |
| **Los Angeles, CA**                                              | ** ** | **90071**                            |
| (Address of principal executive offices)                         |       | (Zip code)                           |

 

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

 

Indicate by check mark whether the Registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months, and (2) has beensubject to such filing requirements for the past 90 days.

 

Yes       x  No       o

 

Indicate by check mark whether the Registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer. (See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of theExchange Act.)

 

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

 

Indicate by check mark whether the Registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act.):

 

Yes       o   No       x

 

As of August 5, 2008 28,495,256 shares of the Registrant’s commonstock were outstanding.

 

 

 

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**INNOVATIVE CARD TECHNOLOGIES, INC.**

 

INDEXTO FORM 10Q

 
| ** **   | ** **                                                                                                                                   | **PAGE** |
|--------------|----------------------------------------------------------------------------------------------------------------------------------------------|----------|
|         |                                                                                                                                         |     |
| PART I  | FINANCIAL INFORMATION                                                                                                                        | 3        |
|         |                                                                                                                                         |     |
| Item 1.      | Financial Statements                                                                                                                         | 3        |
|         |                                                                                                                                         |     |
|         | Restated  Consolidated Balance Sheet at June 30, 2008 (unaudited) and Consolidated  Balance Sheet at December 31, 2007             | 3        |
|         |                                                                                                                                         |     |
|         | Consolidated  Statements of Operations for the three and six months ended June 30,  2008 (unaudited) and June 30, 2007 (unaudited) | 4        |
|         |                                                                                                                                         |     |
|         | Consolidated  Statements of Cash Flows for the six months ended June 30, 2008  (unaudited) and June 30, 2007 (unaudited)           | 5        |
|         |                                                                                                                                         |     |
|         | Notes  to Consolidated Unaudited Financial Statements                                                                                        | 6        |
|         |                                                                                                                                         |     |
| Item 1A      | Risk Factors                                                                                                                                 | 21       |
|         |                                                                                                                                         |     |
| Item 2.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                  | 28       |
|         |                                                                                                                                         |     |
| Item 3.      | Quantitative  and Qualitative Disclosures About Market Risk                                                                                  | 35       |
|         |                                                                                                                                         |     |
| Item 4.      | Controls and  Procedures                                                                                                                     | 35       |
|         |                                                                                                                                         |     |
| PART II | OTHER INFORMATION                                                                                                                            | 36       |
|         |                                                                                                                                         |     |
| Item 1.      | Legal Proceedings                                                                                                                            | 36       |
|         |                                                                                                                                         |     |
| Item 2.      | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                 | 36       |
|         |                                                                                                                                         |     |
| Item 3.      | Defaults  Upon Senior Securities                                                                                                             | 37       |
|         |                                                                                                                                         |     |
| Item 4.      | Submission  of Matters to a Vote of Security Holders                                                                                         | 37       |
|         |                                                                                                                                         |     |
| Item 5.      | Other Information                                                                                                                            | 38       |
|         |                                                                                                                                         |     |
| Item 6.      | Exhibits                                                                                                                                     | 38       |
|         |                                                                                                                                         |     |
|         | SIGNATURES                                                                                                                                   | 38       |

 

EXPLANATORY NOTE

 

This amendment to the Company’s Form 10-Q, which was filed on August 8,2008, corrects an error in the Balance Sheet by netting the Company’s deferredtax liability against its valuation allowance.    As a result ofthis correction, additional paid-in capital at June 30, 2008 increases to$33,072,833 from $31,847,815, total stockholders’ equity increases to$2,270,977 from $1,045,959, and deferred tax liability decreases to $0 from$1,225,018.  There was no effect on the Company’s  total assets,total liabilities and stockholders’ equity, or working capital. Additionally, there was no effect on the Company’s Consolidated Statement ofOperations or Consolidated Statement of Cash Flows.   

 

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**PART I- FINANCIAL INFORMATION**

**ITEM 1.FINANCIAL STATEMENTS**

 

**INNOVATIVE CARD TECHNOLOGIES, INC.****CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                                                  | ** ** | **Restated**      | ** ** | ** **            | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                                                  | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| ** **                                                                                                                  | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                  |       |              |       |                  |       |
| CURRENT ASSETS                                                                                                              |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                   |       | $                 | 1,680,060  |                  | $          | 339,600 |   |
| Accounts receivable                                                                                                         |       | 824,128           |       | 13,077                |       |
| Prepaids and other current assets                                                                                           |       | 341,314           |       | 54,127                |       |
| Deposits on raw materials held for  production                                                                              |       | 869,052           |       | 605,662               |       |
| Raw materials held for production                                                                                           |       | 1,365,254         |       | 1,315,960             |       |
| Work in progress inventory                                                                                                  |       | 1,755,182         |       | 886,259               |       |
| Total current assets                                                                                                        |       | 6,834,990         |       | 3,214,685             |       |
|                                                                                                                        |       |              |       |                  |       |
| Property and equipment, net                                                                                                 |       | 164,940           |       | 193,185               |       |
| Deferred debt issuance cost                                                                                                 |       | 500,420           |       | —                |       |
| Deposits                                                                                                                    |       | 96,860            |       | 177,747               |       |
| Intangible assets, net                                                                                                      |       | 1,762,554         |       | 2,075,953             |       |
| Total assets                                                                                                                |       | $                 | 9,359,764  |                  | $          | 5,661,570 |   |
|                                                                                                                        |       |              |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                               | ** ** | ** **        | ** ** | ** **            | ** ** |
| CURRENT LIABILITIES                                                                                                         |       |              |       |                  |       |
| Accounts payable and accrued expenses                                                                                       |       | $                 | 1,883,228  |                  | $          | 3,660,044 |   |
| Accounts payable - related parties                                                                                          |       | 595,365           |       | 657,254               |       |
| Warranty reserve                                                                                                            |       | 108,806           |       | 27,816                |       |
| Deferred revenue                                                                                                            |       | 949,069           |       | 898,585               |       |
| Total current liabilities                                                                                                   |       | 3,536,468         |       | 5,243,699             |       |
|                                                                                                                        |       |              |       |                  |       |
| 8% convertible debenture, net of $6,010,432  discount                                                                       |       | 2,489,568         |       | —                |       |
| Warrant liability                                                                                                           |       | 1,062,751         |       | —                |       |
| Total liabilities                                                                                                           |       | 7,088,787         |       | 5,243,699             |       |
|                                                                                                                        |       |              |       |                  |       |
| Commitments and contingencies                                                                                               |       |              |       |                  |       |
|                                                                                                                        |       |              |       |                  |       |
| STOCKHOLDERS’ EQUITY                                                                                                   |       |              |       |                  |       |
|                                                                                                                        |       |              |       |                  |       |
| Preferred stock $0.001 par value, 5,000,000  shares authorized, 0 (unaudited) and 0 shares issued and outstanding           |       |              |       | —                |       |
| Common stock $0.001 par value, 75,000,000  shares authorized, 28,495,256 (unaudited) and 28,433,116 issued and  outstanding |       | 28,483            |       | 28,433                |       |
| Additional paid-in capital                                                                                                  |       | 33,072,833        |       | 28,456,621            |       |
| Accumulated deficit                                                                                                         |       | (30,830,339       | )          | (28,067,183           | )          |
| Total stockholders’ equity                                                                                             |       | 2,270,977         |       | 417,871               |       |
| Total liabilities and stockholders’ equity                                                                             |       | $                 | 9,359,764  |                  | $          | 5,661,570 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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**INNOVATIVE CARD TECHNOLOGIES, INC.****CONSOLIDATEDSTATEMENTS OF OPERATIONS**

 
| ** **                                                    | ** ** | **Three months  ended  June 30,  2008** | ** ** | **Three months  ended  June 30,  2007** | ** ** | **Six months  ended  June 30,  2008** | ** ** | **Six months  ended  June 30,  2007** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                    | ** ** | **(unaudited)**                              | ** ** | **(unaudited)**                              | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                            | ** ** |
| Revenues                                                      |       | $                                            | 800,209    |                                         | $          | 1,089                                      |       | $                                          | 1,017,425  |   | $ | 2,509 |   |
| Cost of Goods Sold                                            |       | 859,875                                      |       | 395,396                                      |       | 1,070,209                                  |       | 395,396                                    |       |
| Gross Margin                                                  |       | (59,666                                      | )          | (394,307                                     | )          | (52,784                                    | )          | (392,887                                   | )          |
| Operating expenses                                            |       |                                         |       |                                         |       |                                       |       |                                       |       |
| Administrative                                                |       | 1,656,715                                    |       | 1,832,454                                    |       | 3,046,646                                  |       | 3,344,329                                  |       |
| Consulting fees                                               |       | 134,427                                      |       | 115,739                                      |       | 254,525                                    |       | 231,631                                    |       |
| Professional fees                                             |       | 201,192                                      |       | 203,695                                      |       | 449,223                                    |       | 567,218                                    |       |
| Research and development                                      |       | 118,539                                      |       | 173,081                                      |       | 298,355                                    |       | 469,410                                    |       |
| Total operating expenses                                      |       | 2,110,873                                    |       | 2,324,969                                    |       | 4,048,749                                  |       | 4,612,588                                  |       |
| Loss from operations                                          |       | (2,170,539                                   | )          | (2,719,276                                   | )          | (4,101,533                                 | )          | (5,005,475                                 | )          |
| Other income (expense)                                        |       |                                         |       |                                         |       |                                       |       |                                       |       |
|                                                          |       |                                         |       |                                         |       |                                       |       |                                       |       |
| Change in fair value of warrant liability  and other expense  |       | 1,778,099                                    |       |                                         |       | 1,903,760                                  |       |                                       |       |
| Interest income                                               |       | 11,703                                       |       | 63,152                                       |       | 20,776                                     |       | 142,692                                    |       |
| Interest expense                                              |       | (419,978                                     | )          | (100                                         | )          | (585,359                                   | )          | (248                                       | )          |
| Total other income                                            |       | 1,369,824                                    |       | 63,052                                       |       | 1,339,177                                  |       | 142,444                                    |       |
|                                                          |       |                                         |       |                                         |       |                                       |       |                                       |       |
| Loss before provision for income taxes                        |       | (800,715                                     | )          | (2,656,224                                   | )          | (2,762,356                                 | )          | (4,863,031                                 | )          |
| Provision for income taxes                                    |       | —                                       |       | —                                       |       | (800                                       | )          | —                                     |       |
| Net loss                                                      |       | $                                            | (800,715   | )                                            | $          | (2,656,224                                 | )          | $                                          | (2,763,156 | ) | $ | (4,863,031 | ) |
| Basic and diluted loss per share                              |       | $                                            | (0.03      | )                                            | $          | (0.09                                      | )          | $                                          | (0.10      | ) | $ | (0.17 | ) |
| Basic and diluted weighted-average common  shares outstanding |       | 28,486,411                                   |       | 28,420,616                                   |       | 28,459,763                                 |       | 28,415,133                                 |       |

 

The accompanying notes are an integral partof these consolidated financial statements

 

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**INNOVATIVE CARD TECHNOLOGIES, INC.****CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
| ** **                                                                                                    | ** ** | **For the Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                                                                    | ** ** | **2008**                                                        | ** ** | **2007** | ** ** |
| ** **                                                                                                    | ** ** | **(unaudited)**                                                 | ** ** | **(unaudited)** | ** ** |
| Cash flows  from operating activities:                                                                        |       |                                                            |       |   |   |
|                                                                                                          |       |                                                            |       |   |   |
| Net loss                                                                                                      |       | $                                                               | (2,763,156 | ) | $ | (4,863,031 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities:                                  |       |                                                            |       |   |   |
| Depreciation  and amortization                                                                                |       | 355,129                                                         |       | 445,323 |   |
| Change in  fair value of warrant liability                                                                    |       | (2,024,554                                                      | )          | — |   |
| Amortization  of debt discount                                                                                |       | 314,828                                                         |       | — |   |
| Amortization  of deferred debt issuance cost                                                                  |       | 27,080                                                          |       | — |   |
| Share-based  compensation expense                                                                             |       | 1,049,433                                                       |       | 560,776 |   |
| (Increase)  decrease in Accounts receivable                                                                   |       | (811,051                                                        | )          | (76,389 | ) |
| (Increase)  decrease in Prepaid expenses and other current assets                                             |       | (8,311                                                          | )          | (26,616 | ) |
| (Increase)  decrease in Deposits on raw materials held for production                                         |       | (263,390                                                        | )          | (215,797 | ) |
| (Increase)  decrease in Raw materials held for production                                                     |       | (49,294                                                         | )          |   |   |
| (Increase)  decrease in Work in progress inventory                                                            |       | (868,923                                                        | )          | (721,205 | ) |
| (Increase)  decrease in Deposits                                                                              |       | 80,885                                                          |       | (99,153 | ) |
| Increase  (decrease) in Accounts payable and accrued expenses                                                 |       | (1,776,816                                                      | )          | 733,756 |   |
| Increase  (decrease) in Accounts payable - related parties                                                    |       | (61,889                                                         | )          | (266,784 | ) |
| Increase  (decrease) in Warranty reserve                                                                      |       | 80,990                                                          |       | — |   |
| Increase  (decrease) in Deferred revenue                                                                      |       | 50,484                                                          |       | 516,675 |   |
| Net cash  used in operating activities                                                                        |       | (6,668,555                                                      | )          | (4,012,445 | ) |
|                                                                                                          |       |                                                            |       |   |   |
| Cash flows  from investing activities:                                                                        |       |                                                            |       |   |   |
|                                                                                                          |       |                                                            |       |   |   |
| Purchase of  Property and Equipment                                                                           |       | (13,485                                                         | )          | (64,509 | ) |
| Net cash  used in investing activities                                                                        |       | (13,485                                                         | )          | (64,509 | ) |
|                                                                                                          |       |                                                            |       |   |   |
| Cash flows  from financing activities:                                                                        |       |                                                            |       |   |   |
|                                                                                                          |       |                                                            |       |   |   |
| Gross  proceeds from issuance of 8% convertible debenture                                                     |       | 8,500,000                                                       |       | — |   |
| Payments on  debt issuance cost                                                                               |       | (527,500                                                        | )          | — |   |
| Offering  costs                                                                                               |       |                                                            |       | (3,675 | ) |
| Proceeds  from exercise of options / warrants                                                                 |       | 50,000                                                          |       | 24,375 |   |
| Payments on  capital lease                                                                                    |       |                                                            |       | (4,947 | ) |
| Net cash  provided by financing activities                                                                    |       | 8,022,500                                                       |       | 15,753 |   |
|                                                                                                          |       |                                                            |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                                         |       | 1,340,460                                                       |       | (4,061,201 | ) |
| Cash and  cash equivalents, beginning of year                                                                 |       | 339,600                                                         |       | 8,270,096 |   |
| Cash and  cash equivalents, end of period                                                                     |       | $                                                               | 1,680,060  |   | $ | 4,208,895 |   |
|                                                                                                          |       |                                                            |       |   |   |
| Supplemental  disclosures of cash flow information:                                                           |       |                                                            |       |   |   |
| Interest  paid                                                                                                |       | $                                                               | 65,667     |   | $ | 248 |   |
| Income tax  paid                                                                                              |       | $                                                               | 800        |   | $ | — |   |
|                                                                                                          |       |                                                            |       |   |   |
| Supplemental  disclosure of non-cash operating and financing activities:                                      |       |                                                            |       |   |   |
| Value of  warrants issued as non-employee compensation included in prepaid expenses and  other current assets |       | $                                                               | 278,876    |   | $ | — |   |
| Debt  discount attributable to beneficial conversion feature                                                  |       | $                                                               | 3,237,953  |   | $ | — |   |
| Debt  discount attributable to warrants                                                                       |       | $                                                               | 3,087,307  |   | $ | — |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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**INNOVATIVECARD TECHNOLOGIES, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIALSTATEMENTS****JUNE 30, 2008**

 

**NOTE 1 -ORGANIZATION AND LINE OF BUSINESS**

 

**BASIS OFPRESENTATION**

 

The accompanying condensedconsolidated financial statements of Innovative Card Technologies, Inc.(“InCard”) 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 ofrecurring losses from operations and has an accumulated deficit of $30,830,339as of June 30, 2008.  Sales of theInCard DisplayCard, the Company’s main product, are not expected to generatepositive cash flow until 2009  As aresult, there is substantial doubt about the Company’s ability to continue as agoing concern. The accompanying condensed consolidated unaudited financial statementshave been prepared assuming that the Company will continue as a going concern.This basis of accounting contemplates the recovery of the Company’s assets andthe satisfaction of liabilities in the normal course of business and does notinclude any adjustments to reflect the possible future effects on therecoverability and classification of assets or the amounts and classificationof liabilities that might be necessary should the Company be unable to continueas a going concern.   There can be no assurancesthat funds will be available to the Company when needed or, if available, thatsuch funds would be available under favorable terms.  In the event that the Company is unable togenerate adequate revenues to cover expenses and cannot obtain additional fundsin the near future, the Company may seek protection under bankruptcy laws.

 

**COMPANYOVERVIEW**

 

The Company develops andmarkets secure powered cards for payment, identification, physical and logicalaccess applications. Our main product, the InCard DisplayCard, integrates thesecurity of a one-time password token directly into a card the size of astandard credit or debit card. A token is a portable physical device, typicallyin a key-fob form factor, that generates the one-time password (also referredto as a one-time passcode). At the push of a button on the back of the InCardDisplayCard, a one-time passcode (OTP) is shown on the card’s integrateddisplay. During a transaction, this number is entered into a user interfacewith other information (such as the user’s static PIN and login name). Thisinformation is relayed to a backend system for multi-factor authentication.InCard does not provide the backend authentication server, but rather willintegrate the InCard DisplayCard into authentication systems provided by othercompanies including distributors and other resellers of the InCard DisplayCard.The InCard DisplayCard’s OTP authentication works like tokens issued byActivIdentity, RSA and VASCO but in a more convenient, wallet-sized card formfactor.

 

**NOTE 1A –RESTATEMENT**

** **

This amendment to theCompany’s Form 10-Q, which was filed on August 8, 2008, restates itsConsolidated Balance Sheet at June 30, 2008 to correct the following error:

 

The Company erroneouslyrecorded a deferred tax liability for the difference between book and taxaccounting related to the beneficial conversion features of the Company’s 8%senior secured convertible debentures instead of netting the liability againstthe Company’s valuation allowance.

 

The net effect of  the correction of this error was to:

 

·                  Decrease the Company’s total liabilities by$1,225,018 from $8,313,805 to $7,088,787;

 

·                  Increase the Company’s additional paid-incapital by $1,225,018 from $31,847,815 to $33,072,833;

 

·                  Increase the Company’s total stockholders’equity by $1,225,018 from $1,045,959 to $2,270,977.

 

The correction of the errorhas resulted in no change to the Company’s reported Consolidated Statement ofOperations for the three and six months ending June 30, 2008 and ConsolidatedStatement of Cash Flows for the six months ending June 30, 2008.

 

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Followingis a reconciliation of the Company’s restatement of the Consolidated Balance Sheetat June 30, 2008:

 
| ** **                                                                                                                  | ** ** | **Unaudited**     | ** ** | **Unaudited**     | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                                                                  | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **                                                                                                                  | ** ** | **2008**          | ** ** | **2008**          | ** ** |
| ** **                                                                                                                  | ** ** | **(As restated)** | ** ** | **(As reported)** | ** ** |
| **ASSETS**                                                                                                                  |       |              |       |              |       |
| CURRENT ASSETS                                                                                                              |       |              |       |              |       |
| Cash and cash equivalents                                                                                                   |       | $                 | 1,680,060  |              | $          | 1,680,060 |   |
| Accounts receivable                                                                                                         |       | 824,128           |       | 824,128           |       |
| Prepaids and other current assets                                                                                           |       | 341,314           |       | 341,314           |       |
| Deposits on raw materials held for  production                                                                              |       | 869,052           |       | 869,052           |       |
| Raw materials held for production                                                                                           |       | 1,365,254         |       | 1,365,254         |       |
| Work in progress inventory                                                                                                  |       | 1,755,182         |       | 1,755,182         |       |
| Total current assets                                                                                                        |       | 6,834,990         |       | 6,834,990         |       |
|                                                                                                                        |       |              |       |              |       |
| Property and equipment, net                                                                                                 |       | 164,940           |       | 164,940           |       |
| Deferred debt issuance cost                                                                                                 |       | 500,420           |       | 500,420           |       |
| Deposits                                                                                                                    |       | 96,860            |       | 96,860            |       |
| Intangible assets, net                                                                                                      |       | 1,762,554         |       | 1,762,554         |       |
| Total assets                                                                                                                |       | $                 | 9,359,764  |              | $          | 9,359,764 |   |
|                                                                                                                        |       |              |       |              |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                               | ** ** | ** **        | ** ** | ** **        | ** ** |
| CURRENT LIABILITIES                                                                                                         |       |              |       |              |       |
| Accounts payable and accrued expenses                                                                                       |       | $                 | 1,883,228  |              | $          | 1,883,228 |   |
| Accounts payable - related parties                                                                                          |       | 595,365           |       | 595,365           |       |
| Warranty reserve                                                                                                            |       | 108,806           |       | 108,806           |       |
| Deferred revenue                                                                                                            |       | 949,069           |       | 949,069           |       |
| Total current liabilities                                                                                                   |       | 3,536,468         |       | 3,536,468         |       |
|                                                                                                                        |       |              |       |              |       |
| Deferred tax liability                                                                                                      |       | —            |       | 1,225,018         |       |
| 8% convertible debenture, net of $6,010,432  discount                                                                       |       | 2,489,568         |       | 2,489,568         |       |
| Warrant liability                                                                                                           |       | 1,062,751         |       | 1,062,751         |       |
| Total liabilities                                                                                                           |       | 7,088,787         |       | 8,313,805         |       |
|                                                                                                                        |       |              |       |              |       |
| Commitments and contingencies                                                                                               |       |              |       |              |       |
|                                                                                                                        |       |              |       |              |       |
| STOCKHOLDERS’ EQUITY                                                                                                   |       |              |       |              |       |
|                                                                                                                        |       |              |       |              |       |
| Preferred stock $0.001 par value, 5,000,000  shares authorized, 0 (unaudited) and 0 shares issued and outstanding           |       | —            |       | —            |       |
| Common stock $0.001 par value, 75,000,000  shares authorized, 28,495,256 (unaudited) and 28,433,116 issued and  outstanding |       | 28,483            |       | 28,483            |       |
| Additional paid-in capital                                                                                                  |       | 33,072,833        |       | 31,847,815        |       |
| Accumulated deficit                                                                                                         |       | (30,830,339       | )          | (30,830,339       | )          |
| Total stockholders’ equity                                                                                             |       | 2,270,977         |       | 1,045,959         |       |
| Total liabilities and stockholders’ equity                                                                             |       | $                 | 9,359,764  |              | $          | 9,359,764 |   |

 

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**NOTE 2 -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**BASIS OF PRESENTATION**

 

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

 

Theaccompanying condensed consolidated unaudited financial statements ofInnovative Card Technologies, Inc. have been prepared pursuant to therules and regulations of the Securities and Exchange Commission (“SEC”)regarding interim financial reporting. Accordingly, they do not include all ofthe information and footnotes required by generally accepted accountingprinciples for annual financial statements and should be read in conjunctionwith the consolidated financial statements for the year ended December 31,2007, and notes thereto included in the Company’s Annual Report on Form 10-KSB,filed with the SEC on April 1, 2008, and amendments thereto. In theopinion of management, the accompanying condensed consolidated financialstatements contain all adjustments, consisting only of adjustments of a normalrecurring nature, necessary for a fair presentation of the Company’s financialposition as of June 30, 2008, and its results of operations for theperiods presented. These condensed consolidated unaudited financial statementsare not necessarily indicative of the results to be expected for the entireyear.

 

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**PRINCIPLES OF CONSOLIDATION**

 

The condensed consolidatedunaudited financial statements include the accounts of Innovative CardTechnologies and its wholly owned subsidiary, PSA Co.  All significant inter-company accounts andtransactions are eliminated in consolidation.

 

**REVENUE RECOGNITION**

 

The Company recognizesrevenue in accordance with SEC Staff Accounting Bulletin No. 104, or SAB104. Revenue is recognized when persuasive evidence of an arrangement exists,delivery has occurred or services have been rendered, the price is fixed anddeterminable and collectibility is reasonably assured.   Revenue is not recognized on product salestransacted on a test or pilot basis. Instead, receipts from these types of transactions offset marketingexpenses.   Revenue from royalties isrecognized with the passage of time in accordance with the underlyingagreement.  The Company recognizescertain long-term contracts using the completed-contract method in accordanceto SOP 81-1, “Accounting for Performance of Construction-Type and CertainProduction-Type of Contracts.”  Norevenue has been recognized to date from these contracts.

 

**COMPREHENSIVE INCOME**

 

The Company utilizesStatement of Financial Accounting Standards (“SFAS”) No. 130, “ReportingComprehensive Income.” This statement establishes standards for reportingcomprehensive income and its components in a financial statement. Comprehensiveincome as defined includes all changes in equity (net assets) during a periodfrom non-owner sources. Examples of items to be included in comprehensiveincome, which are excluded from net income, include foreign currencytranslation adjustments, minimum pension liability adjustments, and unrealizedgains and losses on available-for-sale securities. Comprehensive income is notpresented in the Company’s financial statements since the Company did not haveany changes in equity from non-owner sources.

 

**INVENTORY**

 

The Company values itsinventory at the lower of cost (first-in, first-out) or market. The Companyuses estimates and judgments regarding the valuation of inventory to properlyvalue inventory. Inventory adjustments are made for the difference between thecost of the inventory and the estimated market value and charged to cost ofgoods sold in the period in which the facts that give rise to the adjustmentsbecome known.

 

**INTANGIBLE ASSETS AND LONG-LIVED ASSETS**

 

The cost incurred to acquireintangible assets, which are active and relate to products with a definitivelife cycle, are amortized over the estimated useful life of three to fiveyears. The Company assesses the carrying value of long-lived assets inaccordance with SFAS No. 144, “Accounting for the Impairment or Disposalof Long-Lived Assets.” The Company assesses the impairment of identifiableintangibles and long-lived assets whenever events or changes in circumstancesindicate that the carrying value may not be recoverable. Factors consideredimportant that could trigger an impairment review include, but are not limitedto, the following: a significant underperformance to expected historical orprojected future operating results, a significant change in the manner of theuse of the acquired asset or the strategy for the overall business, or asignificant negative industry or economic trend. Based on anticipated futureincome and cash flows and other factors relevant in the opinion of theCompany’s management, the buzzer patent was completely impaired during the yearended December 31, 2007.  Noimpairment was recognized during the three months or six months ended June 30,2008.

 

**CASH AND CASH EQUIVALENTS**

 

For the purpose of thestatements of cash flows, the Company considers all highly liquid investmentspurchased with original maturities of three months or less to be cashequivalents.

 

**MAJOR SUPPLIERS**

 

The Company obtains thebattery, a key component for the Company’s power inlay technology, from asingle source, Solicore, Inc., on a purchase order basis. The Companybelieves that alternative sources for this component in the event of adisruption or discontinuation in supply would not be available on a timely basis,which could disrupt Company operations, delay production for up to one year andimpair the Company’s ability to manufacture and sell products.

 

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The Company obtains thedisplay, a key component for the Company’s InCard DisplayCard, from a singlesource, SmartDisplayer, pursuant to the Company’s agreement withSmartDisplayer. The Company believes that alternative sources for thiscomponent in the event of a disruption or discontinuation in supply would notbe available on a timely basis, which could disrupt Company operations relatingto the InCard DisplayCard, delay production of the InCard DisplayCard for up toone year and impair the Company’s ability to manufacture and sell the InCardDisplayCard.

 

The Company assembles itsInCard DisplayCard using a single source, NagraID, pursuant to a writtenagreement that expired on June 30, 2008. The Company believes that alternative sources for this component in theevent of a disruption or discontinuation in supply would not be available on atimely basis, which could disrupt Company operations relating to the InCardDisplayCard, delay production of the InCard DisplayCard for up to one year andimpair the Company’s ability to manufacture and sell the InCardDisplayCard.  From July 1, 2008forward, the Company will contract with NagraID on a purchase order basis untilsuch time as a new written agreement, which is currently under discussion, isentered into by the parties.

 

**PROPERTY AND EQUIPMENT**

 

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

 

**FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

The Company’s financialinstruments include cash and cash equivalents, prepaid expenses and othercurrent assets, accounts payable and accrued expenses including accountspayable to related parties, advances payable, and deferred revenue. The bookvalue of all financial instruments are representative of their fair values.

 

**RESEARCH AND DEVELOPMENT**

 

Research and developmentcosts 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 lossavailable to common shareholders by the weighted-average number of commonshares outstanding. Diluted loss per share is computed similar to basic lossper share except that the denominator is increased to include the number ofadditional common shares that would have been outstanding if the potentialcommon shares had been issued and if the additional common shares weredilutive. Common equivalent shares are excluded from the computation if theireffect is anti-dilutive.

 

Since their effect wouldhave been anti-dilutive, common stock equivalents of 5,786,537 warrants and3,012,569 stock options were excluded from the calculation of diluted loss pershare for the six months ended June 30, 2008. Since their effect wouldhave been anti-dilutive, common stock equivalents of 4,627,098 warrants and2,254,498 stock options were excluded from the calculation of diluted loss pershare for the six months ended June 30, 2007.

 

**INCOME TAXES**

 

The Company utilizes SFAS No. 109,“Accounting for Income Taxes,” which requires the recognition of deferred taxassets and liabilities for the expected future tax consequences of events thathave been included in the financial statements or tax returns. Under thismethod, deferred income taxes are recognized for the tax consequences in futureyears of differences between the tax bases of assets and liabilities and theirfinancial reporting amounts at each year-end based on enacted tax laws andstatutory tax rates applicable to the periods in which the differences areexpected to affect taxable income. Also, the Company adopted the provisions ofthe Financial Accounting Standards Board (“FASB”) Interpretation No.48,“Accounting for Uncertainty in Income Taxes-an Interpretation of FASB StatementNo. 109” (“FIN 48”), effective January 1, 2007. As a result of theimplementation of FIN 48, the Company made a comprehensive review of itsportfolio of uncertain tax positions in accordance with recognition standardsestablished by FIN 48. As a result of this review, the Company concluded thatat this time there are no uncertain tax positions.  As a result of applying the provisions of FIN48, there was no cumulative effect on retained earnings.

 

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**STOCK INCENTIVE PLAN**

 

The Company accounts for itsstock incentive plan under SFAS No. 123R, “Share-Based Payments”, which itadopted 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 awardand is recognized over the service period, which is usually the vesting period.

 

In December 2004, theFinancial Accounting Standards Board (“FASB”) issued a revision to FASBStatement No. 123, “Share-Based Payment,” “SFAS No. 123(R)”. ThisStatement supersedes APB Opinion No. 25, Accounting for Stock Issued toEmployees. This Statement establishes standards for the accounting fortransactions in which an entity exchanges its equity instruments for goods orservices. It also addresses transactions in which an entity incurs liabilitiesin exchange for goods or services. It also addresses transactions in which anentity incurs liabilities in exchange for goods or services that are based onthe fair value of entity’s equity instruments or that may be settled by theissuance of those equity instruments. This Statement is effective for publicentities that file as small business issuers as of the beginning of the firstinterim or annual reporting period that begins after December 15, 2005.The Company has adopted this statement for the year ended December 31,2006.

 

**ESTIMATES**

 

The preparation of financialstatements requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenue and expenses during the reporting period. Actual resultscould differ from those estimates.

 

The Company reversed anestimate made at December 31, 2007 for an anticipated stock award to aconsultant.  The award will not bemade.  The reversal reduced accountspayable and administrative expenses.

 

**CONCENTRATIONS OF CREDIT RISK**

 

Financial instruments whichpotentially subject the Company to concentrations of credit risk consist ofcash and cash equivalents. The Company places its cash and cash equivalentswith high credit, quality financial institutions. At times, such cash and cashequivalents may be in excess of the Federal Deposit Insurance Corporationinsurance limit of $100,000.  At times,cash balances are in excess of the insured limit.

 

**WARRANTS AND BENEFICIAL CONVERSION****FEATURE ON 8%CONVERTIBLE DEBENTURE**

 

The Company accounts forwarrants as liability instruments in accordance with paragraph 8 of EITF 00-19,“Accounting for Derivative Financial Instruments Indexed to, and PotentiallySettled in, a Company’s Own Stock”.  Thebeneficial conversion feature associated with the senior secured convertibledebenture is measured at its intrinsic value after allocation between thewarrant and the debenture and before transaction costs in accordance with EITF00-27, “Application of Issue 98-5 to Certain Convertible Instruments”.  Debt proceeds are first allocated to thewarrant (as it is a mark-to-market, fair-value liability instrument) and theremaining proceeds are allocated to the debt. The debenture will be accreted to liquidation value over the debenture’sterm of three years, using the effective interest rate method.

 

**RECLASSIFICATION**

 

Certain amounts included inthe prior year financial statements have been reclassified to conform with thecurrent year presentation. Such reclassification did not have any effect on thereported net loss.

 

**RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS**

 

In March 2008 the FASBissued SFAS 161 “Disclosures about Derivative Instruments and HedgingActivities—an amendment of FASB Statement No. 133”.  This Statement changes the disclosurerequirements for derivative instruments and hedging activities. Entities arerequired to provide enhanced disclosures about (a) how and why an entityuses derivative instruments, (b) how derivative instruments and relatedhedged items are accounted for under Statement 133 and its relatedinterpretations, and (c) how derivative instruments and related hedgeditems affect an entity’s financial position, financial performance, and cashflows. This Statement is effective for financial statements issued for fiscalyears and interim periods beginning after November 15, 2008; earlieradoption is encouraged.  Management hasnot yet determined what impact the adoption of this statement will have on theCompany’s financial position, results of operations, or cash flows.

 

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**NOTE 3 -DEPOSITS ON RAW MATERIALS HELD FOR PRODUCTION**

 
| ** **                                                                           | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                           | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| Deposits on raw materials held for  production (display and manufacturing component) |       | $                       | 869,052    |                        | $          | 605,662 |   |
| TOTAL                                                                                |       | $                       | 869,052    |                        | $          | 605,662 |   |

 

These deposits for rawmaterials are held by two vendors, are not refundable and are made pursuant toagreements as discussed in Note 2 under Major Suppliers.

 

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

 

Raw materials and work inprogress inventory held for production at June 30, 2008 and December 31,2007 consisted of the following and are stated at the lower cost or market, netof inventory reserves of $99,335 (unaudited) and $99,335, respectively:

 
| ** **                        | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| Raw materials held for production | ** ** | $                       | 1,365,254  |                        | $          | 1,315,960 | ** ** |
| Work in progress inventory        |       | 1,755,182               |       | 886,259                     |       |
| TOTAL                             |       | $                       | 3,120,436  |                        | $          | 2,202,219 |   |

 

**NOTE 5 -PROPERTY AND EQUIPMENT**

 

Property and equipment at June 30,2008 and December 31, 2007 consisted of the following:

 
| ** **                                      | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                      | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| Computer equipment                              |       | $                       | 103,189    |                        | $          | 96,451 |   |
| Office equipment                                |       | 8,168                   |       | 8,168                       |       |
| Furniture and fixtures                          |       | 24,386                  |       | 24,386                      |       |
| Leasehold improvements                          |       | —                  |       | 5,608                       |       |
| Production equipment                            |       | 284,220                 |       | 277,474                     |       |
|                                            |       | 419,963                 |       | 412,087                     |       |
| Less accumulated depreciation and  amortization |       | (255,023                | )          | (218,902                    | )          |
|                                            |       |                    |       |                        |       |
| TOTAL                                           |       | $                       | 164,940    |                        | $          | 193,185 |   |

 

Depreciation andamortization expense was $19,657 (unaudited) and $46,757 (unaudited) for thethree months ended June 30, 2008 and 2007, respectively.

 

Depreciation andamortization expense was $41,731 (unaudited) and $91,432 (unaudited), for thesix months ended June 30, 2008 and 2007, respectively.

 

The Company wrote-off fullyamortized leasehold improvements amounting to $5,608 at June 30, 2008.

 

**NOTE 6 -PROVISION FOR INCOME TAXES**

 

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

 

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The provision for incometaxes consisted of the following:

 
| ** **                       | ** ** | **Six Months**           | ** ** | **Six Months**           | ** ** |
|----------------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                       | ** ** | **Ended  June 30,** | ** ** | **Ended  June 30,** | ** ** |
| ** **                       | ** ** | **2008**                 | ** ** | **2007**                 | ** ** |
| ** **                       | ** ** | **(unaudited)**          | ** ** | **(unaudited)**          | ** ** |
| Current Provision:               |       |                     |       |                     |       |
| Federal                          |       | —                   |       | —                   |       |
| State                            |       | $                        | 800        |                     | $          | — |   |
| Total Current Provision          |       | $                        | 800        |                     | $          | — |   |
| Deferred provision (benefit)     |       |                     |       |                     |       |
| Federal                          |       | —                   |       | —                   |       |
| State                            |       | —                   |       | —                   |       |
| Total deferred portion (benefit) |       | —                   |       | —                   |       |
| Total provision for income taxes |       | $                        | 800        |                     | $          | — |   |

 

Reconciliations between thestatutory federal income tax rate and the Company’s effective income tax ratewere as follows:

 
| ** **                                           | ** ** | **Six Months  Ended  June 30,** | ** ** | **Six Months  Ended  June 30,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
| ** **                                           | ** ** | **2008**                             | ** ** | **2007**                             | ** ** |
| ** **                                           | ** ** | **(unaudited)**                      | ** ** | **(unaudited)**                      | ** ** |
| Federal income tax at statutory rates                |       | 34                                   | %          | 34                                   | %          |
| State income taxes, net of federal benefit           |       | 8                                    | %          | 6                                    | %          |
| Change in valuation allowance                        |       | (54                                  | )%         | (40                                  | )%         |
| Tax credits                                          |       | 0                                    | %          | 0                                    | %          |
| Change in fair value of warrant liability  and other |       | 12                                   | %          | 0                                    | %          |
| Effective income tax rate                            |       | 0                                    | %          | 0                                    | %          |

 

Utilization of the Company’snet operating losses (“NOLs”) are limited by the provisions of the InternalRevenue Code Section 382.  NOLsearned prior to an “ownership change”, as defined by Section 382, aresubject to limitation.   As a result ofthis limitation, the Company reduced its deferred tax assets by $1,061,379 forthe six months ended June 30, 2008. No such adjustment was recorded in the six months ended June 30,2007.

 

The Company adopted theprovisions of the Financial Accounting Standards Board (“FASB”) Interpretation No. 48,“Accounting for Uncertainty in Income Taxes-an Interpretation of FASB StatementNo. 109” (“FIN 48”), effective January 1, 2007. As a result of theimplementation of FIN 48, the Company made a comprehensive review of itsportfolio of uncertain tax positions in accordance with recognition standardsestablished by FIN 48. As a result of applying the provisions of FIN 48, therewas no cumulative effect on retained earnings.

 

For the six months ended June 30,2008, the cumulative unrecognized tax benefit was $79,352 which was nettedagainst  deferred tax assets with a full valuation allowance, andif recognized there will be no effect on the Company’s effective tax rate.

 

**NOTE 7 -COMMITMENTS AND CONTINGENCIES**

 

**EMPLOYMENT AGREEMENT**

 

In March 2008, theCompany entered into employment agreements with Steven Delcarson, its ChiefExecutive Officer, and Charles Caporale, its Chief Financial Officer.  The initial term of each agreement is for oneyear and is renewable.

 

In May 2008, theCompany entered into employment agreements with Mark Poidomani, its ChiefTechnology Officer, and Vincent Schiavo, its Senior Vice President — GlobalSales.  The initial term of Mr. Poidomani’sagreement is one year and is renewable.  Mr. Schiavo’sagreement may be terminated by either party at any time with or without cause.

 

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**LITIGATION**

 

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

 

**WARRANTY**

 

The Company guarantees the performance of its products for certainperiods of time or usage, depending on the particular agreement with thecustomer.   In order to properly matchrevenue and related expenses, the Company makes an estimate of the costassociated with fulfilling its warranty obligations at the time of sale.

 

**NOTE 8 -STOCKHOLDERS’ EQUITY**

 

**PREFERREDSTOCK**

 

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

 

**COMMONSTOCK**

 

The Company has 75,000,000 authorized shares of $0.001 par value commonstock.  In January 2008, the Companyentered into a Securities Purchase Agreement (the “Purchase Agreement”) with 13institutional and accredited investors (the “Purchasers”). Pursuant to theterms of the Purchase Agreement, the Purchasers purchased $3.5 million of theCompany’s 8% Senior Secured Convertible Debenture (“Debenture”). The Debentureis convertible at the holder’s option into shares of common stock at $2.50 pershare.  The Purchase Agreement has aforced conversion feature which allows the Company to force the conversion ofthe Debenture if the Company’s common stock trades above $5.00 for 20consecutive trading days and certain other conditions are met. The Company alsoissued to the Purchasers five-year common stock purchase warrants to purchase700,000 shares of common stock at an exercise price of $2.75 per share (the“Warrants”).   Both the conversionprice of the Debenture and the Warrant strike price were reset following the April 15,2008 financing described below.

 

In April 2008, the Company entered into a Securities PurchaseAgreement (the “Purchase Agreement”) with EMC Corporation (“EMC”). Pursuant tothe terms of the Purchase Agreement, EMC purchased $5.0 million of theCompany’s 8% Senior Secured Convertible Debenture (“Debenture”). The Debentureis convertible at the holder’s option into shares of common stock at $2.48 pershare.  The Purchase Agreement has aforced conversion feature which allows the Company to force the conversion ofthe Debenture if the Company’s common stock trades above $5.00 for 20 consecutivetrading days and certain other conditions are met. The Company also issued tothe Purchasers five-year common stock purchase warrants to purchase 1,008,064shares of common stock at an exercise price of $2.728 per share (the“Warrants”).

 

**WARRANTS**

 

The following summarizes the warrant transactions:

 
| ** **                                        | ** ** | **Warrants  Outstanding** | ** ** | **Weighted-Average  Exercise Price** | ** ** |
|---------------------------------------------------|------------|---------------------------|------------|-------------------------------------------|------------|
|                                              |       |                      |       |                                      |       |
| December 31, 2007                            |       | 4,614,598                 |       | $                                         | 1.43       |   |
| Issued during 2008 (unaudited)               |       | 2,118,064                 |       | $                                         | 2.69       |   |
| Exercised during 2008 (unaudited)            |       | (25,000                   | )          | $                                         | 1.25       |   |
| Outstanding, June 30,  2008 (unaudited) |       | 6,707,662                 |       | $                                         | 1.83       |   |

 

**2004 STOCKINCENTIVE PLAN**

 

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

 

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

 

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

 

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The following summarizesstock option transactions for the period shown:

 
| ** **                          | ** ** | **Six Months Ended  June 30, 2008** | ** ** |
|-------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                          | ** ** | **(unaudited)**                                         | ** ** |
| **ALL OPTIONS**                     | ** ** | ** **                                              | ** ** | **WEIGHTED  AVERAGE  EXERCISE  PRICE** | ** ** |
| ** **                          | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Outstanding  at beginning of period |       | 2,184,498                                               |       | $ | 1.97 |   |
| Options  granted                    |       | —                                                  |       | $ | — |   |
| Options  forfeited                  |       | (140,000                                                | )          | $ | 3.54 |   |
| Options  expired                    |       | —                                                  |       | $ | — |   |
| Options  exercised                  |       | (50,000                                                 | )          | $ | 1.00 |   |
|                                |       |                                                    |       |   |   |
| Outstanding  at end of period       |       | 1,994,498                                               |       | $ | 1.89 |   |
|                                |       |                                                    |       |   |   |
| Exercisable  at end of period       |       | 1,559,498                                               |       | $ | 1.41 |   |

 
| ** **                          | ** ** | **Six Months Ended  June 30, 2008** | ** ** |
|-------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                          | ** ** | **(unaudited)**                                         | ** ** |
| **NON VESTED OPTIONS**    | ** ** | ** **                                              | ** ** | **WEIGHTED  AVERAGE  EXERCISE  PRICE** | ** ** |
| Non- vested  at beginning of period |       | 585,000                                                 |       |   | 3.72 |   |
| Options  granted                    |       | —                                                  |       | $ | — |   |
| Options  forfeited                  |       | (80,000                                                 | )          | $ | 4.46 |   |
| Options  expired                    |       | —                                                  |       | $ | — |   |
| Options vested                      |       | (70,000                                                 | )          | $ | 3.72 |   |
|                                |       |                                                    |       |   |   |
| Non- vested  at end of period       |       | 435,000                                                 |       | $ | 3.58 |   |

 

The weighted averagegrant-date fair value of options granted during the six month periods ended June 30,2008 and 2007 was $0 (unaudited) and $0 respectively, as no options weregranted.

 

The weighted averageremaining contractual lives of the options outstanding and options exercisableat June 30, 2008, were as follows:

 
| ** **                      | ** ** | **Options  outstanding** | ** ** | **Options  exercisable** | ** ** |
|---------------------------------|------------|--------------------------|------------|--------------------------|------------|
|                            |       |                     |       |                     |       |
| June 30,  2008 (unaudited) |       | 6.53 years               |       | 6.24 years               |       |

 

**2007 EQUITY INCENTIVE PLAN**

 

The Company’s Board ofDirectors approved the 2007 Equity Incentive Plan in September 2007 andstockholders approved the 2007 Equity Incentive Plan in December 2007. The2007 Equity Incentive Plan provides for the grant of incentive stock options tothe Company’s employees, and for the grant of non-statutory stock options,restricted InCard stock, stock appreciation rights, performance units andperformance shares to the Company’s employees, directors and consultants.

 

The Company reserved a totalof 4,000,000 shares of its common stock for issuance pursuant to the 2007Equity Incentive Plan. A committee of the board of directors administers the2007 Equity Incentive Plan. Stock options are generally granted with terms ofup to ten years and vest over a period of five years under the 2007 EquityIncentive Plan. The administrator determines the exercise price of optionsgranted under the 2007 Equity Incentive Plan, but the exercise price must notbe less than 85% of the fair market value of the Company’s common stock on thedate of grant. In the event the participant owns 10% or more of the votingpower of all classes of the Company’s stock, the exercise price must not beless than 110% of the fair market value per share of the Company’s common stockon the date of grant. With respect to all incentive stock options, the exerciseprice must at least be equal to the fair market value of the Company’s commonstock on the date of grant. The 

 

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term of an incentive stock option may not exceed 10years, except that with respect to any participant who owns 10% of the votingpower of all classes of the Company’s outstanding stock or the outstandingstock of any parent or subsidiary of the Company, the term must not exceed fiveyears and the exercise price must equal at least 110% of the fair market valueon 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 ofgrant.

 

Without further stockholder approval, the 2007Equity Incentive Plan may not issue incentive stock options after September 2017.  A summary of stock option activity andweighted average exercise prices for the six months ended June 30, 2008 isas follows:

 
| ** **                          | ** ** | **2008**        | ** ** |
|-------------------------------------|------------|-----------------|------------|
| ** **                          | ** ** | **(unaudited)** | ** ** |
| **ALL OPTIONS**                | ** ** | ** **      | ** ** | **WEIGHTED  AVERAGE  EXERCISE  PRICE** | ** ** |
| Outstanding  at beginning of period |       | 68,511          |       | $ | 2.76 |   |
| Options  granted                    |       | 1,906,666       |       | $ | 2.09 |   |
| Options  forfeited                  |       | —          |       | — |   |
| Options  expired                    |       | —          |       | — |   |
| Options  exercised                  |       | —          |       | — |   |
|                                |       |            |       |   |   |
| Outstanding  at end of period       |       | 1,975,177       |       | $ | 2.11 |   |
|                                |       |            |       |   |   |
| Exercisable  at end of period       |       | 125,000         |       | 2.25 |   |

 
| ** **                          | ** ** | **2008**        | ** ** |
|-------------------------------------|------------|-----------------|------------|
| ** **                          | ** ** | **(unaudited)** | ** ** |
| **NON VESTED OPTIONS**    | ** ** | ** **      | ** ** | **WEIGHTED  AVERAGE  EXERCISE  PRICE** | ** ** |
| Non- vested  at beginning of period |       | 68,511          |       | $ | 2.76 |   |
| Options  granted                    |       | 1,906,666       |       | $ | 2.09 |   |
| Options  forfeited                  |       | —          |       | — |   |
| Options  expired                    |       | —          |       | — |   |
| Options  vested                     |       | (125,000        | )          | $ | 2.25 |   |
|                                |       |            |       |   |   |
| Non- vested  at end of period       |       | 1,850,177       |       | $ | 2.10 |   |

 

The weighted average remaining contractual lives ofthe options outstanding and options exercisable at June 30, 2008, were asfollows:

 
| ** **                      | ** ** | **Options  outstanding** | ** ** | **Options  exercisable** | ** ** |
|---------------------------------|------------|--------------------------|------------|--------------------------|------------|
|                            |       |                     |       |                     |       |
| June 30,  2008 (unaudited) |       | 9.77 years               |       | 9.75 years               |       |

 

The Company recorded $914,957 (unaudited) and$560,776 (unaudited) of compensation expense for employee stock options duringthe six month periods ending June 30, 2008 and June 30, 2007,respectively which is included in the administrative expense category. At June 30,2008, there was a total of $2,985,049 of unrecognized compensation costsrelated to the non-vested share-based compensation arrangements under the 2004and 2007 Plans. The cost is expected to be recognized over a weighted averageperiod of 1.43 years. The total fair value of shares vested during the sixmonth period ended June 30, 2008 was approximately $158,750 (unaudited).The aggregate intrinsic value of total outstanding options and totalexercisable options was $402,299 (unaudited) and $365,849 (unaudited),respectively as of June 30, 2008.

 

Since January 1, 2006, the Company isrecognizing the cost of all employee stock options on a straight-lineattribution basis over their respective vesting periods, net of estimatedforfeitures. The Company has selected the modified prospective method oftransition; accordingly, prior periods have not been restated. Prior to theadoptions of SFAS No. 123(R), the Company applied APB Opinion No. 25and related Interpretations in accounting for its stock-based compensationplans. All employee stock options were granted at or above the grant datemarket price, and accordingly, no compensation cost was recognized for fixedstock option grants in prior periods.

 

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The Black Scholesassumptions used are listed below:

 
| ** **              | ** ** | **Six Months  Ended June 30,** | ** ** | **Six Months  Ended June 30,** | ** ** |
|-------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **              | ** ** | **2008**                       | ** ** | **2007**                       | ** ** |
|                    |       |                           |       |                           |       |
| Risk free interest rate |       | 3.45% to 3.91%       |       | 4.97%                          |       |
| Dividends               |       | —                         |       | —                         |       |
| Volatility factor       |       | 88% to 132%                    |       | 200%                           |       |
| Expected life           |       | 10 years                       |       | 10 years                       |       |
| Annual forfeiture rate  |       | 0%                             |       | 0%                             |       |

 

**NOTE 9 -RELATED PARTY TRANSACTIONS**

 

**ACCOUNTS PAYABLE - RELATED PARTIES**

 

Accounts payable - relatedparties at June 30, 2008 is $595,365 (unaudited), which is due tonCryptone, SA and payable in January 2009. Accounts payable - relatedparties at December 31, 2007 was $657,254 comprised of $642,733 due tonCryptone, SA, and due in January 2009 and $14,521 due to Blakely,Sokoloff, Taylor & Zafman, LLP (BSTZ), a law firm in which formerdirector George Hoover is a partner, for legal services related to ourintellectual property.   BSTZ is not arelated party at June 30, 2008.

 

**CONSULTING AGREEMENTS**

 

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

 

The Company was a party to aConsulting Agreement with Forest Finkelstein, the son of Alan Finklestein duringthe years ended December 31, 2007, 2006 and 2005.  The agreement was cancelled in December 2007.  The Company paid Mr. Finklestein $0(unaudited) and $42,500 (unaudited), respectively, during the six months ended June 30,2008 and 2007. Forest Finkelstein is not a related party at June 30, 2008.

 

**LEGAL SERVICES**

 

The Company receives legalservices from Blakely, Sokoloff, Taylor and Zafman, LLP, a law firm that GeorgeHoover, a former director of the Company, is a partner in. During the sixmonths ended June 30, 2007, the Company paid $78,293 (unaudited) to thisentity for legal services rendered. Blakely, Sokoloff, Taylor & Zaffman is not a related party at June 30,2008.

 

**NOTE 10****-****CONCENTRATION OF SUPPLIERS AND SIGNIFICANT CUSTOMERS**

 

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

 

Three customers account for 91% of the Company’srevenues and 92% of the Company’s accounts receivable.

 

**NOTE 11 - 8%SENIOR SECURED CONVERTIBLE DEBENTURES**

 

On January 8, 2008, theCompany entered into a Securities Purchase Agreement (the “Purchase Agreement”)with 13 institutional and accredited investors (the “Purchasers”). Pursuant tothe terms of the Purchase Agreement, the Purchasers purchased $3.5 million ofthe Company’s 8% Senior Secured Convertible Debenture (“Debenture”). TheDebenture: (i) bears interest at 8% per year, paid quarterly in cash orregistered common stock, at the Company’s discretion; (ii) has a maturityof January 8, 2011, (iii) is convertible at the holder’s option intoshares of common stock at $2.50 per share, (iv) is secured by all of theCompany’s and its subsidiary’s assets including inventory, receivables,unencumbered equipment and intellectual 

 

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property under the terms ofa Security Agreement, and (v) has a forced conversion feature which allowsthe Company to force the conversion of the Debenture if the Company’s commonstock trades above $5.00 for 20 consecutive trading days and certain otherconditions are met. The Company also issued to the Purchasers five-year commonstock purchase warrants to purchase 700,000 shares of common stock at an exerciseprice of $2.75 per share (the “Warrants”). The Company used the net proceeds ofthe financing for working capital requirements and to pay down certainobligations. The Debenture also contains customary events of defaultprovisions. As part of the transaction, the Company agreed to: (i) cut itsmonthly burn rate to $600,000 (ii) be compliant with NASDAQ listingrequirements; and (iii) obtain shareholder approval prior to effectuatinga reverse stock split.

 

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

 

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

 

TheCompany is accounting for the Warrants, issued in connection with theDebenture, as derivative liabilities in accordance with SFAS 133, “Accountingfor Derivative Instruments and Hedging Activities” and EITF 00-19. The warrantliability was valued at $1,464,459 at warrant issuance date. In accordance withEITF 00-19, the value of Warrants has been recorded as liability subject tomarked-to-market revaluation at each period end. At June 30, 2008, thewarrant liability was valued at $424,550.  The Company recorded a gain on the change in fair value of warrantliability of $1,039,907. The Company uses the Black Scholes model to value theliability. The assumptions used at January 8, 2008 and June 30, 2008included expected volatility of 118% and 80%, a risk free interest rate of3.16% and 3.34% and expected life of 5 and 4.5 years, respectively.

 

Thediscount attributable to the issuance date intrinsic value of the conversionfeature and fair value of Warrants totaling $2,998,918 is being amortized usingthe effective interest method over the term of the Debenture. During the sixmonths ended June 30, 2008, $181,863 of this discount was amortized toexpense.

 

Inconnection with this Debenture, the Company incurred financing cost of$290,000. This financing cost was capitalized and amortized over the life ofthe Debenture using the effective interest method. During the six months ended June 30,2008, $17,586 of the capitalized financing cost was amortized to expense.

 

As part of the transaction, the Company granted the investorsregistration rights with regard to: (i) the common shares issuable uponconversion of the Debentures; (ii) the common shares underlying theWarrants; and (iii) the common shares issuable as interest paymentspursuant to the Debentures.  Pursuant tothe registration rights agreement, the Company was required to use its bestefforts to file a registration statement by June 7, 2008 and have it bedeclared effective by August 7, 2008. The registration statement covering the registrable shares was timelyfiled and declared effective on July 3, 2008.   The Company has a continuing obligation touse its best efforts to maintain the registration statement effective untilsuch time as all the registrable securities are eligible for resale withoutvolume or manner-of-sale restrictions and without current public informationpursuant to Rule 144.

 

On April 15, 2008, theCompany entered into a Securities Purchase Agreement with EMC Corporation(“EMC”). Pursuant to the terms of the agreement, EMC purchased $5 million ofthe Company’s 8% Senior Secured Convertible Debenture (“Debenture”). TheDebenture: (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 atEMC’s option into shares of the Company’s common stock at $2.48 per share, (iv) issecured by all of the Company’s assets, including inventory, receivables, unencumberedequipment and intellectual property, and (v) has a forced conversionfeature which allows the Company to force the conversion of the Debenture ifthe Company’s common stock trades above $5.00 for 20 consecutive trading days.Such a forced conversion may be limited by contractual restrictions on theamount of the Company’s common stock which EMC may own and certain otherconditions. The Company also agreed to issue EMC five-year Common StockPurchase Warrants to purchase 1,008,064 shares of the Company’s common stock atan exercise price of $2.728 per share. The Company is using the net proceeds ofthe financing for working capital requirements and to pay down certainobligations. The Debenture also contains customary events of default provisions.As part of the transaction, the Company agreed to: (i) maintain monthlyburn rate at $600,000 or below, (ii) be compliant with NASDAQ listing 

 

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requirements; and (iii) obtain shareholderapproval prior to effectuating a reverse stock split and for the issuance ofadditional shares of the Company’s common stock. Both the conversion price ofthe Debenture and the exercise price of the Warrants are subject to“full-ratchet” price protection in the event of stock issuances below theirrespective conversion or exercise prices, except for specified exemptedissuances 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 aregistration statement covering the shares of common stock issuable upon theconversion of the Senior Secured Convertible Debenture, exercise of the CommonStock 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 executedagreements prohibiting the sales of the Company’s common stock by them until October 31,2008. In connection with the transaction, the Company also secured votingagreements from its officers, directors and 10% shareholders approving thetransaction in the event that the Company is required to seek such approvalpursuant to the rules of the NASDAQ.

 

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

 

Upon review of EITF 00-19, “Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock”, paragraphs 12-32, the Company concluded that all applicablerequirements for equity treatment on the conversion feature were met. Theintrinsic value of the conversion feature amounting to $1,703,494 wascalculated in accordance with EITF 00-27 and recorded as additional paid-incapital and a corresponding reduction of the carrying value of the Debenture.

 

The Company is accounting for the Warrants, issuedin connection with the Debenture, as derivative liabilities in accordance withSFAS 133, “Accounting for Derivative Instruments and Hedging Activities” andEITF 00-19. The warrant liability was valued at $1,622,848 at warrant issuancedate. In accordance with EITF 00-19, the value of Warrants has been recorded asliability subject to marked-to-market revaluation at each period end. At June 30,2008, the warrant liability was valued at $638,201.   The Company recorded a gain on the change infair value of warrant liability of $984,647. The Company uses the Black-Scholesmodel to value the liability. The assumptions used at April 15, 2008 and June 30,2008 included expected volatility of 80% and 80%, a risk free interest rate of2.68% and 3.34% and expected life of 5 and 4.8 years, respectively.

 

The discount attributable to the issuance dateintrinsic value of the conversion feature and fair value of Warrants totaling$3,326,342 is being amortized using the effective interest method over the termof the Debenture. During the six months ended June 30, 2008, $132,965 ofthis discount was amortized to expense.

 

In connection with this Debenture, the Companyincurred financing cost of $237,500. This financing cost was capitalized andamortized over the life of the Debenture using the effective interest method.During the six months ended June 30, 2008, $9,484 of the capitalizedfinancing cost was amortized to expense.

 

As part of the transaction, the Companygranted the investors registration rights with regard to: (i) the commonshares issuable upon conversion of the Debentures;  (ii) the common shares underlying theWarrants; and (iii) the common shares issuable as interest paymentspursuant to the Debentures.  Pursuant tothe registration rights agreement, the Company was required to use its bestefforts to file a registration statement by June 7, 2008 and have it bedeclared effective by August 7, 2008. The registration statement covering the registrable shares was timelyfiled and declared effective on July 3, 2008.   The Company has a continuing obligation touse its best efforts to maintain the registration statement effective untilsuch time as all the registrable securities are eligible for resale withoutvolume or manner-of-sale restrictions and without current public informationpursuant to Rule 144.

 

**NOTE 12- SUBSEQUENT EVENT**

 

On July 16, 2008, Innovative CardTechnologies, Inc. (“Company”) received notice from the NASDAQ that it wasnot in compliance with Marketplace Rules for continued listing.  Specifically, the market value of Company’slisted securities is below $35,000,000 as required for continued inclusion byMarketplace Rule 4310(c)(3)(B) (“Rule”).  Therefore, in accordance with Marketplace Rule4310(c)(8)(C), the Company was provided until August 15, 2008, to regaincompliance.  On August 19, 2008,Innovative Card Technologies, Inc. (NASDAQ: INVC) received a notice ofnon-compliance from the Listing Qualifications Staff (the “Staff”) of TheNASDAQ Stock Market indicating that the Company did not regain compliance withthe minimum $35,000,000 market value of listed securities requirement set forthin Marketplace Rule 4310(c)(8)(B).  As aresult, the Company’s securities are subject to delisting from The NASDAQCapital Market.  The Company has appealedthe determination of the Staff and has scheduled a hearing for October 23, 2008with the NASDAQ Hearings Panel (the “Panel”). The delisting action has beenstayed pending a final written decision by the Panel.  Additionally, the Company does not meet thealternative requirements provided for in Marketplace Rules 4310(c)(3)(A) or4310(c)(3)(C) dealing with shareholders’ equity and net income requirements,respectively.  In the event the Companyis delisted, it will be in default under the Securities Purchase Agreements andDebentures discussed in Note 11 above.

 

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**ITEM 1A.**  **RISK FACTORS**

 

*Thisinvestment has a high degree of risk. Before you invest you should carefullyconsider the risks and uncertainties described below and the other informationin this report.  If any of the followingrisks actually occur, our business, operating results and financial conditioncould be harmed and the value of our stock could go down. As a result, youcould lose all or a part of your investment.*

 

You should carefullyconsider the risks described below as well as other information provided to youin this document.  The risks anduncertainties described below are not the only ones facing the Company.Additional risks and uncertainties not presently known to us or that wecurrently believes are immaterial may also impair our business operations. Ifany of the following risks actually occur, our business, financial condition orresults of operations could be materially adversely affected, the value of ourcommon stock could decline, and you may lose all or part of your investment.

 

***We are an early stage company with an unproven business strategy. Ourlimited history of operations makes evaluation of our business and prospectsdifficult.***

 

Our business prospects aredifficult to predict because of our limited operating history, early stage ofdevelopment and unproven business strategy. Since our incorporation on November 22,2002, we have primarily been and continue to be involved in development of productsusing our power inlay technology and marketing these products to industrypartners. In 1998, our founder commenced commercialization of our firstproduct, the LensCard, and entered into license agreements with banks andcredit card issuers, most of which have terminated. After discovering thepossibility of placing power into an International Organization of Standards(ISO) compliant card, we began to focus our efforts on the development of ourpower inlay technology and not on the marketing of the LensCard. For thesereasons, we expect that future orders for the LensCard will be insignificant.We closed our first commercial sale of our InCard DisplayCard, which uses ourpower inlay technology, in the fourth quarter of 2007. Although we believe thatour power inlay technology and products under development have significantprofit potential, we may not attain profitable operations and may not succeedin realizing our business objectives.

 

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

 

Our auditors have added anexplanatory paragraph to their opinion on our financial statements for the yearended December 31, 2007 because of concerns about our ability to continueas a going concern. These concerns arise from the fact that we have not yetestablished an ongoing source of revenues sufficient to cover our operatingcosts and that we must raise additional capital in order to continue to operateour business. If we fail to generate positive cash flows or obtain additionalfinancing when required, we may have to modify, delay or abandon some or all ofour business and expansion plans.

 

***We have an accumulated deficit of $30,830,339 as of June 30, 2008and we may never achieve profitability***

 

We have incurred significantnet losses every year since our inception, including net losses of $2,763,156,$14,333,622 and $6,866,614 for the six months ended June 30, 2008 and forthe fiscal years ending December 31, 2007 and 2006, respectively. As of June 30,2008, we had an accumulated deficit of $30,830,339. These losses have resultedprincipally from expenses incurred in our research and development programs andgeneral and administrative expenses. To date we have not generated significantrevenues. We have used capital raised in October 2005, May 2006, January 2008and April 2008 to sustain operations through the date of this report. Weanticipate that we will continue to incur substantial operating losses based onprojected sales revenues less manufacturing, general and administrative andother operating costs for an indefinite period of time. However, we cannotassure you that we will ever be profitable.

 

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

 

We believe that our currentcash, combined with anticipated revenue collections, will be sufficient to fundour operations through the middle of the fourth quarter of this year.  Wecurrently do not have any binding commitments for, or readily available sourcesof additional financing, and we cannot assure you that such funding willbe available at all or available on terms acceptable to us.  As we are in the early stage of manufacturingand have not sold substantial quantities of our products, we are unable todetermine the amount of additional capital we will need to become successful.Unless we are able to generate significant sales from the InCard DisplayCardthat cover the manufacturing costs and operating overhead, we will continue toincur net losses that exceed our revenue.

 

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

 

We obtain the battery, a keycomponent for our power inlay technology, from a single source on a purchaseorder basis from Solicore, Inc. In the event of a disruption ordiscontinuation in supply, we could not obtain replacement batteries on atimely basis, which would disrupt our operations, delay production for up toone year and impair our ability to manufacture and sell our products.

 

We obtain the display, a keycomponent for the InCard DisplayCard, from a single source, SmartDisplayer,under a written agreement. In the event of a disruption or discontinuation insupply, we could not obtain replacement displays on a timely basis, which woulddisrupt our operations, delay production for up to one year and impair ourability to manufacture and sell our InCard DisplayCard.

 

We assemble our InCardDisplayCard, using a single source, NagraID, under a written agreement byissuing written purchase orders that we pay in advance. We believe that wewould be unable to obtain on a timely basis alternative sources for assembly inthe event of a disruption, which would disrupt our operations, delay productionfor up to one year and impair our ability to manufacture and sell our InCardDisplayCard.

 

Our dependence upon outsidesuppliers exposes us to risks, including:

 

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

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

·                     the potential inability of our suppliers toobtain required components or products;

·                     reduced control over pricing, quality andtimely delivery, due to the difficulties in switching to alternative suppliers;

·                     the potential delays and expense of seekingalternative sources of suppliers; and

·                     increases in prices of key components.

 

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

 

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

 

·                     mass produce the InCard DisplayCard atsignificantly lower cost;

·                     continue to fund research and developmentendeavors;

·                     complete development of new products; and

·                     successfully introduce and commercialize newproducts.

 

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

 

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

 

Establishment of patents andother proprietary rights by us and our suppliers is important to our successand our competitive position. Performance in the payment card industry candepend, among other factors, on patent protection. Our policy is to identifypatentable inventions developed by our company, and to seek to acquire patent rightsfor such inventions. We mainly develop and patent technology in the fields ofcard enhancements and methods of card manufacturing. We seek to obtain areasonably broad territorial protection for our patented technologies. Weusually file initial patent applications in the United States, and subsequentlyfile corresponding applications in   foreign countries depending on therelevant circumstances. We may elect to forego patent protection for some ofour proprietary technologies   and treat such technologies as tradesecrets. Despite our efforts to establish and protect our patents, tradesecrets or other proprietary rights, unauthorized parties may attempt to copyaspects of our technology or to obtain and use information that we regard asproprietary. In addition, the laws of some foreign countries do not protect ourproprietary rights as much as the laws of the United States protect them. Ourmeans of establishing and protecting our proprietary rights may not beadequate, and our competitors may independently develop similar technology,duplicate our products or design around our patents or our other proprietaryrights.  We do not have patent protection for our InCard DisplayCard.

 

Due to the importance ofproprietary technology in the payment card industry, our business involves arisk of overlap with third party patents and subsequent litigation withcompetitors or patent-holders. Any claims, with or without merit, could betime-consuming, result in costly litigation, or cause us to enter into licensingagreements

 

***We depend on key personnel in a competitive market for skilledemployees, and failure to retain and attract qualified personnel couldsubstantially harm our business.***

 

We rely to a substantialextent on the management, marketing and product development skills of our keyemployees and consultants, particularly Steven Delcarson, our President andChief Executive Officer, Charles Caporale, our Chief Financial Officer, CraigNelson, who supervises the manufacturing and testing of the InCard DisplayCard,Vincent Schiavo, our global head of sales, and Mark Poidomani, our chieftechnology officer, to formulate and implement our business plan, including thedevelopment of our power inlay technology. Our success depends to a significantextent upon our ability to retain and attract key personnel. Competition foremployees can be intense in the payment card industry, and the process oflocating key personnel with the right combination of skills is often lengthy.The loss of the services of our key personnel may significantly delay orprevent the achievement of product development and could have a materialadverse effect on us.

 

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

 

To our knowledge, noenterprise or on-line banking token issuers have adopted power-based cardenhancements to date using our power inlay technology on a mass quantity basis.As a result, our ability to enable enterprises to improve and add cardfunctionality, reduce attrition and increase acquisition rates, and enhancesecurity and anti-fraud protection for customers through power-based cardenhancements has yet to be proven. The commercial success of our futureproducts will depend upon the adoption of our power inlay technology as apreferred method of applying card enhancements to payment cards. In order to besuccessful, our future products must meet the technical and cost requirementsfor card enhancements within the payment card industry. Market acceptance willdepend on many factors, including:

 

·                     our ability to convince prospective strategicpartners and customers to adopt our products;

·                     the willingness and ability of prospectivestrategic partners and customers to adopt our products; and

·                     our ability to sell and service sufficientquantities of our products.

 

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

 

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*** ***

***We have granted third parties substantial marketing rights to certainof our products and products under development. If the third parties are notsuccessful in marketing our products, we may not be able to commercialize ourproducts.***

 

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

 

***We may experience customer concentration in the enterprise and on-linebanking marketplace, which may expose us to all of the risks faced by ourpotential material customers.***

 

Until and unless we securemultiple customer relationships in the enterprise and on-line bankingmarketplaces, we may experience periods during which we will be highlydependent on one or a limited number of customers. Dependence on a single or afew customers will make it difficult to satisfactorily negotiate attractiveprices for our products and will expose us to the risk of substantial losses ifa single dominant customer stops conducting business with us. Moreover, to theextent that we may be dependent on any single customer, we could be subject tothe risks faced by that customer to the extent that such risks impede thecustomer’s ability to stay in business and make timely payments to us.

 

***The power inlay technology has not been proven in full scaleproduction. Failure to manufacture in mass production may have a materialnegative effect on our business strategy and operations***.

 

Our power inlay technologyhas not been produced in mass production quantities as of yet.   We are applying our own resources andworking in cooperation with other companies that have specialized technicalexpertise related to the power inlay technology for thin, flexible non-paymentcards. We expect to enter into agreements that will grant us ownership orexclusive license rights to the manufacturing process of the power inlaytechnology for use in credit and other information-bearing plastic cards.Failure to secure or maintain exclusive rights or failure to successfullytransition to full scale production, without the use of proprietary technologyof others, may have a material negative effect on our business strategy andoperations.

 

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

 

To be successful, we mustmanufacture, or contract for the manufacture of, our future products incompliance with industry standards and on a timely basis, while maintainingproduct quality and acceptable manufacturing costs. As discussed in the risk factorabove, we are working in cooperation with other companies that have specializedtechnical expertise related to the manufacturing process of our power inlaytechnology for the InCard DisplayCard. We also currently use a limited numberof sources for most of the supplies and services that we use in themanufacturing of our power inlay technology and prototypes. Our manufacturingstrategy presents the following risks:

 

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

·                     if we need to change to other commercialmanufacturers, any new manufacturer would have to be educated in, or developsubstantially equivalent processes necessary for, the production of ourproducts;

·                     if market demand for our products increasessuddenly, our current manufacturers might not be able to fulfill our commercialneeds, which would require us to seek new manufacturing arrangements and mayresult 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 themanufacturing processes or new manufacturing processes for our products.

 

Any of these factors coulddelay commercialization of our products under development, entail higher costsand result in our being unable to effectively sell our products.

 

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

 

We are not aware of anyproduct that is being mass produced (or in the final stages of development) inthe same credit card form factor as our InCard DisplayCard that incorporatesthe token technology. However, there are companies creating tokens and randomnumber generators for use in dual-factor authentication (as an item separatefrom the transaction card). For example, RSA, Vasco, and VeriSign token devicesmay be cost competitive to our technology but are not in a credit card formfactor. Smart Card, biometrics, and software programs can provide multi-factorauthentication competitive to our InCard DisplayCard.

 

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We believe that theprincipal competitive factors that affect the market for tokens includeconvenience, price, quality/reliability, ease of use, and distribution cost. Wecannot assure you that we will be able to maintain our competitive positionagainst current and potential competitors, especially those with significantmarketing, service, support, technical and other competitive resources.

 

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

 

**RisksRelated to our Securities**

 

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

 

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

 

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

 

As of August 4, 2008,we have 28,495,256 shares of common stock outstanding. Of theseshares, 25,674,809 can be traded pursuant to a prospectus or via atransaction pursuant to Rule 144 under the Securities Act of 1933. On afully diluted basis, including shares issuable upon exercise of warrants andstock options, we have 43,358,572 shares.

 

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

 

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

 

Our certificate ofincorporation currently authorizes our board of directors to issue up to75,000,000 shares of common stock and 5,000,000 shares of preferred stock. Asof August 4, 2008, after taking into consideration our outstanding commonand preferred shares, our board of directors will be entitled to issue up to46,504,744 additional common shares and 5,000,000 preferred shares. The powerof the board of directors to issue these shares of common stock, preferredstock or warrants or options to purchase shares of our stock is generally notsubject to stockholder approval.

 

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

 

***Our incorporation documents and Delaware law may inhibit a takeoverthat stockholders consider favorable and could also limit the market price ofyour stock, which may inhibit an attempt by our stockholders to change ourdirection or management.***

 

Our amended and restatedcertificate of incorporation and bylaws contain provisions that could delay orprevent a change in control of our company. Some of these provisions:

 

·                     authorize our board of directors to determinethe rights, preferences, privileges and restrInCardions granted to, or imposedupon, the preferred stock and to fix the number of shares constituting anyseries and the designation of such series without further action by ourstockholders;

·                     prohibit stockholders from calling specialmeetings;

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

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

·                     prohibit stockholder action by writtenconsent, requiring all stockholder actions to be taken at a meeting of ourstockholders.

 

In addition, we are governedby the provisions of Section 203 of the Delaware General Corporate Law.These provisions may prohibit large stockholders, in particular those owning15% 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 ourmanagement or the direction in which we are heading. These and other provisionsin our amended and restated certificate of incorporation and bylaws and underDelaware law could reduce the price that investors might be willing to pay forshares of our common stock in the future and result in the market price beinglower than it would be without these provisions.

 

***New rules, including those contained in and issued under theSarbanes-Oxley Act of 2002, may make it difficult for us to retain or attractqualified officers and directors, which could adversely affect the managementof our business and our ability to obtain or retain listing of our commonstock.***

 

We may be unable to attractand retain qualified officers, directors and members of board committeesrequired to provide for our effective management as a result of the recent andcurrently proposed changes in the rules and regulations that governpublicly held companies, including, but not limited to, certifications fromexecutive officers and requirements for financial experts on the board ofdirectors. The perceived increased personal risk associated with these recentchanges may deter qualified individuals from accepting these roles. Theenactment of the Sarbanes-Oxley Act of 2002 has resulted in the issuance of aseries of new rules and regulations and the strengthening of existing rules andregulations by the Securities and Exchange Commission (the “SEC”). Further,certain of these recent and proposed changes heighten the requirements forboard or committee membership, particularly with respect to an individual’sindependence from the corporation and level of experience in finance andaccounting matters. We may have difficulty attracting and retaining directorswith the requisite qualifications. If we are unable to attract and retainqualified officers and directors, the management of our business could beadversely affected.

 

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***Our management has concluded that, as of December 31, 2007, ourdisclosure controls and procedures were not effective in recording, processing,summarizing and reporting, on a timely basis, information required to bedisclosed by the Company in the reports that it files or submits under theExchange Act and were not effective in ensuring that information required to bedisclosed by the Company in the reports that it files or submits under theExchange Act is accumulated and communicated to the Company’s management, asappropriate to allow timely decisions regarding required disclosure. If we failto implement new or improved disclosure controls, investors could loseconfidence in the reliability of our financial statements, which could resultin a decrease in the value of our common stock.***

 

Our management, with theparticipation of our Chief Executive Officer (“CEO”) and Chief FinancialOfficer (“CFO”), has evaluated the effectiveness of the Company’s disclosurecontrols and procedures (as such term is defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”)) as of December 31, 2007. Based on such evaluation which disclosednumerous material weaknesses, our CEO and CFO have concluded that, as of December 31,2007, the Company’s disclosure controls and procedures were not effective inrecording, processing, summarizing and reporting, on a timely basis,information required to be disclosed by the Company in the reports that itfiles or submits under the Exchange Act and were not effective in ensuring thatinformation required to be disclosed by the Company in the reports that itfiles or submits under the Exchange Act is accumulated and communicated to theCompany’s management, including the Company’s CEO and CFO, as appropriate toallow timely decisions regarding required disclosure. If we fail to implementnew or improved disclosure controls, investors could lose confidence in thereliability of our financial statements, which could result in a decrease inthe value of our common stock.

 

***We have identified numerous material weaknesses in our internal controlover financial reporting. If we fail to implement new or improved internalcontrols, investors could lose confidence in the reliability of our financialstatements, which could result in a decrease in the value of our common stock.***

 

As directed by Section 404of the Sarbanes-Oxley Act of 2002, the SEC adopted rules requiring publiccompanies to include a report of management on internal control over financialreporting in their Annual Reports on Form 10-K. This report is required tocontain an assessment by management of the effectiveness of a company’sinternal control over financial reporting. Our non-affiliated market capitalizationqualified us as a non-accelerated filer until the end of the 2007 fiscal year.As a result, we were required to include our management’s report on internalcontrol over financial reporting in our Annual Report on Form 10-KSB forthe 2007 fiscal year and were not required to include our auditors’ attestationreport on our internal control over financial reporting.  Based on our June 30, 2008 marketcapitalization, we are once again a non-accelerated filer and will not berequired to include our auditor’s attestation report in our 2008 fiscal yearfiling on Form 10-K.  As discussedin Item 8A to our Annual Report on Form 10-KSB/A filed with the SEC on June 18,2008, we have concluded that, as of December 31, 2007, our internalcontrol over financial reporting was not effective and have identified a numberof material weaknesses in our internal control over financial reporting. Whilewe intend to remedy these weaknesses during the current fiscal year, we may beunable to do so. If we fail to implement required new or improved controlsthere may be an adverse reaction in the financial markets due to a loss ofconfidence in the reliability of our financial statements, which could causethe market price of our common stock to decline.

 

***If we trigger an “event of default” under our debt agreements enteredinto in January 2008 and April 2008, the debt holders could requireus to repay the loan in full and force a sale of all of our assets to do so,which could cause our common shareholders to incur a total loss on theirinvestments in us.***

 

Our debt agreements, enteredinto in January 2008 and April 2008 in connection with the sale ofour 8% Senior Secured Debentures, require us to adhere to certain covenantsrelating to continued NASDAQ listing and the level of operating expense cashburn to avoid triggering an “event of default.” Failure to remain in compliancecould prompt investors to call the debentures and demand immediaterepayment.  We have been notified that ourlisted securities are subject to delisting from The NASDAQ Capital Market due to our failure to comply withMarketplace Rule 4310(c)(3)(B).  Wehave appealed  the finding and a hearingis scheduled for October 23, 2008 with the NASDAQ Hearings Panel(the “Panel”). The delisting action has been stayed pending a final writtendecision by the Panel.  If we lose ourappeal we will be delisted which will result in an event of default under thedebentures. In such instance, we couldbe forced to seek bankruptcy protection which would result in a total loss of ourcommon shareholders’ investment.

 

***Failure to satisfyNASDAQ Capital Market listing requirements will result in our common stockbeing delisted from the NASDAQ Capital Market.***

 

Our common stock is currently listed on the NASDAQCapital Market under the symbol “INVC.” For continued inclusion on the NASDAQCapital Market, we must maintain, among other requirements, the market value ofour listed securities above $35,000,000 or approximately $1.23 per share basedon current shares outstanding.   On July 16, 2008 we

 

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were informed by NASDAQ thatwe did not meet the continued listing requirement.   Specifically, the market value of our listedsecurities is below $35,000,000 as required for continued inclusion byMarketplace Rule 4310(c)(3)(B) (“Rule”).  Therefore, in accordance with Marketplace Rule 4310(c)(8)(C),we were provided until August 15, 2008 to regain compliance.  On August 19, 2008, we received a noticeof non-compliance from the Listing Qualifications Staff (the “Staff”) of TheNASDAQ Stock Market indicating that we did not regain compliance with theminimum $35,000,000 market value of listed securities requirement set forth inMarketplace Rule 4310(c)(8)(B).  Asa result, our securities are subject to delisting from The NASDAQ CapitalMarket.  The Company has appealed thedetermination of the Staff and has scheduled a hearing for October 23,2008 with the NASDAQ Hearings Panel (the “Panel”). The delisting action hasbeen stayed pending a final written decision by the Panel.  Additionally, the Company does not meet thealternative listing requirements provided for in Marketplace Rules 4310(c)(3)(A) or4310(c)(3)(C) dealing with shareholders’ equity and net income requirements,respectively.  In the event the Companyis delisted, it will be in default under the Securities Purchase Agreements andDebentures discussed in Note 11 to our financial statements.  Ifour common stock were delisted from the NASDAQ Capital Market, the trading ofour common stock, if any, may be conducted in the over-the-counter market inthe so-called “pink sheets” or, if available, the National Association ofSecurities Dealer’s “Electronic Bulletin Board.” Consequently, broker-dealersmay be less willing or able to sell and/or make a market in our common stock.Additionally, an investor would find it more difficult to dispose of, or toobtain accurate quotations for the price of, our common stock. A delistingwould likely also make it more difficult for us to raise funds through the saleof our securities.

 

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

The following Management’sDiscussion and Analysis of our Financial Condition and Results of Operationsshould be read in conjunction with the consolidated financial statements andnotes thereto included as part of this Quarterly Report. This report containsforward-looking statements that are based upon current expectations. Wesometimes identify forward-looking statements with such words as “may”, “will”,“expect”, “anticipate”, “estimate”, “seek”, “intend”, “believe” or similarwords concerning future events. The forward-looking statements containedherein, include, without limitation, statements concerning future revenuesources and concentration, gross profit margins, selling and marketingexpenses, research and development expenses, general and administrativeexpenses, capital resources, additional financings or borrowings and additionallosses and are subject to risks and uncertainties that could cause actualresults to differ materially from the results contemplated by theseforward-looking statements. We also urge you to carefully review the riskfactors set forth in other documents we file from time to time with theSecurities and Exchange Commission, particularly our Form 10-KSB andamendments thereto for the year ended December 31, 2007.

 

**OVERVIEW**

 

Since 2002, we have continuedto develop our power inlay technology that is designed to bring power-basedapplications to the enterprise market and on-line banking market. Our presentfocus is the InCard DisplayCard power inlay technology which consists of abattery, circuit, and switch that can power applications on credit card sizedcards and other information-bearing plastic cards. We have devoted a majorityof our efforts to completing the development of our power inlay technology,initiating marketing and raising the financing required to do so and fund ourexpenses. We have generated limited revenues. Prior to the fourth quarter of2007 these revenues derived primarily from licensing agreements of our LensCardproduct, most of which have terminated. At this time, we have no plans to renewthe LensCard licensing agreements or to further market or sell the LensCard,unless requested by a customer.

 

Since inception, we havebeen unprofitable. We incurred net losses of $2,763,156 and $4,863,031 for thesix months ending June 30, 2008 and 2007, respectively. As of June 30,2008, we had an accumulated deficit of $30,830,339.  Our continued existence is dependent upon ourability to generate sales of the InCard DisplayCard or, if we are unable to doso in sufficient quantity to cover our expenses, to obtain additionalfinancing. We further anticipate that after such introduction of the InCardDisplayCard in 2008, we will continue to incur net losses due to our costsexceeding our revenues for an indefinite period of time. Our capital requirementsfor the next 12 months for acquisition of inventory, retention and hiring ofkey personnel, implementation of a sales force for our products, and furtherresearch and development relating to the production of our power inlaytechnology will continue to be significant. In addition, our gross margin is greatly impacted by productionvolume.  At low levels of production ourgross margin is in the single digits and may be negative.  At the higher volume levels our gross margincan be as high as 35% to 40%.  To date,our operations have been funded primarily through equity and debt financingstotaling $30,303,691.

 

We believe that our currentcash, combined with anticipated revenue collections, will be adequate to fundour operations until mid-way through the fourth quarter 2008.  If we are unable to raise additionalfinancing by that date, we will be forced to curtail our operations or seekbankruptcy protection.  We anticipatethat we will not be able to generate sales of the InCard DisplayCard in substantialquantities until the second half of 2008 to support our cash needs since thesales cycle for that product is longer than originally anticipated.

 

Our backlog,which consists of orders received but not yet shopped, totals $1.2 million at June 30,2008, most of which we expect to deliver in the third and fourth quarter of2008.

 

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

 

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

 

Our discussion and analysisof our financial condition and results of operations are based on ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the U.S. The preparation of thesefinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets, liabilities, revenues and expenses for eachperiod. The following represents a summary of our critical accounting policies,defined as those policies that we believe are the most important to theportrayal of our financial condition and results of operations and that requiremanagement’s most difficult, subjective or complex judgments, often as a resultof the need to make estimates about the effects of matters that are inherentlyuncertain.

 

Revenue recognition. Werecognize revenues in accordance with SEC Staff Accounting Bulletin No. 104(“SAB 104”). Revenues are recognized when persuasive evidence of an arrangementexists, delivery has occurred or services have been rendered, the price isfixed and determinable and collectability is reasonably assured.  Revenue is not recognized on product salestransacted on a test or pilot basis. Instead, receipts from these types of transactions offset marketingexpenses.  Revenue from royalties isrecognized with the passage of time in accordance with the underlyingagreement.  We recognize certainlong-term contracts using the completed-contract method in accordance with SOP81-1, “Accounting for Performance of Construction-Type and CertainProduction-Type of Contracts.”

 

We have generated revenuefrom three sources: sale of the InCard DisplayCard, licensing of the LensCardto various credit card issuers and selling the LightCard to a credit cardissuer. The LensCard is composed of a credit card with a small magnifying lensembedded into the card. The LightCard is composed of a credit card that when abutton is pressed a small LED light is activated. We sell time-based licensesto various credit card issuers for the LensCard. We recognize royaltiesattributable to these time-based licenses as they are sold to the credit cardissuers’ customers. Royalty revenue is recognized when each LensCard is sold byan issuer in accordance with SAB 104.

 

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

 

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

 

Deferred revenue is recordedwhen the payments from a reseller are received by us prior to the sale of anInCard DisplayCard to the resellers’ customer.

 

Accounts receivableallowances. Our sales to date have been to large credit card issuers and wehave been successful in collecting for products and services. Consequently, wehave no allowances for doubtful accounts. We perform a regular review of our customeractivity and associated credit risks and do not require collateral from ourcustomers.

 

Warranty expense.  We estimate the cost associated with meetingour warranty obligations for the sale of our products.  The initial estimate and changes to the estimateare charged to cost of goods sold  at thetime of sale of the product.

 

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

 

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

 

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Valuation of IntangibleAssets and Long-Lived Assets. We assess the impairment of identifiableintangibles and long-lived assets whenever events or changes in circumstancesindicate that the carrying value may not be recoverable. Factors consideredimportant that could trigger an impairment review include, but are not limitedto, the following: a significant underperformance to expected historical orprojected future operating results, a significant change in the manner of theuse of the acquired asset or the strategy for the overall business, or asignificant negative industry or economic trend.  We assess the carrying value of long-livedassets in accordance with SFAS No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets.”

 

Stock Based Compensation. OnJanuary 1, 2006, we adopted SFAS No. 123 (R), “Share Based Payment,” whichestablishes standards for the accounting of transactions in which an entityexchanges its equity instruments for goods or services, primarily focusing onaccounting for transactions where an entity obtains employee services inshare-based payment transactions. SFAS No.123(R) requires a public entityto measure the cost of employee services received in exchange for an award ofequity instruments, including stock options, based on the grant-date fair valueof the award and to recognize it as compensation expense over the period theemployee is required to provide service in exchange for the award, usually thevesting period. SFAS No.123(R) supersedes the Company’s previousaccounting under Accounting Principles Board (APB) Opinion No. 25,Accounting for Stock Issued to Employees for periods beginning in fiscal year2006. In March 2005, the SEC issued Staff Accounting Bulletin (“SAB”) No. 107relating to SFAS No. 123(R). We have applied the provisions of SAB No.107in our adoption of SFAS No. 123(R).

 

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**RESULTS OFOPERATIONS**

 

**COMPARISONOF THE THREE MONTH PERIODS ENDED JUNE 30, 2008 AND JUNE 30, 2007**

 

**OVERVIEW**

 

Our financial results forthe three months ended June 30, 2008 reflect a net loss of $800,715, or$0.03 per share (basic and diluted), compared to a net loss of $2,656,224, or$0.09 per share (basic and diluted), for the three months ended June 30,2007.

 

The major factorscontributing to our decreased net loss of $800,715 during the three monthperiod ended June 30, 2008 were an increase in our gross margin of $334,641,a decrease in operating expenses of $214,096 and a decrease in the fair valueof our warrant liability as a result of the decline in our stock price.  Offsetting this was $419,978 of interestexpense associated with our 2008 financings.

 

Revenue.  In the 2008 period, revenue is from the saleof the InCard DisplayCard and the clamshell. In the 2007 period, revenue consists of royalties from theLensCard.  We believe that future revenuewill be primarily from the sales of the InCard DisplayCard; revenue fromLensCard royalties is expected to be negligible.

 

Total revenue increased from$1,089 for the three months ended June 30, 2007 to $800,209 for the threemonths ended June 30, 2008.  Theincrease is attributable to sales of the InCard DisplayCard and the clamshellin the current period.  For the threemonths ended June 30, 2007, revenue was from LensCard royalties.

 

Cost of goodssold - Cost of goods sold increased to $859,875 for the three months ended June 30,2008 from $395,396 for the same period in the prior year.  The components of cost of goods sold are asfollows:

 
| ** **                   | ** ** | **3 mos ended  June 30, 2008** | ** ** | **3 mos ended  June 30, 2007** | ** ** |
|------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|
| Cost of  finished goods sold |       | $                                   | 709,962    |                                | $          |   |   |
| Inventory  write-off (scrap) |       | 78,917                              |       |                                | 395,396    |   |
| Warranty  reserve            |       | 70,996                              |       |                                |       |
| Total cost  of goods sold    |       | $                                   | 859,875    |                                | $          | 395,396 |   |

 

No cost ofgoods sold is associated with LensCard royalties.

 

Administrative.Administrative expense consists of travel and marketing expenses, compensationexpense, administrative fees and depreciation and amortization expense.

 

Administrative expensedecreased to $1,656,715 for the three months ended June 30, 2008 from$1,832,454 for the three months ended June 30, 2007.  The major contributors to the reduction inadministrative expenses were a reduction in due diligence expenses related toour planned acquisition in the 2007 period of one of our suppliers, a reductionin travel and entertainment expenses and a reduction in marketing expenses.  Offsetting this was an increase in salary andrelated expenses and charges relating to a warrant issuance to our investorrelations consultant.  We anticipate thatadministrative expenses will remain relatively flat for the remainder of 2008.

 

Consulting expense.Consulting expense consists of payments made to independent contractors thatprovided services to us.

 

Consulting expense increasedto $134,427 for the three months ended June 30, 2008 from $115,739 in the2007 period.  We anticipate that ourconsulting expense will remain fairly constant for the remainder of the year.

 

Professional fees expense.Professional fees consist of amounts paid to our outside counsel, auditors andother outside services rendered to us.

 

Professional fees expensedecreased to $201,192 for the three months ended June 30, 2008 from$203,695 for the three months ended June 30, 2007.  We anticipate that professional fees willremain fairly steady for the remainder of 2008.

 

Research and Development.Research and development expense consists primarily of costs relating tofurther development of the InCard DisplayCard.

 

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Research and developmentcosts decreased to $118,539 for the three months ended June 30, 2008 from$173,081 for the three months ended June 30, 2007 primarily due to a shiftin focus from R&D to manufacturing.  Weexpect our research and development expenses to decrease for the remainder ofthe year.

 

Change in fair value ofwarrant liability and other income - Due to the decline in our stock price, thevaluation of our warrant liability decreased by $1,898,895 in the 2008 period.  We had no warrant liability at June 30,2007.  We also recognized a loss on thesublet of our previous office space of $120,796.

 

Interest income. Interestincome decreased to $11,703 for the three months ended June 30, 2008 from$63,152 for the three months ended June 30, 2007 due to the reduced cashon hand during the 2008 period.

 

Interest expense. Interestexpense increased to $419,978 for the three months ended June 30, 2008from $100 for the three months ended June 30, 2007.  The 2008 period interest relates to our $8.5million 8% senior secured convertible debentures issued in January and April 2008.  We had no debt during the 2007 period.

 

**COMPARISONOF THE SIX MONTH PERIODS ENDED JUNE 30, 2008 AND JUNE 30, 2007**

 

**OVERVIEW**

 

Our financial results forthe six months ended June 30, 2008 reflect a net loss of $2,763,156 or$0.10 per share (basic and diluted), compared to a net loss of $4,863,031, or$0.17 per share (basic and diluted), for the six months ended June 30,2007.

 

The major factors contributingto our decreased net loss of $2,763,156 for the six months ended June 30,2008 were an increase in gross margin of $340,103, a decrease in operatingexpenses of $563,839 and a decrease in the fair value of our warrant liabilityas a result of the decline in our stock price. Offsetting this was $585,359 of interest expense associated with our2008 financings.

 

Revenue.  In the 2008 period, revenue is from the saleof the InCard DisplayCard.  In the 2007period, revenue consists of royalties from the LensCard.  We believe that future revenue will beprimarily from the sales of the InCard DisplayCard; revenue from LensCardroyalties is expected to be negligible.

 

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Total revenue increased from$2,509 for the six months ended June 30, 2007 to $1,017,425 for the sixmonths ended June 30, 2008. The increase is attributable to sales of theInCard DisplayCard in the current period. For the six months ended June 30, 2007, revenue was from LensCardroyalties.

 

Cost of goodssold - Cost of goods sold increased to $1,070,209 for the six months ended June 30,2008 from $395,396 for the same period in the prior year.  The components of cost of goods sold are asfollows:

 
| ** **                  | ** ** | **6 mos ended  June 30, 2008** | ** ** | **6 mos ended  June 30, 2007** | ** ** |
|-----------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|
| Cost of finished goods sold |       | $                                   | 846,636    |                                | $          |   |   |
| Inventory write-off (scrap) |       | 84,664                              |       |                                | 395,396    |   |
| Warranty reserve            |       | 138,909                             |       |                                |       |
| Total cost of goods sold    |       | $                                   | 1,070,209  |                                | $          | 395,396 |   |
|                             |            |                                     |            |                                     |            |  |  |  |

 

No cost ofgoods sold is associated with LensCard royalties.

 

Administrative.Administrative expense consists of travel and marketing expenses, compensationexpense, administrative fees and depreciation and amortization expense.

 

Administrative expensedecreased from $3,344,329 for the six months ended June 30, 2007 to$3,046,646 for the six months ended June 30, 2008.  The major contributors to the reduction inadministrative expenses were a reduction in due diligence expenses related toour planned acquisition in the 2007 period of one of our suppliers, a reductionin travel and entertainment expenses, a reduction in marketing expenses and areduction in depreciation.  Offsettingthis was an increase in salary and related expenses and charges relating to awarrant issuance to our investor relations consultant.  We anticipate that administrative expenseswill remain relatively flat for the remainder of 2008.

 

Consulting expense.Consulting expense consists of payments made to an independent contractor thatprovided services to us.

 

Consulting expense increasedfrom $231,631 for the six months ended June 30, 2007 to $254,525 for thesame period in 2008.  We anticipate thatour consulting expense will remain fairly constant for the remainder of theyear.

 

Professional fees expense.Professional fees consist of amounts paid to our outside counsel, auditors andother outside services rendered to us.

 

Professional feesexpense decreased from $567,218 for the six months ended June 30,2007 to $449,223 for the six months ended June 30, 2008.  Professional fees expense decreased as theresult of a reduction in audit and accounting fees.  We anticipate that professional fees willremain fairly steady for the remainder of the year.

 

Research and Development.Research and development expense consists primarily of costs relating to thedevelopment of new credit card enhancements.

 

Research and developmentcosts decreased from $469,410 for the six months ended June 30, 2007 to$298,355 for the six months ended June 30, 2008 due to the termination ofour agreement with nCryptone for technical support and a shift in focus fromR&D to manufacturing.  We expect ourresearch and development expenses to decrease for the remainder of the year.

 

Change in fair value ofwarrant liability - Due to the decline in our stock price, the valuation of ourwarrant liability decreased by $2,024,556 in the 2008 period.  We had no warrant liability at June 30,2007.  We also recognized a loss on thesublet of our previous office space of $120,796.

 

Interest income. Interestincome decreased from $142,692 for the six months ended June 30, 2007 to$20,776 for the six months ended June 30, 2008 due to the reduced cash onhand during the 2008 period.

 

Interest expense. Interestexpense increased from $248 for the six months ended June 30, 2007 to$585,359 for the six months ended June 30, 2008.  The 2008 period interest relates to our $8.5million 8% senior secured convertible debentures issued in January and April 2008.  We had no debt during the 2007 period.

 

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**LIQUIDITY AND CAPITAL RESOURCES**

 

Our principal sources of liquidity have been cash and cash equivalentbalances, which were $1,680,060 at June 30, 2008 and $4,208,895 as of June 30,2007. Since our inception, we have incurred significant losses, and as of June 30,2008 and 2007 we had an accumulated deficit of $30,830,339 and $18,596,592,respectively.

 

Net cash used in operating activities was $6,668,555 for the six monthsended June 30, 2008 as compared with $4,012,445 for the six months ended June 30,2007. This increase in cash used was primarily due to an increased use of workingcapital to build inventory in anticipation of increased sales and reduce tradeaccounts payable to a more current level.

 

Net cash used in investing activities was $13,485 for the six monthsended June 30, 2008 as compared with $64,509 for the six months ended June 30,2007.  We purchased less production andtesting equipment in the 2008 period.

 

Net cash provided by financing activities was $8,022,500 for the sixmonths ended June 30, 2008 as compared to $15,753 for the six months endedJune 30, 2007. The increase is the result of our issuance of $8.5 millionof 8% senior secured convertible debentures in January and April 2008.

 

**EQUITY AND DEBT FINANCINGS AND ACCOUNTS PAYABLE**

 

To date, our operations have been funded primarily through equity anddebt financings totaling $30,303,691. We believe that our current cash, combinedwith anticipated revenue collections, will be sufficient to fund our operationsuntil mid-way through the fourth quarter of 2008.  If we are able to successfully sell theInCard DisplayCard in substantial quantities during the third and fourthquarters of 2008, we may be able to continue operations through the spring of2009.  Our significant equity and debtfinancings from January 1, 2006 through May 6, 2008 are describedbelow.

 

On May 30, 2006, we issued 3,785,500 shares of common stock at aprice of $3.00 per share to accredited investors pursuant to a privateplacement for total gross proceeds of $11,356,500. In connection with thetransaction, T.R. Winston & Company served as placement agent for thesecurities sold and received a net commission of 5% of the total gross proceedsand a warrant to purchase 113,565 shares of our common stock at an exerciseprice 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 isoutstanding, in the event we issue common shares or common share equivalentsfor a price less than $3.00 per share. No adjustment is required in the event of certain exempt issuances asmore fully contained in the warrant.  Thewarrant exercise price was reset following the April 15, 2008 financingdescribed below.

 

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

 

On January 8, 2008, we entered into a Securities PurchaseAgreement (the “Purchase Agreement”) with 13 institutional and accreditedinvestors (the “Purchasers”). Pursuant to the terms of the Purchase Agreement,the Purchasers purchased $3.5 million of our 8% Senior Secured Convertible Debenture(“Debenture”). The Debenture: (i) bears interest at 8% per year, paidquarterly in cash or registered common stock, at our discretion; (ii) hasa maturity of January 8, 2011, (iii) is convertible at the holder’soption into shares of our common stock at $2.50 per share, (iv) is securedby all of our and our subsidiary’s assets including inventory, receivables,unencumbered equipment and intellectual property under the terms of a SecurityAgreement, and (v) has a forced conversion feature which allows us toforce the conversion of the Debenture if our common stock trades above $5.00for 20 consecutive trading days and certain other conditions are met. We alsoissued to the Purchasers five-year common stock purchase warrants to purchase700,000 shares of our common stock at an exercise price of $2.75 per share (the“Warrants”). We used the net proceeds of the financing for our working capitalrequirements and to pay down certain obligations.  Both the conversion price of the Debentureand the Warrant strike price were reset following the April 15, 2008financing discussed below.

 

On April 15, 2008, we entered into a Securities Purchase Agreementwith EMC Corporation (“EMC”). Pursuant to the terms of the agreement, EMCpurchased $5 million of our 8% Senior Secured Convertible Debenture(“Debenture”). The Debenture: (i) bears interest at 8% per year, paidquarterly in cash or, subject to certain conditions, registered shares of ourcommon stock; (ii) has a maturity of April 15, 2011, (iii) isconvertible at EMC’s option into shares of our common stock at $2.48 per share,(iv) is secured by all of our and our subsidiary’s assets, includinginventory, receivables, unencumbered equipment and intellectual property, and (v) hasa forced conversion feature which allows us to force the conversion of theDebenture if our common stock trades above $5.00 for 20 consecutive tradingdays. Such a forced conversion may be limited by contractual restrictions onthe amount of our common stock which EMC may own and certain other conditions.We also agreed to issue EMC five-year Common Stock Purchase Warrants topurchase 1,008,064 shares of our common stock at an exercise price of $2.728per share. We expect to use the net proceeds of the financing for our workingcapital requirements and to pay down certain obligations.

 

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**FUTURENEEDS**

 

We believe that our currentcash of $630,000 as of August 1, 2008, combined with anticipated revenuecollections, will provide us with sufficient resources to fund our operationsmid-way through the fourth quarter 2008. If we are able to successfully sell the InCard DisplayCard insubstantial quantities during the third and fourth quarters of 2008 we may beable to continue operations through the spring of 2009.  If we need additional capital, we do not haveany binding commitments for, or readily available sources of, additionalfinancing. Additional financing, whether through public or private equity ordebt financing, arrangements with stockholders or other sources to fundoperations, may not be available, or if available, may be on terms unacceptableto us. If we issue additional equity securities to raise funds, the ownershippercentage of our existing stockholders would be reduced. New investors maydemand rights, preferences or privileges senior to those of existing holders ofour common stock. Debt incurred by us would be senior to equity in the abilityof debt holders to make claims on our assets. The terms of any debt issuedcould impose restrictions on our operations. If adequate funds are notavailable to satisfy our capital requirements, our operations and liquiditycould be materially adversely affected.

 

**ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**

 

Notapplicable.

 

**ITEM 4.CONTROLS AND PROCEDURES**

 

(a) Evaluation ofdisclosure controls and procedures. As of the end of the period covered by thisreport, we carried out an evaluation, under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended. Basedupon that evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures were not effective as ofthe end of the applicable period to ensure that information required to bedisclosed by us in reports that we file or submit under the Exchange Act (i) isrecorded, processed, summarized and reported within the time periods specifiedin Securities and Exchange Commission rules and forms and (ii) isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate to allow timely decisionsregarding required disclosures.

 

Basedon our assessment at December 31, 2007, management believes that ourinternal control over financial reporting was not effective based on criteriaset forth by the Committee of Sponsoring Organizations of the TreadwayCommission in *Internal Control-Integrated Framework*.The following material weaknesses were identified in our internal control overfinancial reporting at December 31, 2007:

 

·                  We performed a financial close on a quarterlybasis only.  The analysis of actual tobudgeted results was either done marginally or not at all and there was nomechanism in place to evaluate variances, investigate unusual activity orcommunicate findings to senior management or the board of directors. Thefinancial close process is not formally documented.

 

·                  During the quarterly financial close we did notutilize a financial closing checklist to ensure that all items had beenconsidered for inclusion in the three quarterly filings of Form 10-QSB.

 

·                  We are unable to maintain the propersegregation of various accounting and finance duties because of our small sizeand limited resources.  At risk areasinclude cash receipts and payments, processing of journal entries and accountreconciliations.

 

·                  We do not maintain a standard listing ofrecurring journal entries.  We rely onthe previous quarter’s journal entries during the closing process and mayoverlook adjustments that need to be made to ensure our financial statementsare presented fairly.

 

·                  Much of the financial closing process is doneoff-line on electronic spreadsheets that are maintained on individualcomputers, unable to be shared by accounting personnel and not backed up.

 

·                  We have not performed a physical inventory offixed assets.  As a result, we failed toidentify idle fixed assets that were not in our possession until late in theclosing process necessitating an adjustment to our results.

 

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·                  We do not consistently utilize purchaseorders when purchasing inventory, which may lead to uncertainty regarding ourquarter end commitments.

 

·                  Board and management turnover during 2007resulted in an uneven “tone at the top”. The current CEO and CFO were hired in September 2007 and October 2007respectively.  Of the five board membersat December 31, 2007 only two were on the board at the beginning of 2007.Formal job descriptions do not exist, annual reviews are not performed and anorganization chart was not developed until January 2008.

 

·                  We were unable to complete our analysis ofthe Section 382 limitation on loss carryforwards in a timely mannerbecause of poor recordkeeping.

 

·                  We did not properly account for modificationsmade to stock option grants in accordance with SFAS 123(R) resulting in alate journal entry being made to prevent the financial statements from beingmisleading.  The modifications were******the result ofaccelerating the vesting of existing stock options and extended the exerciseperiod for three officers and directors whose service to the Company wasterminated in the fourth quarter of 2007. The modifications were not required by the terms of theofficers/directors employment agreements, or by the terms of the stock optionplans, or by the terms of the stock option grants but were done solely as partof the officers/directors separation agreements.  We accounted for the terminations by expensing thatportion of the unrecognized compensation expense relating to these three formerofficers/directors.  We recalculated theexpense as part of the year end closing following a further review of theauthoritative literature.

 

Weintend to remediate these material weaknesses during 2008.  As concerns the material weakness relating tosegregation of duties, we are re-examining our procedures to includecompensating controls and minimize the risk associated with having limitedresources in the accounting department.

 

Notwithstandingthese material weaknesses, we believe that our financial condition, results ofoperations and cash flows presented in this report of Form 10-Q are fairlypresented in all material respects.  Webase our conclusion on our ability to substantiate, with a high degree ofconfidence, the small number of significant general ledger accounts thatcomprise our financial statements.

 

(b) Changes in internalcontrols over financial reporting.

 

Throughthe date of this report we have made the following changes in internal controlover financial reporting:

 

Beginning in April we instituted a monthlyfinancial closing process.  A formal report,including balance sheet, results of operations and analyses of key accounts,was prepared by the accounting manager, reviewed and signed off by the CFO anddistributed to the CEO and the board of directors.

 

Beginning in April we established a standardlisting of recurring journal entries that are reviewed and signed off by theCFO as part of the monthly closing process.

 

We instituted a formal purchasing policy in May thatrequires the use of purchase orders for all inventory purchases.

 

We established with certainty the Section 382limitation on our loss carryforwards.

 

The CFO has reviewed the accounting literaturesurrounding stock option modifications and is now familiar with the propertreatment.  In addition, we now subscribeto a daily internet service that keeps the CFO apprised of current developmentsaffecting financial reporting.

 

**PART II - OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

 

Not Applicable

 

**ITEM 2.UNREGISTERED SALES OF SECURITIES AND USE OF PROCEEDS**

 

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

 

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·                  On January 8, 2008, we sold $3.5 million of our 8% Senior SecuredConvertible Debentures.  As part of thetransaction, we issued the purchasers common stock purchase warrants topurchase 700,000 of our common shares. For a more detailed description of the transaction, refer to Note 10 ofour financials contained in this report. We incorporate by reference the disclosure of the transaction andaccompanying documents as contained in our Current Report on Form 8-Kfiled with the SEC on January 9, 2008.

 

·                  On February 25, 2008, pursuant to our2007 Equity Incentive Plan, we issued one of our directors an option topurchase 63,333 common shares at $1.95 per share as compensation for serving onthe 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 eventthe director resigns or is removed, the holder has 90 days to exercise of theoption.

 

·                  OnFebruary 25, 2008, pursuant to our 2007 Equity Incentive Plan, we issuedone of our directors an option to purchase 63,333 common shares at $1.95 pershare as compensation for serving on the board and any relevant committeesthereof.  The option has a vesting periodof three years (vesting 1/3 per year), and a duration of 10 years.  In the event the director resigns or isremoved, the holder has 90 days to exercise of the option.

 

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

 

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

 

·                  On April 15, 2008, we sold $5 million ofour 8% Senior Secured Convertible Debentures. As part of the transaction, we issued the purchaser common stockpurchase warrant to purchase 1,008,064 of our common shares.  For a more detailed description of the transaction,refer to Note 11 of our financials contained in this report.  We incorporate by reference the disclosure ofthe transaction and accompanying documents as contained in our Current Reporton Form 8-K filed with the SEC on April 16, 2008.

 

**ITEM 3.DEFAULTS UPON SENIOR SECURITIES**

 

Not Applicable

 

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

 

The following matters werevoted on and approved by stockholders at the annual meeting of the stockholdersof the Company held on June 17, 2008:

 

**1.**The election of five directors to serve untilthe 2009 annual meeting of stockholders.

 

**2.**The ratification of the appointment of SingerLewak LLP as the Company’s independent registered public accounting firm forthe 2008 fiscal year.

 

The number of votes cast atthe annual meeting in person and by proxy for each matter is as set forth inthe following table:

 
| **Matter voted upon**                                 | ** ** | **For**    | ** ** | **Against/Withheld** | ** ** | **Abstentions/Broker  Non-votes** | ** ** |
|-------------------------------------------------------|------------|------------|------------|----------------------|------------|-----------------------------------|------------|
| Election of Donald Joyce                              |       | 18,570,769 |       | 50,018               |       |                              |       |
| Election of W. Robert Ramsdell                        |       | 18,570,684 |       | 50,103               |       |                              |       |
| Election of Richard Nathan                            |       | 18,565,684 |       | 55,103               |       |                              |       |
| Election of Scott V. Ogilvie                          |       | 18,570,769 |       | 50,018               |       |                              |       |
| Election of Henry L. Tredennick III                   |       | 18,565,684 |       | 55,103               |       |                              |       |
| Ratification of appointment of Singer  Lewak LLP |       | 18,603,406 |       | 13,760               |       | 3,621                             |       |

 

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**ITEM 5. OTHER INFORMATION**

 

Not Applicable

 

**ITEM 6. EXHIBITS**

 

(a) Exhibits

 

The exhibits listed in the Exhibit Index are filed as a part ofthis report.

 

**SIGNATURES**

 

In accordance with the requirements of the Exchange Act, the Registrantcaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

 
| ** **               | **INNOVATIVE  CARD TECHNOLOGIES, INC.** |
|--------------------------|-----------------------------------------|
|                     |                                    |   |
|                     |                                    |   |
| Date: September 18, 2008 |                                    | /s/ Steven R.  Delcarson |
|                     |                                    | Steven R. Delcarson |
|                     |                                    | Chief Executive Officer |
|                     |                                    |   |
|                     |                                    |   |
| Date: September 18, 2008 |                                    | /s/ Charles M.  Caporale |
|                     |                                    | Charles M. Caporale |
|                     |                                    | Chief Financial Officer |

 

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**EXHIBIT INDEX**

 
| 2.1(2)           |   | Exchange agreement by and  among the registrant, LensCard US, LLC, Alan Finkelstein, Forest Finkelstein,  Bradley Ross and Luc Berthoud, dated April 1, 2004       |
|------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |   |                                                                                                                                                                    |
| 2.2(2)           |   | Exchange agreement by and  among the registrant, Alan Finkelstein,  Bradley Ross and Michael  Paradise, dated April 1, 2004                                   |
|             |   |                                                                                                                                                                    |
| 2.3(2)           |   | Exchange agreement between  the registrant and its wholly-owned subsidiary, PSACo, Inc., dated  April 1, 2004                                                 |
|             |   |                                                                                                                                                                    |
| 2.4(2)           |   | Merger agreement between  the registrant and LensCard International Limited, a British Virgin Islands  International Business Company, dated April 6, 2004         |
|             |   |                                                                                                                                                                    |
| 3.1(2)           |   | Amended and Restated Certificate  of incorporation of the registrant, as currently in effect                                                                            |
|             |   |                                                                                                                                                                    |
| 3.2(2)           |   | Amended and Restated  Bylaws of the registrant, as currently in effect                                                                                                  |
|             |   |                                                                                                                                                                    |
| 3.3(12)          |   | Certificate of Amendment  of Amended and Restated Certificate of Incorporation.                                                                                         |
|             |   |                                                                                                                                                                    |
| 10.1(2)          |   | 2004 Stock Incentive Plan                                                                                                                                               |
|             |   |                                                                                                                                                                    |
| 10.2(2)          |   | Sublease agreement between  registrant and Bemel & Ross for premises at 11601 Wilshire  Blvd.,#2160, Los Angeles, California 90025, dated January 5, 2003 |
|             |   |                                                                                                                                                                    |
| 10.3(2)          |   | Guaranty of lease between  Alan Finkelstein and Bemel & Ross, dated January 5, 2003                                                                       |
|             |   |                                                                                                                                                                    |
| 10.4(3)          |   | Form of common stock  warrant, as amended on September 7, 2005.                                                                                               |
|             |   |                                                                                                                                                                    |
| 10.5(2)          |   | Securities purchase  agreement between registrant and Bristol Capital, LLC dated December 23,  2003                                                                |
|             |   |                                                                                                                                                                    |
| 10.5(a) (2) |   | Waiver of section 2.3 of  the securities purchase agreement between registrant and Bristol Capital, LLC                                                                 |

 

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| 10.6(2)  |   | Shares for debt agreement  between registrant and Alan Finkelstein, dated June 22, 2004                                                                     |
|----------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                                                             |
| 10.7(2)  |   | Shares for debt agreement  between registrant and Bradley Ross, dated June 22, 2004                                                                         |
|     |   |                                                                                                                                                             |
| 10.8(2)  |   | Shares for debt agreement  between registrant and Luc Berthoud, dated June 22, 2004                                                                         |
|     |   |                                                                                                                                                             |
| 10.9(2)  |   | Promissory note (loan no.  00003) between registrant and City National Bank, dated May 24, 2004                                                             |
|     |   |                                                                                                                                                             |
| 10.10(2) |   | Promissory note (loan no.  00005) between registrant and City National Bank, dated May 24, 2004                                                             |
|     |   |                                                                                                                                                             |
| 10.11(2) |   | Promissory note (1oan no.  00004) between registrant and City National Bank, dated May 24, 2004                                                             |
|     |   |                                                                                                                                                             |
| 10.12(2) |   | Promissory note (loan no.  00006) between registrant and City National Bank, dated May 24 ,2004                                                             |
|     |   |                                                                                                                                                             |
| 10.13(2) |   | Commercial guaranty  between Alan Finkelstein and City National Bank dated May 24, 2004                                                                     |
|     |   |                                                                                                                                                             |
| 10.14(2) |   | Commercial guaranty  between Bradley Ross and City National Bank dated May 24, 2004                                                                         |
|     |   |                                                                                                                                                             |
| 10.15(2) |   | Commercial guaranty  between Luc Berthoud and City National Bank dated May 24, 2004                                                                         |
|     |   |                                                                                                                                                             |
| 10.16(2) |   | Offer letter between  registrant and Murdoch Henretty dated July 28, 2004                                                                                   |
|     |   |                                                                                                                                                             |
| 10.17(2) |   | Employment agreement  between registrant and Alan Finkelstein dated January 1998                                                                            |
|     |   |                                                                                                                                                             |
| 10.18(2) |   | Strategic Alliance  Agreement between registrant and Visa International Service Association dated  May 26, 2004                                             |
|     |   |                                                                                                                                                             |
| 10.19(2) |   | Secured Demand Promissory  Note between registrant and Union Finance International Corp. dated  March 31, 2005                                              |
|     |   |                                                                                                                                                             |
| 10.20(2) |   | Secured Demand Promissory  Note between registrant and Bristol Investment Fund, Ltd. dated  March 30, 2005                                                  |
|     |   |                                                                                                                                                             |
| 10.21(2) |   | Capital Lease Agreement  between registrant and CNC Associates, Inc. dated November 30, 2004                                                           |
|     |   |                                                                                                                                                             |
| 10.22(2) |   | Guaranty between Alan  Finkelstein and CNC Associates, Inc. dated November 30, 2004                                                                    |
|     |   |                                                                                                                                                             |
| 10.23(2) |   | Security Agreement between  registrant and Union Finance International Corp. dated March 31, 2005  (See Exhibit 10.19)                                 |
|     |   |                                                                                                                                                             |
| 10.24(2) |   | Security Agreement between  registrant and Bristol Investment Fund, Ltd. dated March 30, 2005 (See  Exhibit 10.20)                                     |
|     |   |                                                                                                                                                             |
| 10.25(2) |   | Secured Demand Promissory  Note between registrant and Bradley Ross dated August 31, 2005                                                                   |
|     |   |                                                                                                                                                             |
| 10.26(2) |   | Secured Demand Promissory  Note between registrant and Rodger Bemel dated August 31, 2005                                                                   |
|     |   |                                                                                                                                                             |
| 10.27(2) |   | Joint Development  Agreement between registrant and nCryptone dated July 25, 2005                                                                           |
|     |   |                                                                                                                                                             |
| 10.28(2) |   | Agreement between  registrant and SmartDisplayer Technology, Inc. dated July 25, 2005                                                                  |
|     |   |                                                                                                                                                             |
| 10.29(5) |   | Form of Lock-Up  agreement by and between registrant’s directors and executive officers  pursuant to the private placement dated October 19, 2005 |
|     |   |                                                                                                                                                             |
| 10.30(4) |   | Form of Warrant  pursuant to private placement dated October 19, 2005                                                                                  |
|     |   |                                                                                                                                                             |
| 10.31(4) |   | Registration Rights  Agreement by and between the registrant and each investor pursuant to the  private placement dated October 19, 2005                    |

 

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| 10.32(4)  |   | Side Letter Agreement  between the registrant, T.R. Winston & Company and investors  pursuant to the private placement dated October 19, 2005 |
|-----------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
|      |   |                                                                                                                                                        |
| 10.33(6)  |   | Letter of Intent by and  between VASCO Data Security, nCryptone and Registrant, dated October 28,  2005.                                               |
|      |   |                                                                                                                                                        |
| 10.34(9)  |   | Form of Warrant to TR  Winston dated as of May 30, 2006.                                                                                          |
|      |   |                                                                                                                                                        |
| 10.35(9)  |   | Form of Securities  Purchase Agreement dated May 30, 2006.                                                                                        |
|      |   |                                                                                                                                                        |
| 10.36(9)  |   | Form of Registration  Rights Agreement dated May 30, 2006.                                                                                        |
|      |   |                                                                                                                                                        |
| 10.37(10) |   | Asset Agreement dated  June 28, 2006 by and between Registrant NCryptone, SA and its  shareholders.                                                    |
|      |   |                                                                                                                                                        |
| 10.38(10) |   | Registration Rights  Agreement dated June 28, 2006 by and between Registrant and NCrytone, SA                                                          |
|      |   |                                                                                                                                                        |
| 10.39(10) |   | License Agreement dated  June 28, 2006 by and between Registrant as licensor and NCryptone, SA as  licensee                                            |
|      |   |                                                                                                                                                        |
| 10.40(10) |   | License Agreement dated  June 28, 2006 by and between NCryptone, SA as licensor and Registrant as  licensee.                                           |
|      |   |                                                                                                                                                        |
| 10.41(11) |   | Sublease between  Registrant as sublessee and Bergman and Dacey, Inc. as sublessor.                                                                    |
|      |   |                                                                                                                                                        |
| 10.42(8)  |   | Indemnification Agreement                                                                                                                                   |
|      |   |                                                                                                                                                        |
| 10.43(7)  |   | Code of Ethics                                                                                                                                              |
|      |   |                                                                                                                                                        |
| 10.44(13) |   | Separation  and Release Agreement dated October 29, 2007 between Bennet P.  Tchaikovsky and Registrant                                                 |
|      |   |                                                                                                                                                        |
| 10.45(13) |   | Consulting  Services Agreement dated October 29, 2007 between Registrant and Bennet  P. Tchaikovsky                                                    |
|      |   |                                                                                                                                                        |
| 10.46(13) |   | Indemnity  Agreement dated October 29, 2007 between Registrant and Bennet P.  Tchaikovsky                                                              |
|      |   |                                                                                                                                                        |
| 10.47(14) |   | 2007  Equity Incentive Plan                                                                                                                                 |
|      |   |                                                                                                                                                        |
| 10.48(15) |   | Form of  Indemnity Agreement                                                                                                                           |
|      |   |                                                                                                                                                        |
| 10.49(16) |   | Alan  Finkelstein Severance and Resignation Letter                                                                                                          |
|      |   |                                                                                                                                                        |
| 10.50(17) |   | Form of  Securities Purchase Agreement, dated as of January 8, 2008                                                                               |
|      |   |                                                                                                                                                        |
| 10.51(17) |   | Form of  8% Senior Secured Convertible Debenture issued January 8, 2008                                                                           |
|      |   |                                                                                                                                                        |
| 10.52(17) |   | Form of  Common Stock Purchase Warrant issued January 8, 2008                                                                                     |
|      |   |                                                                                                                                                        |
| 10.53(17) |   | Form of  Registration Rights Agreement, dated as of January 8, 2008                                                                               |
|      |   |                                                                                                                                                        |
| 10.54(17) |   | Form of  Security Agreement, dated as of January 8, 2008                                                                                          |
|      |   |                                                                                                                                                        |
| 10.55(17) |   | Form of  Subsidiary Guarantee, dated as of January 8, 2008                                                                                        |
|      |   |                                                                                                                                                        |
| 10.56(17) |   | Form of  Voting Agreement, dated as of January 8, 2008                                                                                            |
|      |   |                                                                                                                                                        |
| 10.57(17) |   | Form of  Lock-Up Agreement, dated as of January 8, 2008                                                                                           |
|      |   |                                                                                                                                                        |
| 10.58(18) |   | Employment  Agreement dated March 27, 2008 between Registrant and Steven R.  Delcarson                                                                 |
|      |   |                                                                                                                                                        |
| 10.59(18) |   | Employment  Agreement dated March 27, 2008 between Registrant and Charles M.  Caporale                                                                 |
|      |   |                                                                                                                                                        |
| 21.1(2)   |   | List of subsidiaries                                                                                                                                        |

 

41

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Table of Contents

 
| 31.1(1) |   | Certification of Chief  Executive Officer, as required by Rule 13a-14(a) or  Rule 15d-14(a) of the Securities Exchange Act of 1934                         |
|---------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                           |
| 31.2(1) |   | Certification of Chief  Financial Officer, as required by Rule 13a-14(a) or  Rule 15d-14(a) of the Securities Exchange Act of 1934                         |
|    |   |                                                                                                                                                                           |
| 32(1)   |   | Certification of Chief  Executive Officer and Chief Financial Officer, as required by  Section 1350 of Chapter 63 of Title 18 of the United States Code (18  U.S.C. 1350) |

 

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(1)                        Filed herewith.

(2)                        Previously filed by the registrant on Form SB-2(File No. 333-119814), as amended, with the Securities and ExchangeCommission.

(3)                        Previously filed by the registrant on Form 8-Kwith the Securities and Exchange Commission on September 7, 2005.

(4)                        Previously filed by the registrant on Form 8-K,as amended, with the Securities and Exchange Commission on October 25,2005.

(5)                        Previously filed by the registrant on Form SB-2(File No. 333-129564) with the Securities and Exchange Commission on November 8,2005.

(6)                        Previously filed by the registrant on Form 8-Kwith the Securities and Exchange Commission on November 18, 2005.

(7)                        Previously filed by the registrant on Form 10-KSBwith the Securities and Exchange Commission on March 20, 2006.

(8)                        Previously filed by the registrant on Form 8-Kwith the Securities and Exchange Commission on March 23, 2007.

(9)                        Previously filed by the registrant on Form 8-Kfiled with the Securities and Exchange Commission on May 31, 2006.

(10)                  Previously filed by the registrant on Form SB-2(File No. 333-135715) with the SEC on July 12, 2006.

(11)                  Previously filed by the registrant on Form 10QSBwith the SEC on November 13, 2006.

(12)                  Previously filed by the registrant on Form 8-Kwith the SEC on January 2, 2008

(13)                  Previously filed by the registrant on Form 8-Kwith the SEC on November 1, 2007

(14)                  Previously filed by the registrant on Form 10-QSBwith the SEC on November 19, 2007

(15)                  Previously filed by the registrant on Form 8-Kwith the SEC on November 29, 2007

(16)                  Previously filed by the registrant on Form 8-Kwith the SEC on December 20, 2007

(17)                  Previously filed by the registrant on Form 8-Kwith the SEC on January 9, 2008

(18)                  Previously filed by the registrant on Form 8-Kwith the SEC on April 2, 2008

 

42

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