UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q




(Mark
one)




x
            Quarterly
      Report Under Section 13 or 15(d) of the Securities Exchange Act of
      1934




For
the Quarterly Period Ended September 30, 2009


Or




 ̈
            Transition
      Report Under Section 13 or 15(d) of the Securities Exchange Act of
      1934




Commission
File Number 001-33353




INNOVATIVE
CARD TECHNOLOGIES, INC.


(Exact
name of registrant as specified in its charter)


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




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





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





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).


 ̈Yes  ̈    No





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





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




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act)


 ̈Yes   x    No





As of
November 9, 2009 there were 28,640,920 shares of common stock, $.001 par value,
issued and outstanding.








Innovative
Card Technologies, Inc.




Table of
Contents




PagePART
      I -
                        
                        FINANCIAL
      INFORMATION
                        3Item
      1.
                        
                        Financial
      Statements
                        3Condensed
      Consolidated Balance Sheets as of September 30, 2009 (Unaudited) and
      December 31, 2008
                        3Condensed
      Consolidated Statements of Operations (Unaudited)

                            Three
      months ended September 30, 2009 and 2008 and Nine months
      ended September 30, 2009 and 2008
                        4Condensed
      Consolidated Statements of Cash Flows (Unaudited)

                            Nine
      months ended September 30, 2009 and 2008
                        5Notes
      to Condensed Consolidated Financial Statements (Unaudited)
                        6Item
      2.
                        
                        Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
                        19Item
      3.
                        
                        Quantitative
      and Qualitative Disclosures about Market Risk
                        32Item
      4.
                        
                        Controls
      and Procedures
                        32PART
      II -
                        
                        OTHER
      INFORMATION
                        34Item
      1.
                        
                        Legal
      Proceedings
                        34Item
      1A.
                        
                        Risk
      Factors
                        34Item
      2.
                        
                        Unregistered
      Sales of Equity Securities and Use of Proceeds
                        40Item
      3.
                        
                        Defaults
      Upon Senior Securities
                        41Item
      4.
                        
                        Submission
      of Matters to a Vote of Security Holders.
                        41Item
      5.
                        
                        Other
      Information
                        41Item
      6.
                        
                        Exhibits
                        41


2





PART
I


FINANCIAL
INFORMATION





ITEM
1.                FINANCIAL
STATEMENTS


INNOVATIVE
CARD TECHNOLOGIES, INC.
 CONDENSED
CONSOLIDATED BALANCE SHEETS
 
 September
      30,
                                      
                                      
                                      December
      31,2009
                                      
                                      
                                      2008(Unaudited)AssetsCurrent
      assets:Cash
      and cash equivalents
                                      
                                      $
                                      852,904
                                      
                                      
                                      $
                                      76,645Accounts
      receivable, net of allowance for doubtful accounts of $60,000 and $60,000,
      respectively
                                      
                                      
                                      365,800
                                      
                                      
                                      
                                      190,767Prepaids
      and other current assets
                                      
                                      
                                      27,906
                                      
                                      
                                      
                                      174,178Deposits
      on raw materials held for production
                                      
                                      
                                      240,787
                                      
                                      
                                      
                                      268,318Raw
      materials held for production
                                      
                                      
                                      264,032
                                      
                                      
                                      
                                      347,529Work
      in progress inventory, net of allowance of $115,059 at December 31,
      2008
                                      
                                      
                                      386,979
                                      
                                      
                                      
                                      1,454,940Finished
      goods inventory
                                      
                                      
                                      52,215
                                      
                                      
                                      
                                      -Total
      current assets
                                      
                                      
                                      2,190,623
                                      
                                      
                                      
                                      2,512,377Property
      and equipment
                                      
                                      
                                      121,338
                                      
                                      
                                      
                                      171,722Deferred
      debt issuance cost
                                      
                                      
                                      -
                                      
                                      
                                      
                                      449,052Deposits
                                      
                                      
                                      6,220
                                      
                                      
                                      
                                      62,971Total
      assets
                                      
                                      $
                                      2,318,181
                                      
                                      
                                      $
                                      3,196,122Liabilities
      and stockholders' deficitCurrent
      liabilities:Accounts
      payable and accrued expenses
                                      
                                      $
                                      1,404,960
                                      
                                      
                                      $
                                      1,281,602Accounts
      payable - related parties
                                      
                                      
                                      -
                                      
                                      
                                      
                                      600,010Accrued
      interest
                                      
                                      
                                      17,471
                                      
                                      
                                      
                                      31,689Warranty
      reserve
                                      
                                      
                                      313,787
                                      
                                      
                                      
                                      198,854Deferred
      rent
                                      
                                      
                                      -
                                      
                                      
                                      
                                      56,929Deferred
      revenue
                                      
                                      
                                      544,054
                                      
                                      
                                      
                                      1,169,957Note
      payable
                                      
                                      
                                      50,000
                                      
                                      
                                      
                                      -Total
      current liabilities
                                      
                                      
                                      2,330,272
                                      
                                      
                                      
                                      3,339,0418%
      convertible debentures, net of discount of $1,423,932 and $5,384,054
      at September 30, 2009 and December 31, 2008, respectively
                                      
                                      
                                      4,424,812
                                      
                                      
                                      
                                      3,425,111Warrant
      liability
                                      
                                      
                                      926,386
                                      
                                      
                                      
                                      19,055Derivative
      liability
                                      
                                      
                                      5,077,866
                                      
                                      
                                      
                                      -Total
      liabilities
                                      
                                      
                                      12,759,336
                                      
                                      
                                      
                                      6,783,207Stockholders'
      deficitPreferred
      stock, $0.001 par value, 5,000,000 shares authorized, no shares
      issued and outstanding
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -Common
      stock, $0.001 par value, 75,000,000 shares authorized, 28,495,256 shares
      issued and outstanding, respectively
                                      
                                      
                                      28,495
                                      
                                      
                                      
                                      28,495Additional
      paid-in capital
                                      
                                      
                                      30,651,678
                                      
                                      
                                      
                                      33,381,140Accumulated
      deficit
                                      
                                      
                                      (41,121,328
                                      )
                                      
                                      
                                      (36,996,720
                                      )Total
      deficiency in stockholders' equity
                                      
                                      
                                      (10,441,155
                                      )
                                      
                                      
                                      (3,587,085
                                      )Total
      liabilities and deficiency in stockholders' equity
                                      
                                      $
                                      2,318,181
                                      
                                      
                                      $
                                      3,196,122
 
 The
accompanying notes are an integral part of these  unaudited condensed
consolidated financial statements.
 
 3
  INNOVATIVE
CARD TECHNOLOGIES, INC.
 CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)
 
 Three
      Months Ended September 30,
                    
                    
                    Nine
      Months Ended September 30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Revenues
                    
                    $
                    1,011,760
                    
                    
                    $
                    840,098
                    
                    
                    $
                    2,842,628
                    
                    
                    $
                    1,857,523Cost
      of goods sold
                    
                    
                    927,015
                    
                    
                    
                    984,024
                    
                    
                    
                    2,690,893
                    
                    
                    
                    2,054,232Gross
      profit/margin
                    
                    
                    84,745
                    
                    
                    
                    (143,926
                    )
                    
                    
                    151,735
                    
                    
                    
                    (196,709
                    )Operating
      expensesAdministrative
                    
                    
                    735,913
                    
                    
                    
                    1,306,148
                    
                    
                    
                    1,879,967
                    
                    
                    
                    4,355,576Consulting
      fees
                    
                    
                    73,286
                    
                    
                    
                    169,996
                    
                    
                    
                    118,902
                    
                    
                    
                    424,521Professional
      fees
                    
                    
                    87,789
                    
                    
                    
                    189,698
                    
                    
                    
                    309,759
                    
                    
                    
                    638,921Research
      and development
                    
                    
                    69,467
                    
                    
                    
                    98,230
                    
                    
                    
                    183,315
                    
                    
                    
                    396,585Total
      operating expense
                    
                    
                    966,455
                    
                    
                    
                    1,764,072
                    
                    
                    
                    2,491,943
                    
                    
                    
                    5,815,603Loss
      from operations
                    
                    
                    (881,710
                    )
                    
                    
                    (1,907,998
                    )
                    
                    
                    (2,340,208
                    )
                    
                    
                    (6,012,312
                    )Other
      income (expense)Change
      in fair value of warrant and conversion liability
                    
                    
                    (4,300,534
                    )
                    
                    
                    841,513
                    
                    
                    
                    (4,461,202
                    )
                    
                    
                    2,866,067Gain
      on extinguishment of debt
                    
                    
                    9,520,784
                    
                    
                    
                    -
                    
                    
                    
                    9,520,784
                    
                    
                    
                    -Other
      income
                    
                    
                    616,315
                    
                    
                    
                    -
                    
                    
                    
                    616,315
                    
                    
                    
                    -Other
      expense
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (120,794
                    )Interest
      income
                    
                    
                    2
                    
                    
                    
                    2,978
                    
                    
                    
                    53
                    
                    
                    
                    26,535Interest
      expense
                    
                    
                    (1,383,750
                    )
                    
                    
                    (498,336
                    )
                    
                    
                    (11,980,024
                    )
                    
                    
                    (1,083,695
                    )Total
      other income (expense)
                    
                    
                    4,452,817
                    
                    
                    
                    346,155
                    
                    
                    
                    (6,304,074
                    )
                    
                    
                    1,688,113Income
      (loss) before provision for income taxes
                    
                    
                    3,571,107
                    
                    
                    
                    (1,561,843
                    )
                    
                    
                    (8,644,282
                    )
                    
                    
                    (4,324,199
                    )Provision
      for income taxes
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (800
                    )Net
      income (loss)
                    
                    $
                    3,571,107
                    
                    
                    $
                    (1,561,843
                    )
                    
                    $
                    (8,644,282
                    )
                    
                    $
                    (4,324,999
                    )Basic
      income (loss) per share
                    
                    $
                    0.13
                    
                    
                    $
                    (0.05
                    )
                    
                    $
                    (0.30
                    )
                    
                    $
                    (0.15
                    )Diluted
      income (loss) per share
                    
                    $
                    0.12
                    
                    
                    $
                    (0.05
                    )
                    
                    $
                    (0.30
                    )
                    
                    $
                    (0.15
                    )Weighted
      average shares outstanding,Basic
                    
                    
                    28,495,256
                    
                    
                    
                    28,495,256
                    
                    
                    
                    28,495,256
                    
                    
                    
                    28,471,681Diluted
                    
                    
                    29,615,853
                    
                    
                    
                    28,495,256
                    
                    
                    
                    28,495,256
                    
                    
                    
                    28,471,681
 
 The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
 4
 
 INNOVATIVE
CARD TECHNOLOGIES, INC.
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
 FOR THE
NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
 (Unaudited)
 
 2009
                              
                              
                              2008Cash
      flows from operating activities:Net
      loss
                              
                              $
                              (8,644,282
                              )
                              
                              $
                              (4,324,999
                              )Adjustments
      to reconcile net loss to netcash
      used in operating activities:Depreciation
      and amortization
                              
                              
                              44,566
                              
                              
                              
                              530,552Change
      in fair value of warrant liability
                              
                              
                              501,920
                              
                              
                              
                              (2,866,069
                              )Change
      in fair value of conversion liability
                              
                              
                              3,959,282
                              
                              
                              
                              -Amortization
      of debt discount
                              
                              
                              7,513,000
                              
                              
                              
                              609,523Amortization
      of deferred debt issuance costs
                              
                              
                              449,052
                              
                              
                              
                              51,181Debt
      default penalty
                              
                              
                              2,642,750
                              
                              
                              
                              -Stock
      based compensation expense
                              
                              
                              430,054
                              
                              
                              
                              1,334,622Fees
      paid with debenture
                              
                              
                              45,000
                              
                              
                              
                              -Noncash
      gain on extinguishment of debt
                              
                              
                              (9,580,784
                              )
                              
                              
                              -Deposit
      forfeitures
                              
                              
                              (616,315
                              )
                              
                              
                              -Change
      in provision for obsolete inventory
                              
                              
                              238,200
                              
                              
                              
                              -(Increase)
      decrease in accounts receivable
                              
                              
                              (175,033
                              )
                              
                              
                              (657,680
                              )(Increase)
      decrease in prepaids and other current assets
                              
                              
                              146,272
                              
                              
                              
                              41,100(Increase)
      decrease in deposits on raw materials held for production
                              
                              
                              27,531
                              
                              
                              
                              244,312(Increase)
      decrease in raw materials held for production
                              
                              
                              (22,890
                              )
                              
                              
                              322,885(Increase)
      decrease in work in progress inventory
                              
                              
                              936,147
                              
                              
                              
                              (1,674,706
                              )(Increase)
      decrease in work in finished goods inventory
                              
                              
                              (52,215
                              )
                              
                              
                              -(Increase)
      decrease in deposits
                              
                              
                              56,751
                              
                              
                              
                              86,803Increase
      (decrease) in accounts payable and accrued expenses
                              
                              
                              129,176
                              
                              
                              
                              (2,034,634
                              )Increase
      (decrease) in accounts payable - related parties
                              
                              
                              -
                              
                              
                              
                              (61,889
                              )Increase
      (decrease) in accrued interest
                              
                              
                              1,380,334
                              
                              
                              
                              -Increase
      (decrease) in warranty reserve
                              
                              
                              114,933
                              
                              
                              
                              136,776Increase
      (decrease) in deferred rent
                              
                              
                              (56,929
                              )
                              
                              
                              -Increase
      (decrease) in deferred revenue
                              
                              
                              132,418
                              
                              
                              
                              137,909Net
      cash used in operating activities
                              
                              
                              (401,062
                              )
                              
                              
                              (8,124,314
                              )Cash
      flows from investing activities:Purchase
      of property and equipment
                              
                              
                              -
                              
                              
                              
                              (36,942
                              )Net
      cash used in investing activities
                              
                              
                              -
                              
                              
                              
                              (36,942
                              )Cash
      flows from financing activities:Proceeds
      from issuance of 8% convertible debentures
                              
                              
                              1,127,321
                              
                              
                              
                              8,500,000Proceeds
      from note
                              
                              
                              100,000
                              
                              
                              
                              -Repayment
      of note
                              
                              
                              (50,000
                              )
                              
                              
                              -Payments
      on debt issuance cost
                              
                              
                              -
                              
                              
                              
                              (527,500
                              )Proceeds
      from exercise of options/warrants
                              
                              
                              -
                              
                              
                              
                              50,000Net
      cash provided by financing activities
                              
                              
                              1,177,321
                              
                              
                              
                              8,022,500Net
      increase (decrease) in cash and cash equivalents
                              
                              
                              776,259
                              
                              
                              
                              (138,756
                              )Cash
      and cash equivalents, beginning of period
                              
                              
                              76,645
                              
                              
                              
                              339,600Cash
      and cash equivalents, end of period
                              
                              $
                              852,904
                              
                              
                              $
                              200,844Supplemental
      Schedule of Cash Flow Information:Cash
      paid for interest
                              
                              $
                              2,705
                              
                              
                              $
                              222,000Non-Cash
      Financial Activity:Debt
      discount attributable to beneficial conversion feature
                              
                              $
                              -
                              
                              
                              $
                              3,237,953Debt
      discount attributable to warrants
                              
                              
                              -
                              
                              
                              
                              3,087,307Value
      of warrants issued as non-employee compensation included in prepaid
      expenses and other current assets
                              
                              
                              -
                              
                              
                              
                              254,580Warrant
      liability for warrants issued with debentures
                              
                              
                              639,522
                              
                              
                              
                              -Warrants
      issued with debentures
                              
                              
                              33,756
                              
                              
                              
                              -Derivative
      conversion feature liability of convertible debt
                              
                              
                              1,373,964
                              
                              
                              
                              -Liabilities
      settled with debentures and warrants
                              
                              
                              672,243
                              
                              
                              
                              -
 
 The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
 
 5




INNOVATIVE
CARD TECHNOLOGIES, INC.
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (Unaudited)
 
 NOTE
1 - ORGANIZATION AND LINE OF BUSINESS
 
 COMPANY
OVERVIEW
 The
Company develops and markets secure powered cards for payment, identification,
physical and logical access applications. Our main focus is on developing
One-Time-Password (“OTP”) solutions.  An OTP is a password that is
only valid for a single login session or transaction. OTPs avoid a number of
shortcomings that are associated with traditional (static) passwords. The most
important shortcoming that is addressed by OTPs is that, in contrast to static
passwords, they are not vulnerable to replay attacks. This means that, if a
potential intruder manages to record an OTP that was already used to log into a
service or to conduct a transaction, he will not be able to abuse it since it
will be no longer valid.
 Currently,
our main OTP product is the ICT DisplayCard.  The ICT DisplayCard
integrates the security of an OTP token directly into a card the size of a
standard credit or debit card. A token is a portable physical device, typically
in a key-fob form factor, that generates the OTP (also referred to as a one-time
passcode).  At the push of a button, the ICT DisplayCard displays, a
one-time passcode. During a transaction, this number is entered into a user
interface with other information (such as the user’s static PIN and login name).
This information is relayed to a backend system for multi-factor authentication.
InCard does not provide the backend authentication server, but rather will
integrate the ICT DisplayCard into authentication systems provided by other
companies including distributors and other resellers of the ICT DisplayCard. The
ICT DisplayCard’s authentication works like tokens issued by VASCO, RSA, and
ActivIdentity, but in a more convenient, wallet-sized card.
 
 Our
primary focus is and will continue to be the further development, sales and
marketing of OTP solutions.  We anticipate we will expand our
current ICT DisplayCard product offering with other innovative OTP
products.  Since 2002, we have continued to develop our power inlay
technology that is the basis of our ICT DisplayCard.
 
 BASIS
OF PRESENTATION AND GOING CONCERN
 
 The
accompanying condensed consolidated financial statements of Innovative Card
Technologies, Inc. (“ICTI”) include the amounts of its wholly-owned
subsidiary, PSA Co. (“PSAC”) which was incorporated in the State of Delaware on
August 27, 2003.
  The
Company has a history of recurring losses from operations and has an accumulated
deficit of $41,121,328 as of September 30, 2009. We incurred net losses of
$8,929,537 for the twelve months ending December 31, 2008. During the nine
months ending September 30, 2009, we incurred additional net losses of
$8,644,282.  Sales of the ICT DisplayCard and newly introduced OTP
products, the Company’s main products, are not expected to generate positive
cash flow until the second quarter of 2010. As a result, there is substantial
doubt about the Company’s ability to continue as a going concern at September
30, 2009.
 
 Management’s
plan regarding these matters is to increase sales, resulting in reduced losses
and raise additional debt and/or equity financing to cover operating costs as
well as its obligations as they become due.
 
 There can
be no assurances that funds will be available to the Company when needed or, if
available, that such funds would be available under favorable terms. In the
event that the Company is unable to generate adequate revenues to cover expenses
and cannot obtain additional funds in the near future, the Company may seek
protection under bankruptcy laws.
  6
 
 The
accompanying condensed consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. This basis of
accounting contemplates the recovery of the Company’s assets and the
satisfaction of liabilities in the normal course of business and does not
include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern.
  As of
October 31, 2009 the Company has approximately $678,000 in cash. Combined
with anticipated revenue collections and planned expense reductions, the Company
believes this amount will last through the first quarter of 2010.
  The
accompanying unaudited condensed consolidated financial statements as of
September 30, 2009 and for the three and nine months ended September 30, 2009
and 2008 have been prepared by the Company pursuant to the rules and regulations
of the Securities and Exchange Commission, including Form 10-Q and Regulation
S-X. The information furnished herein reflects all adjustments (consisting of
normal recurring accruals and adjustments) which are, in the opinion of
management, necessary to fairly present the operating results for the respective
periods. Certain information and footnote disclosures normally present in annual
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been omitted pursuant to such
rules and regulations. The Company believes that the disclosures provided are
adequate to make the information presented not misleading. These financial
statements should be read in conjunction with the audited financial statements
and explanatory notes for the year ended December 31, 2008 as disclosed in the
company's 10-K for that year as filed with the SEC.
  The
results for the nine months ended September 30, 2009 are not necessarily
indicative of the results to be expected for the pending full year ending
December 31, 2009.
 
 NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 PRINCIPLES
OF CONSOLIDATION
 
 The
condensed consolidated financial statements include the accounts of Innovative
Card Technologies and its wholly owned subsidiary, PSA Co. All significant
inter-company accounts and transactions are eliminated in
consolidation.
 
 REVENUE
RECOGNITION
 
 The
Company recognizes revenue in accordance with Financial Accounting Standards
Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 605 “Revenue
Recognition”. Revenue is recognized when persuasive evidence of an arrangement
exists, delivery has occurred or services have been rendered, the price is fixed
and determinable and collectibility is reasonably assured. Revenue is not
recognized on product sales transacted on a test or pilot basis. Instead,
receipts from these types of transactions offset marketing expenses. Revenue
from royalties is recognized with the passage of time in accordance with the
underlying agreement.
 
 MAJOR
SUPPLIERS
 
 The
Company obtains the battery, a key component for the Company’s power inlay
technology, from a single source, Solicore, Inc., on a purchase order
basis. The Company believes that alternative sources for this component in the
event of a disruption or discontinuation in supply would not be available on a
timely basis, which could disrupt Company operations, delay production for up to
twelve months and impair the Company’s ability to manufacture and sell
products.
  7
  The
Company obtains the display, a key component for the Company’s ICT DisplayCard,
from a single source, SmartDisplayer, pursuant to the Company’s agreement with
SmartDisplayer. On November 10, 2007, the Company was required to make a deposit
on a purchase order to maintain its exclusivity. The Company was unable to make
the deposit and therefore does not have exclusivity with SmartDisplayer. The
Company believes that alternative sources for this component in the event of a
disruption or discontinuation in supply would not be available on a timely
basis, which could disrupt Company operations relating to the ICT DisplayCard,
delay production of the ICT DisplayCard for up to twelve months and impair the
Company’s ability to manufacture and sell the ICT DisplayCard.
 
 The
Company assembles its ICT DisplayCard using a single source, NagraID, pursuant
to a written agreement. The Company believes that alternative sources for this
component in the event of a disruption or discontinuation in supply would not be
available on a timely basis, which could disrupt Company operations relating to
the ICT DisplayCard, delay production of the ICT DisplayCard for up to twelve
months and impair the Company’s ability to manufacture and sell the ICT
DisplayCard.
 
 MAJOR
CUSTOMERS
 
 Two
customers accounted for 100% and 97% of the Company’s revenues for the three and
nine months ended September 30, 2009, respectively, and two customers
accounted for 73% and 75% of the Company’s revenue for the three and nine months
ended September 30, 2008, respectively.
 
 One
customer accounted for 93% of our accounts receivable at September 30,
2009.
  FAIR
VALUE OF FINANCIAL INSTRUMENTS
 
 Fair
value of financial instruments
  In April
2009, we adopted accounting guidance which requires disclosures about fair value
of financial instruments in interim financial statements as well as in annual
financial statements.
 
 Our
short-term financial instruments, including cash, accounts receivable, prepaid
expenses and other assets, accounts payable and accrued expenses, warranty
reserve and other liabilities, consist primarily of instruments without extended
maturities, the fair value of which, based on management’s estimates, reasonably
approximate their book value. The fair value of our convertible notes is based
on management estimates and reasonably approximates their book value based on
their current maturity. The fair value of the Company’s derivative instruments
is determined using option pricing models.
 
 Fair
value measurements
 
 Effective
November 1, 2008, we adopted new accounting guidance pursuant to ASC 820
which established a framework for measuring fair value and expands disclosure
about fair value measurements. The Company did not elect fair value accounting
for any assets and liabilities allowed by previous guidance. Effective
January 1, 2009, the Company adopted the provisions of new accounting
guidance that relate to non-financial assets and liabilities that are not
required or permitted to be recognized or disclosed at fair value on a recurring
basis. Effective April 1, 2009, the Company adopted new accounting guidance
which provides additional guidance for estimating fair value in accordance with
ASC 820, when the volume and level of activity for the asset or liability have
significantly decreased. The adoptions of the provisions of ASC 820 did not have
a material impact on our financial position or results of
operations.
  ASC 820
defines fair value as the amount that would be received for an asset or paid to
transfer a liability (i.e., an exit price) in the principal or most advantageous
market for the asset or liability in an orderly transaction between market
participants on the measurement date. ASC 820 also establishes a fair value
hierarchy that requires an entity to maximize the use of observable inputs and
minimize the use of unobservable inputs when measuring fair value. ASC 820
describes the following three levels of inputs that may be
used:
  8
  Level 1 –
Quoted prices in active markets for identical assets or
liabilities.
  Level 2 –
Inputs other than Level 1 that are observable, either directly or indirectly,
such as quoted prices for similar assets or liabilities; quoted prices in
markets that are not active; or other inputs that are observable or can be
corroborated by observable market data for substantially the full term of the
assets or liabilities.
  Level 3 –
Unobservable inputs that are supported by little or no market activity and that
are significant to the fair value of the assets or liabilities.
  In
accordance with ASC 820, the following table represents the Company’s fair value
hierarchy for its financial assets and (liabilities) measured at fair value on a
recurring basis as of September 30, 2009:
  Level
      1
                            
                            Level
      2
                            
                            Level
      3
                            
                            TotalCash
      and cash equivalents
                            
                            
                            852,904
                            
                            
                            
                            
                            
                            852,904Derivative
      liabilities
                            
                            
                            
                            
                            
                            
                            (6,173,909
                            )
                            (6,173,909
                            )
 
 LOSS
PER SHARE
 
 The
Company utilizes ASC 260, “Earnings Per Share” for calculating the basic and
diluted loss per share. Basic loss per share is computed by dividing loss
available to common shareholders by the weighted-average number of common shares
outstanding. Diluted loss per share is computed similar to basic loss per share
except that the denominator is increased to include the number of additional
common shares that would have been outstanding if the potential common shares
had been issued and if the additional common shares were dilutive. Common
equivalent shares are excluded from the computation if their effect is
anti-dilutive.
  Common
equivalent shares are excluded from the computation of diluted loss per share if
their effect would be anti-dilutive. There were 32,977,307 common share
equivalents at September 30, 2009 and 13,934,756 at September 30, 2008. Common
equivalent shares were excluded from the calculation of diluted loss per share
for the three month period ended September 30, 2008 and for the nine month
periods ended September 30, 2009 and 2008 as their inclusion would reduce
diluted loss per share for those periods.
  For the
three month period ended September 30, 2009, diluted weighted average shares
used in the calculation of diluted earnings per share total 29,615,853. This
amount consists of weighted average shares outstanding of 28,495,256 plus
1,120,597 dilutive potential common shares.
 
 USE
OF ESTIMATES
 
 The
preparation of financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
  WARRANTY
RESERVE
 
 The
Company generally warrants its products against defects over a period of one to
three years. An accrual for estimated future costs relating to products returned
under warrants is recorded as a charge to cost of sales when products are
shipped. The accrual is based on a percentage of sales. This percentage was 10%
through March 31, 2009, 5% for the second quarter of 2009 and 3% effective July
1, 2009 (the changes in estimate based on historical trends). Activity in the
accrued warranty reserve liability for the three and nine month periods ended
September 30, 2009 and 2008 is as follows:
  9
 
 Three
      months ended
                        September
      30,
                      
                      
                      Nine
      months ended
                        September
      30,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008Balance
      at beginning of period
                      
                      $
                      288,666
                      
                      
                      $
                      108,806
                      
                      
                      $
                      198,854
                      
                      
                      $
                      27,816Charged
      to cost of sales
                      
                      
                      25,121
                      
                      
                      
                      75,745
                      
                      
                      
                      118,282
                      
                      
                      
                      160,335Deductions
                      
                      
                      -
                      
                      
                      
                      (19,959
                      )
                      
                      
                      (3,349
                      )
                      
                      
                      (23,559
                      )Balance
      at end of period
                      
                      $
                      313,787
                      
                      
                      $
                      164,592
                      
                      
                      $
                      313,787
                      
                      
                      $
                      164,592
  STOCK
BASED COMPENSATION
 
 The
Company accounts for its stock based compensation under ASC 718 “Compensation –
Stock Compensation” which was adopted in 2006, using the fair value based
method. Under this method, compensation cost is measured at the grant date based
on the value of the award and is recognized over the service period, which is
usually the vesting period.  This guidance establishes standards for
the accounting for transactions in which an entity exchanges it equity
instruments for goods or services. It also addresses transactions in which an
entity incurs liabilities in exchange for goods or services that are based on
the fair value of the entity’s equity instruments or that may be settled by the
issuance of those equity instruments.
 
 INCOME
TAXES
 
 The
Company utilizes ASC 740 “Income Taxes” which requires the recognition of
deferred tax assets and liabilities for the expected future tax consequences of
events that have been included in the financial statements or tax returns. Under
this method, deferred income taxes are recognized for the tax consequences in
future years of differences between the tax bases of assets and liabilities and
their financial reporting amounts at each year-end based on enacted tax laws and
statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income.
 
 The
Company adopted new accounting guidance effective January 1, 2007. As a result
of the implementation of this new guidance, the Company made a comprehensive
review of its portfolio of uncertain tax positions in accordance with
recognition standards established by the guidance. As a result of this review,
the Company concluded that at this time there are no uncertain tax positions
that would result in tax liability to the Company. There was no cumulative
effect on retained earnings as a result of applying the provisions of this
guidance.
 
 CHANGE
IN ACCOUNTING PRINCIPLE
 
 In June
2008, the FASB issued new accounting guidance which requires entities to
evaluate whether an equity-linked financial instrument (or embedded feature) is
indexed to its own stock by assessing the instrument’s contingent exercise
provisions and settlement provisions. Instruments not indexed to their own stock
fail to meet the scope exception of ASC 815 and should be classified as a
liability and marked-to-market. The statement is effective for fiscal years
beginning after December 15, 2008 and is to be applied to outstanding
instruments upon adoption with the cumulative effect of the change in accounting
principle recognized as an adjustment to the opening balance of retained
earnings. The Company has assessed its outstanding equity-linked financial
instruments and has concluded that, effective January 1, 2009, the
conversion feature of our convertible debentures will need to be recorded as a
derivative liability due to the fact that the conversion price is subject to
adjustment based on subsequent sales of securities. The cumulative effect of the
change in accounting principle on January 1, 2009 is an increase in our
derivative liability related to the fair value of the conversion feature of
$6,061, an increase in the unamortized discount related to our convertible
debentures of $1,287,781, a decrease in additional paid-in capital of $3,237,954
related to the decrease in beneficial conversion feature attributable to the
debentures, and a $4,519,674 net decrease in accumulated deficit, comprised of a
credit to reflect the change in fair value of the derivative liability from date
of issue to January 1, 2009 of $5,235,242 partially offset by a charge of
$715,568 for additional expense for amortization of debt
discount.
  10
 
 RECENTLY
ISSUED ACCOUNTING PRONOUNCEMENTS
 
 Accounting
Standards Codification and GAAP Hierarchy — Effective for interim and annual
periods ending after September 15, 2009, the Accounting Standards Codification
and related disclosure requirements issued by the FASB became the single
official source of authoritative, nongovernmental GAAP. The ASC simplifies GAAP,
without change, by consolidating the numerous, predecessor accounting standards
and requirements into logically organized topics. All other literature not
included in the ASC is non-authoritative. We adopted the ASC as of September 30,
2009, which did not have any impact on our results of operations, financial
condition or cash flows as it does not represent new accounting literature or
requirements.   All references to pre-codified U.S. GAAP have
been removed from this Form 10-Q.
 
 In
September 2006, the FASB issued new accounting guidance which clarifies the
principle that fair value should be based on the assumptions market participants
would use when pricing an asset or liability and establishes a fair value
hierarchy that prioritizes the information used to develop those assumptions.
Under the guidance, fair value measurements would be separately disclosed by
level within the fair value hierarchy. The guidance is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years, with early adoption permitted. In
February 2008, FASB issued additional guidance which delayed the effective date
of previous guidance to fiscal years and interim periods within those fiscal
years beginning after November 15, 2008 for non-financial assets and
non-financial liabilities, except for items that are recognized or disclosed at
fair value in the financial statements on a recurring basis (at least annually).
We elected to defer the adoption of the guidance for these non-financial assets
and liabilities, and are currently evaluating the impact, if any, that the
deferred provisions of the guidance will have on our consolidated financial
statements. The adoption of the guidance for our financial assets and
liabilities did not have an impact on our consolidated financial position or
operating results.
 
 In
December 2007 the FASB issued new accounting guidance which establishes
accounting and reporting standards for the non-controlling interest in a
subsidiary and for the deconsolidation of a subsidiary. It clarifies that a
non-controlling interest in a subsidiary is an ownership interest in the
consolidated entity that should be reported as equity in the consolidated
financial statements. This guidance changes the way the consolidated income
statement is presented. It requires consolidated net income to be reported at
amounts that include the amounts attributable to both the parent and the
non-controlling interest. It also requires disclosure, on the face of the
consolidated statement of income, of the amounts of consolidated net income
attributable to the parent and to the non-controlling interest. This guidance
establishes disclosure requirements in the consolidated financial statements,
which will enable users to clearly distinguish between the interests of the
parent’s owners and the interests of the non-controlling owners of a subsidiary.
The guidance is effective for fiscal years, and interim periods within those
fiscal years, beginning on or after December 15, 2008; earlier adoption is
prohibited. The adoption of this guidance had no impact to the Company’s
consolidated financial position, results of operations, or cash flows.
 
 In
December 2007, the FASB issued new accounting guidance which establishes
principles and requirements for how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired and the liabilities
assumed, any non-controlling interest in the acquiree and the goodwill acquired.
This guidance also establishes disclosure requirements which will enable users
to evaluate the nature and financial effects of the business combination. This
guidance is effective for business combinations for which the acquisition date
is on or after the beginning of the first annual reporting period beginning on
or after December 15, 2008. The adoption of this guidance had no impact to the
Company’s consolidated financial position, results of operations, or cash
flows.
  11
 
 In March
2008, the FASB issued new accounting guidance which requires enhanced
disclosures about (a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance, and cash flows. This guidance is effective for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008; earlier adoption is encouraged. The adoption of this guidance
had no impact to the Company’s consolidated financial position, results of
operations, or cash flows.
 
 In April
2008, the FASB issued new accounting guidance which amends the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset. This change is
intended to improve the consistency between the useful life of a recognized
intangible asset and the period of expected cash flows used to measure the fair
value of the asset. The new guidance is effective for financial statements
issued for fiscal years beginning after December 15, 2008, and interim periods
within those fiscal years. The requirement for determining useful lives must be
applied prospectively to intangible assets acquired after the effective date and
the disclosure requirements must be applied prospectively to all intangible
assets recognized as of, and subsequent to, the effective date. The adoption of
this guidance had no impact on the Company’s consolidated financial position,
results of operations, or cash flows.
  In June
2008, the FASB issued new accounting guidance which requires that all
unvested share-based payment awards that contain nonforfeitable rights to
dividends should be included in the basic Earnings Per Share (EPS)
calculation. The new guidance is effective for financial statements issued
for fiscal years beginning after December 15, 2008. The adoption of this
guidance had no impact on the Company’s consolidated financial position, results
of operations, or cash flows.
  In April
2009, the FASB issued new accounting guidance to be utilized in determining
whether impairments in debt securities are other than temporary, and which
modifies the presentation and disclosures surrounding such instruments. This
guidance is effective for interim periods ending after June 15, 2009, but early
adoption is permitted for interim periods ending after March 15, 2009. The
adoption of this guidance during the second quarter of 2009 had no impact on the
Company’s consolidated financial position, results of operations, or cash
flows.
  In April
2009, the FASB issued new accounting which provides additional guidance in
determining whether the market for a financial asset is not active and a
transaction is not distressed for fair value measurement purposes. The guidance
is effective for interim periods ending after June 15, 2009, but early adoption
is permitted for interim periods ending after March 15, 2009. The adoption of
this guidance during the second quarter of 2009 had no impact on the Company’s
consolidated financial position, results of operations, or cash flows.
  In April
2009, the FASB issued new accounting guidance which requires disclosures about
fair value of financial instruments in interim financial statements as well as
in annual financial statements. This guidance is effective for interim periods
ending after June 15, 2009, but early adoption is permitted for interim periods
ending after March 15, 2009. The adoption of this guidance during the second
quarter of 2009 had no impact on the Company’s consolidated financial position,
results of operations, or cash flows.
 
 In May
2009, the FASB issued new accounting guidance which establishes general
standards of accounting for and disclosures of events that occur after the
balance sheet date but before financial statements are issued or are available
to be issued. The guidance will be effective for interim and annual financial
periods ending after June 15, 2009. The Company adopted the guidance during
the three months ended June 30, 2009 and has evaluated subsequent events
through the issuance date of these financial statements. The adoption of this
guidance had no impact on the Company’s consolidated financial position, results
of operations, or cash flows.
  12
  In June
2009, the FASB issued new accounting guidance which will require more
information about the transfer of financial assets where companies have
continuing exposure to the risks related to transferred financial assets. This
guidance is effective at the start of a company’s first fiscal year beginning
after November 15, 2009, or January 1, 2010 for companies reporting earnings on
a calendar-year basis.
 
 In June
2009, the FASB issued new accounting guidance which will change how a company
determines when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be consolidated. Under this
guidance, determining whether a company is required to consolidate an entity
will be based on, among other things, an entity's purpose and design and a
company's ability to direct the activities of the entity that most significantly
impact the entity's economic performance. This guidance is effective at the
start of a company’s first fiscal year beginning after November 15, 2009, or
January 1, 2010 for companies reporting earnings on a calendar-year
basis.
 
 Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force), the AICPA, and the SEC did not, or are not believed by
management to, have a material impact on the Company's present or future
consolidated financial statements.
 
 NOTE
3 - INCOME TAXES
 
 Our
effective tax rate was estimated at 0% for the three and nine months ended
September 30, 2009 and 2008.
 
 NOTE
4 - STOCKHOLDER’S EQUITY
 
 PREFERRED
STOCK
 
 The
Company has 5,000,000 authorized shares of $0.001 par value preferred stock. The
preferred stock may be issued in series, from time to time, with such
designations, rights, preferences, and limitations as the Board of Directors may
determine by resolution.
 
 COMMON
STOCK
 
 The
Company has 75,000,000 authorized shares of $0.001 par value common
stock.
  In April
2009 the Company’s board of directors approved stock option awards to two
employees aggregating 150,000 shares of common stock, 100,000 options with an
exercise price of $0.072 per share and vest over one year and 50,000 options
with an exercise price of $0.062 per share and vest over three years. Both
options expire after five years.
 
 In July
2009 the Company’s board of directors approved stock option awards to its
directors aggregating 825,000 shares of common stock with an exercise price of
$0.18 per share. These options vest quarterly over one year. All options expire
after ten years. The options had an aggregate grant date fair value of
$55,146.
 
 In July
2009 the Company’s board of directors approved stock option awards to employees
aggregating 907,000 shares of common stock with an exercise price of $0.18 per
share. These options vest one third on the one year anniversary of the grant and
the remaining two thirds vest quarterly over the following two years. Of these
options, 525,000 expire after ten years and 382,000 expire after five
years. The options had an aggregate grant date fair value of
$95,040.
 
 In July
2009 the Company’s board of directors approved stock option awards to
consultants aggregating 190,000 shares of common stock with an exercise price of
$0.18 per share. These options vest one third on the one year anniversary of the
grant and the remaining two thirds vest quarterly over the following two years.
All options expire after five years. The options will be valued as they vest,
with estimated compensation cost recorded between vesting
periods.
  13
 
 The
Company recorded $430,054 and $1,334,622 of compensation expense for employee
and consultant stock options during the nine months ending September 30, 2009
and 2008, respectively, and recorded $134,096 and $419,665 of compensation
expense for employee and consultant stock options during the three months ending
September 30, 2009 and 2008, respectively, which is included in the
administrative expense category.
 
 NOTE
5 - 8% SENIOR SECURED CONVERTIBLE DEBENTURES
 
 On
February 20, 2009, the Company’s stock was delisted from the NASDAQ National
Market System due to a failure to maintain adequate share pricing. As a result,
the Company defaulted on its 8% Senior Secured Convertible
Debentures.  Such default results in acceleration of the debentures, a
thirty percent (30%) increase in the principal amount of the debentures, and an
increase in the interest rate on the debentures from eight percent (8%) to
eighteen percent (18%). We have accounted for the default in the financial
statements.
 
 In June
2008, the FASB issued new accounting guidance which requires entities to
evaluate whether an equity-linked financial instrument (or embedded feature) is
indexed to its own stock by assessing the instrument’s contingent exercise
provisions and settlement provisions. Instruments not indexed to their own stock
fail to meet the scope exception of ASC 815 and should be classified as a
liability and marked-to-market. The statement is effective for fiscal years
beginning after December 15, 2008 and is to be applied to outstanding
instruments upon adoption with the cumulative effect of the change in accounting
principle recognized as an adjustment to the opening balance of retained
earnings. The Company has assessed its outstanding equity-linked financial
instruments and has concluded that, effective January 1, 2009, the
conversion feature of our convertible debentures will need to be recorded as a
derivative liability due to the fact that the conversion price is subject to
adjustment based on subsequent sales of securities. The cumulative effect of the
change in accounting principle on January 1, 2009 includes an increase in
our derivative liability related to the fair value of the conversion feature of
$6,061. Fair value at January 1, 2009 was determined using the Black-Scholes
method based on the following assumptions:  (1) risk free
interest rate of 0.875%; (2) dividend yield of 0%; (3) volatility
factor of the expected market price of our common stock of 101%; and
(4) an expected life of the conversion feature of 2 years. At January
1, 2009 the Company has also recorded an additional discount related to the
debentures of $1,287,781 as a result of the implementation of EITF
07-05.
 
 As a
result of the default described above, the principal amount of the debentures
was increased by 30%, or $2,642,750. We have recorded a charge to interest
expense related to this increase during the quarter ended March 31,
2009.
 
 Also as a
result of the default, the maturity date of the debentures has been accelerated.
The Company has fully amortized the remaining discount and deferred debt issue
costs during the period ended March 31, 2009. The charge to interest expense for
the amortization of debt discount is $6,671,835 and for amortization of debt
issue costs is $449,052 during the quarter ended March 31, 2009.
 
 At
September 30, 2009 we recalculated the fair value of the conversion feature
subject to derivative accounting and have determined that the fair value at
September 30, 2009 (prior to the debt extinguishment transactions described
below) is $363,477. The fair value of the conversion feature was determined
using the Black-Scholes method based on the following
assumptions:  (1) risk free interest rate of 1.0%;
(2) dividend yield of 0%; (3) volatility factor of the expected market
price of our common stock of 121%; and (4) an expected life of the
conversion feature of 1.4 years.
 
 We
recorded charges of $288,088 and $357,416 during the three and nine months ended
September 30, 2009, respectively, related to the change in fair value of the
conversion feature during those periods.
  14
  The
Company is accounting for the warrants, issued in connection with the debentures
as derivative liabilities in accordance with ASC 815. At September 30, 2009, the
warrant liability was valued at $347,010 (prior to the debt extinguishment
transactions described below). The Company recorded charges of $236,615 and
$327,955 during the three and nine months ended September 30, 2009,
respectively, related to the change in fair value of the warrant liability
during those periods. The fair value of the warrant liability was determined
using the Black-Scholes method based on the following
assumptions:  (1) risk free interest rate of 1%;
(2) dividend yield of 0%; (3) volatility factor of the expected market
price of our common stock of 121%; and (4) an expected life of the
warrants of 3.6 years. The Company recorded gains of $841,513 and
$2,866,067 during the three and nine months ended September 30, 2008,
respectively, related to the change in fair value of the warrant liability
during those periods.
 
 2009
Debenture Transactions
 
 Assignment
of Debenture and Common Stock Warrant agreement
 
 On July
11, 2009, we entered into an Assignment of Debenture and Common Stock Warrant
agreement with EMC Corporation and RSA Security Inc., its wholly owned
subsidiary (collectively “EMC”).  Pursuant to the terms of the
agreement, EMC has agreed to assign and transfer to us approximately $7.1
million of our 8% Senior Secured Convertible Debentures and approximately 1.01
million common stock purchase warrants upon the receipt of certain deliverables
and the certification of the content of such deliverables.  The
aforementioned deliverables are as follows: (i) pay EMC cash in the amount of
$1.00; (ii) return to EMC all intellectual property belonging to EMC that is in
our and SmartDisplayer Technology’s possession; (iii) return to EMC certain
inventory containing EMC-related materials; (iv) grant to EMC certain audit and
confirmation rights as further described in the Agreement; and (v) cancel a
pre-existing Supply Agreement between EMC and us.  Additionally, the
Agreement provides for the mutual release of all claims, whether known or
unknown, between the parties which relate to the securities and the Supply
Agreement. On September 29, 2009 we were notified by EMC Corporation that we had
fulfilled all of our obligations and conditions under the
Assignment.  As a result, approximately $7,600,000 (which includes
interest, penalties and all other costs, expenses and charges associated
therewith) of the Company’s 8% Senior Secured Convertible Debentures along with
1,008,064 common stock purchase warrants were assigned back to the Company and
retired.  Also, the conversion feature subject to derivative
accounting related to these debentures in the amount of approximately $240,000
and the warrant liability related to these warrants of approximately $211,000
have been cancelled. We have made a payment of $60,000 pursuant to the
agreement; have been released from our obligation pursuant to a deposit received
from RSA Security, Inc. in the amount of $142,006; and all parties have been
mutually released from all claims. We have recorded a gain on extinguishment of
debt of approximately $8,115,000 as a result of the above
transactions.
 
 On
September 30, 2009, the Company also entered into a series of transactions with
the holders of the remaining Debentures (“Holders”) and certain creditors as
described below.
 
 Waiver,
Amendment and Exchange Agreement
 
 Pursuant
to the terms of the Waiver, Amendment and Exchange Agreement, the holders agreed
to waive all existing events of default under the Debentures and to waive any
late fees, increased interest and liquidated damages that accrued prior through
September 30, 2009. Such amounts aggregated approximately $1,405,000 at
September 30, 2009.
 
 The
Company also agreed to issue to each of the holders, in exchange for their
debentures and warrants, amended and exchanged original issuance discount
debentures (“Amended Debenture”), with a principal amount equal to each Holder’s
current Debenture plus interest through April 2, 2010 (for an aggregate face
amount of $3,975,975) and amended and exchanged warrants (“Amended Warrant”) in
an amount equal to each Holders current Warrant (for an aggregate of 700,000
warrants).  Each Amended Debenture (i) bears interest at 8% per year
commencing on April 1, 2010, paid quarterly, commencing July 1, 2010, in cash
or, subject to certain conditions, registered shares of our common stock; (ii)
has a maturity of January 8, 2011, (iii) is convertible at the holders’ option
into shares of our common stock at either $1.00 per share (for $686,502 of
Debentures) or $0.25 per share (for $3,289,473 of Debentures), (iv) is secured
by all of our and our subsidiaries’ assets, including inventory, receivables,
unencumbered equipment and intellectual property, and (v) has a forced
conversion feature which allows us to force the conversion of the Amended
Debenture if our common stock trades above $1.00 for 10 consecutive trading
days.  Such a forced conversion may be limited by contractual
restrictions on the amount of our common stock which the holder may own and
certain other conditions.  Each Amended Warrant has a term of 5 years
from the initial issuance date which is January 8, 2008 and an exercise price of
$0.25 per share. The original issue discount of $144,649 will be amortized over
the period October 1, 2009 to April 2, 2010.
  15
 
 Both the
conversion price of the $3,289,473 Amended Debentures initially convertible at
$0.25 per share and the exercise price of 580,000 of the Amended Warrants are
subject to “full-ratchet” price protection in the event of stock issuances below
their respective conversion or exercise prices, except for specified exempted
issuances including grants of stock options and stock issuances to officers,
directors, employees and consultants.  For the Debentures and Warrants
for which price protection have been removed, the related conversion liability
of $21,324 and related warrant liability of $23,358 at September 30, 2009 have
been reclassified to additional paid-in capital.
 
 At
September 30, 2009 we recalculated the fair value of the re-priced conversion
feature of the Amended Debentures with price protection subject to derivative
accounting and have determined that the fair value at September 30, 2009 is
$3,703,903. The fair value of the conversion feature was determined using the
Black-Scholes method based on the following
assumptions:  (1) risk free interest rate of 1.0%;
(2) dividend yield of 0%; (3) volatility factor of the expected market
price of our common stock of 121%; and (4) an expected life of the
conversion feature of 1.25 years. We recorded a charge of $3,601,866 at
September 30, 2009 related to the change in fair value of the conversion feature
of the repriced debentures.
 
 At
September 30, 2009, we recalculated the fair value of the re-priced warrant
liability for the warrants with price protection and have determined that the
fair value at September 30, 2009 is $163,268. The fair value of the warrant
liability was determined using the Black-Scholes method based on the following
assumptions:  (1) risk free interest rate of 1%;
(2) dividend yield of 0%; (3) volatility factor of the expected market
price of our common stock of 121%; and (4) an expected life of the
warrants of 1.25 years. We recorded a charge of $50,370 at September 30,
2009 related to the change in fair value of the re-priced warrant
liability.
 
 We have
recorded a gain on extinguishment of debt of approximately $1,405,000 as a
result of the above transactions.
 
 Debt
Settlement
 
 In
addition to the exchange of the Debentures and Warrants, we also settled certain
outstanding obligations owed to creditors of the Company in an aggregate amount
of $672,243 in exchange for Amended Debentures in the amount of $699,354 and
Amended Warrants to purchase 135,533 shares of common stock. The Debentures are
convertible at the holders’ option into shares of our common stock at either
$1.00 per share (for $652,539 of Debentures) or $0.25 per share (for $46,815 of
Debentures).  The original issue discount of $27,111 will be amortized
over the period October 1, 2009 to April 2, 2010.
 
 Both the
conversion price of the $46,815 Amended Debentures initially convertible at
$0.25 per share and the exercise price of 9,073 of the Amended Warrants are
subject to “full-ratchet” price protection in the event of stock issuances below
their respective conversion or exercise prices, except for specified exempted
issuances including grants of stock options and stock issuances to officers,
directors, employees and consultants.
 
 At
September 30, 2009 we calculated the fair value of the conversion feature of the
Amended Debentures with price protection subject to derivative accounting and
have determined that the fair value at September 30, 2009 is $52,713. The fair
value of the conversion feature was determined using the Black-Scholes method
based on the following assumptions:  (1) risk free interest rate
of 1.0%; (2) dividend yield of 0%; (3) volatility factor of the
expected market price of our common stock of 121%; and (4) an expected
life of the conversion feature of 1.25 years. We recorded a discount of
$52,713 at September 30, 2009 related to the fair value of the conversion
feature of the debentures, of which $10,267 has been immediately charged to
expense. The remaining discount of $42,446 will be amortized to the date of
maturity, January 8, 2011.
  16
 
 At
September 30, 2009, we calculated the fair value of the warrant liability for
the warrants with price protection and have determined that the fair value at
September 30, 2009 is $2,554. The fair value of the warrant liability was
determined using the Black-Scholes method based on the following
assumptions:  (1) risk free interest rate of 1%;
(2) dividend yield of 0%; (3) volatility factor of the expected market
price of our common stock of 121%; and (4) an expected life of the
warrants of 1.25 years. We recorded a discount of $2,554 at September 30,
2009 related to the fair value of the warrant liability. The discount will be
amortized to the date of maturity, January 8, 2011.
 
 At
September 30, 2009, we calculated the relative fair value of the warrants
without price protection and have determined that the relative fair value at
September 30, 2009 is $33,756. The relative fair value of the warrants was
determined using the Black-Scholes method based on the following
assumptions:  (1) risk free interest rate of 1%;
(2) dividend yield of 0%; (3) volatility factor of the expected market
price of our common stock of 121%; and (4) an expected life of the
warrants of 1.25 years. We recorded a discount of $33,756 at September 30,
2009 related to the relative fair value of the warrants. The discount will be
amortized to the date of maturity, January 8, 2011.
 
 Debenture
& Warrant Purchase Agreement
 
 Pursuant
to the terms of a Debenture and Warrant Purchase Agreement, the Company issued
an additional $1,173,416 face value of its Amended Debentures (convertible into
4,693,664 common shares) and 2,254,642 Amended Warrants.  We received
cash proceeds of $1,127,321. The Amended Debentures and Warrants issued to these
investors have a conversion price and exercise price of $0.25 and $0.25,
respectively. Both the conversion price of the Amended Debentures and the
exercise price of the Amended Warrants are subject to “full-ratchet” price
protection in the event of stock issuances below their respective conversion or
exercise prices, except for specified exempted issuances including grants of
stock options and stock issuances to officers, directors, employees and
consultants. The original issue discount of $46,095 will be amortized over the
period October 1, 2009 to April 2, 2010.
 
 At
September 30, 2009 we calculated the fair value of the conversion feature of the
Amended Debentures subject to derivative accounting and have determined that the
fair value at September 30, 2009 is $1,321,251. The fair value of the conversion
feature was determined using the Black-Scholes method based on the following
assumptions:  (1) risk free interest rate of 1.0%;
(2) dividend yield of 0%; (3) volatility factor of the expected market
price of our common stock of 121%; and (4) an expected life of the
conversion feature of 1.25 years. We recorded a discount of $1,321,251 at
September 30, 2009 related to the fair value of the conversion feature of the
debentures, of which $828,604 has been immediately charged to expense. The
remaining discount of $492,647 will be amortized to the date of maturity,
January 8, 2011.
 
 At
September 30, 2009, we calculated the fair value of the warrant liability for
the warrants with price protection and have determined that the fair value at
September 30, 2009 is $634,674. The fair value of the warrant liability was
determined using the Black-Scholes method based on the following
assumptions:  (1) risk free interest rate of 1%;
(2) dividend yield of 0%; (3) volatility factor of the expected market
price of our common stock of 121%; and (4) an expected life of the
warrants of 1.25 years. We recorded a discount of $634,674 at September 30,
2009 related to the fair value of the warrant liability. The discount will be
amortized to the date of maturity, January 8, 2011.
 
 NOTE
6 – NOTE PAYABLE
 
 On
September 9, 2009 we executed a promissory note in the amount of $100,000.The full amount of
principal and accrued but unpaid interest under this note is due on the earlier
of: (i) October 31, 2009; or (ii) the date on which we complete the
restructuring of our 8% Senior Secured Convertible Debentures described above.
We repaid $50,000 on September 30, 2009 and $50,000 on October 1, 2009. As a
result of these repayments, no interest was payable on the
note.
  17
 
 The
holder of the note also received a warrant to purchase 40,000 shares of our
common stock at an exercise price of $2.50 per share. The warrant has a term of
5 years. The warrant is subject to “full-ratchet” price protection in the event
of stock issuances below its exercise price, except for specified exempted
issuances including grants of stock options and stock issuances to officers,
directors, employees and consultants. At September 9, 2009, we calculated the
fair value of the warrant liability for the warrant and have determined that the
fair value at September 9, 2009 is $2,294. The fair value of the warrant
liability was determined using the Black-Scholes method based on the following
assumptions:  (1) risk free interest rate of 1%;
(2) dividend yield of 0%; (3) volatility factor of the expected market
price of our common stock of 121%; and (4) an expected life of the
warrant of 2 years. We recorded a discount of $2,294 at September 9, 2009
related to the fair value of the warrant liability and this discount has been
fully expensed at September 30, 2009.
 
 As a
result of the restructuring of our 8% Senior Secured Convertible Debentures
described above, the warrant was increased to 400,000 shares and the exercise
price was reduced to $0.25 per share. At September 30, 2009, we recalculated the
fair value of the re-priced warrant liability and have determined that the fair
value at September 30, 2009 is $125,889. The fair value of the warrant liability
was determined using the Black-Scholes method based on the following
assumptions:  (1) risk free interest rate of 1%;
(2) dividend yield of 0%; (3) volatility factor of the expected market
price of our common stock of 121%; and (4) an expected life of the
warrants of 2 years. We recorded a charge of $123,595 at September 30, 2009
related to the change in fair value of the re-priced warrant
liability.
 
 NOTE
7 - COMMITMENTS AND CONTINGENCIES
 
 LITIGATION
 
 To date,
the Company has never been a party to and has never been involved with any
litigation. However, in the future, the Company, like any other business or
individual, may become subject to litigation some of which the Company can
control and other litigation that the Company cannot control. If the Company
were to become involved in any litigation, management would have to assess
whether or not such litigation would likely have a material adverse effect on
the Company’s consolidated financial condition or results of
operations.
 
 EMPLOYMENT
AGREEMENT
 
 On
February 20, 2009, we entered in into a written employment agreement with
Richard Nathan.  The agreement provides for a bonus equal to: (i) 3%
of increase in market capitalization occurring during first year of employment;
and (ii) 2% of increase in market capitalization year after year for all periods
thereafter.  Mr. Nathan’s employment under the agreement is
“At-Will.”
 
 NOTE
7 - SUBSEQUENT EVENTS
 
 The date
through which the Company has evaluated subsequent events is November 13,
2009
  18




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





ADVISEMENT





We
urge you to read this entire Quarterly Report on Form 10-Q, including the ”Risk
Factors” section, the consolidated financial statements, and related notes
included herein.  As used in this Quarterly Report, unless the context
otherwise requires, the words “we,” “us,”“our,” “the Company,” “InCard”
“Innovative Card” and “Registrant” refer to Innovative Card Technologies, Inc.
and our subsidiaries.  Also, any reference to “common shares” or
“common stock” refers to our $.001 par value common stock.   The
information contained herein is current as of the date of this Quarterly Report
(September 30, 2009), unless another date is specified.





We
prepare our interim financial statements in accordance with United States
generally accepted accounting principles (“GAAP”). Our financials and results of
operation for the three and nine month periods ended September 30, 2009 are not
necessarily indicative of our prospective financial condition and results of
operations for the pending full fiscal year ending December 31, 2009. The
interim financial statements presented in this Quarterly Report as well as other
information contained herein should be read in conjunction and together with the
reports, statements and information filed by us with the United States
Securities and Exchange Commission (“SEC”).





FORWARD
LOOKING STATEMENTS





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





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





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





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


19





·
            Overview
      — Discussion of our business and plan of operations, overall
      analysis of financial and other highlights affecting our business in order
      to provide context for the remainder of MD&A.·
            Critical Accounting Policies
      — Accounting policies that we believe are important to
      understanding the assumptions and judgments incorporated in our reported
      financial results and forecasts.·
            Results of Operations
      — Analysis of our financial results comparing the: (i) 3
      months ended September 30, 2009 and 2008; and (ii) 9 months ended
      September 30, 2009 and 2008.·
            Liquidity and Capital
      Resources — An analysis of changes in our balance sheets and
      cash flows, and discussion of our financial condition including recent
      developments and potential sources of
liquidity.




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




Overview




We
develop and market secure products for payment, identification, physical and
logical access applications. Our main focus is on developing One-Time-Password
(“OTP”) solutions.  An OTP is a password that is only valid for a
single login session or transaction. OTPs avoid a number of shortcomings that
are associated with traditional (static) passwords. The most important
shortcoming that is addressed by OTPs is that, in contrast to static passwords,
they are not vulnerable to replay attacks. This means that, if a potential
intruder manages to record an OTP that was already used to log into a service or
to conduct a transaction, he will not be able to abuse it since it will be no
longer valid.





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





Our
primary focus is and will continue to be the further development, sales and
marketing of OTP solutions.  We anticipate we will expand our
current ICT DisplayCard product offering with other innovative OTP
products.  Since 2002, we have continued to develop our power inlay
technology that is the basis of our ICT DisplayCard.  To date we have
devoted a majority of our efforts to developing our ICT DisplayCard and
accompanying technology, initiating marketing and raising capital to fund our
business. We have generated limited revenues.




Since
inception, we have been unprofitable. We incurred net losses of $8,929,537 and
$14,333,622 for the twelve months ending December 31, 2008 and 2007,
respectively. During the nine months ended September 30, 2009, we incurred
additional net losses of $8,644,282. As of September 30, 2009, we had an
accumulated deficit of $41,121,328. Sales of the ICT DisplayCard and newly
introduced OTP products, the Company’s main products, are not expected to
generate positive cash flow until the second quarter of 2010. As a result, there
is substantial doubt about the Company’s ability to continue as a going concern
at September 30, 2009.




20


Our
continued existence is dependent upon our ability to generate sales from our OTP
products or, if we are unable to do so in sufficient quantity to cover our
expenses, to obtain additional financing. In 2008, we made our first significant
sale of ICT DisplayCards; however we anticipate that we will continue to incur
net losses due to our costs exceeding our revenues.  Management cannot
yet predict when we will achieve an operating profit or net
income.  Our capital requirements for the next 12 months consist of
the research and development of new OTP products, the acquisition of inventory,
retention and hiring of key personnel, and implementation of a sales force for
our products. These expenditures are anticipated to be significant. To date, our
operations have been funded primarily through equity and debt
financings.





We
believe that our current cash, combined with anticipated revenue collections,
will be adequate to fund our operations through the first quarter of 2010. If we
are unable to raise additional capital or make significant sales by that date,
we may be forced to curtail our operations or seek bankruptcy protection. We
anticipate that we will not be able to generate sales of the ICT DisplayCard and
newly introduced OTP products in quantities that will sustain a positive cash
flow until the second quarter of 2010.





Our backlog, which
consists of orders received but not yet shipped, totaled approximately $1.2
million at October 31, 2009, approximately 85% of which we expect to deliver in
2009.





On
January 13, 2009 we disclosed that we received a purchase order in the amount of
$3,737,988. Subsequently, we disclosed that our customer intended to delay
the delivery of approximately 60% of the order.  During October of
2009, the customer has informed us of its intent to cancel the unshipped balance
of the order, notwithstanding the fact that the order is
non-cancellable.  Prior to receiving our customer’s notification, we
fulfilled approximately $1,320,000 worth of product deliveries under the
order.





Critical
Accounting Policies





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





Accounting
Standards Codification and GAAP Hierarchy — Effective for interim and annual
periods ending after September 15, 2009, the Accounting Standards Codification
and related disclosure requirements issued by the FASB became the single
official source of authoritative, nongovernmental GAAP. The ASC simplifies GAAP,
without change, by consolidating the numerous, predecessor accounting standards
and requirements into logically organized topics. All other literature not
included in the ASC is non-authoritative. We adopted the ASC as of September 30,
2009, which did not have any impact on our results of operations, financial
condition or cash flows as it does not represent new accounting literature or
requirements.   All references to pre-codified U.S. GAAP have
been removed from this Form 10-Q.





Revenue
recognition.





We
recognize revenues in accordance with Financial Accounting Standards Board
(“FASB”) Accounting Standards Codification (“ASC”) Topic 605 “Revenue
Recognition”. Revenues are recognized when persuasive evidence of an arrangement
exists, delivery has occurred or services have been rendered, the price is fixed
and determinable and collectability is reasonably assured. Revenue is not
recognized on product sales transacted on a test or pilot basis. Instead,
receipts from these types of transactions offset marketing expenses. Revenue
from royalties is recognized with the passage of time in accordance with the
underlying agreement. We recognize certain long-term contracts using the
completed-contract method in accordance with ASC 605.





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




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





The
revenue generated from the LensCard and LightCard is negligible, and we expect
that the sales of these products will have an immaterial impact on our results
of operations.


21





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





Accounts
receivable allowances.





Our sales
to date have been to large credit card issuers and we have been successful in
collecting for products and services. We perform a regular review of our
customer activity and associated credit risks and do not require collateral from
our customers. At September 30, 2009, based on our review of customer activity,
we recorded an allowance for doubtful accounts of $60,000.





Warranty
expense.





We
estimate the cost associated with meeting our warranty obligations for the sale
of our products. The initial estimate and changes to the estimate are charged to
cost of goods sold at the time of sale of the product. Effective April 1, 2009
we reduced our estimate for warranty reserves for the second and third quarters,
on a prospective basis, based on historical experience.





Inventory.





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





Research
and Development.





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





Valuation
of Long-Lived Assets.





We assess
the impairment of identifiable long-lived assets whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. Factors
considered important that could trigger an impairment review include, but are
not limited to, the following: a significant underperformance to expected
historical or projected future operating results, a significant change in the
manner of the use of the acquired asset or the strategy for the overall
business, or a significant negative industry or economic trend. We assess the
carrying value of long-lived assets in accordance with ASC Topic 360, "Property, Plant and
Equipment". We have
not recorded any impairment of long-lived assets.





Stock
Based Compensation.





We
account for our stock based compensation under ASC 718 “Compensation – Stock
Compensation” which was adopted in 2006, using the fair value based method.
Under this method, compensation cost is measured at the grant date based on the
value of the award and is recognized over the service period, which is usually
the vesting period.  This guidance establishes standards for the
accounting for transactions in which an entity exchanges it equity instruments
for goods or services. It also addresses transactions in which an entity incurs
liabilities in exchange for goods or services that are based on the fair value
of the entity’s equity instruments or that may be settled by the issuance of
those equity instruments.





Income
Taxes





We
utilize ASC Topic 740 “Income Taxes” which requires the recognition of deferred
tax assets and liabilities for the expected future tax consequences of events
that have been included in the financial statements or tax returns. Under this
method, deferred income taxes are recognized for the tax consequences in future
years of differences between the tax bases of assets and liabilities and their
financial reporting amounts at each year-end based on enacted tax laws and
statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income.





We
adopted new accounting guidance effective January 1, 2007. As a result of the
implementation of this new guidance, we made a comprehensive review of our
portfolio of uncertain tax positions in accordance with recognition standards
established by the guidance. As a result of this review, we concluded that at
this time there are no uncertain tax positions that would result in tax
liability to the Company. There was no cumulative effect on retained earnings as
a result of applying the provisions of this guidance.




22





Change
in Accounting Principle





In June
2008, the FASB issued new accounting guidance which requires entities to
evaluate whether an equity-linked financial instrument (or embedded feature) is
indexed to its own stock by assessing the instrument’s contingent exercise
provisions and settlement provisions. Instruments not indexed to their own stock
fail to meet the scope exception of ASC 815 and should be classified as a
liability and marked-to-market. The statement is effective for fiscal years
beginning after December 15, 2008 and is to be applied to outstanding
instruments upon adoption with the cumulative effect of the change in accounting
principle recognized as an adjustment to the opening balance of retained
earnings. The Company has assessed its outstanding equity-linked financial
instruments and has concluded that, effective January 1, 2009, the
conversion feature of our convertible debentures will need to be recorded as a
derivative liability due to the fact that the conversion price is subject to
adjustment based on subsequent sales of securities. The cumulative effect of the
change in accounting principle on January 1, 2009 is an increase in our
derivative liability related to the fair value of the conversion feature of
$6,061, an increase in the unamortized discount related to our convertible
debentures of $1,287,781, a decrease in additional paid-in capital of $3,237,954
related to the decrease in beneficial conversion feature attributable to the
debentures, and a $4,519,674 net decrease in accumulated deficit, comprised of a
credit to reflect the change in fair value of the derivative liability from date
of issue to January 1, 2009 of $5,235,242 partially offset by a charge of
$715,568 for additional expense for amortization of debt discount.





Recently
Issued Accounting Pronouncements





Accounting
Standards Codification and GAAP Hierarchy — Effective for interim and annual
periods ending after September 15, 2009, the Accounting Standards Codification
and related disclosure requirements issued by the FASB became the single
official source of authoritative, nongovernmental GAAP. The ASC simplifies GAAP,
without change, by consolidating the numerous, predecessor accounting standards
and requirements into logically organized topics. All other literature not
included in the ASC is non-authoritative. We adopted the ASC as of September 30,
2009, which did not have any impact on our results of operations, financial
condition or cash flows as it does not represent new accounting literature or
requirements.   All references to pre-codified U.S. GAAP have
been removed from this Form 10-Q.





In
September 2006, the FASB issued new accounting guidance which clarifies the
principle that fair value should be based on the assumptions market participants
would use when pricing an asset or liability and establishes a fair value
hierarchy that prioritizes the information used to develop those assumptions.
Under the guidance, fair value measurements would be separately disclosed by
level within the fair value hierarchy. The guidance is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years, with early adoption permitted. In
February 2008, FASB issued additional guidance which delayed the effective date
of previous guidance to fiscal years and interim periods within those fiscal
years beginning after November 15, 2008 for non-financial assets and
non-financial liabilities, except for items that are recognized or disclosed at
fair value in the financial statements on a recurring basis (at least annually).
We elected to defer the adoption of the guidance for these non-financial assets
and liabilities, and are currently evaluating the impact, if any, that the
deferred provisions of the guidance will have on our consolidated financial
statements. The adoption of the guidance for our financial assets and
liabilities did not have an impact on our consolidated financial position or
operating results.





In
December 2007 the FASB issued new accounting guidance which establishes
accounting and reporting standards for the non-controlling interest in a
subsidiary and for the deconsolidation of a subsidiary. It clarifies that a
non-controlling interest in a subsidiary is an ownership interest in the
consolidated entity that should be reported as equity in the consolidated
financial statements. This guidance changes the way the consolidated income
statement is presented. It requires consolidated net income to be reported at
amounts that include the amounts attributable to both the parent and the
non-controlling interest. It also requires disclosure, on the face of the
consolidated statement of income, of the amounts of consolidated net income
attributable to the parent and to the non-controlling interest. This guidance
establishes disclosure requirements in the consolidated financial statements,
which will enable users to clearly distinguish between the interests of the
parent’s owners and the interests of the non-controlling owners of a subsidiary.
The guidance is effective for fiscal years, and interim periods within those
fiscal years, beginning on or after December 15, 2008; earlier adoption is
prohibited. The adoption of this guidance had no impact to the Company’s
consolidated financial position, results of operations, or cash flows.





In
December 2007, the FASB issued new accounting guidance which establishes
principles and requirements for how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired and the liabilities
assumed, any non-controlling interest in the acquiree and the goodwill acquired.
This guidance also establishes disclosure requirements which will enable users
to evaluate the nature and financial effects of the business combination. This
guidance is effective for business combinations for which the acquisition date
is on or after the beginning of the first annual reporting period beginning on
or after December 15, 2008. The adoption of this guidance had no impact to the
Company’s consolidated financial position, results of operations, or cash
flows.


23




In March
2008, the FASB issued new accounting guidance which requires enhanced
disclosures about (a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance, and cash flows. This guidance is effective for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008; earlier adoption is encouraged. The adoption of this guidance
had no impact to the Company’s consolidated financial position, results of
operations, or cash flows.





In April
2008, the FASB issued new accounting guidance which amends the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset. This change is
intended to improve the consistency between the useful life of a recognized
intangible asset and the period of expected cash flows used to measure the fair
value of the asset. The new guidance is effective for financial statements
issued for fiscal years beginning after December 15, 2008, and interim periods
within those fiscal years. The requirement for determining useful lives must be
applied prospectively to intangible assets acquired after the effective date and
the disclosure requirements must be applied prospectively to all intangible
assets recognized as of, and subsequent to, the effective date. The adoption of
this guidance had no impact on the Company’s consolidated financial position,
results of operations, or cash flows.




In June
2008, the FASB issued new accounting guidance which requires that all
unvested share-based payment awards that contain nonforfeitable rights to
dividends should be included in the basic Earnings Per Share (EPS)
calculation. The new guidance is effective for financial statements issued
for fiscal years beginning after December 15, 2008. The adoption of this
guidance had no impact on the Company’s consolidated financial position, results
of operations, or cash flows.




In April
2009, the FASB issued new accounting guidance to be utilized in determining
whether impairments in debt securities are other than temporary, and which
modifies the presentation and disclosures surrounding such instruments. This
guidance is effective for interim periods ending after June 15, 2009, but early
adoption is permitted for interim periods ending after March 15, 2009. The
adoption of this guidance during the second quarter of 2009 had no impact on the
Company’s consolidated financial position, results of operations, or cash
flows.




In April
2009, the FASB issued new accounting which provides additional guidance in
determining whether the market for a financial asset is not active and a
transaction is not distressed for fair value measurement purposes. The guidance
is effective for interim periods ending after June 15, 2009, but early adoption
is permitted for interim periods ending after March 15, 2009. The adoption of
this guidance during the second quarter of 2009 had no impact on the Company’s
consolidated financial position, results of operations, or cash flows.




In April
2009, the FASB issued new accounting guidance which requires disclosures about
fair value of financial instruments in interim financial statements as well as
in annual financial statements. This guidance is effective for interim periods
ending after June 15, 2009, but early adoption is permitted for interim periods
ending after March 15, 2009. The adoption of this guidance during the second
quarter of 2009 had no impact on the Company’s consolidated financial position,
results of operations, or cash flows.





In May
2009, the FASB issued new accounting guidance which establishes general
standards of accounting for and disclosures of events that occur after the
balance sheet date but before financial statements are issued or are available
to be issued. The guidance will be effective for interim and annual financial
periods ending after June 15, 2009. The Company adopted the guidance during
the three months ended June 30, 2009 and has evaluated subsequent events
through the issuance date of these financial statements. The adoption of this
guidance had no impact on the Company’s consolidated financial position ,
results of operations, or cash flows.





In June
2009, the FASB issued new accounting guidance which will require more
information about the transfer of financial assets where companies have
continuing exposure to the risks related to transferred financial assets. This
guidance is effective at the start of a company’s first fiscal year beginning
after November 15, 2009, or January 1, 2010 for companies reporting earnings on
a calendar-year basis.





In June
2009, the FASB issued new accounting guidance which will change how a company
determines when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be consolidated. Under this
guidance, determining whether a company is required to consolidate an entity
will be based on, among other things, an entity's purpose and design and a
company's ability to direct the activities of the entity that most significantly
impact the entity's economic performance. This guidance is effective at the
start of a company’s first fiscal year beginning after November 15, 2009, or
January 1, 2010 for companies reporting earnings on a calendar-year
basis.


24




Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force), the AICPA, and the SEC did not, or are not believed by
management to, have a material impact on the Company's present or future
consolidated financial statements.





Results
of Operations





Results for the 3 months
ended September 30, 2009 compared to 2008





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





Revenue




Revenue
for the three months ended September 30, 2009 and 2008 was $1,011,760 and
$840,098, respectively.




Three
      Months Ended September 30,2009
                
                
                2008Revenue
                
                $
                1,011,760
                
                
                $
                840,098





The
increase of $171,662, or 20%, for the three months ended September 30, 2009 as
compared to the same period of 2008 was attributed to increased sales of the
InCard DisplayCard, primarily from the partial fulfillment of our 2009 $3.7
million purchase order. During October of 2009, the customer has informed
us of its intent to cancel the unshipped balance of the order, notwithstanding
the fact that the order is non-cancellable.





Cost
of Goods Sold





Cost of
goods sold for the three months ended September 30, 2009 and 2008, was $927,015
and $984,024, respectively.





Three
      Months Ended September 30,2009
                
                
                2008Cost
      of Goods Sold
                
                $
                927,015
                
                
                $
                984,024





Cost of
goods sold consists of costs to manufacture, inventory write-offs and reserve
adjustments and warranty expense. The decrease of $57,009, or 6%, for the three
months ended September 30, 2009 as compared to the same period of 2008 was
attributed to an increase of $80,015 for costs to manufacture, offset by
decreases of $86,399 for inventory write-offs and reserve adjustments and
$50,625 for warranty expense. The increase in cost to manufacture results
primarily from the increase in revenue during the 2009 period.





Operating
Expenses




Operating
expenses for the three months ended September 30, 2009 and 2008, consist of the
following:




Three
      Months Ended September 30,2009
                
                
                2008Operating
      expensesAdministrative
                
                $
                735,913
                
                
                $
                1,306,148Consulting
      Fees
                
                
                73,286
                
                
                
                169,996Professional
      Fees
                
                
                87,789
                
                
                
                189,698Research
      and Development
                
                
                69,467
                
                
                
                98,230Total
      expense
                
                $
                966,455
                
                
                $
                1,764,072


25





Administrative
Expenses





Administrative
expenses totaled $735,913 for the three months ended September 30, 2009 compared
to $1,306,148 for the same period of 2008.  The decrease of $570,235
or 44% for the three months ended September 30, 2009 compared to the comparable
period in 2008 was primarily attributable to a decrease in share based
compensation of $151,093 (resulting from a decrease in issued and outstanding
equity awards) and reductions in salaries of $82,539, marketing and investor
relations of $16,295, travel of $34,781, depreciation and amortization expense
of $163,434 and reduction in other expenses, resulting from managements cost
cutting measures. Administrative expenses consist of travel, marketing,
compensation, administrative fees, and depreciation and amortization
expense.




Consulting
Fees





Consulting
fees totaled $73,286 for the three months ended September 30, 2009 compared to
$169,996 for the same period of 2008.  The decrease of $96,710 or 57%
for the three months ended September 30, 2009 compared to the comparable period
in 2008 was primarily attributable to the use of fewer consultants in the
current period. Consulting fee expense consists of payments made to independent
contractors that provided services to us.





Professional
Fees




Professional
Fees totaled $87,789 for the three months ended September 30, 2009 compared to
$189,698 for the same period of 2008.  The decrease of $101,909 or 54%
for the three months ended September 30, 2009 compared to the comparable period
in 2008 was primarily attributable to decreased activity and lower cost of
professional fees. Legal fees decreased by $20,000 and accounting fees decreased
by $81,909. Professional fees expense primarily consists of amounts related to
services provided by our outside counsel, auditors and other similar
providers.





Research
 and Development





Research
and development expenses totaled $69,467 for the three months ended September
30, 2009 compared to $98,230 for the same period of 2008.  The
decrease of $28,763 or 29% for the three months ended September 30, 2009
compared to the comparable period in 2008 was primarily attributable to
reduced consulting costs. Research and development expense consists of costs
relating to further development of our OTP solutions and products.





Other
Income (Expense)




Other
income totaled $4,452,817 for the three months ended September 30, 2009 compared
to $346,155 for the same period of 2008.





Three
      Months
                  Ended
      September 30,2009
                
                
                2008Other
      income (expense):Change
      in fair value of warrant and conversion liability
                
                $
                (4,300,534
                )
                
                $
                841,513Gain
      on extinguishment of debt
                
                
                9,520,784
                
                
                
                -Other
      income
                
                
                616,315
                
                
                
                -Interest
      income
                
                
                2
                
                
                
                2,978Interest
      expense
                
                
                (1,383,750
                )
                
                
                (498,336
                )Total
      nonoperating income
                
                $
                4,452,817
                
                
                $
                346,155


26


Change
in fair value of warrants and conversion liability





The
change in the fair value of our warrant and conversion liabilities resulted
primarily from the changes in our stock price, the conversion and exercise
prices of the instruments and the volatility of our common stock during the
reported periods. We had no warrant liability at January 1,
2008.  Refer to Note 5 to the financial statements for further
discussion on our warrant liability  and the related 8% senior secured
convertible debentures.





The
securities were not issued with the intent of effectively hedging any future
cash flow, fair value of any asset, liability or any net investment in a foreign
operation. The securities do not qualify for hedge accounting, and as such, all
future changes in the fair value of these securities will be recognized
currently in earnings until such time as the securities are exercised or
expire.





Gain
on extinguishment of debt





We have
recorded an aggregate of $9,520,784 of gains on extinguishment of debt resulting
from the cancellation or restructuring of our 2008 convertible debentures and
the related common stock purchase warrants. Refer to Note 5 to the
financial statements for further discussion on the cancellation and
restructuring.





Other
Income





Other
income consists of customer deposit forfeitures.





Interest
Income





The
decrease in interest income is primarily attributable to a decrease in balances
in interest bearing accounts.





Interest
expense





Interest
expense totaled $1,383,750 for the three months ended September 30, 2009
compared to $498,336 for the same period of 2008.  Interest
expense for the three months ended September 30, 2009 consists of interest
accrued on our convertible debentures of $519,572, discount on debt of $841,165
and other interest of $23,013. Interest expense for the three months ended
September 30, 2008 consists of interest accrued on our convertible debentures of
$170,000, other interest of $9,540, amortization of debt discount of $294,695
and amortization of debt issue costs of $24,101.





As a
result of the default on our debentures, the interest rate was increased from 8%
to 18% effective February 20, 2009 and the maturity date of the debentures was
accelerated. The Company fully amortized the remaining discount and deferred
debt issue costs during the quarter ended March 31, 2009.





Results for the 9 months
ended September 30, 2009 compared to 2008





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





Revenue




Revenue
for the nine months ended September 30, 2009 and 2008 was $2,842,628 and
$1,857,523, respectively.




Nine
      Months
                  Ended
      September 30,2009
                
                
                2008Revenue
                
                $
                2,842,628
                
                
                $
                1,857,523





The
increase of $985,105, or 53%, for the nine months ended September 30, 2009 as
compared to the same period of 2008 was attributable to increased sales of the
InCard DisplayCard, primarily from the partial fulfillment of our 2009 $3.7
million purchase order, although sales to other customers increased by
approximately $436,000 in 2009 as compared to 2008. During October of 2009, the
customer has informed us of its intent to cancel the unshipped balance of the
order, notwithstanding the fact that the order is
non-cancellable.


27





Cost
of Goods Sold





Cost of
goods sold for the nine months ended September 30, 2009 and 2008, was $2,690,893
and $2,054,232, respectively.





Nine
      Months Ended September 30,2009
                
                
                2008Cost
      of Goods Sold
                
                $
                2,690,893
                
                
                $
                2,054,232





Cost of
goods sold consists of costs to manufacture, inventory write-offs and reserve
adjustments and warranty expense. The increase of $636,661, or 31%, for the nine
months ended September 30, 2009 as compared to the same period of 2008 was
attributed to an increase of $730,466 for costs to manufacture, partially offset
by decreases of $51,679 for inventory write-offs and reserve adjustments and
$42,126 for warranty expense. The increase in cost to manufacture results
primarily from the increase in revenue during the 2009 period.





Operating
Expenses




Operating
expenses for the nine months ended September 30, 2009 and 2008, consist of the
following:




Nine
      Months Ended September 30,2009
                
                
                2008Operating
      expensesAdministrative
                
                $
                1,879,967
                
                
                $
                4,355,576Consulting
      Fees
                
                
                118,902
                
                
                
                424,521Professional
      Fees
                
                
                309,759
                
                
                
                638,921Research
      and Development
                
                
                183,315
                
                
                
                396,585Total
      expense
                
                $
                2,491,943
                
                
                $
                5,815,603




Administrative
Expenses





Administrative
expenses totaled $1,879,967 for the nine months ended September 30, 2009
compared to $4,355,576 for the same period of 2008.  The decrease of
$2,475,609 or 57% for the nine months ended September 30, 2009 compared to the
comparable period in 2008 was primarily attributable to a decrease in share
based compensation of $904,568 (resulting from a decrease in issued and
outstanding equity awards) and reductions in salaries of $492,861, marketing and
investor relations of $133,623, travel of $91,720, and depreciation and
amortization expense of $485,987. Administrative expenses consist of travel,
marketing, compensation, administrative fees, and depreciation and amortization
expense.




Consulting
Fees





Consulting
fees totaled $118,902 for the nine months ended September 30, 2009 compared to
$424,521 for the same period of 2008.  The decrease of $305,619 or 72%
for the nine months ended September 30, 2009 compared to the comparable period
in 2008 was primarily attributable to the use of fewer consultants in the
current period. Consulting fee expense consists of payments made to independent
contractors that provided services to us.





Professional
Fees




Professional
Fees totaled $309,759 for the nine months ended September 30, 2009 compared to
$638,921 for the same period of 2008.  The decrease of $329,162 or 52%
for the nine months ended September 30, 2009 compared to the comparable period
in 2008 was primarily attributable to decreased activity and lower cost of
professional fees. Legal fees decreased by $305,423 and accounting fees
decreased by $23,739. Professional fees expense primarily consists of amounts
related to services provided by our outside counsel, auditors and other similar
providers.


28


Research and
Development
 
 Research
and development expenses totaled $183,315 for the nine months ended September
30, 2009 compared to $396,585 for the same period of 2008.  The
decrease of $213,270 or 54% for the nine months ended September 30, 2009
compared to the comparable period in 2008 was primarily attributable to
reduced consulting costs. Research and development expense consists of costs
relating to further development of our OTP products and solutions.
 
 Other
Income (Expense)
  Other
expense totaled $6,304,074 for the nine months ended September 30, 2009. We
reported net other income of $1,688,113 for the nine months ended September 30,
2008.
  Nine
      Months
                                  Ended
      June 30,2009
                                
                                
                                2008Other
      income (expense):Change
      in fair value of warrant and conversion liability
                                
                                $
                                (4,461,202
                                )
                                
                                $
                                2,866,067Gain
      on extinguishment of debt
                                
                                
                                9,520,784
                                
                                
                                
                                -Other
      income
                                
                                
                                616,315
                                
                                
                                
                                -Other
      expense
                                
                                
                                -
                                
                                
                                
                                (120,794
                                )Interest
      income
                                
                                
                                53
                                
                                
                                
                                26,535Interest
      expense
                                
                                
                                (11,980,024
                                )
                                
                                
                                (1,083,695
                                )Total
      nonoperating income
                                
                                $
                                (6,304,074
                                )
                                
                                $
                                1,688,113
 
 Change
in fair value of warrants and conversion liability
 
 The
change in the fair value of our warrant and conversion liabilities resulted
primarily from the changes in our stock price, the conversion and exercise
prices of the instruments and the volatility of our common stock during the
reported periods. We had no warrant liability at January 1,
2008.  Refer to Note 5 to the financial statements for further
discussion on our warrant liability  and the related 8% senior secured
convertible debentures.
 
 The
securities were not issued with the intent of effectively hedging any future
cash flow, fair value of any asset, liability or any net investment in a foreign
operation. The securities do not qualify for hedge accounting, and as such, all
future changes in the fair value of these securities will be recognized
currently in earnings until such time as the securities are exercised or
expire.
 
 Gain
on extinguishment of debt
 
 We have
recorded an aggregate of $9,520,784 of gains on extinguishment of debt resulting
from the cancellation or restructuring of our 2008 convertible debentures and
the related common stock purchase warrants. Refer to Note 5 to the
financial statements for further discussion on the cancellation and
restructuring.
 
 Other
Income
 
 Other
income consists of customer deposit forfeitures.
 
 Other
Expense
 
 Other
expense for the nine months ended September 30, 2008 consists of a loss
recognized on a sublease.
 
 Interest
Income
 
 The
decrease in interest income is primarily attributable to a decrease in balances
in interest bearing accounts.
  29
  Interest
expense
 
 Interest
expense totaled $11,980,024 for the nine months ended September 30, 2009
compared to $1,083,695 for the same period of 2008.  Interest
expense for the nine months ended September 30, 2009 consists of interest
accrued on our convertible debentures of $1,337,356, other interest of $37,866,
amortization of debt discount of $7,513,000, amortization of debt issue costs of
$449,052 and a charge of $2,642,750 for the 30% increase in the principal
amount of our convertible debentures as a result of the default described
in Note 5 to the financial statements. Interest expense for the nine
months ended September 30, 2008 consists of interest accrued on our convertible
debentures of $403,910, other interest of $19,081, amortization of debt discount
of $609,523 and amortization of debt issue costs of $51,181.
 
 As a
result of the default on our debentures, the interest rate was increased from 8%
to 18% effective February 20, 2009 and the maturity date of the debentures was
accelerated. The Company fully amortized the remaining discount and deferred
debt issue costs during the quarter ended March 31, 2009.
 
 Liquidity and Capital
Resources
  Our
principal sources of operating capital since inception through September 30,
2009 have been equity and debt financings totaling approximately $31,431,000,
and to a lesser degree our revenues.  Since inception, we have
incurred significant losses, and as of September 30, 2009 we had an accumulated
deficit of $41,121,328.
 
 Sales of
the ICT DisplayCard and newly introduced OTP products, the Company’s main
products, are not expected to generate positive cash flow until the second
quarter of 2010. As a result, there is substantial doubt about the Company’s
ability to continue as a going concern at September 30, 2009.
  As of
September 30, 2009 we had approximately $853,000 in cash and cash
equivalents. Combined with anticipated revenue collections and planned expense
reductions, the Company believes this amount will last through the first quarter
of 2010.
  Nine
      Months
                    Ended
      September 30,2009
                  
                  
                  2008Cash
      & Cash Equivalents
                  
                  $
                  852,904
                  
                  
                  $
                  200,844Net
      cash used in operating activities
                  
                  $
                  (401,062
                  )
                  
                  $
                  (8,124,314
                  )Net
      cash used in investing activities
                  
                  $
                  -
                  
                  
                  $
                  (36,942
                  )Net
      cash provided by financing activities
                  
                  $
                  1,177,321
                  
                  
                  $
                  8,022,500
 
 Net
Cash Provided by (Used in) Operating Activities
  For the
nine months ended September 30, 2009 we used $401,062 in cash for our operating
activities as compared to cash used of $8,124,314 for the same period of 2008.
The decrease in cash used of $7,723,252 was primarily attributable to a decrease
in payments for accounts payable and accrued expenses of $2,225,699, an increase
in collections on accounts receivable of $482,647, a decrease in cash applied to
inventory of $1,996,082, an increase in accrued interest of $1,380,334
and  a decrease in loss (after adjustment for non-cash charges) of
$1,647,633.
 
 Net
Cash Provided by Financing Activities
 
 During
the nine months ended September 30, 2009, we received $1,127,321 from the sale
of our Amended Debentures. We also received $100,000 in bridge financing, of
which $50,000 was repaid in September and the balance repaid in
October.
 
 Listed
below are key financing transactions entered into by us in the last three
years:
  30
 
 ·
              On
      January 8, 2008, we entered into a securities purchase agreement with
      13 institutional and accredited investors. Pursuant to the terms of the
      agreement, we sold $3.5 million of our 8% Senior Secured Convertible
      Debenture. The debentures: (i) bear interest at 8% per year, paid
      quarterly in cash or registered common stock, at our discretion;
      (ii) have a maturity of January 8, 2011, (iii) are
      convertible at the holder’s option into shares of our common stock at
      $2.50 per share, (iv) are secured by all of our and our subsidiary’s
      assets including inventory, receivables, unencumbered equipment and
      intellectual property, and (v) have a forced conversion feature which
      allows us to force the conversion of the debentures if our common stock
      trades above $5.00 for 20 consecutive trading days and certain other
      conditions are met. In connection with the sale of the debentures, we also
      issued the purchasers five-year common stock purchase warrants to purchase
      an aggregate of 700,000 shares of our common stock at an exercise price of
      $2.75 per share. We used the net proceeds of the financing for our working
      capital requirements and to pay down certain obligations. Both the
      conversion price of the debentures and the warrants’ exercise price were
      reset following the April 15, 2008 financing discussed
      below.
 
 ·
              On
      April 15, 2008, sold an additional $5 million of our 8% Senior
      Secured Convertible Debenture to EMC Corporation.   As a
      result of market conditions, the conversion price of the debenture is
      $2.48 per share.  This resulted in a re-pricing of our January
      8, 2008 debentures.   In connection with the sale of the
      additional debentures, we issued EMC a five-year common stock purchase
      warrant to purchase 1,008,064 shares of our common stock at an exercise
      price of $2.728 per share. Similar to the conversion of the debentures,
      this resulted in a re-pricing of the January 8, 2008 warrant exercise
      price to $2.728 per share.  We used the net proceeds of the
      financing for our working capital requirements and to pay down certain
      obligations.
  ·
              On
      September 30, 2009 we sold an additional $1,173,416 face value of our
      Amended Debentures (convertible into 4,693,664 common shares) and
      2,254,642 Amended Warrants.  We received cash proceeds of
      $1,127,321. The Amended Debentures (i) bear interest at 8% per year
      commencing on April 1, 2010, paid quarterly, commencing July 1, 2010, in
      cash or, subject to certain conditions, registered shares of our common
      stock; (ii) have a maturity of January 8, 2011, (iii) are convertible at
      the holders’ option into shares of our common stock at $0.25 per share,
      (iv) are secured by all of our and our subsidiaries’ assets, including
      inventory, receivables, unencumbered equipment and intellectual property,
      and (v) have a forced conversion feature which allows us to force the
      conversion of the Amended Debentures if our common stock trades above
      $1.00 for 10 consecutive trading days.  Such a forced conversion
      may be limited by contractual restrictions on the amount of our common
      stock which the holder may own and certain other
      conditions.  Each Amended Warrant has a term of 5 years and an
      exercise price of $0.25 per share. The Amended Warrants also provide for
      the issuance of a replacement warrant in the event they are exercised for
      cash.
                
                Both
      the conversion price of the Amended Debentures and the exercise price of
      the Amended Warrants are subject to “full-ratchet” price protection in the
      event of stock issuances below their respective conversion or exercise
      prices, except for specified exempted issuances including grants of stock
      options and stock issuances to officers, directors, employees and
      consultants.
 
 Restructuring
and Sales of Our 8% Senior Secured Debentures and
 
 On
September 30, 2009, we completed the restructuring of our 8% Senior Secured
Convertible Debentures as well as certain warrants held by the debenture
holders.  In connection with the restructuring, we sold an additional
$1,173,416 face value of our Amended Debentures (convertible into 4,693,664
common shares) and 2,254,642 Amended Warrants.  The effect of these
transactions is a follows:
 
 ·
              Cancellation
      of 8% Senior Secured Convertible Debentures in the amount of $7,581,981
      and warrants to purchase
  1,008,064  shares;
 
 ·
              Issuance
      of Amended 8% Senior Secured Convertible Debentures in the amount
      $1,339,041 ($1.00 conversion price) and Amended Warrants to purchase
      246,460 ($0.25 exercise price) common shares.  These debentures
      and warrants do not contain any anti-dilution or repricing
      provisions;
  31
  ·
              Issuance
      of Amended 8% Senior Secured Convertible Debentures in the amount
      $4,509,703 ($0.25 conversion price) and Amended Warrants 2,843,715 ($0.25
      exercise price); These debentures and warrants have anti-dilution and
      repricing provisions;
 
 ·
              Gross
      cash proceeds to the Company in the amount of $1,127,321;
    and
 
 ·
              Conversion
      of past due obligations to creditors and short term financing in the
      amount of $672,243.
 
 The
foregoing summary of the transaction is qualified in its entirety by reference
to the full text of the transaction documents filed as exhibits to our Current
Report on Form 8-K which was filed with the SEC on October 5,
2009.  The information contained in such Current Report regarding the
transaction is incorporated herein by reference. Refer to Note 5 to the
financial statements for further discussion on the cancellation and
restructuring.
 
 Future
Needs
 
 Through
the date of this report, our operations have been funded primarily through
equity and debt financings totaling approximately $31,431,000 since
inception.
 
 We
believe that our current cash of approximately $853,000 as of September 30,
2009, combined with anticipated revenue collections, will provide us with
sufficient resources to fund our operations through the first quarter of
2010.
 
 If we are
able to successfully sell the ICT DisplayCard and our newly introduced OTP
products in substantial quantities during the and fourth quarter of 2009 and
first quarter of 2010 we may be able to continue operations through the second
quarter of 2010.  If we need additional capital, we do not have any
binding commitments for, or readily available sources of, additional financing.
Additional financing, whether through public or private equity or debt
financing, arrangements with stockholders or other sources, may not be
available, or if available, may be on terms unacceptable to us. If we issue
additional equity securities to raise funds, the ownership percentage of our
existing stockholders would be reduced. New investors may demand rights,
preferences or privileges senior to those of existing holders of our common
stock. Debt incurred by us would be senior to equity in the ability of debt
holders to make claims on our assets. The terms of any debt issued could impose
restrictions on our operations. If adequate funds are not available to satisfy
our capital requirements, our operations and liquidity could be materially
adversely affected.
 
 Going
Concern
 
 Our
independent registered public accountants have included a going concern
explanatory paragraph in their unqualified opinion of our 2008 financial
statements.
 
 ITEM
3.                QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
 We are
not required to provide the information required by this items as we are
considered a smaller reporting company, as defined by Rule
229.10(f)(1).
 
 ITEM
4.                CONTROLS
AND PROCEDURES.
 
 Evaluation
of Disclosure Controls and Procedures
  Our
management, with the participation of our Chief Executive Officer (“CEO”) and
Chief Financial Officer (“CFO”), has evaluated the effectiveness of the
Company’s disclosure controls and procedures (as such term is defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended
(the “Exchange Act”)) as of the end of the period covered by this report
(September 30, 2009). Based on such evaluation which disclosed numerous material
weaknesses as noted below, our CEO and CFO has concluded that, as of the end of
such period, the Company’s disclosure controls and procedures were not effective
in recording, processing, summarizing and reporting, on a timely basis,
information required to be disclosed by the Company in the reports that it files
or submits under the Exchange Act and are not effective in ensuring that
information required to be disclosed by the Company in the reports that it files
or submits under the Exchange Act is accumulated and communicated to the
Company’s management, including the Company’s CEO and CFO, as appropriate to
allow timely decisions regarding required disclosure.
  32
  Management
Report on Internal Control Over Financial Reporting
  Management
is responsible for establishing and maintaining adequate internal control over
financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the
Securities Exchange Act of 1934. Internal control over financial reporting is a
process designed by, or under the supervision of, the Company’s principal
executive and principal financial officers to provide reasonable assurance to
the Company’s management and board of directors regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. Internal
control over financial reporting includes those policies and procedures
that:
 
 ·
              pertain
      to the maintenance of records that in reasonable detail accurately and
      fairly reflect the transactions and dispositions of the assets of the
      Company;
  ·
              provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the Company
      are being made only in accordance with authorizations of management and
      directors of the Company; and
  ·
              provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of the Company’s assets that
      could have a material effect on the financial
  statements.
  Because
of inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Projections of any evaluation of effectiveness
to future periods are subject to the risks that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate. A control system, no matter how well
designed and operated, can provide only reasonable, but not absolute, assurance
that the control system’s objectives will be met. The design of a control system
must reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs.
  Management
assessed the effectiveness of the Company’s internal control over financial
reporting as of September 30, 2009. In making this assessment, management used
the criteria set forth inInternal
Control-Integrated Framework  issued by the Committee of
Sponsoring Organizations of the Treadway Commission (“COSO”)   Based on our
assessment at September 30, 2009, management believes that our internal control
over financial reporting was not effective based on criteria set forth by the
COSO. The following material weaknesses were identified in our internal control
over financial reporting at September 30, 2009:
  ·
              We
      have performed a financial close on a monthly basis effective April 2008.
      The analysis of actual to budgeted results is either done marginally or
      not at all and there is no mechanism in place to evaluate variances,
      investigate unusual activity or communicate findings to senior management
      or the board of directors.
  ·
              We
      are unable to maintain the proper segregation of various accounting and
      finance duties because of our small size and limited resources. At risk
      areas include cash receipts and payments, processing of journal entries
      and account reconciliations.
  ·
              Much
      of the financial closing process is done off-line on electronic
      spreadsheets that are maintained on individual computers, unable to be
      shared by accounting personnel and not backed
  up.
  ·
              We
      have not performed a physical inventory of fixed assets. As a result, we
      failed to identify idle fixed assets that were not in our possession until
      late in the closing process necessitating an adjustment to our
      results.
  ·
              Annual
      employee reviews are not performed.
  ·
              During
      the fourth quarter of 2008 our CEO and CFO resigned. This caused us to
      have limited oversight of operations and less review of
      activity.
  ·
              Due
      to the deficiencies discussed above, we were not able to complete our
      December 31, 2008 annual close in a timely manner which lead to the late
      filing of our Form 10-K.
  33
 
 We intend
to remediate these material weaknesses during 2009. We have implemented the use
of a financial closing checklist or to ensure that all items have been
considered for inclusion in this report. We have also employed a new CEO who has
increased oversight of operations and review of activity. As concerns the
material weakness relating to segregation of duties, we are re-examining our
procedures to include compensating controls and minimize the risk associated
with having limited resources in the accounting department.
 
 Notwithstanding
these material weaknesses, we believe that our financial condition, results of
operations and cash flows presented in this report on Form 10-Q are fairly
presented in all material respects. We base our conclusion on our ability to
substantiate, with a high degree of confidence, the small number of significant
general ledger accounts that comprise our financial statements.
 
 Changes
in Internal Control Over Financial Reporting
 
 There
were no changes to our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during
the period covered by this report that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
 
 PART
II
 OTHER
INFORMATION
 
 ITEM
1.                LEGAL
PROCEEDINGS
 
 None
 
 ITEM
1A.             RISK
FACTORS
 
 Investing
in our common stock involves a high degree of risk. We describe below a number
of uncertainties and risks which, in addition to uncertainties and risks
presented elsewhere in this Quarterly Report, may adversely affect our business,
operating results and financial condition.  The uncertainties and risks
enumerated below, as well as those presented elsewhere in this Quarterly Report,
should be considered carefully in evaluating our company and our business and
the value of our securities.
 
 The
occurrence of any event contained in the following risk factors could have a
materially negative impact on the value of our common stock and other
securities.
 
 Risk
Related to Our Business and Operations
 
 There
is serious doubt regarding our ability to continue as a going
concern.
 
 We have a
history of recurring losses from operations and have an accumulated deficit of
$41,121,328 as of September 30, 2009. Sales of our products are not expected to
generate positive cash flow until the second quarter of 2010.  As a
result, there is substantial doubt about our ability to continue as a going
concern.  Our plan regarding these matters is to raise additional debt
and/or equity financing to allow us the ability to cover our current cash flow
requirements and meet our obligations as they become due.  There can
be no assurances that financing will be available or if available, that such
financing will be available under favorable terms. In the event that we are
unable to generate adequate revenues to cover expenses and cannot obtain
additional financing in the near future, we may seek protection under bankruptcy
laws.
 
 Our prior
auditors added an explanatory paragraph to their opinion on our financial
statements for the year ended December 31, 2008 because of concerns about
our ability to continue as a going concern. These concerns arise from the fact
that we have not yet established an ongoing source of revenues sufficient to
cover our operating costs.  As a result, we must raise additional
capital in order to continue to operate our business. If we fail to generate
positive cash flows or obtain additional financing when required, we will have
to modify, delay or abandon some or all of our business and expansion
plans.
  34
  We
are an early stage company with an unproven business strategy.
 
 Our
business prospects are difficult to predict because of our limited operating
history, early stage of development and unproven business strategy. We are
primarily focused on developing OTP solutions and products.  We made
our first significant commercial sale of our ICT DisplayCard in 2008. Although
we believe that our current product and those under development have significant
profit potential, we may not attain profitable operations and may not succeed in
realizing our business objectives.
 
 We
will require additional capital which we may be unable to obtain.
 
 We
believe that our current cash, combined with anticipated revenue collections,
will be enough to fund our operations through the first quarter of 2010. 
We currently do not have any sources of additional financing and cannot assure
you that such funding will be available.  If we are unable to
raise additional capital we may be forced to file for bankruptcy.
 
 We depend on a
limited number of suppliers for our current product.
 
 We obtain
the battery for our current product from Solicore, Inc., our single source
supplier, on a purchase order basis.  In the event of a disruption or
discontinuation in supply, we may not be able to obtain batteries on a
timely basis, which would disrupt our operations, delay production and
impair our ability to manufacture and sell our products.
 
 We obtain
the display for our current product from SmartDisplayer, our single source
supplier, under a written agreement. In the event of a disruption or
discontinuation in supply, we  may not be able to obtain displays on a
timely basis, which would disrupt our operations, delay
production  and impair our ability to manufacture and sell our ICT
DisplayCard.
  Our
dependence upon outside suppliers exposes us to risks, including:
  ·
              the
      possibility that our suppliers will experience major disruptions in
      production, which is exacerbated by the fact that we are a major customer
      of our suppliers;
 
 ·
              the
      solvency of our suppliers and the potential that our suppliers will be
      solely dependent upon us;
  ·
                the
      potential inability of our suppliers to obtain required components or
      products;·
                reduced
      control over pricing, quality and timely delivery, due to the difficulties
      in switching to alternative
suppliers;
 
 ·
              potential
      delays and expense of seeking alternative sources of suppliers;
      and
 
 ·
              increases
      in prices of key components.
  We
may not be able to develop our products due to inadequate
resources.
 
 Our
business strategy is to develop and market new OTP solutions and products. We
believe that our revenue growth and profitability, if any, will substantially
depend upon our ability to:
  ·
              mass
      produce the ICT DisplayCard at significantly lower
  cost;
 
 ·
              continue
      to fund research and development endeavors;
and
  ·
              develop,
      introduce and commercialize new
products.
 
 If we are
not able to devote adequate resources to our new product development efforts, we
may be unable to develop new products, which would adversely affect our revenue
growth and profitability.
 
 We depend on key
personnel.
 
 We rely
to a substantial extent on the management, marketing and product development
skills of our key employees and consultants, particularly Richard Nathan, our
President and Chief Executive Officer, Craig Nelson, who supervises the
manufacturing and testing of the InCard DisplayCard, and Mark Poidomani, our
chief technology officer, to formulate and implement our business plan. Our
success depends to a significant extent upon our ability to retain and attract
key personnel. Competition for employees can be intense in the payment card
industry, and the process of locating key personnel with the right combination
of skills is often lengthy. The loss of any key personnel may significantly
delay or prevent the achievement of product development and could have a
material adverse effect on us.
  35
  Our
products might not achieve market acceptance.
 
 The
commercial success of our products will depend upon the adoption of our products
by payment card providers. In order to be successful, our products must meet the
technical and cost requirements for card enhancements within the payment card
industry. Market acceptance will depend on many factors, including:
  ·
              our
      ability to convince prospective strategic partners and customers to adopt
      our products;
 
 ·
              the
      willingness and ability of prospective strategic partners and customers to
      adopt our products; and
  ·
              our
      ability to sell and service sufficient quantities of our
      products.
  Because
of these and other factors, our products may not achieve market acceptance. If
our products do not achieve market acceptance, demand for our products will not
develop as expected and it is highly unlikely that we will become
profitable.
 
 We
have not current produced our product in commercial quantities.
 
 The ICT
DisplayCard has only been produced in limited production quantities. We are
applying our own resources and working in cooperation with other companies that
have specialized technical expertise related to the manufacturing and production
of thin flexible non-payment cards. Failure to secure or maintain these
relationships or failure to successfully transition to full scale production may
have a material negative effect on our business.
 
 We rely
substantially on third-party manufacturers.
 
 To be
successful, we must manufacture, or contract for the manufacture of, our
products in compliance with industry standards and on a timely basis. As
discussed in the risk factor above, we are working in cooperation with other
companies that have specialized technical expertise related to the manufacturing
of our ICT DisplayCard. We also currently use a limited number of sources for
most of the supplies and services that we use in the manufacturing processes.
Our manufacturing strategy presents the following risks:
 
 ·
              delays
      in the quantities needed for product development could delay
      commercialization of our products in
  development;
 
 ·
              if
      we need to change to other commercial manufacturers, any new manufacturer
      would have to be educated in, or develop substantially equivalent
      processes necessary for, the production of our
  products;
  ·
              if
      market demand for our products increases suddenly, our current
      manufacturers might not be able to fulfill our commercial needs, which
      would require us to seek new manufacturing arrangements and may result in
      substantial delays in meeting market demand;
and
 
 ·
              we
      may not have intellectual property rights, or may have to share
      intellectual property rights, to any improvements in the manufacturing
      processes or new manufacturing processes for our
  products.
 
 Any of
these factors could delay commercialization of our products under development,
entail higher costs and result in our being unable to effectively manufacture
our products.
 
 Some
of our competitors have significantly greater resources than we.
 
 We
believe that the principal competitive factors that affect the market for tokens
include convenience, price, quality/reliability, ease of use, and distribution
cost. We cannot assure you that we will be able to maintain our competitive
position against current and potential competitors, especially those with
significant marketing, service, support, technical and other competitive
resources.
 
 Our
competitors have significantly greater financial, technical, marketing,
purchasing and other resources than we do, and as a result, may be able to
respond more quickly to new or emerging technologies and changes in customer
requirements, or to devote greater resources to the development, promotion and
sale of products, or to deliver competitive products at a lower end-user price.
Our inability to successfully compete will materially and adversely affect our
business.
  36
 
 Risks
Related to our Securities
 
 Our
common shares were delisted from the NASDAQ Capital Market.
 
 On
February 20, 2009, our common shares were delisted from the NASDAQ Capital
Market.  As a result, our shares now trade on the Over-the-Counter
Bulletin Board and on the Pinksheets.  Historically, the volume and
liquidity of these markets has been significantly less than on the NASDAQ
Capital Market.  Addition, shares traded in these markets are unlikely
to be followed by market analysts and there may be few market makers for our
common stock.  Also, an investor may find it difficult to dispose of,
or to obtain accurate quotations as to the price of our common
stock.  Any of these factors could adversely affect the liquidity and
trading price of our common stock and could result in large fluctuations in
market price.
 
 Our common stock
is subject to the penny stock regulations and restrictions.
  Rule
3a51-1 of the Securities Exchange Act of 1934 establishes the definition of a
"penny stock," for purposes relevant to us, as any equity security that has a
minimum bid price of less than $5.00 per share, subject to a limited number of
exceptions which are not available to us. It is likely that our shares will be
considered to be penny stocks for the immediately foreseeable future. This
classification severely and adversely affects any market liquidity for our
common stock.
  For any
transaction involving a penny stock, unless exempt, the penny stock rules
require that a broker or dealer approve a person's account for transactions in
penny stocks and the broker or dealer receive from the investor a written
agreement to the transaction setting forth the identity and quantity of the
penny stock to be purchased.  In order to approve a person's account for
transactions in penny stocks, the broker or dealer must obtain financial
information and investment experience and objectives of the person and make a
reasonable determination that the transaction is suitable for that person and
that that person has sufficient knowledge and experience in financial matters to
be capable of evaluating the risks of transactions in penny stocks.
  The
broker or dealer must also deliver, prior to any transaction in a penny stock, a
disclosure schedule prepared by the SEC relating to the penny stock market which
sets forth:
  ·
              the
      basis on which the broker or dealer made the suitability determination,
      and
 
 ·
              that
      the broker or dealer received a signed, written agreement from the
      investor prior to the transaction.
  Disclosure
also has to be made about the risks of investing in penny stocks in both public
offerings and in secondary trading and commissions’ payable to both the
broker-dealer and the registered representative, current quotations for the
securities and the rights and remedies available to an investor in cases
of fraud in penny stock transactions. Finally, monthly statements have to
be sent disclosing recent price information for the penny stock held in the
account and information on the limited market in penny stocks.
  Because
of these regulations, broker-dealers may not wish to engage in transactions with
penny stocks.  Accordingly, investors may encounter difficulties in
their attempt to sell shares of our common stock.  These additional
sales practice and disclosure requirements could impede the sale of our common
stock. In addition, the liquidity for our common stock may decrease, with a
corresponding decrease in the price of our common stock. Our shares, in all
probability, will be subject to such penny stock rules for the foreseeable
future and our shareholders will, in all likelihood, find it difficult to sell
their common stock.
  The
market for penny stocks has experienced numerous frauds and abuses.
  We
believe that the market for penny stocks has suffered from patterns of fraud and
abuse. Such patterns include:
  ·
              Control
      of the market for the security by one or a few broker-dealers that are
      often related to the promoter or
issuer;
 
 ·
              Manipulation
      of prices through prearranged matching of purchases and sales and false
      and misleading press releases;
  37
 
 ·
              “Boiler
      room" practices involving high pressure sales tactics and unrealistic
      price projections by inexperienced sales
  persons;
 
 ·
              Excessive
      and undisclosed bid-ask differentials and markups by selling
      broker-dealers; and
  ·
              Wholesale
      dumping of the same securities by promoters and broker-dealers after
      prices have been manipulated to a desired level, along with the inevitable
      collapse of those prices with consequent investor
  losses.
  As a
result, many investors have the perception that penny stocks are too risky or
involve a high degree of fraud.  These factors will make the
development of an active market for our common shares more difficult which
further affects the liquidity of our common stock.
 
 We
do not anticipate paying any cash dividends.
 
 We plan
to use all of our earnings; to the extent we have earnings, to fund our
operations. We do not plan to pay any cash dividends in the foreseeable
future.  Therefore, any return on your investment will be derived from
an increase in the price of our stock, which may or may not occur.
 
 Sales
of our common stock in the public market may depress our stock
price.
 
 As of
September 30, 2009, we had 28,495,256 shares of common stock outstanding. On a
fully diluted basis, including shares issuable upon exercise of warrants and
stock options and convertible debentures, we have 61,472,563 shares outstanding
or issuable.  Additionally, on September 30, 2009, we completed the
restructuring of our 8% Senior Secured Convertible Debentures.  As a
result, the conversion price of the debentures as well as substantially all our
outstanding warrants was adjusted to $0.25. All of these shares can be traded
pursuant to a prospectus or via a transaction pursuant to Rule 144 under
the Securities Act of 1933.  If our stockholders sell substantial
amounts of common stock in the public market, or the market perceives that such
sales may occur, the market price of our common stock could fall, which could
result in a significant loss on any investment you make in our common stock. The
sale of a large number of shares could impair our ability to raise needed
capital by depressing the price of our common stock.
 
 We
may be subject to securities litigation as the price of our common stock has
drastically decreased over the past twelve months.
 
 During
the past nine months, the price of our common stock has decreased from $1.27 on
June 30, 2008 to $0.27 as of November 9, 2009.  Although management
feels that at all times it has acted in the best interest of the company’s
shareholders, such declines in stock price have historically increased the
probability of becoming the subject of a securities class action law
suit.  If we were to become the target of such litigation, we will
have to spend considerable time and resources in defending such
litigation.  This would result in management diverting its focus from
the development and sale of our products.  Additionally, such
litigation is extremely costly and will deplete our assets.
 
 We
may raise additional capital through a securities offering that could dilute
your ownership interest and voting rights.
 
 Our
certificate of incorporation currently authorizes our board of directors to
issue up to 75,000,000 shares of common stock and 5,000,000 shares of preferred
stock. As of September 30, 2009, after taking into consideration our outstanding
common and preferred shares and our contingently issuable shares, our board of
directors will be entitled to issue up to 13,527,437 additional common shares
and 5,000,000 preferred shares. The power of the board of directors to issue
these shares of common stock, preferred stock or warrants or options to purchase
shares of our stock is generally not subject to stockholder
approval.
  We will
require additional working capital to fund our business. If we raise additional
funds through the issuance of equity, equity-related or convertible debt
securities, these securities may have rights, preferences or privileges senior
to those of the holders of our common stock. The issuance of additional common
stock or securities convertible into common stock will also have the effect of
diluting the proportionate equity interest and voting power of holders of our
common stock.
 
 Our
incorporation documents and Delaware law may inhibit a takeover that
stockholders consider favorable and could also limit the market price of your
stock, which may inhibit an attempt by our stockholders to change our direction
or management.
 
 Our
amended and restated certificate of incorporation and bylaws contain provisions
that could delay or prevent a change in control of our company. Some of these
provisions:
  38
 
 ·
              authorize
      our board of directors to determine the rights, preferences, privileges
      and restrictions granted to, or imposed upon, the preferred stock and
      to fix the number of shares constituting any series and the designation of
      such series without further action by our stockholders;·
              prohibit
      stockholders from calling special
meetings;
  ·
              prohibit
      cumulative voting in the election of directors, which would otherwise
      allow less than a majority of stockholders to elect director
      candidates;
 
 ·
              establish
      advance notice requirements for submitting nominations for election to the
      board of directors and for proposing matters that can be acted upon by
      stockholders at a meeting; and
 
 ·
              prohibit
      stockholder action by written consent, requiring all stockholder actions
      to be taken at a meeting of our
stockholders.
  In
addition, we are governed by the provisions of Section 203 of the Delaware
General Corporate Law. These provisions may prohibit large stockholders, in
particular those owning 15% or more of our outstanding voting stock, from
merging or combining with us, which may prevent or frustrate any attempt by our
stockholders to change our management or the direction in which we are heading.
These and other provisions in our amended and restated certificate of
incorporation and bylaws and under Delaware law could reduce the price that
investors might be willing to pay for shares of our common stock in the future
and result in the market price being lower than it would be without these
provisions.
 
 New
rules, including those contained in and issued under the Sarbanes-Oxley Act of
2002, may make it difficult for us to retain or attract qualified officers and
directors.
 
 We may be
unable to attract and retain qualified officers, directors and members of board
committees required to provide for our effective management as a result of the
recent and currently proposed changes in the rules and regulations that
govern publicly held companies, including, but not limited to, certifications
from executive officers and requirements for financial experts on the board of
directors. The perceived increased personal risk associated with these recent
changes may deter qualified individuals from accepting these roles. The
enactment of the Sarbanes-Oxley Act of 2002 has resulted in the issuance of a
series of new rules and regulations and the strengthening of existing
rules and regulations by the Securities and Exchange Commission (the
“SEC”). Further, certain of these recent and proposed changes heighten the
requirements for board or committee membership, particularly with respect to an
individual’s independence from the corporation and level of experience in
finance and accounting matters. We may have difficulty attracting and retaining
directors with the requisite qualifications. If we are unable to attract and
retain qualified officers and directors, the management of our business could be
adversely affected.
 
 Our
management has concluded that, as of September 30, 2009, our disclosure controls
and procedures were not effective.
 
 Our
management, with the participation of our Chief Executive Officer (“CEO”) and
Chief Financial Officer (“CFO”), has evaluated the effectiveness of the
Company’s disclosure controls and procedures (as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as amended (the “Exchange Act”)) as of September 30, 2009. Based on such
evaluation which disclosed numerous material weaknesses, our CEO and CFO have
concluded that, as of September 30, 2009, the Company’s disclosure controls and
procedures were not effective in recording, processing, summarizing and
reporting, on a timely basis, information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act and were
not effective in ensuring that information required to be disclosed by the
Company in the reports that it files or submits under the Exchange Act is
accumulated and communicated to the Company’s management, including the
Company’s CEO and CFO, as appropriate to allow timely decisions regarding
required disclosure. If we fail to implement new or improved disclosure
controls, investors could lose confidence in the reliability of our financial
statements, which could result in a decrease in the value of our common
stock.
  39
  We
have identified numerous material weaknesses in our internal control over
financial reporting.
 
 As
directed by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adopted
rules requiring public companies to include a report of management on
internal control over financial reporting in their Annual Reports on
Form 10-K. This report is required to contain an assessment by management
of the effectiveness of a company’s internal control over financial reporting.
Our non-affiliated market capitalization qualified us as a “Smaller Reporting
Company” effective in 2009. As a result, we are required to include our
management’s report on internal control over financial reporting in this Annual
Report but are not required to include our auditors’ attestation report on our
internal control over financial reporting.   As discussed in our
December 31, 2008 Annual Report, we have concluded that, as of December 31,
2008, our internal control over financial reporting were not effective and
identified a number of material weaknesses in our internal control over
financial reporting. While we intend to remedy these weaknesses during the
current fiscal year, we may be unable to do so. If we fail to implement required
new or improved controls there may be an adverse reaction in the financial
markets due to a loss of confidence in the reliability of our financial
statements, which could cause the market price of our common stock to
decline.
 
 ITEM
2.                UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
 The
following information is given with regard to our equity securities sold
during the period covered by this report that were not registered under the
Securities Act and were not previously included in a Current Report on Form
8-K.
 
 ·
              In April of 2009 we granted stock
      option to purchase an aggregate of 150,000 common shares.  The
      options were granted to employees and consultants.  The options
      have a five (5) year term.  The exercise price and vesting of
      the options are as follows:
 —
              Options
      to purchase 100,000 common shares have an exercise price of $0.062 and
      vest immediately; and
 
 —
                Options
      to purchase 50,000 common shares have an exercise price of $0.072 and
      vest: (i) 1/3 on February 20, 2009; and (ii) 2/3 vest quarterly over the
      following 2 years commencing on such
date.
 
 The
options were issued pursuant to our 2007 Equity Incentive Plan.
 
 ·
              On
      July 22, 2009, we granted stock options to our directors, officers,
      employees and consultants, pursuant to our 2007 Equity Compensation Plan,
      as follows:
 
 Directors
(pursuant to our director’s compensation policy as follows):
 
 Robert Ramsdell
                        
                        Options
      to purchase 250,000 common shares of which 25,000 vest immediately and the
      balance vest quarterly over the grant year.  The options expire
      on July 22, 2019 and have an exercise price of $0.18 per
      share;Scott Ogilvie
                        
                        Options
      to purchase 200,000 common shares of which 25,000 vest immediately and the
      balance vest quarterly over the grant year.  The options expire
      on July 22, 2019 and have an exercise price of $0.18 per
      share;Donald Joyce
                        
                        Options
      to purchase 150,000 common shares of which 25,000 vest immediately and the
      balance vest quarterly over the grant year.  The options expire
      on July 22, 2019 and have an exercise price of $0.18 per
      share;Harry Tredennick
                        
                        Options
      to purchase 125,000 common shares of which 25,000 vest immediately and the
      balance vest quarterly over the grant year.  The options expire
      on July 22, 2019 and have an exercise price of $0.18 per
      share;Officers:Richard Nathan
                        
                        Options
      to purchase an aggregate of 625,000 common shares.  The options
      vest as follows:  (i) options to purchase 100,000 common shares
      vest quarterly over the year following the grant date; and (ii) options to
      purchase 525,000 common shares vest over three years with 1/3 vesting on
      the one year anniversary of the grant date and 2/3 vesting quarterly over
      the following two years.  The options all have an exercise price
      of $0.18 and expire on July 22, 2019.Employees & Consultants
                        
                        We
      issued options to purchase an aggregate of 572,000 common shares to
      employees and consultants.  The options vest over three years
      with 1/3 vesting on the one year anniversary of the granted date and 2/3
      vesting quarterly over the following two years.  The options all
      have an exercise price of $0.18 and expire on July 22,
    2014.
  40
 
 ITEM
3.                DEFAULT
UPON SENIOR SECURITIES
 
 We
previously disclosed the default of our 8% Senior Secured Convertible Debentures
in our Current Report on Form 8-K filed with the SEC February 20,
2009.   The information contained in the October 5, 2009 Current
Report on Form 8-K is incorporated herein by reference.
 
 ITEM
4.                SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
 None
 
 ITEM
5.                OTHER
INFORMATION
 
 On
September 30, 2009, we completed the restructuring of our 8% Senior Secured
Convertible Debentures.  We discussed the transaction in our Current
Report filed on Form 8-K with the SEC on October 5, 2009.  The
information contained in the October 5, 2009 Current Report on Form 8-K is
incorporated herein by reference.
 
 ITEM
5.                OTHER
INFORMATION
 
 None
 
 ITEM
6.                EXHIBITS
 
 The
exhibits listed in the accompanying index to exhibits are incorporated by
reference.
 
 SIGNATURES
 
 In
accordance with the requirements of the Securities Exchange Act of 1934, the
Registrant has caused this report to be signed by the undersigned hereunto duly
authorized.
 
 INNOVATIVE
      CARD TECHNOLOGIES, INCDated:
      November 13, 2009
                    By:
                    /S/
      Richard NathanRichard
      Nathan
                      Chief
      Executive Officer and Chief Financial
                      Officer
  41
 
 INDEX
TO EXHIBITS
 Incorporated
      by ReferenceExhibit
                                                                          No.
                                                                        
                                                                        Description
                                                                        
                                                                        Filed
                                                                          Herewith
                                                                        
                                                                        Form
                                                                        
                                                                        Exhibit
                                                                          No.
                                                                        
                                                                        File No.
                                                                        
                                                                        Filing Date10.01
                                                                        
                                                                        Form
      of Securities Purchase Agreement Dated January 8, 2008
                                                                        
                                                                        
                                                                        
                                                                        8-K
                                                                        
                                                                        10.1
                                                                        
                                                                        001-33353
                                                                        
                                                                        1/9/0710.02
                                                                        
                                                                        Form
      of 8% Senior Secured Convertible Debenture issued January 8,
      2008
                                                                        
                                                                        
                                                                        
                                                                        8-K
                                                                        
                                                                        10.2
                                                                        
                                                                        001-33353
                                                                        
                                                                        1/9/0710.03
                                                                        
                                                                        Form
      of Common Stock Purchase Warranted issued January 8, 2008
                                                                        
                                                                        
                                                                        
                                                                        8-K
                                                                        
                                                                        10.3
                                                                        
                                                                        001-33353
                                                                        
                                                                        1/9/0710.04
                                                                        
                                                                        Form
      of Registration Rights Agreement dated January 8, 2008
                                                                        
                                                                        
                                                                        
                                                                        8-K
                                                                        
                                                                        10.4
                                                                        
                                                                        001-33353
                                                                        
                                                                        1/9/0710.05
                                                                        
                                                                        Form
      of Security Agreement dated January 8, 2008
                                                                        
                                                                        
                                                                        
                                                                        8-K
                                                                        
                                                                        10.5
                                                                        
                                                                        001-33353
                                                                        
                                                                        1/9/0710.06
                                                                        
                                                                        Form
      of Subsidiary Guarantee dated January 8, 2008
                                                                        
                                                                        
                                                                        
                                                                        8-K
                                                                        
                                                                        10.6
                                                                        
                                                                        001-33353
                                                                        
                                                                        1/9/0710.07**
                                                                        
                                                                        Form
      of Lock-Up Agreement dated January 8, 2008
                                                                        
                                                                        
                                                                        
                                                                        8-K
                                                                        
                                                                        10.7
                                                                        
                                                                        001-33353
                                                                        
                                                                        1/9/0710.08
                                                                        
                                                                        Form
      of Securities Purchase Agreement Dated April 15, 2008
                                                                        
                                                                        
                                                                        
                                                                        8-K
                                                                        
                                                                        10.1
                                                                        
                                                                        001-33353
                                                                        
                                                                        4/16/0810.09
                                                                        
                                                                        Form
      of 8% Senior Secured Convertible Debenture issued April 15,
      2008
                                                                        
                                                                        
                                                                        
                                                                        8-K
                                                                        
                                                                        10.2
                                                                        
                                                                        001-33353
                                                                        
                                                                        4/16/0810.10
                                                                        
                                                                        Form
      of Common Stock Purchase Warranted issued April 15, 2008
                                                                        
                                                                        
                                                                        
                                                                        8-K
                                                                        
                                                                        10.3
                                                                        
                                                                        001-33353
                                                                        
                                                                        4/16/0810.11
                                                                        
                                                                        Form
      of Registration Rights Agreement dated April 15, 2008
                                                                        
                                                                        
                                                                        
                                                                        8-K
                                                                        
                                                                        10.4
                                                                        
                                                                        001-33353
                                                                        
                                                                        4/16/0810.12
                                                                        
                                                                        Form
      of Security Agreement dated April 15, 2008
                                                                        
                                                                        
                                                                        
                                                                        8-K
                                                                        
                                                                        10.5
                                                                        
                                                                        001-33353
                                                                        
                                                                        4/16/0810.13
                                                                        
                                                                        Form
      of Subsidiary Guarantee dated April 15, 2008
                                                                        
                                                                        
                                                                        
                                                                        8-K
                                                                        
                                                                        10.6
                                                                        
                                                                        001-33353
                                                                        
                                                                        4/16/0810.14
                                                                        
                                                                        Form
      of Lock-Up Agreement dated April 15, 2008
                                                                        
                                                                        
                                                                        
                                                                        8-K
                                                                        
                                                                        10.7
                                                                        
                                                                        001-33353
                                                                        
                                                                        4/16/08
  42
 
 10.15
                                    
                                    Assignment
      of Debenture and Common Stock Warrants Agreement with EMC
                                    
                                    
                                    
                                    8-K
                                    
                                    10.01
                                    
                                    001-33353
                                    
                                    7/17/0910.16
                                    
                                    Waiver,
      Amendment and Exchange Agreement
                                    
                                    
                                    
                                    8-K
                                    
                                    10.16
                                    
                                    001-33353
                                    
                                    10/05/0910.17
                                    
                                    Debenture
      & Warrant Purchase Agreement
                                    
                                    
                                    
                                    8-K
                                    
                                    10.17
                                    
                                    001-33353
                                    
                                    10/05/0910.18
                                    
                                    Form
      of Amended Debenture dated September 30, 2009
                                    
                                    
                                    
                                    8-K
                                    
                                    10.18
                                    
                                    001-33353
                                    
                                    10/05/0910.19
                                    
                                    Form
      of Amended Warrant dated September 30, 2009
                                    
                                    
                                    
                                    8-K
                                    
                                    10.19
                                    
                                    001-33353
                                    
                                    10/05/0931.1
                                    
                                    Certification
      of the Principal Executive Officer Pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002
                                    
                                    *31.2
                                    
                                    Certification
      of the Principal Financial Officer Pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002
                                    
                                    *32.1
                                    
                                    Certification
      of Principal Executive Officer Pursuant to 18 U.S.C. §
1350
                                    
                                    *32.2
                                    
                                    Certification
      of Principal Financial Officer Pursuant to 18 U.S.C. §
1350
                                    
                                    *
  **Management
contracts or compensation plans or arrangements in which directors or executive
officers are eligible to participate.
  43