U.S.
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 June 30, 2010


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.  xYes  ̈     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).        xYes   ̈    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
August 11, 2010 there were 31,575,937 shares of common stock, $.001 par value,
issued and outstanding.








Innovative
Card Technologies, Inc.





Table of
Contents


PagePART
      I -
                            
                            FINANCIAL
      INFORMATION
                            
                            1Item
      1.
                            
                            Financial
      Statements
                            
                            1Condensed
      Consolidated Balance Sheets as of June 30, 2010 (Unaudited) and December
      31, 2009
                            
                            1Condensed
      Consolidated Statements of Operations (Unaudited)Three
      and Six months ended June 30, 2010 and 2009
                            
                            2Condensed
      Consolidated Statements of Cash Flows (Unaudited)Six  months
      ended June 30, 2010 and 2009
                            
                            3Notes
      to Condensed Consolidated Financial Statements (Unaudited)
                            
                            4Item
      2.
                            
                            Management's
      Discussion and Analysis of Financial Condition and Results
      of Operations
                            
                            12Item
      3.
                            
                            Quantitative
      and Qualitative Disclosures about Market Risk
                            
                            21Item
      4.
                            
                            Controls
      and Procedures
                            
                            21PART
      II -
                            
                            OTHER
      INFORMATION
                            
                            22Item
      1.
                            
                            Legal
      Proceedings
                            
                            22Item
      1A.
                            
                            Risk
      Factors
                            
                            22Item
      2.
                            
                            Unregistered
      Sales of Equity Securities and Use of Proceeds
                            
                            27Item
      3.
                            
                            Defaults
      Upon Senior Securities
                            
                            28Item
      4.
                            
                            (Removed
      and Reserved)
                            
                            28Item
      5.
                            
                            Other
      Information
                            
                            28Item
      6.
                            
                            Exhibits
                            
                            28










PART
I


FINANCIAL
INFORMATION





ITEM 1.
            FINANCIAL
      STATEMENTS




INNOVATIVE
CARD TECHNOLOGIES, INC.
 CONDENSED
CONSOLIDATED BALANCE SHEETS
 
 June
      30,
                        
                        
                        December
      31,2010
                        
                        
                        2009(Unaudited)AssetsCurrent
      assets:Cash
      and cash equivalents
                        
                        $
                        226,676
                        
                        
                        $
                        245,765Accounts
      receivable, net of allowance for doubtful accounts of $60,000 and $61,398,
      respectively
                        
                        
                        33,568
                        
                        
                        
                        699,854Prepaids
      and other current assets
                        
                        
                        39,100
                        
                        
                        
                        76,130Deposits
      on raw materials held for production
                        
                        
                        38,892
                        
                        
                        
                        165,138Raw
      materials held for production
                        
                        
                        68,239
                        
                        
                        
                        134,754Work
      in progress inventory, net
                        
                        
                        232,671
                        
                        
                        
                        107,212Finished
      goods inventory
                        
                        
                        38,053
                        
                        
                        
                        34,421Total
      current assets
                        
                        
                        677,199
                        
                        
                        
                        1,463,274Property
      and equipment, net
                        
                        
                        71,449
                        
                        
                        
                        93,763Deposits
                        
                        
                        3,720
                        
                        
                        
                        3,720Total
      assets
                        
                        $
                        752,368
                        
                        
                        $
                        1,560,757Liabilities
      and deficiency in stockholders' equityCurrent
      liabilities:Accounts
      payable and accrued expenses
                        
                        $
                        942,146
                        
                        
                        $
                        912,271Accrued
      interest
                        
                        
                        75,956
                        
                        
                        
                        27,737Warranty
      reserve
                        
                        
                        312,646
                        
                        
                        
                        289,135Deferred
      revenue
                        
                        
                        230,846
                        
                        
                        
                        450,1898%
      convertible debentures, net of discount of $486,241 at June 30,
      2010
                        
                        
                        4,934,843
                        
                        
                        
                        -Total
      current liabilities
                        
                        
                        6,496,437
                        
                        
                        
                        1,679,3328%
      convertible debentures, net of discount of $1,074,752 at December 31,
      2009
                        
                        
                        -
                        
                        
                        
                        4,687,576Warrant
      liability
                        
                        
                        313,540
                        
                        
                        
                        470,592Derivative
      liability
                        
                        
                        394,150
                        
                        
                        
                        2,151,632Total
      liabilities
                        
                        
                        7,204,127
                        
                        
                        
                        8,989,132Deficiency
      in stockholders' equityPreferred
      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, 31,142,250 and
      28,840,920 shares issued and outstanding at June 30, 2010 and December 31,
      2009, respectively
                        
                        
                        31,142
                        
                        
                        
                        28,841Additional
      paid-in capital
                        
                        
                        31,598,764
                        
                        
                        
                        30,902,885Accumulated
      deficit
                        
                        
                        (38,081,665
                        )
                        
                        
                        (38,360,101
                        )Total
      deficiency in stockholders' equity
                        
                        
                        (6,451,759
                        )
                        
                        
                        (7,428,375
                        )Total
      liabilities and deficiency in stockholders' equity
                        
                        $
                        752,368
                        
                        
                        $
                        1,560,757
 
 The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
  1
  INNOVATIVE
CARD TECHNOLOGIES, INC.
 CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)
 
 Three
      Months Ended June 30,
                  
                  
                  Six
      Months Ended June 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Revenues
                  
                  $
                  881,204
                  
                  
                  $
                  1,296,645
                  
                  
                  $
                  1,622,283
                  
                  
                  $
                  1,830,868Cost
      of goods sold
                  
                  
                  701,699
                  
                  
                  
                  1,176,918
                  
                  
                  
                  1,371,313
                  
                  
                  
                  1,763,878Gross
      profit
                  
                  
                  179,505
                  
                  
                  
                  119,727
                  
                  
                  
                  250,970
                  
                  
                  
                  66,990Operating
      expensesAdministrative
                  
                  
                  393,442
                  
                  
                  
                  598,390
                  
                  
                  
                  866,468
                  
                  
                  
                  1,148,304Consulting
      fees
                  
                  
                  -
                  
                  
                  
                  25,773
                  
                  
                  
                  -
                  
                  
                  
                  41,366Professional
      fees
                  
                  
                  56,923
                  
                  
                  
                  149,771
                  
                  
                  
                  136,768
                  
                  
                  
                  221,970Research
      and development
                  
                  
                  45,324
                  
                  
                  
                  70,639
                  
                  
                  
                  120,473
                  
                  
                  
                  113,848Total
      operating expense
                  
                  
                  495,689
                  
                  
                  
                  844,573
                  
                  
                  
                  1,123,709
                  
                  
                  
                  1,525,488Loss
      from operations
                  
                  
                  (316,184
                  )
                  
                  
                  (724,846
                  )
                  
                  
                  (872,739
                  )
                  
                  
                  (1,458,498
                  )Other
      income (expense)Change
      in fair value of warrant and conversion liability
                  
                  
                  1,350,354
                  
                  
                  
                  (57,401
                  )
                  
                  
                  1,702,118
                  
                  
                  
                  (160,668
                  )Gain
      on extinguishment of debt
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  136,321
                  
                  
                  
                  -Interest
      income
                  
                  
                  5
                  
                  
                  
                  22
                  
                  
                  
                  23
                  
                  
                  
                  51Interest
      expense
                  
                  
                  (343,177
                  )
                  
                  
                  (526,895
                  )
                  
                  
                  (687,287
                  )
                  
                  
                  (10,596,274
                  )Total
      other income (expense)
                  
                  
                  1,007,182
                  
                  
                  
                  (584,274
                  )
                  
                  
                  1,151,175
                  
                  
                  
                  (10,756,891
                  )Income
      (loss) before provision for income taxes
                  
                  
                  690,998
                  
                  
                  
                  (1,309,120
                  )
                  
                  
                  278,436
                  
                  
                  
                  (12,215,389
                  )Provision
      for income taxes
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Net
      income (loss)
                  
                  
                  690,998
                  
                  
                  
                  (1,309,120
                  )
                  
                  
                  278,436
                  
                  
                  
                  (12,215,389
                  )Income
      (loss) per share:Basic
                  
                  $
                  0.02
                  
                  
                  $
                  (0.05
                  )
                  
                  $
                  0.01
                  
                  
                  $
                  (0.43
                  )Diluted
                  
                  $
                  0.02
                  
                  
                  $
                  (0.05
                  )
                  
                  $
                  0.01
                  
                  
                  $
                  (0.43
                  )Weighted
      average shares outstanding:Basic
                  
                  
                  30,742,924
                  
                  
                  
                  28,495,256
                  
                  
                  
                  30,255,165
                  
                  
                  
                  28,495,256Diluted
                  
                  
                  31,581,958
                  
                  
                  
                  28,495,256
                  
                  
                  
                  31,244,995
                  
                  
                  
                  28,495,256
 
 The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
  2
 INNOVATIVE
CARD TECHNOLOGIES, INC.
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
 FOR THE
SIX MONTHS ENDED JUNE 30, 2010 AND 2009
 (Unaudited)
 
 2010
                          
                          
                          2009Cash
      flows from operating activities:Net
      income (loss)
                          
                          $
                          278,436
                          
                          
                          $
                          (12,215,389
                          )Adjustments
      to reconcile net lincome (loss) to netcash used in operating
      activities:Depreciation
      and amortization
                          
                          
                          22,314
                          
                          
                          
                          32,578Change
      in fair value of warrant liability
                          
                          
                          (157,052
                          )
                          
                          
                          91,340Change
      in fair value of conversion liability
                          
                          
                          (1,545,066
                          )
                          
                          
                          69,328Amortization
      of debt discount
                          
                          
                          574,665
                          
                          
                          
                          6,671,835Amortization
      of deferred debt issuance costs
                          
                          
                          -
                          
                          
                          
                          449,052Debt
      default penalty
                          
                          
                          -
                          
                          
                          
                          2,642,749Stock
      based compensation expense
                          
                          
                          185,898
                          
                          
                          
                          295,958Noncash
      gain on extinguishment of debt
                          
                          
                          (136,321
                          )
                          
                          
                          -Change
      in provision for obsolete inventory
                          
                          
                          46,368
                          
                          
                          
                          173,630(Increase)
      decrease in accounts receivable
                          
                          
                          666,286
                          
                          
                          
                          (169,899
                          )(Increase)
      decrease in prepaids and other current assets
                          
                          
                          37,030
                          
                          
                          
                          129,294(Increase)
      decrease in deposits on raw materials held for production
                          
                          
                          126,246
                          
                          
                          
                          (511
                          )(Increase)
      decrease in raw materials held for production
                          
                          
                          49,104
                          
                          
                          
                          (147,343
                          )(Increase)
      decrease in work in progress inventory
                          
                          
                          (154,416
                          )
                          
                          
                          664,859(Increase)
      decrease in finished goods inventory
                          
                          
                          (3,632
                          )
                          
                          
                          -(Increase)
      decrease in deposits
                          
                          
                          -
                          
                          
                          
                          5,052Increase
      (decrease) in accounts payable and accrued expenses
                          
                          
                          69,011
                          
                          
                          
                          (69,849
                          )Increase
      (decrease) in accrued interest
                          
                          
                          112,622
                          
                          
                          
                          837,789Increase
      (decrease) in warranty reserve
                          
                          
                          23,511
                          
                          
                          
                          89,812Increase
      (decrease) in deferred rent
                          
                          
                          -
                          
                          
                          
                          (36,354
                          )Increase
      (decrease) in deferred revenue
                          
                          
                          (219,343
                          )
                          
                          
                          423,530Net
      cash used in operating activities
                          
                          
                          (24,339
                          )
                          
                          
                          (62,539
                          )Cash
      flows from financing activities:Proceeds
      from exercise of options/warrants
                          
                          
                          5,250
                          
                          
                          
                          -Net
      cash provided by financing activities
                          
                          
                          5,250
                          
                          
                          
                          -Net
      decrease in cash and cash equivalents
                          
                          
                          (19,089
                          )
                          
                          
                          (62,539
                          )Cash
      and cash equivalents, beginning of period
                          
                          
                          245,765
                          
                          
                          
                          76,645Cash
      and cash equivalents, end of period
                          
                          $
                          226,676
                          
                          
                          $
                          14,106Supplemental
      Schedule of Cash Flow Information:Cash
      paid for interest
                          
                          $
                          -
                          
                          
                          $
                          2,666Non-Cash
      Financial Activity:Debt
      converted to common stock
                          
                          $
                          341,244
                          
                          
                          $
                          -Conversion
      liability extinguished upon conversion of debt
                          
                          
                          212,416
                          
                          
                          
                          -Options
      exercised by application of accrued compensationto exercise
      price
                          
                          
                          39,137
                          
                          
                          
                          -Common
      stock issued as payment of accrued interest
                          
                          
                          64,403
                          
                          
                          
                          -
 
 The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
  3
  INNOVATIVE
CARD TECHNOLOGIES, INC.
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
30, 2010
 (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. In December of 2009,
we introduced the ICard, our new low cost OTP product intended to serve the
masses.
 
 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 unaudited 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.
 
 For the
six months ended June 30, 2010 we have incurred a loss from operations of
$872,739. As of June 30, 2010, we have negative working capital of $5,819,238,
an accumulated deficit of $38,081,665 and a stockholders’ deficiency of
$6,451,759. Sales of the ICT DisplayCard and newly introduced OTP products, the
Company’s main products, are not expected to generate positive cash flow until
2011. As a result, there is substantial doubt about the Company’s ability to
continue as a going concern at June 30, 2010.
 
 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.
  4
 
 The
accompanying unaudited 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
July 31, 2010 the Company has approximately $87,000in cash. Combined with anticipated revenue collections and planned
expense reductions, the Company believes this amount will be enough to fund our
operations until October, 2010. In the
event we do not receive additional financing or orders for our products, we
anticipate ceasing operations during October of 2010.
 
 The
accompanying unaudited condensed consolidated financial statements as of June
30, 2010 and for the three and six months ended June 30, 2010 and 2009 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, 2009 as disclosed in the company's 10-K
for that year as filed with the SEC, as it may be amended.
 
 The
results for the six months ended June 30, 2010 are not necessarily indicative of
the results to be expected for the pending full year ending December 31,
2010.
 
 NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 PRINCIPLES
OF CONSOLIDATION
 
 The
unaudited 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.
 
 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.
 
 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.
  5
 
 MAJOR
SUPPLIERS
 
 The
Company obtains the battery, a key component for the Company’s power inlay
technology, from a single source, Solicore, Inc., on a purchase order
basis. The Company believes that alternative sources for this component in the
event of a disruption or discontinuation in supply would not be available on a
timely basis, which could disrupt Company operations, delay production for up to
twelve months and impair the Company’s ability to manufacture and sell
products.
 
 The
Company obtains the display, a key component for the Company’s ICT DisplayCard,
from a single source, SmartDisplayer, pursuant to the Company’s agreement with
SmartDisplayer. On November 10, 2007, the Company was required to make a deposit
on a purchase order to maintain its exclusivity. The Company was unable to make
the deposit and therefore does not have exclusivity with SmartDisplayer. The
Company believes that alternative sources for this component in the event of a
disruption or discontinuation in supply would not be available on a timely
basis, which could disrupt Company operations relating to the ICT DisplayCard,
delay production of the ICT DisplayCard for up to twelve months and impair the
Company’s ability to manufacture and sell the ICT DisplayCard.
  MAJOR
CUSTOMERS
 
 Two
customers accounted for all of our revenue for the three months ended June 30,
2010 and three customers accounted for all of our revenue for the six months
ended June 30, 2010. Two customers accounted for 99% and 96% of the Company’s
revenues for the three and six months ended June 30, 2009,
respectively.
 
 One
customer accounted for all of our accounts receivable at June 30,
2010.
 
 FAIR
VALUE OF FINANCIAL INSTRUMENTS
 
 Fair
value of financial instruments
 
 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
 
 We have
adopted accounting guidance pursuant to ASC 820 “Fair Value Measurements and
Disclosure”, which established a framework for measuring fair value and expands
disclosure about fair value measurements.
 
 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:
  6
 
 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 June 30, 2010:
  Level 1
                  
                  
                  Level 2
                  
                  
                  Level 3
                  
                  
                  TotalAssetsCash
      and cash equivalents
                  
                  $
                  226,676
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  226,676Total
      Assets
                  
                  $
                  226,676
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  226,676LiabilitiesConvertible
      debentures
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  4,934,843
                  
                  
                  $
                  4,934,843Warrant
      Liability
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  313,540
                  
                  
                  
                  313,540Derivative
      liabilities
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  394,150
                  
                  
                  
                  394,150Total
      liabilities
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  5,642,533
                  
                  
                  $
                  5,642,533
 
 The table
below sets forth a summary of changes in the fair value of the Company’s Level 3
financial liabilities (warrant derivative liability and conversion derivative
liability) for the six months ended June 30, 2010 and 2009.
 
 2010
                  
                  
                  2009Balance
      at beginning of year
                  
                  $
                  2,622,224
                  
                  
                  $
                  19,055Additions
      to derivative instruments
                  
                  
                  -
                  
                  
                  
                  6,061Change
      in fair value of derivative liabilities
                  
                  
                  (1,702,118
                  )
                  
                  
                  160,668Reclassification
      to equity upon conversion of debentures
                  
                  
                  (212,416
                  )
                  
                  
                  -Balance
      at end of period
                  
                  $
                  707,690
                  
                  
                  $
                  185,784
 
 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.
  7
  Common equivalent shares are excluded
from the computation of diluted loss per share if their effect would be
anti-dilutive. There were 30,751,250 common share equivalents at June 30, 2010
and 15,454,880 at June 30, 2009. Common equivalent shares were excluded from the
calculation of diluted loss per share for the three and six month periods ended
June 30, 2009 as their inclusion would reduce diluted loss per share for those
periods. Common
equivalent shares that were included in the calculation of diluted earnings per
share for the three and six month periods ended June 30, 2010, as their
inclusion would reduce earnings per share for those periods, were 839,034
and 989,830, respectively.
  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 December 31, 2008, 3% for the period January 1 to September 30, 2009 and
2% effective October 1, 2009 (the changes in estimate based on historical
trends). Activity in the accrued warranty reserve liability for the three and
six months ended June 30, 2010 and 2009 is as follows:
 
 Three
      months ended June 30,
                  
                  
                  Six
      months ended June 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Balance
      at beginning of period
                  
                  $
                  299,821
                  
                  
                  $
                  239,641
                  
                  
                  $
                  289,135
                  
                  
                  $
                  198,854Charged
      to cost of sales
                  
                  
                  12,825
                  
                  
                  
                  50,499
                  
                  
                  
                  23,511
                  
                  
                  
                  93,161Deductions
                  
                  
                  -
                  
                  
                  
                  (1,474
                  )
                  
                  
                  -
                  
                  
                  
                  (3,349
                  )Balance
      at end of period
                  
                  $
                  312,646
                  
                  
                  $
                  288,666
                  
                  
                  $
                  312,646
                  
                  
                  $
                  288,666
 
 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.
  RECLASSIFICATIONS
 Certain
reclassifications have been made to the prior year financial statements to
conform to the current year presentation.
 RECENTLY
ISSUED ACCOUNTING PRONOUNCEMENTS
 
 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. The adoption of this guidance did not have a material
impact on the Company’s financial position or results of
operations.
 
 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. The
adoption of this guidance did not have a material impact on the Company’s
financial position or results of operations.
  8
 
 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 - 8% SENIOR SECURED
CONVERTIBLE DEBENTURES
 
 During
the first quarter of 2010, certain debenture holders converted an aggregate of
$341,244 of debentures into 1,364,975 shares of common stock. We recorded a
charge of $46,424 related to the change in fair value of the conversion feature
of the converted debentures through the dates of conversion. At the dates of
conversion, we extinguished a conversion feature liability in the amount of
$212,416.  Since the conversion feature was accounted for as a
liability, we have recorded a gain upon conversion of debt in the amount of
$136,321.
 
 NOTE
4 – DERIVATIVE LIABILITIES
 
 During
the first quarter of 2010, certain debenture holders converted an aggregate of
$341,244 of debentures into 1,364,975 shares of common stock. We recorded a
charge of $46,424 related to the change in fair value of the conversion feature
of the converted debentures through the dates of conversion. At the dates of
conversion, we extinguished a conversion feature liability in the amount of
$212,416. The fair value of the conversion feature was determined using the
Black-Scholes method based on the following weighted average
assumptions: (1) risk free interest rate of 0.32%;
(2) dividend yield of 0%; (3) volatility factor of the expected market
price of our common stock of 138%; and (4) an expected life of the
conversion feature of 0.88 years.
 
 At June
30, 2010 we recalculated the fair value of the conversion feature of the
remaining debentures subject to derivative accounting and have determined that
the fair value at June 30, 2010 is $394,150. 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 0.215%;
(2) dividend yield of 0%; (3) volatility factor of the expected market
price of our common stock of 105%; and (4) an expected life of the
conversion feature of 0.5 years. We recorded credits of $1,166,543 and
$1,591,490 during the three and six months ended June 30, 2010, respectively,
related to the change in fair value of the conversion feature of the debentures
during those periods.
 
 At June
30, 2010, we recalculated the fair value of our warrants subject to derivative
accounting and have determined that the fair value at June 30, 2010 is $313,540.
The fair value of the warrant liability was determined using the Black-Scholes
method based on the following weighted average
assumptions:  (1) risk free interest rate of 0.475%;
(2) dividend yield of 0%; (3) volatility factor of the expected market
price of our common stock of 144%; and (4) an expected life of the
warrants of 1.5 years. We recorded credits of $183,811 and $157,052 during
the three and six months ended June 30, 2010, respectively, related to the
change in fair value of the warrant liability.
 
 NOTE
5 - 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.
  9
 
 During
the first quarter of 2010 the Company issued 1,364,975 shares of common stock
upon conversion debentures in the amount of $341,244.
 
 During
the six months ended June 30, 2010 the Company issued 502,667 shares of common
stock upon the exercise of 502,667 employee stock options. We received $5,250 in
cash proceeds from the exercise of the options; the balance of the exercise
price was paid through the reduction of accrued compensation in the amount of
$39,137.
 
 During
June 2010 we issued 433,688 shares of common stock as partial payment of accrued
interest in the amount of $64,403.
  NOTE 6- STOCK OPTIONS AND
WARRANTS
 
 On
February 22, 2010, our Board and Compensation Committee approved the 2010
Equity Compensation Plan (“2010 Plan”).  The 2010 Plan permits the
granting of up to 6,000,000 shares of common stock through the issuance of
Incentive Stock Options, Nonstatutory Stock Options, Restricted Stock, Stock
Appreciation Rights, Restricted Stock Units, Performance Units, Performance
Shares and Other Stock Based Awards to our employees, directors and
consultants.  We anticipate submitting the plan for shareholder
approval during the following 12 months.  In the event the Plan is not
approved by our shareholders during this time, the 2010 Plan will be considered
a non-qualified plan.
 
 In
January 2010 the Company’s board of directors approved a stock option award to a
director in the amount of 100,000 shares of common stock with an exercise price
of $0.35 per share. The option vests over one year. The option expires after ten
years. The option had a grant date fair value of $9,702. The fair value of the
option was determined using the Black-Scholes method based on the following
assumptions: (1) risk free interest rate of 0.25%;
(2) dividend yield of 0%; (3) volatility factor of the expected market
price of our common stock of 161%; and (4) an expected life of the
option of 0.625 years.
 
 The
Company recorded a credit of $7,668 to compensation expense for consultant stock
options for the three months ended June 30, 2010, of which $436 is included in
professional fees and $7,232 is included in the administrative expense category.
The Company recorded a net credit of $307 to compensation expense for consultant
stock options for the six months ended June 30, 2010, of which $1,155 has been
charged to professional fees and $1,462 credited to the administrative expense
category. During the three and six months ended June 30, 2009, the Company
recorded $2,411 and $4,251, respectively, of compensation expense for consultant
stock options which is included in the administrative expense
category.
 
 The
Company recorded $89,021 and $149,465 of compensation expense for employee stock
options during the three months ended June 30, 2010 and 2009, respectively, and
$186,205 and $291,708 of compensation expense for employee stock options during
the six months ended June 30, 2010 and 2009, respectively, which is included in
the administrative expense category.
 
 NOTE
7 - PROVISION FOR INCOME TAXES
 
 Our
effective tax rate was estimated at 0% for the three and six months ended June
30, 2010 and 2009.
 
 NOTE
8 - COMMITMENTS AND CONTINGENCIES
 
 LEASE
 
 The
Company leases office space on a month-to-month basis.
 
 Rent
expense was $9,498 and $13,447 for the three months ended June 30, 2010 and
2009, respectively, and $22,495 and $25,894 for the six months ended June 30,
2010 and 2009, respectively.
  10
  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.
  NOTE
9 – SUBSEQUENT EVENTS
 During
July 2010 we issued 296,426 shares of common stock as payment of $44,019
interest accrued at June 30, 2010.
  11




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 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,” “Common
Stock,” “common stock” or “Common Shares” refers to our $.001 par value common
stock.   The information contained herein is current as of the
date of this Quarterly Report June 30, 2010), 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 six month period ended June 30, 2010 are not necessarily
indicative of our prospective financial condition and results of operations for
the pending full fiscal year ending December 31, 2010. The interim financial
statements presented in this Quarterly Report as well as other information
relating to our company contained in this Quarterly Report 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 on Form 10-Q 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.





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





When
reading any forward-looking statement, you should remain mindful that actual
results or developments may vary substantially from those expressed in or
implied by such statement for a number of reasons or factors.  Each
forward-looking statement should be read in context with and in understanding of
the various other disclosures concerning our company and our business made
elsewhere in this 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.





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





·
            Overview
      — Discussion of our business and overall analysis of financial
      and other highlights affecting the company in order to provide context for
      the remainder of MD&A.




12





·
            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 three and
      six months ended June 30, 2010 to
2009.





·
            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 and particularly in the “Overview” section (see
also “Risk Factors” in Part II, Item 1A of this Report). Our actual results may
differ materially.





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 devoted a majority of our efforts to
developing our ICard and 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 $5,883,055 and
$8,929,537 for 2009 and 2008, respectively. Additionally, we had operating
losses of $316,184 and $724,846 and $872,739 and $1,458,498 for the three and
six month periods ended June 30, 2010 and 2009, respectively. Sales of the ICT
DisplayCard and newly introduced OTP products, the Company’s main products, are
not expected to generate positive cash flow until 2011.  As a result,
there is substantial doubt about the Company’s ability to continue as a going
concern at June 30, 2010.





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.  Notwithstanding the sales
of our devices, 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 until October 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 2011.





Our
backlog, which consists of orders received but not yet shipped, totaled
approximately $418,000 at June 30, 2010.




13





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 July 1, 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 Report.





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
anticipate that the majority of our revenues in the future will come from the
InCard DisplayCard and new 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.





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 June 30, 2010, 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. We generally warrant our products against defects over a period
of one to three years. The initial estimate and changes to the estimate are
charged to cost of goods sold at the time of sale of the product. The accrual is
based on a percentage of sales. This percentage was 10% through December 31,
2008, 3% for the period January 1 to September 30, 2009 and 2% effective October
1, 2009 (the changes in estimate based on historical trends).





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.





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.


14





Recently
Issued Accounting Pronouncements





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. The adoption of this guidance did not have a material
impact on the Company’s financial position or results of
operations.





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. The
adoption of this guidance did not have a material impact on the Company’s
financial position or results of operations.





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.





Result
of Operations— Three Months
Ended June 30, 2010 Compared to Same Period of 2009





Our
results of operations have varied significantly from year to year and quarter to
quarter and may vary significantly in the future.





Revenue





Revenues
totaled $881,204 and $1,296,645 for the three months ended June 30, 2010 and
2009, respectively.




Change in2010Three Months Ended June
      30,
                                                    
                                                    Versus 20092010
                                                    
                                                    
                                                    2009
                                                    
                                                    $
                                                    
                                                    
                                                    %Revenue
                                                    
                                                    $
                                                    881,204
                                                    
                                                    
                                                    $
                                                    1,296,645
                                                    
                                                    
                                                    $
                                                    (415,441
                                                    )
                                                    
                                                    
                                                    (32
                                                    )%





The
decrease of $415,441 or 32% for the three months ended June 30, 2010 compared to
the same period in 2009 was attributable to the cancellation of a purchase order
during October of 2009 (notwithstanding the fact that the order is
non-cancellable).  During the second quarter of 2009, we fulfilled
approximately $660,000 worth of product deliveries under the order. Sales in
2010 pursuant to other orders increased by approximately $245,000 as compared to
2009.





Cost
of Goods Sold





Cost of
Goods Sold totaled $701,699 and $1,176,918 for the three months ended June 30,
2010 and 2009, respectively.





Change in2010Three Months Ended June
      30,
                                                          
                                                          
                                                          Versus 20092010
                                                          
                                                          
                                                          2009
                                                          
                                                          
                                                          $
                                                          
                                                          
                                                          %Cost
      of Goods Sold
                                                          
                                                          $
                                                          701,699
                                                          
                                                          
                                                          $
                                                          1,176,918
                                                          
                                                          
                                                          $
                                                          (475,219
                                                          )
                                                          
                                                          
                                                          (40
                                                          )
      %





Cost of
goods consists of costs to manufacture, inventory write-offs and reserve
adjustment and warranty expense.  The decrease of $475,219 or 40% for
the three months ended June 30, 2010 compared to the same period in 2009 was
attributable to decreases of $375,969 for costs to manufacture, $37,675 for
warranty expense and $61,575 for inventory write-offs and reserve adjustment.
The decrease in cost to manufacture results primarily from the decrease in
revenue during the 2010 period.


15


Operating
Expenses





Operating
expenses totaled $495,689 and $844,573 for the three months ended June 30, 2010
and 2009, respectively.




Change in2010Three Months Ended June
      30,
                                                  
                                                  
                                                  Versus 20092010
                                                  
                                                  
                                                  2009
                                                  
                                                  
                                                  $
                                                  
                                                  
                                                  %Operating
      ExpensesAdministrative
                                                  
                                                  $
                                                  393,442
                                                  
                                                  
                                                  $
                                                  598,390
                                                  
                                                  
                                                  $
                                                  (204,948
                                                  )
                                                  
                                                  
                                                  (34
                                                  )%Consulting
      Fees
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  25,773
                                                  
                                                  
                                                  
                                                  (25,773
                                                  )
                                                  
                                                  
                                                  (100
                                                  )%Professional
      Fees
                                                  
                                                  
                                                  56,923
                                                  
                                                  
                                                  
                                                  149,771
                                                  
                                                  
                                                  
                                                  (92,848
                                                  )
                                                  
                                                  
                                                  (62
                                                  )%Research
      and development
                                                  
                                                  
                                                  45,324
                                                  
                                                  
                                                  
                                                  70,639
                                                  
                                                  
                                                  
                                                  (25,315
                                                  )
                                                  
                                                  
                                                  (36
                                                  )%Total
      expense
                                                  
                                                  $
                                                  495,689
                                                  
                                                  
                                                  $
                                                  844,573
                                                  
                                                  
                                                  $
                                                  (348,884
                                                  )
                                                  
                                                  
                                                  (41
                                                  )%





Administrative
Expenses





Administrative expenses
totaled $393,442 and $598,390 for the three months ended June 30, 2010 and 2009,
respectively. The decrease of $204,948 or 34% for the three months ended June
30, 2010 compared to the same period in 2009 was primarily attributable to a
decrease in share based compensation of $70,087 (resulting from a decrease in
issued and outstanding equity awards) and reductions in insurance of $34,191,
delivery costs of $102,702 and overall decreases in other administrative
expenses, partially offset by an increase in cash based compensation expense and
related costs of $41,473. Administrative expenses consist of travel, marketing,
compensation, administrative fees and costs, and depreciation
expense.





Consulting
Fees





Consulting
fees totaled $0 and $25,773 for the three months ended June 30, 2010 and 2009,
respectively. The decrease of $25,773 or 100% for the three months ended
June 30, 2010 compared to the same period in 2009 was attributable to the
consultant becoming an employee in late 2009. Consulting fees consists of
payments made to independent contractors for services.





Professional
Fees





Professional
Fees totaled $56,923 and $149,771 for the three months ended June 30, 2010 and
2009, respectively. The decrease of $92,848 or 62% for the three months
ended June 30, 2010 compared to the same period in 2009 was attributable to an
overall higher cost of professional fees in the current period due to an
increase in professional services. A decrease of $99,705 in accounting and audit
fees was partially offset by an increase of $6,857 in legal fees. Professional
fees expense primarily consists of amounts related to services provided by our
outside counsel, auditors and other similar providers.





Research
and Development





Research
and development expenses totaled $45,324 and $70,639 for the three months ended
June 30, 2010 and 2009, respectively. The decrease of $25,315 or 36% for
the three months ended June 30, 2010 compared to the same period in 2009 was
attributable to reductions in spending during the 2010 period. Research and
development expense consists of costs relating to further development of our OTP
products and solutions.





Other
Income (Expense)





Other
income (expense) totaled $1,007,182 of income for the three months ended June
30, 2010.  We reported other expense of $584,274 for the three months
ended June 30, 2009





Change in2010Three Months Ended June
      30,
                                          
                                          
                                          Versus 20092010
                                          
                                          
                                          2009
                                          
                                          
                                          $
                                          
                                          
                                          %Other
      income (expense):Change
      in fair value of warrant and conversion liabilities
                                          
                                          $
                                          1,350,354
                                          
                                          
                                          $
                                          (57,401
                                          )
                                          
                                          $
                                          1,407,755
                                          
                                          
                                          
                                          2,452
                                          %Interest
      income
                                          
                                          
                                          5
                                          
                                          
                                          
                                          22
                                          
                                          
                                          
                                          (17
                                          )
                                          
                                          
                                          (77
                                          )%Interest
      expense
                                          
                                          
                                          (343,177
                                          )
                                          
                                          
                                          (526,895
                                          )
                                          
                                          
                                          183,718
                                          
                                          
                                          
                                          35
                                          %Total
      other income (expense)
                                          
                                          $
                                          1,007,182
                                          
                                          
                                          $
                                          (584,274
                                          )
                                          
                                          $
                                          1,591,456
                                          
                                          
                                          
                                          272
                                          %





Change
in fair value of warrants





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. Refer to Note 4 to the financial statements for further
discussion on our warrant liabilities and the related 8% senior secured
convertible debentures.




16


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.





Interest
Income





Interest
income totaled $5 and $22 for the three months ended June 30, 2010 and 2009,
respectively. Interest income consists of earning on balances in interest
bearing accounts.





Interest
expense





Interest
expense totaled $343,177 and $526,895 for the three months ended June 30,
2010 and 2009, respectively. Interest expense for 2010 consists of
interest accrued on our convertible debentures of $108,422, other interest of
$2,100 and amortization of debt discount of $232,655. Interest
expense for 2009 consists of interest accrued on our convertible debentures
of $513,924 and other interest paid of $12,971.





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. We fully amortized the remaining discount and deferred debt issue
costs during the quarter ended March 31, 2009.





Results
of Operations — Six Months Ended June 30, 2010 Compared to Same Period of
2009





Our
results of operations have varied significantly from year to year and quarter to
quarter and may vary significantly in the future.





Revenue





Revenues
totaled $1,622,283 and $1,830,868 for the six months ended June 30, 2010 and
2009, respectively.




Change in2010Six Months Ended June
      30,
                              
                              Versus 20092010
                              
                              2009
                              
                              $
                              
                              %Revenue
                              
                              $
                              1,622,283
                              
                              
                              $
                              1,830,868
                              
                              
                              $
                              (208,585
                              )
                              
                              
                              (11
                              )%





The
decrease of $208,585 or 11% for the six months ended June 30, 2010 compared
to the same period in 2009 was attributable to the cancellation of a purchase
order during October of 2009 (notwithstanding the fact that the order is
non-cancellable).  During the six months ended June 30, 2009, we
fulfilled approximately $660,000 worth of product deliveries under the order.
Sales in 2010 pursuant to other orders increased by approximately $451,000 as
compared to 2009.





Cost
of Goods Sold





Cost of
Goods Sold totaled $1,371,313 and $1,763,878 for the six months ended June 30,
2010 and 2009, respectively.





Change in2010Six Months Ended June
      30,
                            
                            
                            Versus 20092010
                            
                            
                            2009
                            
                            
                            $
                            
                            
                            %Cost
      of Goods Sold
                            
                            $
                            1,371,313
                            
                            
                            $
                            1,763,878
                            
                            
                            $
                            (392,565
                            )
                            
                            
                            (22
                            )%





Cost of
goods consists of costs to manufacture, inventory write-offs and reserve
adjustment and warranty expense.  The decrease of $392,565 or 22% for
the six months ended June 30, 2010 compared to the same period in 2009 was
attributable to decreases of $196,732 for costs to manufacture, $69,651 for
warranty expense and $126,182 for inventory write-offs and reserve adjustments.
The decrease in cost to manufacture results primarily from the decrease in
revenue during the 2010 period.





Operating
Expenses





Operating
expenses totaled $1,123,709 and $1,525,488 for the six months ended June 30,
2010 and 2009, respectively.




Change in2010Six Months Ended June
      30,
                                                
                                                
                                                Versus 20092010
                                                
                                                
                                                2009
                                                
                                                
                                                $
                                                
                                                
                                                %Operating
      ExpensesAdministrative
                                                
                                                $
                                                866,468
                                                
                                                
                                                $
                                                1,148,304
                                                
                                                
                                                $
                                                (281,836
                                                )
                                                
                                                
                                                (25
                                                )%Consulting
      Fees
                                                
                                                
                                                -
                                                
                                                
                                                
                                                41,366
                                                
                                                
                                                
                                                (41,366
                                                )
                                                
                                                
                                                (100
                                                )%Professional
      Fees
                                                
                                                
                                                136,768
                                                
                                                
                                                
                                                221,970
                                                
                                                
                                                
                                                (85,202
                                                )
                                                
                                                
                                                (38
                                                )%Research
      and development
                                                
                                                
                                                120,473
                                                
                                                
                                                
                                                113,848
                                                
                                                
                                                
                                                6,625
                                                
                                                
                                                
                                                6
                                                %Total
      expense
                                                
                                                $
                                                1,123,709
                                                
                                                
                                                $
                                                1,525,488
                                                
                                                
                                                $
                                                (401,779
                                                )
                                                
                                                
                                                (26
                                                )%




17


Administrative
Expenses





Administrative Expenses
totaled $866,468 and $1,148,304 for the six months ended June 30, 2010 and 2009,
respectively. The decrease of $281,836 or 25% for the six months ended June 30,
2010 compared to the same period in 2009 was primarily attributable to a
decrease in share based compensation of $110,914 (resulting from a decrease in
issued and outstanding equity awards) and reductions in insurance of $67,191,
license and fees of $34,295 and overall decreases in other administrative
expenses, partially offset by an increase in cash based compensation expense and
related costs of $99,707. Administrative expenses consist of travel, marketing,
compensation, administrative fees and costs, and depreciation
expense.





Consulting
Fees





Consulting
fees totaled $0 and $41,366 for the six months ended June 30, 2010 and 2009,
respectively. The decrease of $41,366 or 100% for the six months ended June
30, 2010 compared to the same period in 2009 was attributable to the consultant
becoming an employee in late 2009. Consulting fees consists of payments
made to independent contractors for services.





Professional
Fees





Professional
Fees totaled $136,768 and $221,970 for the six months ended June 30, 2010 and
2009, respectively. The decrease of $85,202 or 38% for the six months ended
June 30, 2010 compared to the same period in 2009 was attributable to an overall
reduction in cost of professional fees in the current period due to a decrease
in professional services. We had decreases of $82,752 in accounting and audit
fees and $2,450 in legal fees. Professional fees expense primarily consists of
amounts related to services provided by our outside counsel, auditors and other
similar providers.





Research
and Development





Research
and development expenses totaled $120,473 and $113,848 for the six months ended
June 30, 2010 and 2009, respectively. The increase of $6,625 or 6% for the
six months ended June 30, 2010 compared to the same period in 2009 was
attributable to an accrual reversal of approximately $30,000 in 2009 with no
comparable item in 2010, offset by reductions in spending during
2010. Research and development expense consists of costs relating to
further development of our OTP products and solutions.





Other
Income (Expense)





Other
income (expense) totaled $1,151,175 of income for the six months ended June 30,
2010 and $10,756,891 of expense for the six months ended June 30,
2009.





Change in2010Six Months Ended June
      30,
                                  
                                  
                                  Versus 20092010
                                  
                                  
                                  2009
                                  
                                  
                                  $
                                  
                                  
                                  %Other
      income (expense):Change
      in fair value of warrant and conversion liabilities
                                  
                                  $
                                  1,702,118
                                  
                                  
                                  $
                                  (160,668
                                  )
                                  
                                  $
                                  1,862,786
                                  
                                  
                                  
                                  1,159
                                  %Gain
      on extinguishment of debt
                                  
                                  
                                  136,321
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  136,321
                                  
                                  
                                  
                                  100
                                  %Interest
      income
                                  
                                  
                                  23
                                  
                                  
                                  
                                  51
                                  
                                  
                                  
                                  (28
                                  )
                                  
                                  
                                  (55
                                  )%Interest
      expense
                                  
                                  
                                  (687,287
                                  )
                                  
                                  
                                  (10,596,274
                                  )
                                  
                                  
                                  9,908,987
                                  
                                  
                                  
                                  93
                                  %Total
      other income (expense)
                                  
                                  $
                                  1,151,175
                                  
                                  
                                  $
                                  (10,756,891
                                  )
                                  
                                  $
                                  11,908,066
                                  
                                  
                                  
                                  111
                                  %





Change
in fair value of warrants





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. Refer to Note 4 to the financial statements for further
discussion on our warrant liabilities 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.


18





Gain
on extinguishment of debt





During
the first quarter of 2010, certain debenture holders converted an aggregate of
$341,244 of debentures into 1,364,975 shares of common stock. Since the
conversion feature was accounted for as a liability, we have recorded a gain
upon conversion of debt in the amount of $136,321. Refer to Note 3 to the
financial statements for further discussion.





Interest
Income





Interest
income totaled $23 and $51 for the six months ended June 30, 2010 and 2009,
respectively. Interest income consists of earning on balances in interest
bearing accounts.





Interest
expense





Interest
expense totaled $687,287 and $10,596,274 for the six months ended June 30,
2010 and 2009, respectively. Interest expense for 2010 consists of
interest accrued on our convertible debentures of $108,422, other interest of
$4,200 and amortization of debt discount of $574,665.  Interest
expense for 2009 consists of interest accrued on our convertible debentures
of $817,784, other interest of $14,853, amortization of debt discount of
$6,671,835, amortization of debt issue costs of $449,052 and a charge of
$2,642,750 for the 30% increase in the principal amount our convertible
debentures as a result of the default described above.





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. We 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 June 30, 2010
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 December 31, 2009 we had an accumulated deficit of
$38,360,101. Our accumulated deficit totaled $38,081,665 at June 30, 2010. Our
cash and cash equivalents balance at June 30, 2010 was $226,676, compared to
$14,106 for the same period of 2009.





Sales of
our products are not expected to generate positive cash flow until 2011. As a
result, there is substantial doubt about our ability to continue as a going
concern at June 30, 2010.





As of
June 30, 2010 we had approximately $227,000 in cash and cash equivalents.
We believe that our cash, combined with anticipated revenue collections and
planned expense reductions, will last until October, 2010. In the
event we do not receive additional financing or orders for our products, we
anticipate ceasing operations during October of 2010.




Change in2010Six Months Ended June
      30,
                                  
                                  
                                  Versus 20092010
                                  
                                  
                                  2009
                                  
                                  
                                  $
                                  
                                  
                                  %At
      June 30:Cash
      & Cash Equivalents
                                  
                                  $
                                  226,676
                                  
                                  
                                  $
                                  14,106
                                  
                                  
                                  $
                                  212,570
                                  
                                  
                                  
                                  1,506
                                  %Six
      months ended June 30:Net
      cash (used in) provided by operating activities
                                  
                                  $
                                  (24,339
                                  )
                                  
                                  $
                                  (62,539
                                  )
                                  
                                  $
                                  38,200
                                  
                                  
                                  
                                  61
                                  %Net
      cash provided by financing activities
                                  
                                  
                                  5,250
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  5,250
                                  
                                  
                                  
                                  100
                                  %





Net
Cash (Used in) Provided by Operating Activities





We used
cash of $24,339 for our operating activities during the six months ended June
30, 2010 and used cash of $62,539 for our operating activities during the six
months ended June 30, 2009. The decrease in cash used of $38,200 or 61% for
the six months ended June 30, 2010 compared to the same period in 2009 was
primarily attributable to a decrease in loss (after adjustment for non-cash
charges) of $1,058,161, a decrease in accounts receivable of $836,185 and an
increase in accounts payable of $138,860, offset by increases in prepaid
expenses and other current assets of $92,264 and inventory of $499,703 and
decreases in deferred revenue of $642,873 and accrued interest of
$725,167.





Net
Cash Provided by Financing Activities





We
received cash from our financing activities of $5,250 during the six months
ended June 30, 2010, from the exercise of employee stock options, with no cash
provided by financing activities during the six months ended June 30,
2009.




19


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


·
            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





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;





·
            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;




20





·
            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 $227,000 as of June 30, 2010,
combined with anticipated revenue collections, will provide us with sufficient
resources to fund our operations until October, 2010.





If we are
able to successfully sell our products in substantial quantities during the
third and fourth quarters of 2010 we may be able to continue operations until or
through the first quarter of 2011.  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 opinions on our 2009 and 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 (June
30, 2010). Based on such evaluation 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.





Notwithstanding
the conclusion that our disclosure and control procedures were not effective, we
believe that our financial condition, results of operations and cash flows
presented in this Report 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.





Limitations
on Effectiveness of Controls and Procedures





Our
management does not expect that our disclosure controls and procedures or our
internal controls will prevent all errors and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
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. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the Company have been detected. These inherent
limitations include, but are not limited to, the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain assumptions about the likelihood of future events and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions. Over time, controls may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.


21





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





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





ITEM
1A.   RISK FACTORS





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





Risk
Related to Our Business and Operations





There
is serious doubt regarding our ability to continue as a going
concern.




As of
July 31, 2010, the Company had approximately $87,000 in
cash.  Combined with anticipated revenue collections and planned
expenses, the Company believes this amount will be enough to fund our operations
until October of 2010.  In the event we do not secure additional
financing or orders for our products, we anticipate ceasing operations during
October of 2010.


We have a
history of recurring losses from operations and have an accumulated deficit of
$38,081,665 as of June 30, 2010. Sales of our products are not expected to
generate positive cash flow until 2011.  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
auditors have added an explanatory paragraph to their opinion on our financial
statements for the year ended December 31, 2009 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.




We
will need to raise additional capital to continue operation.


We do not
generate enough cash to fund our ongoing operations.  We have relied
heavily on external financing to fund operations. Such financing has come
primarily from the sale of our securities.   As of July 31, 2010,
we had cash on hand of approximately $87,000 which we anticipate will fund our
operations through October of 2010.  In the event we do not secure
additional financing or orders for our products, we anticipate ceasing
operations during October of 2010.
 
 All
of our assets are pledged as collateral to our secured debenture
holders.
 
 Any event
of default in our obligations to the holders of the secured convertible
debentures, including the commencement of a bankruptcy, insolvency,
reorganization or liquidation proceeding against us, could require the early
repayment of the secured convertible debentures.  We presently do not
have sufficient capital to repay the secureddebentures when required.  In the event we are unable
to repay the secured debentures, the debenture holders could commence legal
action against us and foreclose on all of our assets to recover the amounts
due.  Any such actions would require us to severely limit operations
or to file for protection under United States Bankruptcy
laws.




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 until October, 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.


22





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 substantial risks, including but
not limited to:





·
            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, Chief Executive Officer and Chief Financial Officer 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.





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
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 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 substantial risk, including but not limited
to:





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




23





·
            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 us.





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.





Our
business is dependent on the stability of the Banking Industry.





A great
deal of our business requires a certain degree of stability in the banking
industry in order for us to effectively provide and market our products to
consumers.  Unforeseen problems or turmoil in the banking industry may
negatively impact our business.





Our
business may be negatively impacted by a lasting recession.





If a
recession continues for an extended period and consumer spending is sharply
curtailed, our revenue stream may diminish to such a degree that the business is
no longer feasible.





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.  In 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:


24





·
            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;





·
            “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 pay any 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
June 30, 2010, we had 31,142,250 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 61,893,500 shares outstanding or
issuable, as of June 30, 2010.   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 prospectus or
via Rule 144 of 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
are contractually obligated to issue shares in the future, diluting the interest
of current stockholders.





As of
June 30, 2010, there were outstanding options, warrants and other convertible
securities entitling the holder to purchase 30,751,250 shares of our common
stock, at a weighted average exercise price of $0.51 per share. We expect to
issue additional options, warrants and other convertible securities to
compensate employees, consultants and directors, and may issue additional shares
to raise capital, to acquire other companies or technologies, to pay for
services, or for other corporate purposes. Any such issuances will have the
effect of diluting the interest of current stockholders.




25





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 two years, the price of our common stock has decreased
drastically.  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 June 30, 2010, 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 13,106,500 additional common shares
and 5,000,000 preferred shares. The power of the board of directors to issue
these shares or securities convertible into these shares 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:





·
            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.





We
face risks related to compliance with corporate governance laws and financial
reporting standards.





The
Sarbanes-Oxley Act of 2002, as well as related new rules and regulations
implemented by the SEC and the Public Company Accounting Oversight Board,
require changes in the corporate governance practices and financial reporting
standards for public companies.  These new laws, rules and
regulations, including compliance with Section 404 of the Sarbanes-Oxley Act of
2002 relating to internal control over financial reporting (“Section 404”), will
materially increase the Company's legal and financial compliance costs and make
some activities more time-consuming and more burdensome. As a result, management
will be required to devote more time to compliance which could result in a
reduced focus on the development thereby adversely affecting the Company’s
development activities. Also, the increased costs will require the Company to
seek financing sooner that it may otherwise have had to.


26





Starting
in 2007, Section 404 of the Sarbanes-Oxley Act of 2002 requires a company’s
management to assess the company’s internal control over financial reporting
annually and include a report on such assessment in our annual report filed with
the SEC.  Some of this concern has been alleviated due to the signing
of the “Dodd-Frank Wall Street Reform and Consumer Protection Act.” (Wall Street
Reform Act).  This was signed On July 21, 2010 by President Barack
Obama.  The Wall Street Reform Act permanently exempts small public
companies with less than $75 million in market capitalization (nonaccelerated
filers) from the requirement to obtain an external audit on the effectiveness of
internal financial reporting controls provided in Section 404(b) of the
Sarbanes-Oxley Act of 2002 (SOX). Section 404(b) requires a registrant to
provide an attestation report on management’s assessment of internal controls
over financial reporting by the registrant’s external auditor. Disclosure of
management attestations on internal control over financial reporting under
existing Section 404(a) is still required for smaller
companies.  Although we are currently a smaller reporting company and
will be in the foreseeable future, there is no guarantee that we will remain so
if circumstances in our business change.  If we lost our status as a
smaller reporting company, we would then be subject to Section 404(b) of the
Sarbanes-Oxley Act of 2002. In the event we become subject to 404(b), we
will be required to expand substantial capital in connection with
compliance.





Our
management has concluded that, as of June 30, 2010, 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 June 30, 2010. Based on such evaluation which
disclosed numerous material weaknesses, our CEO and CFO have concluded that, as
of June 30, 2010, 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.





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





The
following information is given with regard to unregistered securities sold
during the year beginning January 1, 2010.




·
            On
      January 4, 2010, we issued John Ward, III, one of our non-executive
      directors, an option to purchase 100,000 common shares as compensation
      under our non-executive board compensation policy.  The option
      has an exercise price of $0.35, vests quarterly over the grant year and
      has a term of 10 year.





·
            On
      January 7, 2010, we issued 100,000 common shares in connection with the
      conversion of $25,000 of our convertible
  debentures.





·
            During
      February of 2010 we issued 352,667 shares of common stock upon the
      exercise of 352,667 employee stock options. We received $5,250 in cash
      proceeds from the exercise of the options; the balance of the exercise
      price was paid through the reduction of accrued compensation in the amount
      of $24,137.





·
            On
      February 17, 2010, we issued 1,264,975 common shares in connection with
      the conversion of $316,224 of our convertible
  debentures.





·
            In
      June of 2010, we issued 150,000 common shares upon the exercise of 150,000
      employee stock options.  The exercise price was paid through a
      reduction of accrued compensation in the amount of
  $15,000.




In
connection with the foregoing, the Company relied upon the exemption from
securities registration afforded by Rule 506 of Regulation D as promulgated by
the United States Securities and Exchange Commission under the Securities Act of
1933, as amended (the “Securities Act”) and/or Section 4(2) of the Securities
Act. No advertising or general solicitation was employed in offering the
securities. The issuances were made to a limited number of persons, and transfer
of the securities was restricted in accordance with the requirements of the
Securities Act of 1933.


27





ITEM
3.    DEFAULT UPON SENIOR SECURITIES





None





ITEM
4.    (REMOVED AND RESERVED)





None





ITEM
5.    OTHER INFORMATION





None





ITEM
6.    OTHER INFORMATION





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





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: August
      16, 2010
            
            By:
            /S/
      Richard NathanRichard
      Nathan
              Chief
      Executive Officer Chief Financial Officer
              and
      Director (Principal Executive Officer and
              Principal
      Accounting Officer)





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




28





INDEX
TO EXHIBITS




Incorporated by ReferenceExhibit
                No.
              
              Description
              
              Filed
                Herewith
              
              Form
              
              Exhibit
                No.
              
              File No.
              
              Filing Date3.01(i)
              
              Amended
      and Restated Certificate of Incorporation of Innovative Card Technologies,
      Inc. filed on 5/11/05
              
              
              
              10-K
              
              3.01(i)
              
              001-33353
              
              5/15/093.02(i)
              
              Certificate
      of Amendment to Certificate of Incorporation of Innovative Card
      Technologies, Inc. filed on 12/21/07
              
              
              
              8-K
              
              3.1
              
              001-33353
              
              1/2/083.03(ii)
              
              Amended
      and Restated Bylaws of Innovative Card Technologies, Inc. adopted on May
      5, 2005
              
              
              
              10-K
              
              3.03(ii)
              
              001-33353
              
              5/15/0910.01**
              
              2004
      Stock Incentive Plan as amended
              
              
              
              S-8
              
              10.1
              
              333-137033
              
              3/25/0810.02
              
              Form
      of Warrant pursuant to private placement dated October 19,
      2005
              
              
              
              8-K
              
              4.1
              
              000-51260
              
              10/25/0510.03
              
              Form
      of Warrant issued to TR Winston & Company, LLC dated May 30,
      2006
              
              
              
              8-K
              
              4.1
              
              000-51260
              
              5/31/0610.04
              
              Form
      of Securities Purchase Agreement dated May 30, 2006
              
              
              
              8-K
              
              10.1
              
              000-51260
              
              5/31/0610.05
              
              Form
      of Registration Rights Agreement dated May 30, 2006
              
              
              
              8-K
              
              10.2
              
              000-51260
              
              5/31/0610.06
              
              Licensing
      Agreement dated September 26, 2006 by and between Innovative Card
      Technologies, Inc. and NCryptone, SA as license
              
              
              
              SB-2
              
              10.35
              
              333-135715
              
              7/12/0610.07
              
              Licensing
      Agreement dated September 26, 2006 by and betweenNCryptone, SA as licensor
      and  Innovative Card as license
              
              
              
              SB-2
              
              10.36
              
              333-135715
              
              7/12/0610.08
              
              Form
      of Indemnification Agreement for Executive Officers and Directors of
      Innovative Card Technologies, Inc.
              
              
              
              8-K
              
              10.1
              
              001-33353
              
              3/23/0710.09**
              
              2007
      Equity Incentive Plan
              
              
              
              10-QSB
              
              10.44
              
              001-33353
              
              11/19/0710.10
              
              Form
      of Indemnification Agreement entered into between the Company and Messrs.
      Delcarson and Caporale
              
              
              
              8-K
              
              10.1
              
              001-33353
              
              11/29/07




29




10.11
                
                Form
      of Securities Purchase Agreement Dated January 8, 2008
                
                
                
                8-K
                
                10.1
                
                001-33353
                
                1/9/0710.12
                
                Form
      of 8% Senior Secured Convertible Debenture issued January 8,
      2008
                
                
                
                8-K
                
                10.2
                
                001-33353
                
                1/9/0710.13
                
                Form
      of Common Stock Purchase Warranted issued January 8, 2008
                
                
                
                8-K
                
                10.3
                
                001-33353
                
                1/9/0710.14
                
                Form
      of Registration Rights Agreement dated January 8, 2008
                
                
                
                8-K
                
                10.4
                
                001-33353
                
                1/9/0710.15
                
                Form
      of Security Agreement dated January 8, 2008
                
                
                
                8-K
                
                10.5
                
                001-33353
                
                1/9/0710.16
                
                Form
      of Subsidiary Guarantee dated January 8, 2008
                
                
                
                8-K
                
                10.6
                
                001-33353
                
                1/9/0710.17
                
                Form
      of Securities Purchase Agreement Dated April 15, 2008
                
                
                
                8-K
                
                10.1
                
                001-33353
                
                4/16/0810.18
                
                Form
      of 8% Senior Secured Convertible Debenture issued April 15,
      2008
                
                
                
                8-K
                
                10.2
                
                001-33353
                
                4/16/0810.19
                
                Form
      of Common Stock Purchase Warranted issued April 15, 2008
                
                
                
                8-K
                
                10.3
                
                001-33353
                
                4/16/0810.20
                
                Form
      of Registration Rights Agreement dated April 15, 2008
                
                
                
                8-K
                
                10.4
                
                001-33353
                
                4/16/0810.21
                
                Form
      of Security Agreement dated April 15, 2008
                
                
                
                8-K
                
                10.5
                
                001-33353
                
                4/16/0810.22
                
                Form
      of Subsidiary Guarantee dated April 15, 2008
                
                
                
                8-K
                
                10.6
                
                001-33353
                
                4/16/0810.23**
                
                Form
      of Executive Employment Agreement of Vincent M. Schiavo, dated as of May
      22, 2008
                
                
                
                8-K
                
                10.1
                
                001-33353
                
                5/27/0810.24**
                
                Employment
      Agreement of Mr. Richard Nathan dated February 20, 2009
                
                
                
                8-K
                
                10.01
                
                001-33353
                
                2/24/0910.25
                
                Assignment
      of Debenture and Common Stock Warrants Agreement with EMC
                
                
                
                8-K
                
                10.01
                
                001-33353
                
                7/17/0910.26
                
                Waiver,
      Amendment and Exchange Agreement
                
                
                
                8-K
                
                10.16
                
                001-33353
                
                10/05/0910.27
                
                Debenture
      & Warrant Purchase Agreement
                
                
                
                8-K
                
                10.17
                
                001-33353
                
                10/05/0910.28
                
                Form
      of Amended Debenture dated September 30, 2009
                
                
                
                8-K
                
                10.18
                
                001-33353
                
                10/05/09




30




10.29
              
              Form
      of Amended Warrant dated September 30, 2009
              
              
              
              8-K
              
              10.19
              
              001-33353
              
              10/05/0910.30**
              
              2010
      Equity Compensation Plan
              
              
              
              8-K
              
              4.01
              
              001-33353
              
              2/22/1014.01
              
              Code
      of Ethics
              
              
              
              10-KSB
              
              14.0
              
              000-51260
              
              3/20/0621.1
              
              List
      of Subsidiaries
              
              
              
              SB-2
              
              21.1
              
              333-119814
              
              10/19/0431.1
              
              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.




31