Identiphi (IDPIQ) 10-Q 2007 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from                    to                    

COMMISSION FILE NUMBER 0-20270

SAFLINK CORPORATION

(Exact name of registrant as specified in its charter)

Delaware	95-4346070
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

12413 Willows Road NE, Suite 300, Kirkland, WA 98034

(Address of principal executive offices and zip code)

(425) 278-1100

(Registrant’s telephone number, including area code)

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. Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act):

Large accelerated filer ¨         Accelerated filer ¨         Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes ¨ No x

There were 157,178,245 shares of Saflink Corporation’s common stock outstanding as of August 9, 2007.

Saflink Corporation

FORM 10-Q

For the Quarter Ended June 30, 2007

INDEX

Part I. Financial Information
	Item 1.	Financial Statements (Unaudited)
	a.	Condensed Consolidated Balance Sheets as of June 30, 2007 and December 31, 2006	3
	b.	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2007 and 2006	4
	c.	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2007 and 2006	5
	d.	Notes to Condensed Consolidated Financial Statements	6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	22
	Item 4.	Controls and Procedures	22
Part II. Other Information			23
	Item 1.	Legal Proceedings	23
	Item 1A.	Risk Factors	23
	Item 5.	Other Information	29
	Item 6.	Exhibits	30
Signatures			31

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PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SAFLINK CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands)

	June 30, 2007			December 31, 2006
ASSETS
Current assets:
Cash and cash equivalents	$	760		$	1,407
Accounts receivable, net		7			390
Inventory, net		111			86
Prepaid expenses and other current assets		611			601
Total current assets		1,489			2,484
Furniture and equipment, net of accumulated depreciation of $1,236 and $1,640 as of June 30, 2007, and December 31, 2006, respectively		181			420
Debt issuance costs, net		345			550
Total assets	$	2,015		$	3,454
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Accounts payable	$	1,014		$	1,186
Accrued expenses		1,413			1,308
Convertible debt, net of discount		4,796			4,619
Current portion of notes payable to related party		1,450			1,250
Other current obligation		—			213
Deferred revenue		708			229
Total current liabilities		9,381			8,805
Long-term note payable to related party		200			—
Total liabilities		9,581			8,805
Stockholders’ deficit:
Common stock, $0.01 par value:
Authorized—200,000 shares as of June 30, 2007 and December 31, 2006
Issued—150,178,320 and 97,495 shares as of June 30, 2007 and December 31, 2006, respectively		1,502			975
Common stock subscribed		—			163
Additional paid-in capital		279,746			275,421
Accumulated deficit		(288,814	)		(281,910	)
Total stockholders’ deficit		(7,566	)		(5,351	)
Total liabilities and stockholders’ deficit	$	2,015		$	3,454

See accompanying notes to condensed consolidated financial statements.

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SAFLINK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)

	Three months ended June 30,						Six months ended June 30,
	2007			2006			2007			2006
Revenue:
Product	$	85		$	786		$	460		$	1,542
Service		93			158			222			259
Total revenue		178			944			682			1,801
Cost of revenue:
Product		78			366			205			693
Service		56			130			109			256
Amortization of intangible assets		—			671			—			1,342
Total cost of revenue		134			1,167			314			2,291
Gross profit (loss)		44			(223	)		368			(490	)
Operating expenses:
Product development		310			2,423			496			4,842
Sales and marketing		374			2,053			792			3,931
General and administrative		1,329			1,956			2,571			4,013
Impairment loss on goodwill		—			30,700			—			60,400
Total operating expenses		2,013			37,132			3,859			73,186
Operating loss		(1,969	)		(37,355	)		(3,491	)		(73,676	)
Interest expense		(1,394	)		(323	)		(3,420	)		(362	)
Other income, net		2			59			7			171
Loss before income taxes		(3,361	)		(37,619	)		(6,904	)		(73,867	)
Income tax provision		—			13			—			26
Net loss		(3,361	)		(37,632	)		(6,904	)		(73,893	)
Modification of outstanding warrants		—			(76	)		—			(585	)
Net loss attributable to common stockholders	$	(3,361	)	$	(37,708	)	$	(6,904	)	$	(74,478	)
Basic and diluted net loss per common share attributable to common stockholders	$	(0.02	)	$	(0.43	)	$	(0.06	)	$	(0.85	)
Weighted average number of common shares outstanding		138,018			88,106			125,207			88,101

See accompanying notes to condensed consolidated financial statements.

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SAFLINK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

	Six months ended June 30,
	2007			2006
Cash flows from operating activities:
Net loss	$	(6,904	)	$	(73,893	)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock-based compensation		246			518
Depreciation and amortization		80			1,730
Non-cash interest expense		3,287			228
Impairment loss on goodwill		—			60,400
Loss on disposal of fixed assets		20			5
Deferred taxes		—			26
Changes in operating assets and liabilities:
Accounts receivable, net		383			198
Inventory		(25	)		(26	)
Prepaid expenses and other current assets		46			(338	)
Accounts payable		(172	)		(87	)
Accrued expenses		166			383
Deferred revenue		479			(41	)
Net cash used in operating activities		(2,394	)		(10,897	)
Cash flows from investing activities:
Purchases of furniture and equipment		—			(475	)
Proceeds from sale of furniture and equipment		2			6
Net cash provided by (used in) investing activities		2			(469	)
Cash flows from financing activities:
Proceeds from exercises of stock options		—			17
Proceeds from issuance of convertible debt, net of issuance costs		1,543			7,479
Proceeds from related party bridge loan		400			—
Warrant redemptions		(198	)		(855	)
Net cash provided by financing activities		1,745			6,641
Net decrease in cash and cash equivalents		(647	)		(4,725	)
Cash and cash equivalents at beginning of period		1,407			15,217
Cash and cash equivalents at end of period	$	760		$	10,492
Supplemental disclosure of cash flow information:
Cash paid for interest		—			31
Modification of outstanding warrants		—			585
Reclassification of warrants from liability to equity		—			196
Debt issuance costs included in accounts payable and accrued liabilities		—			93
Beneficial conversion feature related to convertible debentures		—			1,655
Warrants issued in connection with convertible debenture financing		—			2,812
Placement agent warrant issued in connection with convertible debenture financing		—			337
Non-cash additions to furniture and equipment		—			350
Common stock issued in lieu of cash for convertible debenture redemption payments		3,367			—

See accompanying notes to condensed consolidated financial statements.

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SAFLINK CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. Description of Business

Saflink Corporation offers biometric security, smart card and cryptographic technologies that help protect intellectual property and control access to secure facilities. Saflink security technologies are key components in identity assurance management solutions that allow administrators and security personnel to positively confirm a person’s identity before access is granted. Saflink cryptographic technologies help to ensure that sensitive information is accessed only by the intended recipient(s).

Saflink Corporation was incorporated in the State of Delaware on October 23, 1991, and maintains its headquarters in Kirkland, Washington.

Condensed Consolidated Financial Statements

The accompanying condensed consolidated financial statements present unaudited interim financial information and therefore do not contain certain information included in the annual consolidated financial statements of Saflink Corporation and its wholly-owned subsidiaries, Saflink International, Inc., Litronic, Inc. and FLO Corporation (together, the “Company” or “Saflink”). As of July 3, 2007, FLO Corporation was no longer a wholly-owned subsidiary of Saflink Corporation (see Note 14. Subsequent Event). The balance sheet at December 31, 2006, has been derived from the Saflink audited financial statements as of that date. In the opinion of management, all adjustments (consisting only of normally recurring items) it considers necessary for a fair presentation have been included in the accompanying condensed consolidated financial statements. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Saflink Annual Report on Form 10-K for the fiscal year ended December 31, 2006, as filed with the Securities and Exchange Commission (the “SEC”) on March 30, 2007.

2. Liquidity and Capital Resources

These consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As further discussed below, the Company has suffered recurring losses from operations and has a net capital deficiency that raises substantial doubt about its ability to continue as a going concern. These condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Since inception, the Company has been unable to generate net income from operations. The Company has accumulated net losses of approximately $288.8 million from its inception through June 30, 2007, and has continued to accumulate net losses since June 30, 2007. The Company has historically been financed through issuances of common and preferred stock and convertible debt. The Company financed operations during the six months ended June 30, 2007, primarily from existing working capital at December 31, 2006, proceeds from the issuance of a subordinated $400,000 promissory note to a related party, $778,000 in proceeds from the sale of its SAFsolution and SAFmodule source code, and net cash proceeds of $1.5 million from the issuance of convertible promissory notes by FLO Corporation. As of June 30, 2007, the Company’s principal source of liquidity consisted of $760,000 of cash and cash equivalents, while it had a working capital deficit of $7.9 million.

On January 24, 2007, the Company borrowed $400,000 from Richard P. Kiphart, a member of the Company’s board of directors and existing stockholder, and issued an unsecured promissory note to Mr. Kiphart bearing interest at the rate of 10% per annum. The note is due and payable in four equal quarterly installments beginning January 1, 2008, with accrued interest payable with each installment of principal. The note is subordinated to the Company’s 8% convertible debentures due December 12, 2007, and contains customary default provisions.

On February 27, 2007, the Company sold its rights in its SAFsolution and SAFmodule software programs to IdentiPHI, LLC for an initial payment of $778,000 plus quarterly payments based on a percentage of IdentiPHI’s gross margin over the next three years. The $778,000 in proceeds is being deferred and recognized as revenue on a pro rata basis over the three year period that the Company agreed to provide certain patent protection rights under the Company’s patent portfolio. As of June 30, 2007, the Company had deferred revenue of $692,000 related to this sale and recognized $65,000 and $86,000 as revenue during the three and six months ended June 30, 2007, respectively. The quarterly payments are due over a period of three years and the amount of the quarterly payments will be equal to a percentage of IdentiPHI’s gross margin on sales that include the software programs’ source code, including (i) 20% of gross margin on OEM sales that include SAFsolution, (ii) 15% of gross margin on non-OEM sales that include SAFsolution, and (iii) 30% of gross margin on sales that include SAFmodule.

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On March 9, 2007, the Company created FLO Corporation, as a wholly-owned subsidiary, to focus on the Company’s Registered Traveler (RT) business. On April 16, 2007, FLO Corporation issued approximately $3.5 million of convertible promissory notes (the “Notes”) in a private placement. The Notes bear interest at 8% per year and are due April 1, 2008. The Notes are convertible into FLO equity upon the completion of an equity offering or series of offerings that yields FLO gross proceeds of at least $6.0 million. The aggregate consideration for the Notes consisted of approximately $1.8 million in cash, the assignment to FLO of approximately $1.6 million of outstanding 8% convertible debentures issued by Saflink, and the assignment to FLO of a $140,000 promissory note also issued by Saflink to a related party. Total cash received by the Company was approximately $1.5 million, net of issuance costs of $222,000. For additional information regarding the Notes, see Note 8. Stockholders’ Equity under the headingApril 2007 Promissory Notes Issued by FLO Corporation.

Saflink and FLO entered into an Asset Purchase and Contribution Agreement, effective April 16, 2007, pursuant to which FLO acquired all of Saflink’s assets and certain liabilities of Saflink’s Registered Traveler business, in exchange for a promissory note with a principal amount of $6.3 million. The promissory note bears interest at 8% per year and matures on April 16, 2008. The principal outstanding will be immediately due and payable in full upon an event of default or if FLO (a) merges or consolidates with or into any other entity, or any other reorganization of FLO, in which the holders of FLO’s outstanding capital stock do not retain a majority of the voting power of the surviving entity or its parent in substantially the same relative proportions as immediately prior to the transaction, (b) sells all or substantially all of the its assets, or (c) issues 20% or more of its capital stock. Payment on the note may be in the form of cash or through the cancellation of outstanding debentures or promissory note issued by Saflink that has been assigned to FLO. FLO made payments to Saflink totaling $400,000 during May 2007 and $1.8 million during July 2007, all of which were applied against the principal balance of the note. As of August 9, 2007, the remaining principal balance on the note receivable from FLO was approximately $2.2 million.

As a result of the capital raised from the promissory note issued in January 2007, the proceeds from the sale of SAFsolution and SAFmodule, the reduction of operating expenses related to the creation of FLO, and the cash payments received from FLO against the $6.3 million promissory note issued in connection with the sale of the Registered Traveler assets to FLO, the Company believes it has sufficient funds to continue operations at current levels through at least November 2007. However, upon receipt of the remaining $2.2 million balance on the note receivable from FLO, the Company believes it will have sufficient funds to continue operations at its current levels through June 2008. The Company currently does not have a credit line or other borrowing facility to fund its operations. To continue its current level of operations beyond these dates, it is expected that the Company will need to seek additional funds through the issuance of additional equity or debt securities or other sources of financing.

3. Summary of Significant Accounting Policies

Basis of Financial Statement Presentation and Principles of Consolidation

The capital structure presented in these condensed consolidated financial statements is that of Saflink. The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. Preparation of the condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the balance sheets and revenues and expenses for the periods. Significant estimates include allowance for doubtful accounts and inventory reserve, revenue recognition, and assumptions used in determining stock-based compensation expense. Actual results could differ from those estimates.

Revenue Recognition

The Company derives revenue from license fees for software products, selling hardware manufactured by the Company, reselling third party hardware and software applications, and fees for services related to these software and hardware products including maintenance services, installation and integration consulting services.

The Company recognizes revenue in accordance with the provisions of Statement of Position (SOP) 97-2, “Software Revenue Recognition” (SOP 97-2), as amended by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain Transactions,” and related interpretations, including Technical Practice Aids, which provides specific guidance and stipulates that revenue recognized from software arrangements is to be allocated to each element of the arrangement based on the relative fair values of the elements, such as software products, upgrades, enhancements, post-contract customer support, installation, integration, and/or training. Under this guidance, the determination of fair value is based on objective evidence that is specific to the vendor. In multiple element arrangements in which fair value exists for undelivered elements, the fair value of the undelivered elements is deferred and the residual arrangement fee is assigned to

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the delivered elements. If evidence of fair value for any of the undelivered elements does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist, or until all elements of the arrangement are delivered.

Revenue from biometric software and data security license fees is recognized upon delivery, net of an allowance for estimated returns, provided persuasive evidence of an arrangement exists, collection is probable, the fee is fixed or determinable, and vendor-specific objective evidence exists to allocate the total fee to the undelivered elements of the arrangement. If customers receive pilot or test versions of products, revenue from these arrangements is recognized upon customer acceptance of permanent license rights. If the Company’s software is sold through a reseller, revenue is recognized on a sell-through basis when the reseller delivers its product to the end-user. Certain software delivered under a license requires a separate annual maintenance contract that governs the conditions of post-contract customer support. Post-contract customer support services can be purchased under a separate contract on the same terms and at the same pricing, whether purchased at the time of sale or at a later date. Revenue from these separate maintenance support contracts is recognized ratably over the maintenance period. If software maintenance is included under the terms of the software license agreement, then the value of such maintenance is deferred and recognized ratably over the initial license period. The value of such deferred maintenance revenue is established by the price at which the customer may purchase a renewal maintenance contract.

Revenue from hardware manufactured by the Company is generally recognized upon shipment, unless contract terms call for a later date, net of an allowance for estimated returns, provided persuasive evidence of an arrangement exists, collection is probable, the fee is fixed or determinable, and vendor-specific objective evidence exists to allocate the total fee to elements of the arrangement. Revenue from some data security hardware products contains embedded software. However, the embedded software is considered incidental to the hardware product sale. The Company also acts as a reseller of third party hardware and software applications. Such revenue is also generally recognized upon shipment of the hardware, unless contract terms call for a later date, provided that all other conditions above have been met.

Service revenue includes payments under support and upgrade contracts and consulting fees. Support and upgrade revenue is recognized ratably over the term of the contract, which typically is twelve months. Consulting revenue primarily relates to installation, integration and training services performed on a time-and-materials or fixed-fee basis under separate service arrangements. Fees from consulting are recognized as services are performed. If a transaction includes both license and service elements, license fees are recognized separately upon delivery of the licensed software, provided services do not include significant customization or modification of the software product, the licenses are not subject to acceptance criteria, and vendor-specific objective evidence exists to allocate the total fee to elements of the arrangement.

Stock-Based Compensation

The Company uses the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123R, “Share Based Payment” (SFAS 123R), and applied the provision of Staff Accounting Bulletin No. 107, “Share-Based Payment,” using the modified-prospective transition method. Under this transition method, stock-based compensation expense is recognized in the consolidated financial statements for grants of stock options. Compensation expense recognized includes the estimated expense for stock options granted on and subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R, and the estimated expense for the portion vesting in the period for options granted prior to, but not vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123. Further, as required under SFAS 123R, forfeitures are estimated for share-based awards that are not expected to vest.

Recently Issued Accounting Standards

The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB No. 109” (“FIN 48”) on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized no liability for unrecognized income tax benefits at June 30, 2007.

As a result of the net operating loss carryforwards, substantially all tax years are open for federal and state income tax matters. Foreign tax filings are open for years 2001 forward.

In May 2007, the Financial Accounting Standards Board (“FASB”) issued FSP FIN 48-1, Definition of a Settlement in FASB Interpretation No. 48 (“FSP FIN 48-1”). FSP FIN 48-1 clarifies when a tax position is considered settled under FIN 48. Per FSP FIN 48-1, a tax position is considered “effectively settled” upon completion of the examination by the taxing authority without being legally extinguished. For “effectively settled” tax positions, a company can recognize the full amount of the tax benefit. FSP FIN 48-1 is effective upon a company’s adoption of FIN 48. See further discussion of FIN 48 below and the Company’s adoption of FIN 48 in Note 11. FSP FIN 48-1 did not have a material impact on the Company’s financial position or results of operations.

The Company’s continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. At June 30, 2007, the Company had no accrued interest related to uncertain tax positions and no accrued penalties.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 provides companies with an option to report selected financial assets and liabilities at

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fair value. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities and to provide additional information that will help investors and other financial statement users to more easily understand the effect of the company’s choice to use fair value on its earnings. Finally, SFAS 159 requires entities to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. SFAS 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of SFAS 157 (see below). The Company is currently assessing the impact of SFAS 159 which it will be required to adopt no later than the first quarter of its 2008 fiscal year.

In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements (“SFAS 157”). SFAS 157 provides enhanced guidance for using fair value to measure assets and liabilities and also expands information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS 157 applies whenever other accounting standards require or permit assets and liabilities to be measured at fair value and does not expand the use of fair value in any new circumstances. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is currently assessing the impact of SFAS 157 which it will be required to adopt no later than the first quarter of its 2008 fiscal year.

4. Business Combination

On April 16, 2007, Saflink entered into an Asset Purchase and Contribution Agreement with its wholly-owned subsidiary, FLO Corporation, pursuant to which FLO acquired all of Saflink’s assets and certain liabilities of Saflink’s Registered Traveler (RT) business, in exchange for a promissory note with a principal amount of $6.3 million. Pursuant to the agreement, FLO acquired $12,000 in furniture and equipment, and assumed certain contracts and acquired tradenames related to the RT business. In addition, Saflink employees who primarily worked on the RT program transferred their employment to FLO. Liabilities assumed in the transaction included $181,000 in accounts payable related to the RT business and $68,000 in accrued paid time-off related to the transferred employees. The excess of the purchase price over the fair value of net identifiable assets acquired and liabilities assumed is reflected as goodwill. The allocation of the purchase price will be further evaluated by FLO and revised in a subsequent reporting period, if necessary. Since FLO was a wholly-owned subsidiary during the first six months of 2007 and as of June 30, 2007, the goodwill and $6.3 million note has been eliminated in consolidation (see Note 14. Subsequent Event for a description of a subsequent event whereby the Company became a minority stockholder of FLO).

5. Stock-Based Compensation

On September 6, 2000, the Company’s Board of Directors adopted, and on June 29, 2001 amended, the Saflink Corporation 2000 Stock Incentive Plan (the “2000 Plan”). The Company’s shareholders approved the 2000 Plan on September 24, 2001. The Company maintains the plan for officers, directors, employees and consultants. In general, option grants vest monthly over a 36 month term and expire ten years from the date of grant. As of June 30, 2007, there were 4,203,438 shares available for issuance under the 2000 Plan.

Determining Fair Value

Valuation and Amortization Method. The Company estimates the fair value of stock-based awards granted using the Black-Scholes-Merton (BSM) option valuation model. Generally, these awards have an exercise price that is equal to the fair value of the Company’s common stock at the date of grant with monthly vesting over a 36 month term, no post-vesting restrictions and expire ten years from the date of grant. The Company amortizes the fair value of all stock option awards using the single option valuation approach over the requisite service periods, which are generally the vesting periods.

The Company did not grant any stock options during the three and six months ended June 30, 2007.

The following table summarizes stock-based compensation expense for the three and six months ended June 30, 2007 and 2006, which was incurred as follows (in thousands):

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	Three months ended June 30,				Six months ended June 30,
	2007		2006		2007		2006
Product development	$	2	$	30	$	4	$	58
Sales and marketing		9		23		18		42
General and administrative		109		163		224		418
Total stock-based compensation	$	120	$	216	$	246	$	518

No compensation cost was capitalized as part of an asset during the three and six months ended June 30, 2007 and 2006.

At June 30, 2007, the Company had 738,654 non-vested stock options that had a weighted average grant date fair value of $0.34, which excludes a performance option granted on September 28, 2006, to the Company’s interim chief executive officer to purchase up to 700,000 shares of the Company’s common stock. These shares are excluded because none of the performance criteria was probable of being met as of June 30, 2007. In addition, as of June 30, 2007, the Company had $245,000 of total unrecognized compensation cost related to non-vested stock-based awards granted under the 2000 Plan. The Company expects to recognize this cost over a weighted average period of 10 months.

Restricted Stock Awards

On June 23, 2004, Glenn Argenbright, the Company’s former Chief Executive Officer and currently FLO Corporation’s President and Chief Executive Officer, was issued 301,928 restricted shares of the Company’s common stock, which became fully vested on June 23, 2007. On August 9, 2004, Kris Shah, a former member of the Company’s board of directors and former President of Litronic Inc., a wholly-owned subsidiary of the Company, was issued 500,000 restricted shares of the Company’s common stock, which became fully vested on August 9, 2006.

The compensation cost related to these awards was calculated based on the market price of the Company’s common stock on the grant date of the restricted stock. Compensation expense related to restricted stock awards was $58,000 and $121,000 for the three and six months ended June 30, 2007, respectively. Compensation expense related to restricted stock awards for the three and six months ended June 30, 2006, was $132,000 and $263,000, respectively.

6. Goodwill

The Company concluded that certain factors, such as the lack of significant revenue and the continued decline of the price of its common stock as reported on the Nasdaq Capital Market, constituted triggering events under Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets” (SFAS 142) during the first and second quarters of 2006. As a result of the Company’s impairment testing, the Company determined that its goodwill had been impaired. Impairment losses on goodwill were $30.7 million and $60.4 million for the three and six months ended June 30, 2006, respectively. Given the volatility in the Company’s historical revenue trends, the significant decline in its market capitalization, and other indicators of fair value, the Company determined that the best estimate of fair value for the goodwill impairment tests during these periods was its market capitalization. The Company no longer had goodwill balances as of June 30, 2007, and December 31, 2006.

7. Inventory

The following is a summary of inventory as of June 30, 2007, and December 31, 2006 (in thousands):

	June 30, 2007		December 31, 2006
Raw materials	$	87	$	47
Work-in-process		—		1
Finished goods		24		38
	$	111	$	86

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8. Stockholders’ Equity and Convertible Debt

April 2007 Promissory Notes Issued by FLO Corporation

On March 9, 2007, the Company created FLO Corporation, as a wholly-owned subsidiary, to focus on the Company’s Registered Traveler (RT) business. On April 16, 2007, FLO Corporation issued approximately $3.5 million of convertible promissory notes (the “Notes”) in a private placement. The Notes bear interest at 8% per year and are due April 1, 2008. The Notes are convertible into FLO equity upon the completion of an equity offering or series of offerings that yields FLO gross proceeds of at least $6.0 million. The aggregate consideration for the Notes consisted of approximately $1.8 million in cash, the assignment to FLO of approximately $1.6 million of outstanding 8% convertible debentures issued by Saflink, and the assignment to FLO of a $140,000 promissory note also issued by Saflink to a related party. Total cash received by the Company was approximately $1.5 million, which is net of $222,000 in issuance costs for banking and other fees. The issuance costs related to these promissory notes have been recorded as a long-term asset and are being amortized over the term of the notes to interest expense. The Company applied the guidance of Emerging Issue Task Force (EITF) No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios” and EITF No. 00-27, “Application of Issue No. 98-5 Certain Convertible Instruments and concluded that the beneficial conversion feature contained in the Notes is a contingent event and the Company was unable to calculate the number of shares that would be issued upon conversion of the Notes as of the issuance date of April 16, 2007. Accordingly, the Company will not recognize any charge related to the beneficial conversion feature until the contingency is resolved.

June 2006 Convertible Debenture and Warrant Issuance

On June 12, 2006, the Company raised $8.0 million in gross proceeds through a private placement of 8% convertible debentures and warrants to purchase up to 8,889,002 shares of the Company’s common stock. The warrants have an exercise price of $0.48 per share and are exercisable for a period of five years beginning December 10, 2006. The Company also issued a warrant to purchase 1,066,680 shares of its common stock, exercisable at $0.48 per share, to the placement agent for services rendered in connection with this financing.

The debentures bear interest at 8% per annum and are due December 12, 2007. The debentures are convertible into shares of the Company’s common stock at any time at a conversion rate of $0.45 per share; however, the conversion price is subject to adjustment in the event the Company issues common stock or common stock equivalents at a price per share of common stock below the conversion price of the debentures. The principal amount of the debentures is redeemable at the rate of 1/12 of the original principal amount per month plus accrued but unpaid interest on the debentures, which commenced on December 1, 2006. The Company may, in its discretion, elect to pay the interest due on the debentures and the monthly redemption amount in cash or in shares of its common stock, subject to certain conditions related to the market for shares of the Company’s common stock and the registration of the shares issuable upon conversion of the debentures under the Securities Act of 1933.

The company elected to pay the December 2006, January 2007, February 2007, March 2007, April 2007, May 2007, and June 2007 redemption amounts and interest due in shares of its common stock. For the July 2007 redemption amounts, the Company paid 50% in shares of its common stock and 50% in cash. In addition, the Company paid the July 2007 interest payment in cash and notified the debenture holders of its election to pay all future interest payments in cash. For the August 2007 redemption date, the Company paid the entire redemption and interest amounts in cash. The Company has issued an aggregate of 68,270,039 shares of its common stock for payment of principal and interest on the debentures issued in June 2006. The Company recorded the differences between the fair market value of the common stock issued in payment of the principal and interest using the price per common share on the date the shares were issued, as reported on the Nasdaq Capital Market or the OTC Bulletin Board, and the calculated redemption conversion price and interest conversion price to interest expense in the Company’s statement of operations.

The following table summarizes the balances related to the Company’s convertible debentures issued in June 2006 as of June 30, 2007 (in thousands):

Original face value of convertible debentures	$	8,000
Redemption payments (paid in shares of common stock)		(4,125	)
July 2007 pre-redemption share issuance of common stock issued on June 4, 2007		(41	)
Less: unamortized debt discounts		(804	)
Total carrying value, net of debt discount June 30, 2007	$	3,030
Current portion of debt, net of debt discount	$	3,030
Long term portion of debt, net of debt discount	$	—

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The following table summarizes interest expense for the year three and six months ended June 30, 2007 and 2006, related to the Company’s convertible debentures issued in June 2006 (in thousands):

	Six months ended June 30,				Six months ended June 30,
	2007		2006		2007		2006
Nominal interest expense (8% stated rate paid in shares of common stock).	$	86	$	32	$	206	$	32
Amortization of debt discount		730		123		1,779		123
Amortization of capitalized financing costs		155		26		379		26
Difference between fair value of common shares issued for redemption and interest and calculated Redemption Conversion Price and Interest Conversion Price		280		—		875		—
Total interest expense related to convertible debentures	$	1,251	$	181	$	3,239	$	181

Modification of Outstanding Warrants

On January 1, 2006, anti-dilution provisions were triggered in certain outstanding warrants issued by the Company as a result of the Company’s December, 31, 2005, modification to a convertible note payable to a related party. Accordingly, the Company recorded adjustments to the exercise price and, in certain cases, to the number of common shares issuable upon exercise of these warrants. The total number of shares of the Company’s common stock issuable upon exercise of these warrants increased by approximately 5,000 shares and the exercise price of the warrants issued in connection with the Company’s June 2005 financing was reduced from $2.50 to $0.71 per common share as of that date. The exercise price of these warrants was subsequently reduced to $0.45 per common share as a result of the Company’s June 2006 convertible debenture financing.

The fair value of the modification of these warrants was determined by using a BSM option valuation model immediately before and after the effective date of January 1, 2006, with the following assumptions: an expected dividend yield of 0.0%, a risk-free interest rate between 4% and 5%, expected volatility between 71% and 98%, and estimated lives between 2 and 5 years, the remaining contractual lives of these warrants. The fair value of the modification was estimated to be $509,000 and was recorded as a modification of outstanding warrants. This charge increased net loss attributable to common stockholders

On June 12, 2006, the Company amended certain warrants to purchase 2,250,000 shares of its common stock issued in connection with its June 2005 private placement. The amendment required that the Company call one hundred percent of the warrants (“called warrant shares”) if it completed a debt or equity financing for a minimum of $8.0 million in gross proceeds prior to the expiration of the warrants. In addition, the rights and privileges granted pursuant to the warrants would expire on the tenth day after the holders receive a call notice if the warrants were not exercised. In the event the warrants were not exercised with respect to the called warrant shares, the Company agreed to remit to the warrant holders $0.38 per called warrant share. The amendment did not otherwise change any terms of the warrants, including the exercise price or the number of shares issuable upon exercise of the warrants.

As a result of the $8.0 million raised in the convertible debenture issuance on June 12, 2006, and pursuant to the warrant amendments, the Company issued call notices to the holders of the called warrant shares. The warrant holders waived their right to the ten day exercise period and, accordingly, the Company remitted $0.38 per called warrant share, an aggregate of $855,000, to the warrant holders during June 2006. Due to the warrant amendments, the Company reclassified the warrants as a liability because the amended warrants then contained characteristics of debt instruments. The Company estimated the fair value of the warrants to be $0.38 per called warrant share, an aggregate of $855,000, which was the amount to be remitted to the warrant holders if the warrants were not exercised after being called and was reclassified to a liability from equity in June 2006.

As a result of the Company’s convertible debenture issuance on June 12, 2006, anti-dilution provisions contained in certain outstanding warrants issued by the Company were triggered. Accordingly, the Company recorded adjustments to the exercise price and, in certain cases, to the number of common shares issuable upon exercise of these warrants. The total number of shares of the Company’s common stock issuable upon exercise of these warrants increased by approximately 253,000 shares and the exercise price reductions varied depending upon the type of warrant.

The fair value of the modification of these warrants was determined by using a BSM option valuation model immediately before and after the effective date of June 12, 2006, with the following assumptions: an expected dividend yield

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of 0.0%, a risk-free interest rate of approximately 5%, expected volatility between 71% and 75%, and estimated lives between 6 months and 4 years, the remaining contractual lives of these warrants. The fair value of the modification was estimated to be $76,000 and was recorded as a modification of outstanding warrants. This charge increased net loss attributable to common stockholders.

Series A Warrant Expiration and Redemption Notices

The SSP-Litronic acquisition in August 2004 triggered certain redemption provisions in connection with the Company’s Series A warrants. The cash redemption value was estimated to be $765,000 as of August 2, 2004, the date the Company notified the warrant holders of the merger, and was fixed as long as the warrants were outstanding or until expiration in June 2006. On August 6, 2004, the closing date of the merger, these warrants were reclassified as a liability because the warrants then contained characteristics of debt instruments.

During the second quarter of 2006 and prior to the expiration of these warrants on June 5, 2006, the Company received notices from certain warrant holders exercising the redemption provision. Based on the redemption notices received and the cash redemption calculation contained in the warrant, the Company reduced the current obligation from $765,000 to $569,000 during the three months ended June 30, 2006, reclassifying $196,000 into stockholders’ equity. As of June 30, 2007, all cash redemption payments were made to the warrant holders and the current obligation has been reduced to zero.

9. Concentration of Credit Risk and Significant Customers

Three customers accounted for 38%, 17% and 12% of the Company’s revenue for the three months ended June 30, 2007, while three customers accounted for 23%, 17% and 13% of the Company’s revenue for the six months ended June 30, 2007. The Company had no significant credit risk related to customer concentrated accounts receivable as of June 30, 2007.

Four customers accounted for 12%, 12%, 11% and 10% of the Company’s revenue for the three months ended June 30, 2006, while two customers accounted for 11% and 10% of the Company’s revenue for the six months ended June 30, 2006.

Sales to the U.S. government and state and local government agencies, either directly or indirectly, accounted for 55% and 38% of the Company’s revenue for the three and six months ended June 30, 2007, respectively, while these sales accounted for 64% and 56% of the Company’s revenue for the three and six months ended June 30, 2006. In addition, accounts receivable related to direct and indirect sales to the U.S. government and state and local government agencies accounted for 73% and 76% of the Company’s total accounts receivable balance as of June 30, 2007, and December 31, 2006, respectively.

10. Comprehensive Loss

For the three and six months ended June 30, 2007, and 2006, the Company had no components of other comprehensive loss; accordingly, total comprehensive loss equaled the net loss for the respective periods.

11. Net Loss Per Share

Basic net loss per common share is computed on the basis of the weighted average number of common shares outstanding for the period. Diluted net loss per common share is computed on the basis of the weighted average number of common shares plus dilutive potential common shares outstanding. Dilutive potential common shares are calculated under the treasury stock method. Securities that could potentially dilute basic income per share consist of outstanding stock options, warrants, convertible debentures and a convertible promissory note. As the Company had a net loss in each of the periods presented, basic and diluted net loss per common share are the same. All potentially dilutive securities were excluded from the calculation of dilutive net loss per share as their effect was anti-dilutive.

Potential common shares outstanding consisted of options, warrants, convertible debentures and a convertible note to purchase or acquire 28,494,524 and 43,644,186 shares of common stock as of June 30, 2007, and 2006, respectively. There were zero and 801,928 unvested shares of restricted common stock outstanding as of June 30, 2007, and 2006, respectively.

12. Segment Information

In accordance with SFAS No. 131, “Disclosure About Segments of an Enterprise and Related Information,” operating segments are defined as revenue-producing components of an enterprise for which discrete financial information is available and whose operating results are regularly reviewed by the Company’s chief operating decision maker. On March 9, 2007, the Company created FLO Corporation, a subsidiary focused on the Company’s Registered Traveler business. As of June 30, 2007, neither Saflink nor FLO had generated revenue from the Registered Traveler business and, accordingly, the Company did not consider its Registered Traveler Solution Group or FLO as a separate operating segment during the three and six months ended June 30, 2007, and 2006. Therefore, in management’s view, the Company operated as a single segment for all periods presented.

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13. Contingencies

G2 Resources, Inc. (G2) and Classical Financial Services, LLC (Classical) filed complaints in January 1998 against Pulsar Data Systems, Inc., a wholly-owned subsidiary of Litronic, Inc., which in turn became Saflink’s wholly-owned subsidiary in August 2004. The complaints alleged that Pulsar breached a contract by failing to make payments of approximately $500,000 to G2 in connection with services allegedly provided by G2. In April 2001, the court dismissed the complaint for lack of prosecution activity for more than twelve months. G2 re-filed the action in May 2001. In 2005, G2 amended its complaint to add Litronic, Inc. as a defendant. In April 2007, G2 filed a motion seeking the Court’s permission to add Saflink as a defendant. On June 29, 2007, the Company entered into a settlement agreement with G2 under which the Company agreed to pay $150,000 to G2 as consideration for the release of all claims against Pulsar Data Systems, Litronic and Saflink and the dismissal of the lawsuit. This charge was recorded in the Company’s statement of operations during the three months ended June 30, 2007 and the liability is reflected in the Company’s accrued expenses as of June 30, 2007. The Company paid $100,000 to G2 on July 6, 2007, and, under the terms of the settlement agreement, the remaining $50,000 is due within 90 calendar days of the effective date of the settlement agreement.

On July 19, 2007, Verified Identity Pass, Inc. filed a complaint in the U.S. District Court in the Southern District of New York naming Saflink Corporation, FLO Corporation and an employee of FLO as defendants. In the complaint, Verified Identity Pass alleges that the employee breached certain contractual provisions related to the employee’s former employment with Verified Identity Pass and that Saflink and FLO induced the employee to do so. The complaint seeks equitable relief and unspecified damages. The Company intends to vigorously defend against this action.

14. Subsequent Event

On July 3, 2007, FLO raised approximately $4.7 million through the private placement to accredited investors of approximately 522 shares of FLO’s Series A preferred stock. The aggregate consideration for the preferred stock consisted of approximately $4.5 million in cash and the assignment to FLO of $166,667 of outstanding 8% convertible debentures issued by Saflink. Each share of preferred stock is convertible into 4,000 shares of FLO common stock at a conversion price of $2.25 per common share. FLO’s Series A preferred stock has an 8% (per year) cumulative dividend, payable annually or upon conversion on a pro-rated basis. In connection with this financing, FLO issued to these investors Series A-1 warrants to purchase up to an aggregate of 1,024,451 shares of FLO’s common stock with an exercise price of $3.00 per share, and Series A-2 warrants to purchase up to an aggregate of 1,024,451 shares of FLO’s common stock with an exercise price of $4.00 per share. Both series of warrants are exercisable a period five years and contain customary anti-dilution provisions. Concurrent with this financing, FLO issued 1,793,118 shares of its common stock to Saflink, and as a result of the recapitalization and financing, Saflink is no longer a majority stockholder of FLO.

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

This discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes included in this document and our 2006 audited consolidated financial statements and notes thereto included in our annual report on Form 10-K, which was filed with the Securities and Exchange Commission on March 30, 2007.

This quarterly report on Form 10-Q contains statements and information about management’s view of our future expectations, plans and prospects that constitute forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results and events to differ materially from those anticipated, including the factors described in the section of this quarterly report on Form 10-Q entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and identified in Item 1A of Part II entitled “Risk Factors.” We undertake no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events, conditions or circumstances.

The following management’s discussion and analysis of financial condition and results of operations should be read in conjunction with management’s discussion and analysis of financial condition and results of operations included in our annual report on Form 10-K for the year ended December 31, 2006.

As used in this quarterly report on Form 10-Q, unless the context otherwise requires, the terms “we,” “us,” “our,” “the Company,” and “Saflink” refer to Saflink Corporation, a Delaware corporation, and its subsidiaries.

Overview

During the last half of 2006, we began to take a series of steps to reduce expense and attempt to maximize our chances for success in key markets and programs. Those steps included management changes, a substantial reduction of our work force, a consolidation of facilities and narrowed focus for the business. As a result, we restructured the business in order to focus on two key areas, including our Core Technologies Group and our Registered Traveler Group.

Core Technologies Group— our Core Technologies Group focuses on seeking partnerships with companies that can combine their own investment in marketing, production, distribution and support with our products and intellectual property to offer solutions to the market that are mutually beneficial.

On February 1, 2007, we licensed our NetSign^® for mobile middleware with Biometric Associates, Inc. (BAI). The agreement provides BAI a non-exclusive license for use of NetSign for mobile middleware in the development and subsequent sale of its products that utilize our middleware. The license agreement included an initial payment of $100,000 and an additional $25,000 upon BAI’s acceptance of the middleware. We also agreed to provide engineering services for $30,000 over a three month period and the agreement includes royalties due quarterly over a period of four years. Royalties are based on the number of seats sold by BAI that include our middleware.

On February 27, 2007, we sold our rights in our SAFsolution and SAFmodule software source code to IdentiPHI, LLC for an initial payment of $778,000 plus deferred payments due quarterly over a period of three years. The amount of the deferred payments will be equal to a percentage of the provider’s gross margin on sales that include the software programs’ source code. The deferred payments are based on a percentage of IdentiPHI’s gross margin over the next three years that includes the SAFsolution or SAFmodule source code.

Registered Traveler Solutions Group— our Registered Traveler Solutions Group was designed to combine our reputation and intellectual property in identity assurance management with our founding membership in the FLO Alliance to offer a premier solution for the Registered Traveler (RT) program. On March 9, 2007, we created FLO Corporation as a wholly-owned subsidiary to focus on our RT business.

In March 2007, Huntsville International Airport selected the FLO Alliance, an alliance we formed with leading companies in the credentialing, security, access control, software development and travel services market, to develop a Registered Traveler solution for the airport. In order to obtain sufficient funds to capitalize on this and other opportunities in the Registered Traveler market, FLO Corporation engaged in efforts to secure additional financing through the issuance of equity or debt securities.

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On April 16, 2007, FLO Corporation issued approximately $3.5 million of convertible promissory notes in a private placement. The aggregate consideration for the notes consisted of approximately $1.8 million in cash and the assignment to FLO of approximately $1.7 million of our outstanding debt. In connection with this financing, we transferred to FLO all of our Registered Traveler assets and certain liabilities related to our Registered Traveler business, in exchange for a promissory note with a principal amount of $6.3 million. As of August 9, 2007, the remaining principal balance on the note receivable from FLO was approximately $2.2 million.

On July 3, 2007, FLO raised approximately $4.7 million through the private placement of shares of its Series A preferred stock to accredited investors. The aggregate consideration for the preferred stock consisted of approximately $4.5 million in cash, and the assignment to FLO of $166,667 of our outstanding 8% convertible debentures. In connection with this financing, FLO also issued to these investors warrants to purchase up to 2,048,902 shares of its common stock. As a result of the issuance of FLO capital stock in this financing, we are no longer a majority stockholder in FLO.

Historically, our primary source of revenue has been the sale of our software and hardware products and consulting services combined with the resale of software applications and hardware products sourced or assembled from third parties.We believe our primary source of revenue over the next year will be (i) royalties based on IdentiPHI’s sales of products containing the SAFsolution and SAFmodule source code and (ii) royalties under the BAI license agreement.

With many restructuring activities completed, we have new risks and challenges facing us, including our working capital position. We believe we have sufficient funds to continue operations at current levels through at least November 2007. However, upon receipt of the remaining $2.2 million balance on the note receivable from FLO, we believe we will have sufficient funds to continue operations at current levels through June 2008. We currently do not have a credit line or other borrowing facility to fund our operations. To continue our current level of operations beyond these dates, we will need to seek additional funds through the issuance of additional equity or debt securities or other sources of financing.

Critical Accounting Policies and Estimates

Our discussion and analysis of financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of commitments and contingencies. On an on-going basis, we evaluate our critical accounting policies and estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We believe our most critical accounting policies and estimates include revenue recognition and stock-based compensation. Actual results may differ from these estimates under different assumptions or conditions.

Results of Operations

We believe that period-to-period comparisons of our operating results may not be a meaningful basis to predict our future performance. Consideration should be given to our prospects in light of the risks and difficulties described in this quarterly report and in our annual report on Form 10-K for the year ended December 31, 2006. We may not be able to successfully address these risks and difficulties.

We incurred net losses attributable to common stockholders of $3.4 million and $6.9 million for the three and six months ended June 30, 2007, respectively. These results included non-cash interest expense related to our June 2006 convertible debenture issuance of $1.3 million and $3.2 million for the three and six months ended June 30, 2007, respectively. The results for the three and six months ended June 30, 2007, are compared to net losses attributable to common stockholders of $37.7 million and $74.5 million for the three and six months ended June 30, 2006, respectively. The net loss attributable to common stockholders for the six months ended June 30, 2006, included impairment losses on goodwill of $60.4 million. There was no impairment loss on goodwill during the six months ended June 30, 2007.

The following discussion presents certain changes in our revenue and expenses that have occurred during the three and six months ended June 30, 2007, as compared to the three and six months ended June 30, 2006.

Revenue and Cost of Revenue

We recorded revenue primarily from four sources during the three and six months ended June 30, 2007, and 2006: software licenses, manufactured hardware, third party hardware and software, and services. Product revenue consisted of license fees for our software products, sales of our manufactured hardware and the reselling of third party hardware and software products and applications. Service revenue consisted of payments for maintenance and support contracts, as well as labor fees related to government and commercial projects and programs.

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During the three months ended June 30, 2007, software license sales were $68,000; sales of manufactured hardware were $14,000; and sales of third party software and hardware were $3,000, while service revenue was $93,000, which is comprised of $51,000 related to fees for consulting, integration and project labor and $42,000 related to customer support and product maintenance. During the same period in 2006, software license sales were $89,000; sales of manufactured hardware were $481,000; and sales of third party software and hardware were $216,000, while service revenue was $158,000, which was entirely related to customer support and maintenance.

Total revenue of $682,000 for the six months ended June 30, 2007, decreased $1.1 million, or 62%, from revenue of $1.8 million for the six months ended June 30, 2006. Product and service revenue for the six months ended June 30, 2007, were $460,000 and $222,000, respectively, compared to $1.5 million and $259,000, respectively, for the six months ended June 30, 2006. The decrease in total revenue for the three and six months ended June 30, 2007, can be primarily attributed to the significant decrease in revenue from the sale of third party and manufactured hardware during the three and six months ended June 30, 2007. As a result of our source code sale, we don’t expect significant revenue from the sale of third party hardware or software as the majority of that revenue was derived from complementary products to our SAFsolution and SAFmodule software products. However, we do expect to receive quarterly payments based on a percentage of the buyer’s gross margin on products it sells over the next three years that includes the SAFsolution or SAFmodule source code. The amount of the deferred payments will be equal to a percentage of the buyer’s gross margin on sales that include the software programs’ source code, including (i) 20% of gross margin on OEM sales that include SAFsolution, (ii) 15% of gross margin on non-OEM sales that include SAFsolution, and (iii) 30% of gross margin on sales that include SAFmodule. In addition, we expect to receive royalties under our agreement with BAI for the use of our NetSign for mobile middleware product over the next four years. The BAI license agreement included an initial $100,000 payment plus a $25,000 fee in connection with the acceptance of the software, which were both received and recognized as revenue during the first quarter of 2007.

Total cost of revenue included product cost of revenue and service cost of revenue. Product cost of revenue consisted of raw materials, packaging and production costs for our software and manufactured hardware sales, and cost of hardware and software applications purchased from third parties. Service cost of revenue consisted of labor and expenses for post-contract customer support, consulting and integration services, and training.

During the three months ended June 30, 2007, cost of revenue from software and manufactured hardware were $0 and $10,000, respectively, cost of third party software and hardware was $68,000, while cost of service revenue was $56,000. During the same period in 2006, cost of revenue from software and manufactured hardware was $1,000 and $205,000, respectively, cost of revenue from third party software and hardware was $160,000, while cost of service revenue was $130,000. Total cost of revenue also included $671,000 in amortization of intangible assets for three months ended June 30, 2006.

Total cost of revenue of $134,000 for the three months ended June 30, 2007, decreased $1.0 million, or 89%, from cost of revenue of $1.2 million for the same period in 2006, primarily attributable to the decrease in total revenue and a $671,000 decrease in amortization of intangible assets being included in cost of revenue as the carrying value of intangible assets was zero as of December 31, 2006. Total cost of revenue of $314,000 for the six months ended June 30, 2007, decreased $2.0 million, or 86%, from cost of revenue of $2.3 million for the same period in 2006. Product and service cost of revenue for the six months ended June 30, 2007 were $205,000 and $109,000, respectively, compared to $693,000 and $259,000, respectively, for the six months ended June 30, 2006. Amortization of intangible assets recorded in cost of revenue was $0 and $1.3 million for the first six months of 2007 and 2006, respectively. The overall decrease in total cost of revenue can be primarily attributed to lower revenue during the first six months of 2007 when compared to the same period in 2006 and a $1.3 million reduction in amortization of intangible assets being include in cost of revenue during the six months ended June 30, 2007, as the carrying value of intangible assets was zero as of December 31, 2006.

Our gross profit for the three months ended June 30, 2007, was $44,000, or 25%, compared to a gross loss of $223,000, or negative 24%, for the same period in 2006. Our gross profit for the six months ended June 30, 2007, was $368,000, or 54%, compared to a gross loss of $490,000, or negative 27%, for the same period in 2006. The increase in gross margin percentage for the three and six months ended June 30, 2007, compared to the same periods in 2006 can be attributed to the decrease of amortization of intangible assets being included in cost of sales during 2007 as the carrying value of intangible assets was zero as of December 31, 2006.

Operating Expenses

Total operating expenses for the three months ended June 30, 2007, decreased approximately $35.1 million, or 95%, to $2.0 million from $37.1 million for the same period in 2006. The overall decrease was primarily due to reduced headcount in all departments and a net impairment loss on goodwill of $30.7 million that was recorded during the three months ended June 30, 2006. Excluding the net impairment loss on goodwill, operating expenses for the three months ended June 30, 2007,

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decreased $4.4 million, when compared to the same period in 2006. From a functional operating expense perspective, excluding the impairment losses on goodwill, the decrease was primarily due to a $3.1 million decrease in compensation and related benefits driven by headcount being reduced to 14 employees at June 30, 2007, compared to 112 employees at June 30, 2006. The decrease was also related to a $492,000 decrease in occupancy, telephone and internet expense, a $482,000 decrease in other expenses, and a $208,000 decrease in advertising and promotion expense. These decreases, however, were partially offset by a $207,000 increase in legal and professional services.

Total operating expenses for the six months ended June 30, 2007, decreased approximately $69.3 million, or 95%, to $3.9 million from $73.2 million for the comparable period in 2006. This decrease was primarily attributable to the impairment losses on goodwill of $60.4 million during the first six months of 2006 in addition to lower operating expenses across all departments for the six months ended June 30, 2007, which was related to the significant reduction in headcount and consolidation of facilities during the third and fourth quarters of 2006.

The following table provides a breakdown of the dollar and percentage changes in operating expenses for the three and six months ended June 30, 2007, as compared to the same period in 2006 (in thousands):

	Three months					Six Months
	$ Change			% Change		$ Change			% Change
Product development	$	(2,113	)	(87	)%	$	(4,346	)	(90	)%
Sales and marketing		(1,679	)	(82	)		(3,139	)	(80	)
General and administrative		(627	)	(32	)		(1,442	)	(36	)
Impairment loss on goodwill		(30,700	)	(100	)		(60,400	)	(100	)
	$	(35,119	)	(95	)%	$	(69,327	)	(95	)%

Product Development— Product development expenses consist primarily of salaries, benefits, supplies and materials for software developers, hardware engineers, product architects and quality assurance personnel, fees paid for outsourced software development and hardware design. Product development expenses decreased $2.1 million, or 87%, during the three months ended June 30, 2007, to $310,000 from $2.4 million for the same period in 2006. From a functional operating expense perspective, this decrease was primarily due to a $1.8 million decrease in compensation and related benefits and a $345,000 decrease in occupancy, telephone and internet expense. The decrease in compensation and related benefits was due to a reduction in product development headcount of 59 employees, or 89%, from June 30, 2006 to June 30, 2007. The decrease in occupancy, telephone and internet expense for the second quarter of 2007 was also related to large reductions in headcount and facility consolidations, which resulted in less expense being allocated to product development. These decreases, however, were offset by a $236,000 increase in legal and professional services which was related to an increase in outsourced hardware design costs, primarily related to the Registered Traveler program.

For the six months ended June 30, 2007, total product development expenses decreased $4.3 million compared to the same period in 2006. This decrease can be primarily attributed to a $3.5 million decrease in compensation and related benefits and a $650,000 decrease in occupancy, telephone and internet expense.

Sales and Marketing— Sales and marketing expenses consist primarily of salaries and commissions earned by sales and marketing personnel, trade shows, advertising and promotional expenses, fees for consultants, and travel and entertainment costs. Sales and marketing expenses decreased $1.7 million, or 82%, during the three months ended June 30, 2007, compared to the same period in 2006. From a functional operating expense perspective, this decrease was primarily due to a $1.0 million decrease in compensation and related benefits, a $206,000 decrease in advertising and promotion expense and a $190,000 decrease in legal and professional services. The decrease in compensation and related benefits was primarily due to a reduction in sales and marketing headcount of 28 employees, or 78%, from June 30, 2006 to June 30, 2007, while the decrease in advertising and promotion expenses was related to the narrowed scope of our product offerings and fewer active marketing campaigns for the three months ended June 30, 2007. The decrease in legal and professional services was related to the reduction of outsourced consulting services, which were contracted to help with lobbying efforts, brand identity and general advertising and promotion.

For the six months ended June 30, 2007, total sales and marketing expenses decreased $3.1 million compared to the same period in 2006. This decrease can be primarily attributed to a $1.9 million decrease in compensation and related benefits due to the 78% headcount reduction from June 30, 2006 to June 30, 2007.

General and Administrative— General and administrative expenses consist primarily of salaries, benefits and related costs for our executive, finance, legal, human resource, information technology and administrative personnel, professional services fees and allowances for bad debts. General and administrative expenses decreased $627,000, or 32%, during the

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three months ended June 30, 2007, compared to the same period in 2006. From a functional operating expense perspective, this decrease was primarily due to a $358,000 decrease in compensation and related benefits, a decrease of $298,000 in other expense and a decrease of $68,000 in depreciation expense. The decrease in compensation and benefits was primarily driven by a reduction in general and administrative headcount of 11 employees, or 52%, from June 30, 2006 to June 30, 2007. The decrease in other expense was primarily related to the reclassification of the remaining deferred rent balance for our Kirkland location as we assigned the lease to another entity in April 2007. The decrease in depreciation expenses was primarily related to a $716,000 impairment charge on furniture and equipment, which we recorded during the third quarter of 2006, which significantly reduced the depreciable basis of our furniture and equipment.

For the six months ended June 30, 2007, total general and administrative expenses decreased $1.4 million compared to the same period in 2006. This decrease can be primarily attributed to an $830,000 decrease in compensation and related benefits due to the headcount reduction from June 30, 2006 to June 30, 2007, and decrease of $333,000 in other expenses, primarily the result of the reclassification of the remaining deferred rent balance for our Kirkland location.

Impairment Loss on Goodwill— We concluded that certain factors, such as the lack of significant revenue and the continued decline of the price of our common stock as reported on the Nasdaq Capital Market, constituted triggering events under Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets” (SFAS 142) during the first and second quarters of 2006. As a result of our impairment testing, we determined that our goodwill had been impaired. Impairment losses on goodwill were $30.7 million and $60.4 million for the three and six months ended June 30, 2006, respectively. Given the volatility in our historical revenue trends, the significant decline in our market capitalization, and other indicators of fair value, we determined that the best estimate of fair value for the goodwill impairment tests during these periods was our market capitalization. We no longer had goodwill balances as of June 30, 2007, and December 31, 2006.

Interest expense

Interest expense for the three and six months ended June 30, 2007, was $1.4 million and $3.4 million, respectively, compared to $323,000 and $362,000 for the three and six months ended June 30, 2006, respectively. Interest expense for the three and six months ended June 30, 2007 and 2006 consisted of interest expense from the financing of certain insurance policies over a nine month period, interest related to a convertible note payable to a related party that we assumed in the SSP-Litronic acquisition, interest on an unsecured promissory note we issued to the same related party in January 2007, and interest on promissory notes issued by our subsidiary, FLO Corporation. As of June 30, 2007 and 2006, we had one convertible note outstanding with a related party with a face value of $1.25 million, an annual interest rate of 10% and a maturity date of December 31, 2006. Although the unpaid principal and accrued interest under the promissory note was due and payable on December 31, 2006, we did not pay the balance due but intend to pay the outstanding balance to the related party upon request. Until that time, we plan to continue to accrue and pay interest at 10% on the outstanding principal balance. As of June 30, 2007, we had one unsecured promissory note to the same related party with a face value of $400,000, and an annual interest rate of 10%, which is payable in four equal quarterly installments beginning January 1, 2008. Interest expense during the three months ended June 30, 2007 also included $1.3 million in non-cash expense related to our issuance of 8% convertible debentures and warrants in June 2006, as described below.

On June 12, 2006, we raised $7.4 million in net proceeds through a private placement of 8% convertible debentures. The principal amount of the debentures is redeemable at the rate of 1/12 of the original principal amount per month plus accrued but unpaid interest on the debentures commencing December 1, 2006. We may, in our discretion, elect to pay the interest due on the debentures and the monthly redemption amount in cash or in shares of our common stock. We elected to pay the December 2006, January 2007, February 2007, March 2007, April 2007, May 2007, and June 2007 redemption amounts and interest due in shares of our common stock. We elected to pay 50% of the July 2007 redemption in shares of common stock and 50% in cash. We paid July 2007 interest due in cash and paid the August 2007 monthly redemption and interest due in cash.

Other income, net

Other income for the three and six months ended June 30, 2007, was $2,000 and $7,000, respectively. This is compared to $59,000 and $171,000 for the three and six months ended June 30, 2006, respectively. Other income primarily consisted of interest earned on cash and money market balances.

Change in fair value of outstanding warrants

The SSP-Litronic acquisition in August 2004 triggered certain redemption provisions in connection with our Series A warrants. The cash redemption value was estimated to be $765,000 as of August 2, 2004, the date we notified the warrant

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holders of the merger, and was fixed as long as the warrants were outstanding or until expiration in June 2006. On August 6, 2004, the closing date of the merger, we reclassified these warrants as a liability because the warrants then contained characteristics of debt instruments.

During the second quarter of 2006 and prior to the expiration of these warrants on June 5, 2006, we received notices from certain warrant holders exercising the redemption provision. Based on the redemption notices received and the cash redemption calculation contained in the warrant, we reduced the current obligation from $765,000 to $569,000 during the three months ended June 30, 2006, reclassifying $196,000 into stockholders’ equity.

Income tax provision

There was no income tax expense for the three and six months ended June 30, 2007, while we recorded income tax expense of $13,000 and $26,000 for the three and six months ended June 30, 2006, respectively. We recorded income tax expense of $13,000 during the first and second quarters of 2006, which represented the income tax effect of goodwill amortization created by our asset purchase from BSG in December 2003. For tax purposes we amortized the goodwill over 15 years whereas for book purposes the goodwill was not amortized, but instead tested at least annually for impairment. The effective tax rate applied to the tradenames intangible asset and goodwill amortization deductible for tax purposes was 36%.

Modification of Outstanding Warrants

There was no significant modification of warrants recorded for the three and six months ended June 30, 2007. Our convertible debenture issuance on June 12, 2006, triggered anti-dilution provisions contained in certain outstanding warrants. Accordingly, we recorded adjustments to the exercise price and, in certain cases, to the number of common shares issuable upon exercise of these warrants. The total number of shares of our common stock issuable upon exercise of these warrants increased by approximately 253,000 shares and the exercise price reductions varied depending upon the type of warrant.

We determined the fair value of the modification of these warrants by using a Black-Scholes-Merton option valuation model immediately before and after the effective date of June 12, 2006, with the following assumptions: an expected dividend yield of 0.0%, a risk-free interest rate of approximately 5%, expected volatility between 71% and 75%, and estimated lives between 6 months and 4 years, the remaining contractual lives of these warrants. We estimated the fair value of the modification to be $76,000 and we recorded this modification of outstanding warrants. This charge increased net loss attributable to common stockholders.

The modification to our convertible note payable to a related party on December 31, 2005 triggered anti-dilution provisions in certain outstanding warrants issued by us. Accordingly, we recorded adjustments to the exercise price and, in certain cases, to the number of common shares issuable upon exercise of these warrants. The total number of shares of our common stock issuable upon exercise of these warrants increased by approximately 5,000 shares and the exercise price of the warrants issued in connection with our June 2006 financing was reduced from $2.50 to $0.71 per common share. The exercise price of these warrants was subsequently reduced to $0.45 per common share as a result of the June 2006 convertible debenture financing.

We determined the fair value of the modification of these warrants by using a Black-Scholes-Merton model immediately before and after the effective date of January 1, 2006, with the following assumptions: an expected dividend yield of 0.0%, a risk-free interest rate between 4% and 5%, volatility between 71% and 98%, and estimated lives between 2 and 5 years, the remaining contractual lives of these warrants. We estimated the fair value of the modification to be $509,000 and we recorded this modification of outstanding warrants during the three months ended March 31, 2006. This charge increased net loss attributable to common stockholders.

Liquidity and Capital Resources

We financed our operations during the six months ended June 30, 2007, primarily from our existing working capital at December 31, 2006, and through the issuance of a $400,000 promissory note to a related party, through the proceeds of the sale of our rights to our SAFsolution and SAFmodule software programs to IdentiPHI, and through the issuance in April 2007 of $3.5 million of convertible promissory notes by our subsidiary, FLO Corporation, which resulted in net cash proceeds of $1.5 million. As of June 30, 2007, our principal source of liquidity largely consisted of $760,000 of cash and cash equivalents and our working capital deficit was $7.9 million. This is compared $1.4 million of cash and cash equivalents and a working capital deficit of $6.3 million as of December 31, 2006.

We expended $2.4 million in operating activities during the first six months of 2007, compared to $10.9 million for the same period in 2006. The net loss of $6.9 million for the six months ended June 30, 2007, included a $3.3 million charge

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related to non-cash interest expense. Other significant adjustments to the net loss included an increase in deferred revenue of $479,000, a decrease in accounts receivable of $383,000, and stock-based compensation of $246,000.

Net cash provided by investing activities was $2,000 during the six months ended June 30, 2007, related to the sale of furniture and equipment. This is compared to $469,000 used for purchases of furniture and equipment for the same period in 2006, which was primarily related to the purchase of equipment and leasehold improvements for our executive offices in Kirkland, Washington, which we began to occupy in May 2006.

Net cash provided from financing activities was $1.7 million during the six months ended June 30, 2007, compared to $6.6 million during the same period in 2006. In April 2007, we received net proceeds of $1.5 million through the issuance of 8% promissory notes, by our subsidiary, FLO Corporation. In addition, we received proceeds from the issuance of a $400,000 promissory note to a related party during the three months ended March 31, 2007. These proceeds were offset by $198,000 in payments related to redemption provisions contained in our Series A warrants.

In April 2007, we sold all of our assets related to our Registered Traveler business to FLO Corporation, our wholly-owned subsidiary, for $6.3 million. Subsequent to that time, FLO Corporation raised funds for the development of the Registered Traveler business through the issuance of debt and equity securities. As a result of FLO’s financing transactions, we no longer hold a majority of FLO’s outstanding equity securities. The sale of our Registered Traveler business marks a shift in the allocation of our working capital and resources, as in the future we will be focused on expenditures related to our Core Technologies Group.

As a result of the capital raised from the promissory note issued in January 2007, the proceeds from the sale of SAFsolution and SAFmodule, the reduction of operating expenses related to the creation of FLO, and the payments received from FLO against the $6.3 million note receivable, we believe we have sufficient funds to continue operations at current levels through at least November 2007. However, upon receipt of the remaining $2.2 million balance on the note receivable from FLO, we believe we will have sufficient funds to continue operations at current levels through June 2008. We currently do not have a credit line or other borrowing facility to fund our operations. To continue our current level of operations beyond these dates, we will need to seek additional funds through the issuance of additional equity or debt securities or other sources of financing.

Our ability to secure additional financing may be significantly impaired by our issuance of common stock to pay the principal and interest payments on our outstanding 8% convertible debentures. To date, we have issued an aggregate of 68,270,039 shares of our common stock in payment of monthly redemption amounts and interest due on the debentures. However, as a result of the proceeds from the partial payments against the $6.3 million promissory note from FLO, we were able to pay 50% of the July redemption amount in cash and pay the entire August redemption amount in cash. We also elected to pay all future interest due in cash until revised by subsequent notice to the debenture holders. However, we still have the right to pay the redemption and interest amounts in shares of our common stock and if we were to make that election, existing stockholders would suffer substantial dilution and it would be more difficult for us to raise additional funds through the issuance of equity or debt securities.

On April 13, 2007, we assigned the Kirkland facility lease to another entity and we sublease back from it 4,973 square feet in the same facility through March 31, 2008. This facility continues to serve as our principal executive offices.

In Reston, Virginia, we lease 6,083 square feet of office space under a lease that expires in April 2009. In February 2007, we sublet the entire Reston facility to another entity through the lease termination date. The differences in rental rates between our original lease and the sublease are minimal and did not have a material effect on our consolidated financial statements.

Also in Reston, Virginia, our wholly-owned subsidiary Litronic holds a lease for 5,130 square feet of office space that expires in February 2009. In April 2006, we entered into a sublease agreement with another entity to sublease the entire Reston facility through our lease expiration date. The differences in rental rates between the original lease and the sublease are minimal and did not have a material effect on our financial statements.

We believe that our facilities are adequate to satisfy our projected requirements for the foreseeable future, and that additional space will be available if needed. The following is a summary of our current property leases:

Property Description	Location	Square Feet	Lease Expiration Date
Saflink executive offices	Kirkland, Washington	4,973	3/31/2008
Saflink Reston office (sublet as of February 2007)	Reston, Virginia	6,083	4/30/2009
Litronic Reston office (sublet as of April 2006)	Reston, Virginia	5,130	2/28/2009

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Our significant fixed commitments with respect to our convertible note obligations and our operating leases as of June 30, 2007, were as follows (in thousands):

	Payments For The Year Ended December 31,
	Total			Remainder 2007			2008			2009			2010
Operating leases	$	525		$	142		$	290		$	92		$	1
Sublease rental receipts		(502	)		(135	)		(281	)		(86	)		—
Convertible debentures		2,188			2,188			—			—			—
Convertible debentures interest		39			39			—			—			—
Promissory notes issued by FLO		3,542			—			3,542			—			—
Interest on FLO promissory notes		272			—			272			—			—
Convertible note payable to related party		1,250			1,250			—			—			—
Convertible note to related party interest		188			188			—			—			—
Promissory notes to related party		400			—			400			—			—
Promissory note to related party interest		40			—			40			—			—
Total contractual cash obligations	$	7,942		$	3,672		$	4,263		$	6		$	1

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market rate risk for changes in interest rates relates primarily to money market funds included in our investment portfolio. Investments in fixed rate earning instruments carry a degree of interest rate risk as their fair market value may be adversely impacted due to a rise in interest rates. As a result, our future investment income may fall short of expectations due to changes in interest rates. We do not use any hedging transactions or any financial instruments for trading purposes and we are not a party to any leveraged derivatives. Due to the nature of our investment portfolio, we believe that we are not subject to any material market risk exposure.

ITEM 4. CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

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PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

G2 Resources, Inc. and Classical Financial Services, LLC filed complaints in January 1998 against Pulsar Data Systems, Inc., a wholly-owned subsidiary of Litronic, Inc., which in turn became our wholly-owned subsidiary in August 2004. The complaints alleged that Pulsar breached a contract by failing to make payments of approximately $500,000 to G2 in connection with services allegedly provided by G2. In 2005, G2 amended its complaint to add Litronic, Inc. as a defendant. In April 2007, G2 filed a motion seeking the Court’s permission to add Saflink as a defendant. On June 29, 2007, we entered into a settlement agreement with G2 under which we agreed to pay $150,000 to G2 as consideration for the release of all claims against Pulsar Data Systems, Litronic and Saflink and the dismissal of the lawsuit. We paid $100,000 to G2 on July 6, 2007, and, under the terms of the settlement agreement, the remaining $50,000 is due within 90 calendar days of the effective date of the settlement agreement.

On July 19, 2007, Verified Identity Pass, Inc. filed a complaint in the U.S. District Court in the Southern District of New York naming Saflink Corporation, FLO Corporation and an employee of FLO as defendants. Verified Identity Pass alleges that the employee breached certain contractual provisions related to the employee’s former employment with Verified Identity Pass and that Saflink and FLO induced the employee to do so. The complaint seeks equitable relief and unspecified damages. We intend to vigorously defend against this action.

ITEM 1A. RISK FACTORS

Factors That May Affect Future Results

This annual report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. Our business, operating results, financial performance, and share price may be materially adversely affected by a number of factors, including but not limited to the following risk factors, any one of which could cause actual results to vary materially from anticipated results or from those expressed in any forward-looking statements made by us in this annual report on Form 10-K or in other reports, press releases or other statements issued from time to time. Additional factors that may cause such a difference are set forth elsewhere in this annual report on Form 10-Q.

If we do not secure additional financing or receive the remaining $2.2 million balance on our note receivable from FLO Corporation by November 2007, we must reduce the scope of, or cease, our operations.

We have accumulated net losses of approximately $288.8 million from our inception through June 30, 2007. We have continued to accumulate losses after June 30, 2007, to date, and we may be unable to generate significant revenue or net income in the future. We have funded our operations primarily through the issuance of equity and debt securities to investors and may not be able to generate a positive cash flow in the future. We believe we have sufficient funds to continue operations at current levels through at least November 2007. However, upon receipt of the remaining $2.2 million balance on the note receivable from FLO, we believe we will have sufficient funds to continue operations at current levels through June 2008. We do not have a credit line or other borrowing facility to fund our operations. To continue our current level of operations beyond these dates we will need to seek additional funds through the issuance of additional equity or debt securities or other sources of financing. We may not be able to secure such additional financing on favorable terms, or at all. Any additional financings will likely cause substantial dilution to existing stockholders. If we are unable to obtain necessary additional financing or collect the remaining $2.2 million balance on the note receivable from FLO by November 2007, we will be required to reduce the scope of, or cease, our operations.

We may not fully participate in or benefit from the Registered Traveler business because we no longer hold a majority of the equity securities of FLO Corporation.

On April 16, 2007, we sold all of the assets related to our Registered Traveler business to FLO Corporation, our wholly-owned subsidiary, for $6.3 million. Subsequent to that time, FLO Corporation raised funds for the development of the Registered Traveler business through the issuance of debt and equity securities. As a result of FLO’s financing transactions, we no longer hold a majority of FLO’s outstanding equity securities and we are unable to significantly influence FLO’s business, affairs and operations and the vote on corporate matters to be decided by FLO’s stockholders, including the outcome of elections of directors. In addition, because we hold less than a majority of FLO’s outstanding equity securities, neither we nor our stockholders may fully participate in or benefit from the Registered Traveler business, including:

• any future revenue generated by FLO;

• any potential increases in FLO’s valuation; or

• any proceeds related to FLO’s financing efforts.

If we pay the monthly redemption amounts and interest due on the debentures we issued in June 2006 in shares of common stock, existing shareholders will suffer substantial dilution and it will be more difficult for us to raise capital.

As of August 9, 2007, 157,178,245 shares of our common stock were outstanding. In addition, there were a total of 26,037,136 shares of our common stock issuable upon exercise or conversion of outstanding options, warrants, and convertible debt. These convertible securities to acquire shares of common stock are held by our employees and certain other persons at various exercise or conversion prices, none of which have exercise or conversion prices below the market price for our common stock of $0.08 as of August 9, 2007. Options to acquire 7,011,139 shares of our common stock were outstanding as of August 9, 2007, and our existing stock incentive plan had 4,309,689 shares available for future issuance as of that date.

We may, at our discretion, elect to pay the monthly redemption amounts and interest due on the debentures we issued in June 2006 in cash or in shares of our common stock. To date, we have elected to pay December 2006 through June 2007 redemption amounts and interest due in shares of our common stock. We elected to pay 50% of the July redemption amount

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and the entire August redemption amount in cash. We also elected to pay all future interest due in cash until revised by subsequent notice to the debenture holders. As a result of these elections, we have issued 68,270,039 shared of our common stock for these redemption and interest payments.

The issuance of large numbers of additional shares of our common stock to pay the principal and interest of our convertible debt or upon the exercise or conversion of outstanding options, warrants or convertible debt would cause substantial dilution to existing stockholders and could decrease the market price of our common stock due to the sale of a large number of shares of common stock in the market, or the perception that these sales could occur. These sales, or the perception of possible sales, could also impair our ability to raise capital in the future.

We have not generated any significant sales of our products within the competitive commercial market, nor have we demonstrated sales techniques or promotional activities that have proven to be successful on a consistent basis, which makes it difficult to evaluate our business performance or our future prospects.

We are in an emerging, complex and competitive commercial market for digital commerce and communications security solutions. Potential customers in our target markets are becoming increasingly aware of the need for security products and services in the digital economy to conduct their business. Historically, only enterprises that had substantial resources developed or purchased security solutions for delivery of digital content over the Internet or through other means. Also, there is a perception that security in delivering digital content is costly and difficult to implement. Therefore, we will not succeed unless we can educate our target markets about the need for security in delivering digital content and convince potential customers of our ability to provide this security in a cost-effective and easy-to-use manner. Even if we convince our target markets about the importance of and need for such security, there can be no assurance that it will result in the sale of our products. We may be unable to establish sales and marketing operations at levels necessary for us to grow this portion of our business, especially if we are unsuccessful at selling our products into vertical markets. We may not be able to support the promotional programs required by selling simultaneously into several markets. If we are unable to develop an efficient sales system, or if our products or components do not achieve wide market acceptance, then our operating results will suffer and our earnings per share will be adversely affected.

If the market for our products and services does not experience significant growth or if our biometric, token and smart card products do not achieve broad acceptance in this market, our ability to generate significant revenue in the future would be limited and our business would suffer.

A substantial portion of our product and service revenue are derived from the sale of biometric, token and smart card products and services. Biometric, token and smart card solutions have not gained widespread acceptance. It is difficult to predict the future growth rate of this market, if any, or the ultimate size of the biometric, token and smart card technology market. The expansion of the market for our products and services depends on a number of factors such as:

• the cost, performance and reliability of our products and services compared to the products and services of our competitors;

• customers’ perception of the benefits of biometric, token and smart card solutions;

• public perceptions of the intrusiveness of these solutions and the manner in which organizations use the biometric information collected;

• public perceptions regarding the confidentiality of private information;

• customers’ satisfaction with our products and services; and

• marketing efforts and publicity regarding our products and services.

Even if biometric, token and smart card solutions gain wide market acceptance, our products and services may not adequately address market requirements and may not gain wide market acceptance. If biometric or smart card solutions or our products and services do not gain wide market acceptance, our business and our financial results will suffer.

As our current services and product offerings evolve, we may derive a material portion of our revenue from royalties, which is inherently risky.

Because a material portion of our future revenue may be derived from license royalties, our future success depends on:

• our ability to secure broad patent coverage for our new technologies and enter into license agreements with potential licensees; and

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• the ability of our licensees to develop and commercialize successful products that incorporate our technologies.

We face risks inherent in a royalty-based business model, many of which are outside of our control, such as the following:

• the rate of adoption of our technologies by, and the incorporation of our technologies into products of, OEMs;

• the willingness of our licensees and others to make investments to support our licensed technologies, and the amount and timing of those investments;

• actions by our licensees that could severely harm our ability to use our proprietary rights;

• the pricing and demand for products incorporating our licensed technologies;

• our ability to structure, negotiate and enforce agreements for the determination and payment of royalties; and

• competition we may face with respect to our licensees competing with our business.

It is difficult to predict when we will enter into additional license agreements, if at all. The time it takes to establish a new licensing arrangement can be lengthy. We may also incur delays or deferrals in the execution of license agreements as we develop new technologies. The timing of our receipt of royalty payments and the timing of how we recognize license revenue under license agreements may fluctuate and significantly impact our quarterly or annual operating results. Because we may recognize a significant portion of license fee revenue in the quarter that the license is signed, the timing of signing license agreements may significantly impact our quarterly or annual operating results. Under our license agreements, we also may receive ongoing royalty payments, and these may fluctuate significantly from period to period based on sales of products incorporating our licensed technologies.

If we fail to protect, or incur significant costs in defending, our intellectual property and other proprietary rights, our business and results of operations could be materially harmed.

Our success depends, in large part, on our ability to protect our intellectual property and other proprietary rights. We rely primarily on trademarks, copyrights, trade secrets and unfair competition laws, as well as license agreements and other contractual provisions, to protect our intellectual property and other proprietary rights. However, our technology is not patented, and we may be unable or may not seek to obtain patent protection for our technology. Moreover, existing U.S. legal standards relating to the validity, enforceability and scope of protection of intellectual property rights offer only limited protection, may not provide us with any competitive advantages, and may be challenged by third parties. Accordingly, despite our efforts, we may be unable to prevent third parties from infringing upon or misappropriating our intellectual property or otherwise gaining access to our technology. Unauthorized third parties may try to copy or reverse engineer our products or portions of our products or otherwise obtain and use our intellectual property. Moreover, many of our employees have access to our trade secrets and other intellectual property. If one or more of these employees leave us to work for one of our competitors, then they may disseminate this proprietary information, which may as a result damage our competitive position. If we fail to protect our intellectual property and other proprietary rights, then our business, results of operations or financial condition could be materially harmed.

We depend heavily on our network infrastructure and its failure could result in unanticipated expenses and prevent users from effectively utilizing our services, which could negatively impact our ability to attract and retain users.

Our success will depend upon the capacity, reliability and security of our network infrastructure. We must continue to expand and adapt our network infrastructure as the number of users and the amount of information at risk increases, and to meet changing customer requirements. The expansion and adaptation of our network infrastructure will require substantial financial, operational and management resources. There can be no assurance that we will be able to expand or adapt our infrastructure to meet additional demand or our customers’ changing requirements on a timely basis, at a commercially reasonable cost, or at all. If we fail to expand its network infrastructure on a timely basis or adapt it either to changing customer requirements or to evolving industry standards, our business could be significantly impacted.

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In addition, our operations are dependent upon our ability to protect our network infrastructure against damage from fire, earthquakes, floods, mudslides, power loss, telecommunications failures and similar events. Despite precautions taken by us, the occurrence of a natural disaster or other unanticipated problem at our network operations center, co-locations centers (sites at which we will locate routers, switches and other computer equipment which make up the backbone of our network infrastructure) could cause interruptions in the services we provide. The failure of our telecommunications providers to provide the data communications capacity required by us as a result of a natural disaster, operational disruption or for any other reason could also cause interruptions in the services we provide. Any damage or failure that causes interruptions in our operations could have a material adverse effect on our business, financial condition and results of operations.

We rely on industry leading encryption and authentication technology to provide the security and authentication necessary to effect secure transmission of confidential information. Despite the implementation of intense security measures, there can be no assurance that advances in computer capabilities, new discoveries in the field of cryptography or other events or developments will not result in a compromise or breach of the algorithms used by us to protect customer data. If any such compromise of our security were to occur, it could have a material adverse effect on our business, results of operations and financial condition.

Any acquisition we make in the future could disrupt our business and harm our financial condition.

To date, most of our revenue growth has been created by acquisitions. In any future acquisitions or business combinations, we are subject to numerous risks and uncertainties, including:

• dilution of our current stockholders’ percentage ownership as a result of the issuance of stock;

• incurrence or assumption of debt;

• assumption of unknown liabilities; or

• incurrence of expenses related to the future impairment of goodwill and the amortization of other intangible assets.

We may not be able to successfully complete the integration of the businesses, products or technologies or personnel in the businesses or assets that we might acquire in the future, and any failure to do so could disrupt our business and seriously harm our financial condition.

We have depended on a limited number of customers for a substantial percentage of our revenue, and due to the non- recurring nature of these sales, our revenue in any quarter may not be indicative of future revenue.

Three customers accounted for 38%, 17% and 12% of our revenue, for the three months ended June 30, 2007, while three customers accounted for 23%, 17% and 13% of our revenue for the six months ended June 30, 2007. Two customers accounted for 13% and 11% of our revenue for the twelve months ended December 31, 2006. A substantial reduction in revenue from any of our significant customers would adversely affect our business unless we were able to replace the revenue received from those customers. As a result of this concentration of revenue from a limited number of customers, our revenue has experienced wide fluctuations, and we may continue to experience wide fluctuations in the future. Many of our sales are not recurring sales, and quarterly and annual sales levels could fluctuate and sales in any period may not be indicative of sales in future periods.

Doing business with the United States government entails many risks that could adversely affect us by decreasing the profitability of government contracts we are able to obtain and interfering with our ability to obtain future government contracts.

Sales to the U.S. government and state and local government agencies, either directly or indirectly, accounted for 55% and 38% of our total sales for the three and six months ended June 30, 2007, respectively. Our sales to the U.S. government are subject to risks that include:

• early termination of contracts;

• disallowance of costs upon audit; and

• the need to participate in competitive bidding and proposal processes, which are costly and time consuming and may result in unprofitable contracts.

In addition, the government may be in a position to obtain greater rights with respect to our intellectual property than we would grant to other entities. Government agencies also have the power, based on financial difficulties or investigations

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of their contractors, to deem contractors unsuitable for new contract awards. Because we will engage in the government contracting business, we will be subject to audits and may be subject to investigation by governmental entities. Failure to comply with the terms of any government contracts could result in substantial civil and criminal fines and penalties, as well as suspension from future government contracts for a significant period of time, any of which could adversely affect our business by requiring us to spend money to pay the fines and penalties and prohibiting us from earning revenues from government contracts during the suspension period.

Furthermore, government programs can experience delays or cancellation of funding, which can be unpredictable. For example, the U.S. military’s involvement in Iraq has caused the diversion of some Department of Defense funding away from certain projects in which we participate, thereby delaying orders under certain of our government contracts. This makes it difficult to forecast our revenues on a quarter-by-quarter basis.

The lengthy and variable sales cycle of some of our products makes it difficult to predict operating results.

Certain of our products have lengthy sales cycles while customers complete in-depth evaluations of the products and receive approvals for purchase. In addition, new product introduction often centers on key trade shows and failure to deliver a product prior to such an event can seriously delay introduction of a product. As a result of the lengthy sales cycles, we may incur substantial expenses before we earn associated revenues because a significant portion of our operating expenses is relatively fixed and based on expected revenues. The lengthy sales cycles make forecasting the volume and timing of orders difficult. In addition, the delays inherent in lengthy sales cycles raise additional risks that customers may cancel or change their minds. If customer cancellations or product delays occur, we could lose anticipated sales.

A security breach of our internal systems or those of our customers due to computer hackers or cyber terrorists could harm our business by adversely affecting the market’s perception of our products and services.

Since we provide security for Internet and other digital communication networks, we may become a target for attacks by computer hackers. The ripple effects throughout the economy of terrorist threats and attacks and military activities may have a prolonged effect on our potential commercial customers, or on their ability to purchase our products and services. Additionally, because we provide security products to the United States government, we may be targeted by cyber terrorist groups for activities threatened against United States-based targets.

We will not succeed unless the marketplace is confident that we provide effective security protection for Internet and other digital communication networks. Networks protected by our products may be vulnerable to electronic break-ins. Because the techniques used by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques. Although we have never experienced any act of sabotage or unauthorized access by a third party of our internal network to date, if an actual or perceived breach of security for Internet and other digital communication networks occurs in our internal systems or those of our end-user customers, it could adversely affect the market’s perception of our products and services. This could cause us to lose customers, resellers, alliance partners or other business partners.

Our financial and operating results often vary significantly from quarter to quarter and may be adversely affected by a number of factors.

Our financial and operating results have fluctuated in the past and our financial and operating results could fluctuate in the future from quarter to quarter for the following reasons:

• reduced demand for our products and services;

• price reductions, new competitors, or the introduction of enhanced products or services from new or existing competitors;

• changes in the mix of products and services we or our distributors sell;

• contract cancellations, delays or amendments by customers;

• the lack of government demand for our products and services or the lack of government funds appropriated to purchase our products and services;

• unforeseen legal expenses, including litigation costs;

• expenses related to acquisitions;

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• impairments of goodwill and intangible assets;

• other financial charges;

• the lack of availability or increase in cost of key components and subassemblies; and

• the inability to successfully manufacture in volume, and reduce the price of, certain of our products that may contain complex designs and components.

Particularly important is our need to invest in planned technical development programs to maintain and enhance our competitiveness, and to develop and launch new products and services. Improving the manageability and likelihood of success of such programs requires the development of budgets, plans and schedules for the execution of these programs and the adherence to such budgets, plans and schedules. The majority of such program costs are payroll and related staff expenses, and secondarily materials, subcontractors and promotional expenses. These costs will be very difficult to adjust in response to short-term fluctuations in our revenue, compounding the difficulty of achieving profitability.

We may be exposed to significant liability for actual or perceived failure to provide required products or services.

Products as complex as those we offer may contain undetected errors or may fail when first introduced or when new versions are released. Despite our product testing efforts and testing by current and potential customers, it is possible that errors will be found in new products or enhancements after commencement of commercial shipments. The occurrence of product defects or errors could result in adverse publicity, delay in product introduction, diversion of resources to remedy defects, loss of or a delay in market acceptance, or claims by customers against us, or could cause us to incur additional costs, any of which could adversely affect our business. Because our customers rely on our products for critical security applications, we may be exposed to claims for damages allegedly caused to an enterprise as a result of an actual or perceived failure of our products. An actual or perceived breach of enterprise network or information security systems of one of our customers, regardless of whether the breach is attributable to our products or solutions, could adversely affect our business reputation. Furthermore, our failure or inability to meet a customer’s expectations in the performance of our services, or to do so in the time frame required by the customer, regardless of our responsibility for the failure, could result in a claim for substantial damages against us by the customer, discourage customers from engaging us for these services, and damage our business reputation.

Government regulations affecting security of Internet and other digital communication networks could limit the market for our products and services.

The United States government and foreign governments have imposed controls, export license requirements and restrictions on the import or export of some technologies, including encryption technology. Any additional governmental regulation of imports or exports or failure to obtain required export approval of encryption technologies could delay or prevent the acceptance and use of encryption products and public networks for secure communications and could limit the market for our products and services. In addition, some foreign competitors are subject to less rigorous controls on exporting their encryption technologies. As a result, they may be able to compete more effectively than us in the United States and in international security markets for Internet and other digital communication networks. In addition, governmental agencies such as the Federal Communications Commission periodically issue regulations governing the conduct of business in telecommunications markets that may adversely affect the telecommunications industry and us.

If we fail to attract and retain qualified senior executive and key technical personnel, our business will not be able to expand.

We will be dependent on the continued availability of the services of our employees, many of whom are individually keys to our future success, and the availability of new employees to implement our business plans. Although our compensation program is intended to attract and retain the employees required for us to be successful, there can be no assurance that we will be able to retain the services of all of our key employees or a sufficient number to execute our plans, nor can there be any assurance that we will be able to continue to attract new employees as required.

Our personnel may voluntarily terminate their relationship with us at any time, and competition for qualified personnel, especially engineers, is intense. The process of locating additional personnel with the combination of skills and attributes required to carry out our strategy could be lengthy, costly and disruptive.

If we lose the services of key personnel, or fail to replace the services of key personnel who depart, we could experience a severe negative impact on our financial results and stock price. In addition, there is intense competition for highly qualified engineering and marketing personnel in the locations where we will principally operate. The loss of the

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services of any key engineering, marketing or other personnel or our failure to attract, integrate, motivate and retain additional key employees could adversely affect on our business and financial results and stock price.

Provisions in our certificate of incorporation may prevent or adversely affect the value of a takeover of our company even if a takeover would be beneficial to stockholders.

Our certificate of incorporation authorizes our board of directors to issue up to 1,000,000 shares of preferred stock, the issuance of which could adversely affect our common stockholders. We can issue shares of preferred stock without stockholder approval and upon terms and conditions, and having those types of rights, privileges and preferences, as our board of directors determines. Specifically, the potential issuance of preferred stock may make it more difficult for a third party to acquire, or may discourage a third party from acquiring, voting control of our company even if the acquisition would benefit stockholders.

ITEM 5. OTHER INFORMATION

On August 14, 2007, we issued a press release announcing our financial results for the three and six months ended June 30, 2007. The press release is attached as Exhibit 99.1 to this report and is incorporated herein by reference.

The attached press release presents certain financial measures that exclude certain non-cash charges such as amortization of intangible assets, impairments losses on goodwill and intangible assets, stock-based compensation expense and non-cash interest expense, which would otherwise be required by U.S. generally accepted accounting principles (GAAP). We believe that these non-GAAP financial measures facilitate evaluation by management and investors of our ongoing operating business and enhance overall understanding of our financial performance by reconciling more closely our actual cash expenses in operations as well as excluding expenses that in management’s view are unrelated to our core operations, the inclusion of which may make it more difficult for investors to compare our results from period to period.

You should not consider non-GAAP financial measures in isolation from, as a substitute for, or superior to, financial information presented in compliance with GAAP, and non-GAAP financial measures we report may not be comparable to similarly titled items reported by other companies. We have provided a reconciliation between our GAAP financial measures and our non-GAAP financial measures in the press release.

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ITEM 6. EXHIBITS

The following exhibits are filed as part of this quarterly report:

Exhibit No.	Description	Filed Herewith	Form	Incorporated by Reference
				Exhibit No.	File No.	Filing Date
10.1	Severance and Release Agreement dated April 16, 2007, by and between Saflink Corporation and Glenn L. Argenbright*	X
10.2	Promissory Note, dated April 16, 2007, by and between Saflink Corporation and Glenn L. Argenbright	X
10.3	Asset Purchase and Contribution Agreement, dated April 16, 2007, by and between Saflink Corporation and FLO Corporation	X
10.4	Promissory Note, dated April 16, 2007, by and between FLO Corporation and Saflink Corporation	X
10.5	Form of Unsecured Convertible Promissory Note issued by FLO Corporation on April 16, 2007	X
10.6	Agreement to enter into Assignment Agreement and Sublease Agreement, dated April 13, 2007, by and between Saflink Corporation and Mantis Technology Group, Inc.	X
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	X
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	X
32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	X
32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	X
99.1	Press release of Saflink Corporation dated August 14, 2007	X

* Management contract or compensatory plan or arrangement

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	Saflink Corporation
DATE: August 14, 2007	By:	/S/ JEFFREY T. DICK
		Jeffrey T. Dick Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

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Exhibit Index

Exhibit No.	Description	Filed Herewith	Form	Incorporated by Reference
				Exhibit No.	File No.	Filing Date
10.1	Severance and Release Agreement dated April 16, 2007, by and between Saflink Corporation and Glenn L. Argenbright*	X
10.2	Promissory Note, dated April 16, 2007, by and between Saflink Corporation and Glenn L. Argenbright	X
10.3	Asset Purchase and Contribution Agreement, dated April 16, 2007, by and between Saflink Corporation and FLO Corporation	X
10.4	Promissory Note, dated April 16, 2007, by and between FLO Corporation and Saflink Corporation	X
10.5	Form of Unsecured Convertible Promissory Note issued by FLO Corporation on April 16, 2007	X
10.6	Agreement to enter into Assignment Agreement and Sublease Agreement, dated April 13, 2007, by and between Saflink Corporation and Mantis Technology Group, Inc.	X
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	X
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	X
32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	X
32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	X
99.1	Press release of Saflink Corporation dated August 14, 2007	X

* Management contract or compensatory plan or arrangement

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