Identiphi 10Q 2008 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, 2008

¨	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

IdentiPHI, Inc.

(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.)

13809 Research Blvd., Suite 275

Austin, Texas 78750

(Address of principal executive offices and zip code)

(512) 492-6220

(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 ¨ Smaller Reporting Company 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 60,440,606 shares of IdentiPHI, Inc. common stock outstanding as of August 12, 2008.

IDENTIPHI, INC.

FORM 10-Q

For the Quarter Ended June 30, 2008

INDEX


Part I. Financial Information		3

Item 1.	Financial Statements (Unaudited)	3

a.	Condensed Consolidated Balance Sheets as of June 30, 2008 and December 31, 2007	3

b.	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2008 and 2007	4

c.	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2008 and 2007	5

d.	Notes to Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	21

Item 4T.	Controls and Procedures	21

Part II. Other Information		21

Item 1.	Legal Proceedings	21

Item 1A.	Risk Factors	21

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	26

Item 5.	Other Information	27

Item 6.	Exhibits	29

Signatures		30

PART I—FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

IDENTIPHI, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands)


	June 30, 2008			December 31, 2007
Assets
Current assets:
Cash and cash equivalents	$	559		$	53
Trade accounts receivable, net		1,022			846
Inventory		162			134
Other current assets		282			102

Total current assets		2,025			1,135
Other assets		—			51
Property and equipment, net		55			33
Goodwill		2,820			—
Intangible assets, net		3,753			648

Total assets	$	8,653		$	1,867

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	2,079		$	886
Accrued expenses		529			225
Note payable to Saflink Corporation		—			400
Notes payable to related parties		1,854			—
Deferred revenue		151			111

Total current liabilities		4,613			1,622
Stockholders’ equity:
Common stock, $0.01 par value:		629			100
Authorized—100,000 and 40,999 shares as of June 30, 2008 and December 31, 2007, respectively
Issued—62,880 and 40,999 shares as of June 30, 2008 and December 31, 2007, respectively
Stock subscription receivable		(141	)		(176	)
Additional paid-in capital		11,343			4,730
Accumulated deficit		(7,791	)		(4,409	)

Total stockholders’ equity		4,040			245

Total liabilities and stockholders’ equity	$	8,653		$	1,867

See accompanying notes to unaudited condensed consolidated financial statements.

IDENTIPHI, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)


	Three months ended June 30,						Six months ended June 30,
	2008			2007			2008			2007
Revenue:
Product	$	1,515		$	709		$	2,971		$	1,373
Service		70			63			124			157

Total revenue		1,585			772			3,095			1,530
Cost of revenue:
Product		1,229			648			2,313			1,128
Service		28			(25	)		38			35
Amortization of intangible assets		381			39			655			52

Total cost of revenue		1,638			662			3,006			1,215

Gross profit (loss)		(53	)		110			89			315
Operating expenses:
Product development		332			149			644			255
Sales and marketing		721			254			1,349			438
General and administrative		910			195			1,392			371

Total operating expenses		1,963			598			3,385			1,064

Operating loss		(2,016	)		(488	)		(3,296	)		(749	)
Interest expense		(76	)		(61	)		(87	)		(113	)
Other income, net		—			—			1			3

Net loss	$	(2,092	)	$	(549	)	$	(3,382	)	$	(859	)

Basic and diluted net loss per common share	$	(0.04	)	$	(0.02	)	$	(0.07	)	$	(0.03	)
Weighted average number of common shares outstanding		55,025			34,217			51,980			33,879

See accompanying notes to unaudited condensed consolidated financial statements.

IDENTIPHI, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)


	Six months ended June 30,
	2008			2007
Cash flows from operating activities:
Net loss	$	(3,382	)	$	(859	)
Adjustments to reconcile net loss to net cash used in operating activities:
Non-cash interest expense		51			—
Stock-based compensation		349			—
Depreciation and amortization		672			59
Non-cash services rendered by related party		35			—
Changes in operating assets and liabilities:
Accounts receivable, net		(175	)		(218	)
Inventory		3			34
Prepaid expenses and other current assets		40			27
Accounts payable		754			(1,144	)
Accrued expenses		(136	)		37
Deferred revenue		19			201

Net cash used in operating activities		(1,770	)		(1,863	)
Cash flows from investing activities:
Cash acquired in merger		542			—
Purchase of intangible asset		—			(778	)
Purchases of property and equipment		(27	)		(11	)

Net cash provided by (used in) investing activities		515			(789	)
Cash flows from financing activities:
Proceeds from notes payable to related party, net of transaction costs		1,704			—
Proceeds from note payable to Saflink Corporation		100			—
Repurchase of common stock		(43	)		—
Proceeds from note payable to Key Ovation, LLC		—			781
Proceeds from issuance of membership interest		—			778

Net cash provided by financing activities		1,761			1,559

Net increase (decrease) in cash and cash equivalents		506			(1,093	)
Cash and cash equivalents at beginning of period		53			1,229

Cash and cash equivalents at end of period	$	559		$	136

Supplemental disclosure of cash flow information:
Fair value of common stock, warrants and options assumed in business combination	$	6,785		$	—
Debt assumed in business combination		150			—
Common stock warrants issued in connection with note payable to related party		51			—

See accompanying notes to unaudited condensed consolidated financial statements.

IDENTIPHI, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. Description of Business

IdentiPHI, Inc., which was formerly known as Saflink Corporation, together with its wholly-owned subsidiaries Saflink International, Inc. and Litronic, Inc., is sometimes referred to herein as the “Company” or “IdentiPHI.”

On February 8, 2008, Saflink Corporation completed its merger (the “Merger”) with IdentiPHI, Inc. (“Former IdentiPHI”), a Delaware corporation, whereby the Company acquired all of the outstanding shares of Former IdentiPHI in a stock-for-stock transaction. The Merger was deemed a “reverse merger” and Former IdentiPHI was treated as the “acquiring” company for accounting and financial reporting purposes, while the Company was the legal acquirer. As a result of the merger, Former IdentiPHI became a wholly-owned subsidiary of the Company. The two companies subsequently combined into a single entity and changed its name to “IdentiPHI, Inc.” with its principal offices in Austin, Texas. The Company was incorporated in the State of Delaware on October 23, 1991.

On February 19, 2008, the Company effected a 1-for-15 reverse stock split of its common stock. As a result of the reverse stock split, every 15 shares of the Company’s common stock outstanding prior to the reverse stock split was combined and reconstituted into one share of the Company’s common stock. The financial statements and associated notes to the financial statements have been restated to reflect the reverse stock split.

IdentiPHI is a technology company offering a suite of enterprise security solutions and consulting services. IdentiPHI provides flexible tools that meet or exceed current legislation requirements to strengthen identity management and authentication systems. The IdentiPHI suite of services enables clients to leverage their investments in information security in order to improve productivity, optimize business processes and focus on their core business. Each IdentiPHI solution can be purchased as a stand-alone managed service or as part of a larger solution including business process consulting or application integration.

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 IdentiPHI, Inc. and its wholly-owned subsidiaries, Saflink International, Inc., and Litronic, Inc. As described above, Former IdentiPHI was treated as the “acquiring” company for accounting purposes and therefore the balance sheet at December 31, 2007, has been derived from Former IdentiPHI’s audited financial statements as of that date. In addition, the statements of operations and statements of cash flows prior to the Merger reflect only Former IdentiPHI’s financial results. 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 financial statements and the notes thereto included in the IdentiPHI Annual Report on Form 10-K for the fiscal year ended December 31, 2007, as filed with the Securities and Exchange Commission (the “SEC”) on March 31, 2008.

2. Liquidity and Capital Resources

These financial statements have been prepared assuming that IdentiPHI will continue as a going concern. IdentiPHI 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 financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Since inception, IdentiPHI has been unable to generate net income from operations. IdentiPHI has accumulated net losses of approximately $7.8 million from its inception date of October 1, 2005 through June 30, 2008, and has continued to accumulate net losses since June 30, 2008. Prior to the Merger, IdentiPHI had been financed through a related party note payable from Key Ovation, LLC and a note payable from Saflink Corporation that was issued in connection with the execution of the merger agreement with Saflink Corporation in August 2007. On February 8, 2008, IdentiPHI completed the Merger and at that date the respective cash balances of the two companies were combined and the $500,000 that was drawn down on the promissory note issued to Saflink Corporation was eliminated due to the combination of the two companies.

On March 12, 2008, IdentiPHI issued a promissory note to Zaychan Pty Limited, an Australian corporation, for an aggregate principal amount of up to AUD$1.75 million. The loaned amounts accrued interest at 8.0% per annum and IdentiPHI agreed to repay the principal, plus all accrued and unpaid interest, by June 29, 2008. Chris Linegar, a beneficial owner of more than 10% of IdentiPHI’s common stock, is a principal of Zaychan Pty Limited. On June 30, 2008, IdentiPHI entered into a Renewal, Modification and Extension of Promissory Note agreement with respect to this promissory note. Under the terms of the renewal agreement, the new aggregate principal amount of the promissory note, which included accrued interest, is USD$1.7 million and will accrue interest at a

rate of 8.0% per annum. Since the denomination was changed from Australian dollars to US dollars as part of this renewal agreement, IdentiPHI discontinued its hedging activities related to the promissory note on June 29, 2008, with any currency gain or loss transferred into the restated principal balance. Through subsequent amendments after June 30, 2008, the aggregate principal amount of the promissory note was increased up to an additional $400,000, which IdentiPHI may draw down in one or more installments, and the maturity date has been extended to the earlier of October 31, 2008 or the closing of an equity financing of at least US$5.0 million. To date, IdentiPHI has not drawn down on the additional $400,000.

In connection with the renewal agreement, Zaychan assigned the promissory note and the warrants Zaychan received in connection with the promissory note to Key Ovation, LLC, a Texas limited liability company. In addition, IdentiPHI entered into a Security Agreement with Key Ovation pursuant to which IdentiPHI granted a security interest in all of its assets to Key Ovation to secure performance and payment of the obligations under the promissory note. The term of the security agreement continues until all amounts owed under the promissory note have been paid to Key Ovation. Chris Linegar, a beneficial owner of more than 10% of IdentiPHI’s common stock, is the principal member of Key Ovation. Peter A. Gilbert, IdentiPHI’s Vice Chairman and Senior Vice President of Sales and Marketing, and Mark A. Norwalk, IdentiPHI’s Chief Technology Officer, are minority members of Key Ovation.

IdentiPHI also has a $150,000 unsecured promissory note held by Richard Kiphart, a former member of Saflink’s board of directors prior to the Merger and current shareholder of IdentiPHI. The promissory note bears interest at 10% per annum and was due and payable on August 5, 2008. To date, this promissory note is still outstanding.

As of June 30, 2008, IdentiPHI’s principal source of liquidity consisted of $559,000 of cash and cash equivalents and working capital (deficit) was negative $2.6 million.

IdentiPHI does not have a credit line or other borrowing facility to fund its operations other than the additional $400,000 under the promissory note held by Key Ovation. To continue its current level of operations beyond October 31, 2008, the current maturity date of the promissory note, it is expected that IdentiPHI will need to seek additional funds through the issuance of additional equity or debt securities or other sources of financing. Additional financing sources may not be available when and if needed by IdentiPHI. If IdentiPHI were unable to obtain the necessary additional financing, it would be required to reduce the scope of its operations, primarily through the reduction of discretionary expenses, which include personnel, benefits, marketing and other costs, or discontinue operations.

3. Summary of Significant Accounting Policies

Basis of Financial Statement Presentation and Principles of Consolidation

The condensed consolidated financial statements include the accounts of IdentiPHI and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Accordingly, actual results could differ from those estimates.

Revenue Recognition

IdentiPHI derives revenue from license fees for software products, selling hardware manufactured by IdentiPHI, 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.

IdentiPHI 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 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 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 IdentiPHI’s software is sold through a reseller, revenue is recognized 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 IdentiPHI is generally recognized upon delivery, 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. IdentiPHI also acts as a reseller of third party hardware and software applications. Such revenue is also generally recognized upon delivery 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.

Recently Issued Accounting Standards

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 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. IdentiPHI adopted SFAS 159 during the first quarter of its 2008 fiscal year and it did not have a material impact on its financial statements.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements,” which establishes accounting and reporting standards to improve the relevance, comparability, and transparency of financial information in its consolidated financial statements that include an outstanding noncontrolling interest in one or more subsidiaries. SFAS 160 is effective for fiscal years, and the interim periods within those fiscal years, beginning on or after December 15, 2008. Management of IdentiPHI does not expect the adoption of this pronouncement to have a material impact on its financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). The Company adopted SFAS 157 effective January 1, 2008. SFAS 157 established a framework for measuring fair value in GAAP and clarified the definition of fair value within that framework. SFAS 157 does not require assets and liabilities that were previously recorded at cost to be recorded at fair value or for assets and liabilities that are already required to be disclosed at fair value, SFAS 157 introduced, or reiterated, a number of key concepts which form the foundation of the fair value measurement approach to be used for financial reporting purposes. The fair value of the Company’s financial instruments reflects the amounts that the Company estimates to receive in connection with the sale of an asset or paid in connection with the transfer of a liability in an orderly transaction between market participants at the measurement date (exit price). SFAS 157 also established a fair value hierarchy that prioritizes the use of inputs used in valuation techniques into the following three levels:

Level 1—quoted prices in active markets for identical assets and liabilities.

Level 2—observable inputs other than quoted prices in active markets for identical assets and liabilities.

Level 3—unobservable inputs.

The adoption of FAS 157 did not have an effect on the Company’s financial condition or results of operations, but SFAS 157 introduced new disclosures about how the Company values certain assets and liabilities. Much of the disclosure is focused on the inputs used to measure fair value, particularly in instances where the measurement uses significant unobservable (Level 3) inputs. As of June 30, 2008, the Company did not have financial assets or liabilities that would require measurement on a recurring basis based on the guidance in SFAS 157. At June 30, 2008, all financial assets consisted of cash and cash equivalents at financial institutions in the United States.

In December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations – Revised 2007 (“SFAS 141R”). SFAS 141R provides guidance on improving the relevance, representational faithfulness, and comparability of information that a reporting entity provides in its financial reports about a business combination and its effects. SFAS 141R applies to business combinations where the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. IdentiPHI is in the process of analyzing the effects SFAS 141R will have on IdentiPHI’s financial statements.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 amends and expands the disclosure requirements for derivative instruments and hedging activities, with the intent to provide users of financial statements with an enhanced understanding of how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for, and how derivative instruments and related hedged items affect an entity’s financial statements. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. The Company has not yet evaluated the impact, if any, this standard might have on the Company’s disclosures to its consolidated financial statements.

In April 2008, the FASB issued FSP 142-3, Determination of the Useful Life of Intangible Assets, which amends the factors that must be considered in developing renewal or extension assumptions used to determine the useful life over which to amortize the cost of a recognized intangible asset under SFAS No. 142. The FSP amends paragraph 11(d) of SFAS No. 142 to require an entity to consider its own assumptions about renewal or extension of the term of the arrangement, consistent with its expected use of the asset.

The FSP also requires the following incremental disclosures for renewable intangible assets:

•

The weighted-average period prior to the next renewal or extension (whether explicit and implicit) for each major intangible asset class

•

The entity’s accounting policy for the treatment of costs incurred to renew or extend the term of a recognized intangible asset

•

For intangible asset renewed or extended during the period:

•

For entities that capitalize renewal or extension costs, the costs incurred to review or extend the asset, for each major intangible asset class

•

The weighted-average period prior to the next renewal or extension (whether explicit and implicit) for each major intangible asset class

The FSP is effective for financial statements for fiscal years beginning after December 15, 2008. The guidance for determining the useful life of a recognized intangible asset must be applied prospectively to intangible assets acquired after the effective date. Early adoption is prohibited. Accordingly, the FSP would not serve as a basis to change the useful life of an intangible asset that was acquired prior to the effective date (January 1, 2009 for a calendar year company). However, the incremental disclosure requirements described above would apply to all intangible assets, including those recognized in periods prior to the effective date of the FSP. The Company is currently evaluating the impact that the adoption of this FSP will have on its consolidated financial statements.

4. Business Combination

On August 30, 2007, Saflink Corporation entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”) with Former IdentiPHI and on February 8, 2008, the Merger was completed. Pursuant to the Merger Agreement and adjusted for the 1-for-15 reverse stock split, each outstanding share of Former IdentiPHI common stock was exchanged for 0.4099 shares of Saflink Corporation common stock, resulting in an aggregate of 40,998,664 shares of Saflink Corporation common stock being issued to the stockholders of Former IdentiPHI. Upon completion of the Merger, the former security holders of Former IdentiPHI held approximately 75% of the combined company’s common stock (on a fully-converted basis) and the security holders of Saflink Corporation continued to hold the remaining 25% of the combined company’s common stock (on a fully-converted basis). As a result of the Merger, Former IdentiPHI became a wholly-owned subsidiary of Saflink Corporation. Saflink Corporation and Former IdentiPHI subsequently combined into a single entity and changed the combined company’s name to “IdentiPHI, Inc.” with its principal offices in Austin, Texas.

The Merger has been accounted for under the purchase method of accounting in accordance with Statement of Financial Accounting Standard (SFAS) No. 141, “Business Combinations.” After considering all the relevant factors in determining the acquiring enterprise, including, but not limited to, relative voting rights, composition of the board of directors and senior management, and the relative size of the companies, the merger was deemed a “reverse merger” and Former IdentiPHI was treated as the “acquiring” company for accounting and financial reporting purposes. Under the purchase method of accounting, the assets and liabilities of Saflink Corporation, the “acquired company,” were recorded at their respective fair values and added to those of Former IdentiPHI, the “acquiring company,” including identifiable intangible assets and an amount for goodwill representing the difference between the purchase price and the fair value of the identifiable net assets of Saflink Corporation.

A summary of the components of the estimated purchase price for the acquisition, in thousands, is as follows:


Fair value of Saflink Corporation common stock	$	6,521
Fair value of Saflink Corporation common stock options outstanding		47
Fair value of Saflink Corporation common stock warrants outstanding		217
Merger related costs		51

Total	$	6,836

The fair value of Saflink Corporation common stock was determined by taking the average closing price of its common stock on the OTC Bulletin Board from December 28, 2007 (the day that Saflink Corporation began trading ex-dividend related to its pro rata distribution of its ownership of FLO Corporation common stock) through February 7, 2008 (the day before the closing of the Merger). Using this methodology and adjusting for the 1-for-15 reverse stock split, the fair value of Saflink Corporation common stock was determined to be $0.4695 and was multiplied by the 13,888,234 shares of Saflink Corporation common stock outstanding immediately prior to the Merger, resulting in a fair value of Saflink Corporation common stock of $6,521,000.

The fair value of common stock options and warrants outstanding was determined using the fair value of Saflink Corporation common stock of $0.4695 per share and a Black-Scholes model with the following assumptions: Options—an expected dividend yield of 0.0%, a risk free interest rate of 3%, volatility of 100%, and an expected life of approximately 5.6 years. Warrants—an expected dividend yield of 0.0%, a risk free interest rate between 2%-3%, volatility of 100%, and an expected life between 0-4 years (the remaining contractual life of the individual warrants).

The purchase price was allocated based on a determination of the value of the tangible and intangible assets acquired and liabilities assumed. The goodwill recorded as a result of the acquisition will not be amortized, but will be included in IdentiPHI’s annual review of goodwill for impairment. The following represents the allocation of the purchase price to the acquired assets and liabilities of Saflink Corporation. This allocation was based on the fair value of the assets and liabilities of Saflink Corporation as of February 8, 2008. The excess of the purchase price over the fair value of net identifiable assets acquired is reflected as goodwill (in thousands):


Net tangible assets	$	1,314
Liabilities		(1,058	)
Identifiable intangible assets:
Developed technology		3,260
Patents		500
Goodwill		2,820

Total	$	6,836

The Company engaged a third party valuation specialist to assist in its valuation of the intangible assets acquired in the Merger. Intangible assets acquired in the Merger consist of the following as of June 30, 2008:


	Gross Carrying Amount		Accumulated Amortization			Life (Years)
Amortized intangible assets:
Developed technology acquired		3,260		(535	)	1-4
Patent acquired		500		(42	)	5

Total	$	3,760	$	(577	)

Remaining amortization expense:
For the six months ended 12/31/2008			$	693
For Year-ended 12/31/2009				1,330
For Year-ended 12/31/2010				821
For Year-ended 12/31/2011				225
For Year-ended 12/31/2012				106
Thereafter				8

Total			$	3,183

The unaudited pro forma combined historical results of operations for the six months ended June 30, 2007, assuming the Merger had closed on January 1, 2007, are as follows (in thousands):


	Six Months ended June 30, 2007
Total revenue	$	2,126
Net loss	$	(7,842	)
Net loss per share	$	(0.14	)

The unaudited pro forma combined historical results of operations for the six months ended June 30, 2008, assuming the Merger had closed on January 1, 2008, are as follows (in thousands):


	Six Months ended June 30, 2008
Total revenue	$	3,095
Net loss	$	(3,880	)
Net loss per share	$	(0.07	)

The pro forma information does not purport to be indicative of the results that would have been attained had these events actually occurred at the beginning of the period presented and is not necessarily indicative of future results.

5. Stock-Based Compensation

On February 7, 2008, the Company’s stockholders approved the IdentiPHI, Inc. 2007 Stock Incentive Plan (the “2007 Plan”). IdentiPHI maintains the plan for officers, directors, employees and consultants. As of June 30, 2008, there were 2,239,873 shares available for issuance under the 2007 Plan.

Restricted Stock and Restricted Stock Unit Awards

Under the 2007 Plan, IdentiPHI may from time to time grant equity awards consisting of restricted stock and restricted stock units (“RSU”) to its directors, employees and consultants. A restricted stock award consists of shares of the Company’s common stock issued to the recipient on the date of the award with such shares being subject to vesting conditioned upon the satisfaction of service requirements or other conditions specified in the award agreements. The shares issued in connection with a restricted stock award are generally subject to the Company’s right to repurchase these shares prior to vesting under certain circumstances and generally may not be transferred by the recipient until the shares have vested. A RSU award consists of an unsecured promise to transfer unrestricted shares of the Company’s common stock to the recipient of the RSU award at the time the RSU award vests. RSU awards are generally subject to restrictions which may include performance criteria and circumstances under which the RSU unit award will be forfeited, such as termination of employment or services. Repurchased shares of restricted stock and shares underlying forfeited RSU awards become available again for issuance under the 2007 Plan. Shares of restricted stock surrendered by the recipient to satisfy tax withholding obligations that arise in connection with the vesting of those awards do not become available again for issuance under the 2007 Plan.

IdentiPHI measures its restricted stock and RSU awards on the date of grant using IdentiPHI’s market price multiplied by the number of shares granted. For service-based restricted stock and RSU awards, compensation expense is recognized over the vesting period on a straight-line basis.

In general, for employees, the awards vest quarterly over a two year period beginning on the date of grant. For certain officers, vesting of the awards are as follows: (a) 50% on a quarterly basis for a period of two years beginning on March 5, 2008, (b) 25% upon IdentiPHI’s achievement of an average market capitalization equal to or greater than $50 million during any period of twenty consecutive trading days after March 5, 2008, and (c) 25% upon IdentiPHI’s achievement of an average market capitalization equal to or greater than $75 million during any period of twenty consecutive trading days after March 5, 2008. Lastly, the awards granted to non-employee members of IdentiPHI’s board of directors cliff vest on March 5, 2009, if such individuals are serving as directors on such date.

During the six months ended June 30, 2008, IdentiPHI reacquired from certain restricted stock and RSU holders an aggregate of 100,819 shares valued at approximately $42,000 in compliance with statutory tax withholding requirements. IdentiPHI retired these shares and disclosed their value as ‘Repurchase of common stock’ under financing activities in the consolidated statements of cash flows.

Restricted stock and RSU activity for the six months ended June 30, 2008 was as follows (in thousands):


	Shares		Weighted average grant date fair value
Nonvested stock outstanding at December 31, 2007	—			—
Granted(1)	8,393		$	0.40
Vested	(626	)		0.40
Surrendered for statutory tax withholding requirements	(101	)		0.40
Forfeited	—			—

Nonvested stock outstanding at June 30, 2008	7,666		$	0.40

(1)	Includes 8,056,112 shares of restricted stock and 336,522 shares of RSUs.

Stock Option Awards

At June 30, 2008, the Company had 344,870 stock options outstanding, of which 58,279 were still subject to vesting restrictions. These stock option awards were issued and outstanding under Saflink Corporation’s 2000 Stock Incentive Plan (the “2000 Plan”), prior to the Merger. The weighted-average exercise price of these options is approximately $13.47. As of June 30, 2008, there were no shares available for issuance under the 2000 Plan.

Stock-based Compensation Expense

The following table summarizes stock-based compensation expense for the three and six months ended June 30, 2008, which was incurred as follows (in thousands):


	Three months ended June 30,				Six months ended June 30,
	2008		2007		2008		2007
Product development	$	39	$	—	$	50	$	—
Sales and marketing		111		—		138		—
General and administrative		125		—		161		—

Total stock-based compensation	$	275	$	—	$	349	$	—

No compensation cost was capitalized as part of an asset during the three months ended June 30, 2008 and 2007.

6. Stockholders’ Equity

Prior to August 30, 2007, Former IdentiPHI operated as a Delaware limited liability company known as “IdentiPHI, LLC.” On August 30, 2007, IdentiPHI, LLC changed its corporate form from a Delaware limited liability company to a Delaware corporation with authorized capital of 100,000,000 shares of $0.001 par value common stock. After the Merger and the 1-for- 15 reverse stock split described further below, IdentiPHI had authorized capital of 100,000,000 shares at $0.01 par value common stock as of June 30, 2008.

Merger of Saflink Corporation and IdentiPHI, Inc.

On February 8, 2008, the Merger was completed. The Merger was deemed a “reverse merger” and Former IdentiPHI was treated as the “acquiring” company for accounting and financial reporting purposes, while Saflink Corporation was the legal acquirer. Under accounting rules for a “reverse merger,” the historical stockholders’ equity of Saflink was eliminated except for the par value of Saflink Corporation common stock outstanding, which replaced the common stock outstanding of Former IdentiPHI. After the issuance of shares related to the Merger and adjusted for the 1-for-15 reverse stock split, the Company had approximately 55 million shares outstanding at a par value of $0.01 per share. The net $8.1 million adjustment of common stock on the Company’s balance sheet was reflected as an increase in common stock and a decrease in additional paid-in capital.

Reverse Stock Split

On February 19, 2008, IdentiPHI effected a 1-for-15 reverse stock split. As a result of the reverse stock split, every 15 shares of IdentiPHI’s common stock outstanding prior to the reverse stock split was combined and reconstituted into one share of IdentiPHI’s common stock. The reverse stock split decreased the number of shares of common stock outstanding from approximately 823 million shares to 54,889,826 shares. To reflect the reverse stock split, IdentiPHI recorded a $7.7 million decrease in common stock and a corresponding increase to additional paid-in capital.

Warrant Issuances

During the six months ended June 30, 2008, IdentiPHI issued three separate warrants to purchase an aggregate of 320,934 shares of common stock at an exercise price of US$0.80 to Zaychan Pty Limited in connection with draw downs on the secured promissory note issued to Zaychan on March 12, 2008. These warrants have a three year term and were exercisable immediately upon issuance. On June 30, 2008, these warrants were assigned from Zaychan to Key Ovation, LLC in connection with the Renewal, Modification and Extension of Promissory Note agreement as further described in Note 1 – Liquidity and Capital Resources. The fair value of these warrants was determined to be $51,000 using a Black-Scholes model with the following assumptions: an expected dividend yield of 0.0%, a risk-free interest rate between 2-3%, volatility of 100%, and an estimated life of three years, the contractual life of the warrants. The fair value of the warrants was recorded as a debt discount and was amortized to interest expense over the original term of the promissory note.

IdentiPHI has other warrants outstanding to purchase an aggregate of 985,011 shares of its common stock. The exercise prices of these warrants range between $0.30 and $12.60, with remaining contractual lives between five months and three years. There were no warrant exercises during the three and six months ended June 30, 2008 and 2007.

Stock Subscription Receivable

During 2007, Former IdentiPHI converted $4 million of its note payable to Key Ovation, LLC into shares of its common stock. The $4 million conversion amount was greater than the total debt outstanding at the time of conversion and, as a result, the excess amount of $176,000 was recorded as stock subscription receivable from a related party in stockholders’ equity (deficit) section of IdentIPHI’s balance sheet as of December 31, 2007. During the first six months of 2008, Key Ovation, LLC provided $5,000 in services and $30,000 in inventory to IdentiPHI, which reduced the outstanding balance of the stock subscription receivable to $141,000 as of June 30, 2008.

The following table summarizes equity transactions during the six months ended June 30, 2008, including entries related to the Merger and “reverse merger” accounting expressed in pre-reverse split numbers and the entry recorded for the 1-for-15 reverse split on February 19, 2008 (in thousands):


	Common Stock					Stock subscription receivable			Additional paid-in capital			Accumulated deficit			Total Stockholders’ equity
	Shares		Amount			Stock subscription receivable			Additional paid-in capital			Accumulated deficit			Total Stockholders’ equity
Balance, December 31, 2007	100,000		$	100		$	(176	)	$	4,730		$	(4,409	)	$	245
Elimination of Former IdentiPHI common stock	(100,000	)		(100	)		—			100			—			—
Addition of Saflink Corporation common stock	208,324			2,083			—			4,702			—			6,785
Merger with Saflink Corporation	614,980			6,150			—			(6,150	)		—			—
Common stock 1-for-15 reverse split	(768,414	)		(7,684	)		—			7,684			—			—
Warrant issued in conjunction with promissory note to related party	—			—			—			51			—			51
Stock-based compensation	—			—			—			349			—			349
Shares issued under equity incentive plan	8,091			81			—			(81	)		—			—
Repurchase of common stock	(101	)		(1	)		—			(42	)		—			(43	)
Services and inventory provided by Key Ovation, LLC	—			—			35			—			—			35
Net loss	—			—			—			—			(3,382	)		(3,382	)

Balance, June 30, 2008	62,880		$	629		$	(141	)	$	11,343		$	(7,791	)	$	4,040

2007 Membership Issuance

In February 2007, IdentiPHI, LLC issued additional membership interest in exchange for $778,000 in cash. These proceeds were used primarily to fund the acquisition of the SAFsolution and SAFmodule software products from Saflink Corporation.

7. Concentrations

During the three and six months ended June 30, 2008, revenue from customers representing more than 10% of the Company’s total revenue were as follows (in thousands):


	Three months ended June 30, 2008			Six months ended June 30, 2008
	$		%	$		%
Customer A	$	1,256	79	$	1,928	62
Customer B		—	—		440	14

During the three and six months ended June 30, 2007, revenue from customers representing more than 10% of the Company’s total revenue were as follows (in thousands):


	Three months ended June 30, 2007			Six months ended June 30, 2007
	$		%	$		%
Customer A	$	573	74	$	1,082	71

As of June 30, 2008 and December 31, 2007, trade accounts receivables by customers representing more than 10% of the Company’s total trade accounts receivables balance were as follows (in thousands):


	As of June 30, 2008			As of December 31, 2007
	$		%	$		%
Customer A	$	884	83	$	499	59
Customer C		2	*		172	20

*	Less than 1%

8. Net Loss Per Share

On August 30, 2007, Former IdentiPHI issued 40,998,664 shares of its common stock (adjusted for the 6.1498 Saflink shares for each Former IdentiPHI share and the Company’s 1-for-15 reverse stock split) to its stockholders in connection with its conversion from a Delaware limited liability company to a Delaware corporation. The net loss per common share data (adjusted for the 6.1498 Saflink shares for each Former IdentiPHI share and the Company’s 1-for-15 reverse stock split) for the three and six months ended June 30, 2007 is computed assuming the weighted average shares of common stock of IdentiPHI were outstanding for these periods. The weighted average number of common shares outstanding reflects the equity and membership interest events that occurred during 2007. The net loss per common share data for the three and six months ended June 30, 2008 is computed assuming 40,998,664 shares of the Company’s common stock (adjusted for the 6.1498 Saflink shares for each Former IdentiPHI share and the Company’s 1-for-15 reverse stock split) were outstanding from January 1, 2008 and the 13,888,234 shares of the Company’s common stock outstanding at the completion of the Merger (adjusted for the Company’s 1-for-15 reverse stock split) were treated as issued at February 8, 2008. 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, however, as IdentiPHI had a net loss in all of the periods presented, basic and diluted net loss per common share are the same.

Potential common shares outstanding consisted of options and warrants to purchase 1,650,815 and 0 shares of common stock at June 30, 2008, and 2007, respectively.

9. 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 IdentiPHI’s chief operating decision maker. IdentiPHI management and chief operating decision makers review financial information on a consolidated basis and, therefore, IdentiPHI operated as single segment for all periods presented.

10. Subsequent Events

On July 21, 2008, IdentiPHI amended the terms of its $1.7 million secured promissory note held by Key Ovation, LLC, a Texas limited liability company. Under the terms of the amendment, the aggregate principal amount of the promissory note was increased by up to an additional $400,000 and the maturity date of the principal and accrued but unpaid interest under the promissory note was extended from July 31, 2008 to August 31, 2008. IdentiPHI may draw down the additional principal amount under the note in one or more installments at IdentiPHI’s discretion. On August 12, 2008, IdentiPHI again amended the promissory note to extend the maturity date, such that the principal and accrued but unpaid interest under the promissory note now becomes due and payable on the earlier of October 31, 2008, or upon the closing of an equity financing of at least $5.0 million. IdentiPHI’s obligations under the promissory note continue to be secured by all of IdentiPHI’s assets.

Effective July 21, 2008, Steven M. Oyer resigned from his position of Chief Executive Officer of IdentiPHI and as a member of the board of directors, for personal reasons and to pursue other interests. In connection with Mr. Oyer’s termination of employment, IdentiPHI entered into a Separation Agreement and General Release of All Claims. In lieu of the severance terms in Mr. Oyer’s employment agreement, the separation agreement provides for a lump sum payment of $100,000 upon termination of employment and a lump sum payment of $75,000 if IdentiPHI completes an equity or debt financing prior to December 31, 2008 under certain circumstances. The Company further agreed to repurchase 3,396,127 shares of restricted common stock held by Mr. Oyer for an aggregate purchase price of $0.01, and to grant Mr. Oyer an option to purchase 2,547,905 shares of its common stock at an exercise price of $0.23 per share. The stock option expires ten years from the date of grant.

In connection with Mr. Oyer’s resignation, the Company appointed Christer Bergman, a member of the Company’s board of directors since February 2008, to serve as Interim Chief Executive Officer. The Company agreed to pay Mr. Bergman a base salary of $300,000 per year, plus reimbursement for out-of-pocket expenses, in connection with his duties as Interim Chief Executive Officer.

On August 12, 2008, the Company appointed Mr. Bergman as its Chief Executive Officer and entered into an employment agreement with Mr. Bergman. Mr. Bergman’s employment agreement provides that he will serve as the Company’s Chief Executive Officer for an initial term of two years and automatically renews for subsequent one year terms unless either party provides 45 days’ advance written notice that it does not wish to renew the agreement. The Company paid Mr. Bergman a $50,000 signing bonus and agreed to pay Mr. Bergman an annual base salary of $300,000. Pursuant to the terms of the employment agreement, the Company granted Mr. Bergman an option to purchase 2,000,000 shares of its common stock and a stock award of 2,000,000 shares of its common stock. The option has an exercise price of $0.15 per share and vests in equal quarterly installments over a period of two years. The stock award consists of 1,000,000 shares of stock and 1,000,000 restricted stock units. The restricted stock units vest with respect to 500,000 shares upon the Company’s achievement of an average market capitalization equal to or greater than $50 million during any period of twenty (20) consecutive trading days after the date of grant and with respect to the remaining 500,000 shares upon the Company’s achievement of an average market capitalization equal to or greater than $75 million during any period of twenty (20) consecutive trading days after the date of grant.

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 2007 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 31, 2008.

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, 2007.

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

Overview

We are a technology company offering a suite of enterprise security solutions and consulting services direct to end-users and through partners, distributers and resellers. We were formerly known as Saflink Corporation and, on February 8, 2008, we completed a merger with IdentiPHI, Inc., a Delaware corporation, to which we sometimes refer in this report as “Former IdentiPHI.” The merger resulted in the former security holders of Former IdentiPHI holding approximately 75% of the combined company’s common stock and our security holders holding the remaining 25% of the combined company’s common stock. The merger was deemed a “reverse merger” with Former IdentiPHI being treated as the “acquiring” company for accounting and financial reporting purposes. As a result of the merger, Former IdentiPHI became our wholly-owned subsidiary. We subsequently combined with Former IdentiPHI into a single entity and changed the combined company’s name to “IdentiPHI, Inc.” with our principal offices in Austin, Texas.

For financial reporting purposes, Former IdentiPHI, and not Saflink Corporation, is considered the accounting acquirer. Accordingly, the financial statements for the three and six months ended June 30, 2007 presented in this quarterly report are those of Former IdentiPHI and do not include Saflink Corporation’s historical financial results. The financial statements for the three and six months ended June 30, 2008 presented in this quarterly report and the discussion of financial condition and results of operations herein are those of Former IdentiPHI through February 8, 2008, the date of the merger, and are thereafter combined with Saflink Corporation’s operations.

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. You should give consideration 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, 2007. We may not be able to successfully address these risks and difficulties.

We incurred net losses of $2.1 million and $3.4 million for the three and six months ended June 30, 2008, respectively, compared to net losses of $549,000 and $859,000 for the three and six months ended June 30, 2007, respectively.

The following discussion presents certain changes in our revenue and expenses that have occurred during the three and six months ended June 30, 2008, as compared to the three and six months ended June 30, 2007.

Revenue and Cost of Revenue

We recorded revenue primarily from three sources during the three and six months ended June 30, 2008 and 2007: enterprise software license sales; third party software and hardware sales; and maintenance and support services. Product revenue consisted of license fees for our software products and sales of third party software and hardware products and applications. Service revenue consisted of payments for maintenance and support contracts, technical support, installation, integration, implementation and training services.

Revenue of $1.6 million for the three months ended June 30, 2008 increased 105% compared to revenue of $772,000 for the three months ended June 30, 2007. Revenue of $1.5 million came from product sales and $70,000 from services during the three months ended June 30, 2008. Product revenue increased 114%, or $806,000, in the three months ended June 30, 2008, when compared to the $709,000 recorded in the three months ended June 30, 2007. Service revenue increased 11%, or $7,000, compared to the $63,000 recorded in the three months ended June 30, 2007.

During the three months ended June 30, 2008, product revenue consisted of enterprise software license sales of $84,000 and third party software and hardware product sales of $1.4 million. In comparison, during the three months ended June 30, 2007, enterprise software license sales were $18,000, while third party software and hardware product sales were $691,000.

Total revenue of $3.1 million for the six months ended June 30, 2008 increased 102% compared to revenue of $1.5 million for the six months ended June 30, 2007. Revenue of $3.0 million came from product sales and $124,000 from services during the six months ended June 30, 2008. Product revenue increased 116%, or $1.6 million, in the six months ended June 30, 2008, when compared to the $1.4 million recorded in the six months ended June 30, 2007. Service revenue decreased 21%, or $33,000, compared to the $157,000 recorded in the six months ended June 30, 2007.

The primary reasons total revenue increased during these periods was due to additional sales personnel and the maturation of our distribution channels and third party relationships, as well as incremental revenue related to the software products acquired from Saflink in late February 2007.

For the three and six months ended June 30, 2008, Synnex Corporation, a technology products distributor, accounted for 79% and 62% of our total revenue, respectively. For the three and six months ended June 30, 2007, Synnex accounted for 74% and 71% of our total revenue.

Total cost of revenue included enterprise software license cost of revenue, third party product cost of revenue, services cost of revenue and amortization of intangible assets. Enterprise software license cost of revenue included purchased software that was integrated into our products. Product cost of revenue included the cost of software and hardware applications purchased from third parties and resold to our customers, resellers and distributors. Services cost of revenue consisted of the cost of maintenance and technical support provided on our enterprise software, as well as labor costs for consulting, installation, implementation, integration and training services. Amortization of intangible assets is primarily related the purchase of technology and software products from Saflink in February 2007 and the subsequent Merger with Saflink in February 2008.

During the three months ended June 30, 2008, cost of revenue from enterprise software licenses was $5,000, the cost of product sales of third party software and hardware was $1.2 million, the cost of services revenue was $28,000, and intangible asset amortization was $381,000. During the three months ended June 30, 2007 cost of revenue from enterprise software licenses was $68,000, the cost of product sales of third party software and hardware was $580,000, while the cost of services revenue was a negative $25,000 and intangible asset amortization was $39,000.

Total cost of revenue of $3.0 million for the six months ended June 30, 2008, increased 147% compared to total cost of revenue of $1.2 million for the six months ended June 30, 2007. Cost of revenue of $2.3 million came from product sales, $38,000 from services and $655,000 from the amortization of intangible assets during the six months ended June 30, 2008. Product cost of revenue increased 105%, or $1.2 million, in the six months ended June 30, 2008, when compared to the $1.1 million recorded in the six months ended June 30, 2007. Service cost of revenue increased 9%, or $3,000, compared to the $35,000 recorded in the six months ended June 30, 2007. Amortization of intangible assets increased by $603,000 compared to the $52,000 recorded in the six months ended June 30, 2007.

Our gross loss for the three months ended June 30, 2008 was $53,000, or a negative 3%, while our gross profit for the three months ended June 30, 2007 was $110,000, or 14%. Our gross profit for the six months ended June 30, 2008 was $89,000, or 3%, while our gross profit for the six months ended June 30, 2007 was $315,000, or 21%. Our gross profit percentage decrease in the three and six months ended June 30, 2008 was primarily attributable to increased intangible asset amortization as a result of the merger with Saflink in February 2008, which have remaining lives between one and four years.

Operating Expenses

Total operating expenses for the three months ended June 30, 2008 increased approximately $1.4 million, or 228%, to $2.0 million from $598,000 for the three months ended June 30, 2007. Total operating expenses for the six months ended June 30, 2008 increased approximately $2.3 million, or 218%, to $3.4 million from $1.1 million for the six months ended June 30, 2007. These overall increases were primarily due to the merger with Saflink on February 8, 2008, which added headcount and public reporting company expenses that were not incurred during the three and six months ended June 30, 2007.

The following table provides a breakdown of the dollar and percentage changes in operating expenses for the three and six months ended June 30, 2008, as compared to the three and six months ended June 30, 2007 (in thousands):


	Three months				Six Months
	$ Change		% Change		$ Change		% Change
Product development	$	183	123	%	$	389	153	%
Sales and marketing		467	184			911	208
General and administrative		715	367			1,021	275

	$	1,365	228	%	$	2,321	218	%

Product Development—Product development expenses consisted 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. For the three months ended June 30, 2008, product development expenses were $332,000, while for the three months ended June 30, 2007 product development expenses were $149,000. For the six months ended June 30, 2008, product development expenses were $644,000, while for the six months ended June 30, 2007, product development expenses were $255,000. These increases were primarily related to additional software development headcount in Edmonton, Alberta, Canada and quality assurance personnel in Austin, Texas that were added during the last nine months of 2007 and early 2008. We expect our product development expenses for last two quarters of 2008 to be consistent with the actual results from first two quarters of 2008.

Sales and Marketing—Sales and marketing expenses consisted 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 were $721,000 for the three months ended June 30, 2008, while sales and marketing expenses were $254,000 for the three months ended June 30, 2007. Sales and marketing expenses were $1.3 million for the six months ended June 30, 2008, while sales and marketing expenses were $438,000 for the six months ended June 30, 2007. This increase was primarily related to increased compensation expense for additional sales headcount in connection with the merger with Saflink during the first quarter of 2008. We expect sales and marketing expenses to moderately increase during the last two quarters of 2008 due to planned increases in sales headcount and marketing programs.

General and Administrative—General and administrative expenses consisted 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 were $910,000 for the three months ended June 30, 2008, while general and administrative expenses were $195,000 for the three months ended June 30, 2007. General and administrative expenses were $1.4 million for the six months ended June 30, 2008, while general and administrative expenses were $371,000 for the six months ended June 30, 2007. These increases were primarily related to additional compensation and related benefits and professional service fees related to the merger with Saflink during the first half of 2008 and incremental expenses related to being a public reporting entity. We expect our general and administrative expenses to decrease slightly in the last two quarters of 2008 when compared to the three months ended June 30, 2008, as several nonrecurring administrative and integration costs related to the merger with Saflink that were incurred during this period.

Interest expense

Interest expense for the three and six months ended June 30, 2008 was $76,000 and $87,000, respectively. This is compared to interest expense of $61,000 and $113,000 for three and six months ended June 30, 2007, respectively. Interest expense in the three and six months ended June 30, 2008 related to promissory notes to related parties, while interest expense in the three and six months ended June 30, 2007 primarily consisted of interest accrued on our unsecured borrowings from Key Ovation, LLC.

Other income, net

Other income for three and six months ended June 30, 2008 was $0 and $1,000, respectively. This is compared to other income of $0 and $3,000 for three and six months ended June 30, 2007, respectively. Other income primarily consisted of interest earned on cash and money market balances.

Liquidity and Capital Resources

We financed our operations during the six months of 2008 primarily from our existing working capital, a promissory note from Saflink Corporation that was issued in connection with the execution of the merger agreement in August 2007, and a promissory note from a related party secured by all of our assets. As of June 30, 2008, we had $559,000 of cash and cash equivalents and a working capital deficit was negative $2.6 million.

On February 8, 2008, we issued a promissory note to Richard Kiphart, a former member of Saflink’s board of directors prior to the merger and current shareholder of IdentiPHI. The principal amount of the promissory note is $150,000. The outstanding principal under the promissory note accrues interest at 10% per annum and the principal and accrued but unpaid interest became due and payable on August 5, 2008. We have not paid the amounts owing on this promissory note, which may have a material adverse effect on our future business operations should such Mr. Kiphart initiate litigation or otherwise demand payment.

We have not historically been profitable in any fiscal period since our inception, and may not be profitable in future periods. We expect that our expenses relating to sales and marketing, technology development, general and administrative functions, as well as operating and maintaining our technology infrastructure, will increase in the future. We will need to increase our revenues to be able to achieve and then maintain profitability in the future. We may not be able in a timely manner to reduce our expenses in response to any decrease or shortfall in our revenues, and our failure to do so would adversely affect our operating results and our efforts to achieve or maintain profitability. We cannot predict when, or if, we will become profitable in the future. Even if we achieve profitability, we may not be able to sustain it.

Other than the ability to draw down an additional $400,000 under the Key Ovation promissory note, we do not have a credit line or other borrowing facility to fund our operations. With our current working capital and the amounts we may draw down under the Key Ovation promissory note, we believe we have sufficient funds to continue operations at current levels through October 31, 2008. To continue our current level of operations beyond this date we will need to seek additional funds through the issuance of additional equity or debt securities or other sources of financing. If we are unable to obtain necessary additional financing, our ability to run our business will be adversely affected and we may be required to reduce the scope of our research and business activity or cease our operations. In addition, we will need to seek additional funds through the issuance of equity or debt securities or other sources of financing to pay our obligations under the promissory notes issued to Mr. Kiphart and to pay our obligations under the Key Ovation promissory note when they become due and payable. Because our obligations under the Key Ovation promissory note are secured by all of our assets, if we default under the terms of the Key Ovation promissory note, Key Ovation could foreclose its security interest and liquidate all of our assets. This would cause our operations to cease.

Our net cash used for operating activities was $1.8 million during six months ended June 30, 2008. The net loss of $3.4 million for the first six months of 2008 included $51,000 in non-cash interest expense, $349,000 in stock-based compensation and $672,000 in amortization intangible assets and depreciation.

Our net cash provided by investing activities was $515,000 during the six months ended June 30, 2008, with $542,000 related to cash acquired in the merger, offset by $27,000 used in the acquisition of property and equipment.

Our net cash provided from financing activities was $1.8 million during the six months ended June 30, 2008, with $1.7 million related to net proceeds from the issuance of a related party promissory note and $100,000 in proceeds from the promissory note issued to Saflink Corporation, prior to the merger. In addition, we repurchased $43,000 of common stock in connection with the surrender of restricted shares by employees to satisfy tax withholding obligations related to the vesting of the equity awards.

Our net cash used for operating activities was $1.9 million for the six months ended June 30, 2007. Significant adjustments to the net loss included an increase in accounts receivable of $218,000 and a decrease in accounts payable and accrued expenses of $1.1 million.

Our net cash used in investing activities was $789,000 during the six months ended June 30, 2007, with $778,000 related to the acquisition of software products from Saflink Corporation and $11,000 related to the purchase of property and equipment.

Our net cash provided from financing activities was $1.6 million during the six months ended June 30, 2007, with $781,000 provided through our unsecured loan from Key Ovation and $778,000 through members’ contribution.

We maintain our headquarters in a facility with 6,676 square feet in Austin, Texas under two separate leases that both expire in November 2009. We also lease 1,724 square feet of office space in Edmonton, Alberta, Canada for our product development staff under a lease that expires in July 2011. In Reston, Virginia, we lease 6,083 square feet of office space under a lease that expires in April 2009. This entire facility is sublet to another entity through our lease termination date. Also in Reston, we lease 5,130 square feet of office space under a lease that expires in February 2009. This entire facility is sublet to another entity through our lease expiration date as well. The differences in rental rates between the original leases and the subleases are minimal and should not have a material effect on our financial statements in the future.

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 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 4T.

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.

PART II—OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

None.

ITEM 1A.

RISK FACTORS

Factors That May Affect Future Results

This quarterly 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 quarterly report 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 quarterly report.

We have accumulated significant losses and we may not be able to generate significant revenue or any net income in the future, which would negatively impact our ability to run our business.

We have accumulated net losses of $7.8 million from our inception through June 30, 2008. We have continued to accumulate losses after June 30, 2008, to date, and we may be unable to generate significant revenue or any net income in the future. We expect that we will need to raise additional funds through the issuance of debt or equity securities or other sources of financing for us to continue our operations beyond October 31, 2008. Even if we are successful in obtaining additional financing, if we are unable to generate sufficient cash flow from operations, 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, we may be required to reduce the scope of, or cease, our operations.

If we do not pay our obligations under a secured promissory note by October 31, 2008, the holder could foreclose its security interest and liquidate all of our assets.

On March 12, 2008, we issued a promissory note to Zaychan Pty Limited, an Australian corporation, which is secured by all of our assets and which was assigned to Key Ovation, LLC, a Texas limited liability company, on June 30, 2008. The aggregate principal amount of the promissory note (which includes accrued interest through June 30, 2008) is $1.7 million, and we may draw down an additional $400,000 in one or more installments for working capital and general corporate purposes. The outstanding principal under the promissory note accrues interest at 8.0% per annum and the principal and accrued but unpaid interest becomes due and payable on the earlier of October 31, 2008, or our completion of an equity financing of at least $5.0 million. We will need to seek additional funds through the issuance of equity or debt securities or other sources of financing to pay our obligations under the secured promissory note when they become due and payable. Because our obligations under this promissory note are secured by all of our assets, if we default under the terms of this promissory note Key Ovation could foreclose its security interest and liquidate all of our assets. This would cause our operations to cease.

We have not been profitable since our inception, and we may not achieve or maintain profitability in the future.

A significant number of shares of our common stock are or will be eligible for sale in the open market, which could reduce the market price for our common stock and make it difficult for us to raise capital.

As of August 12, 2008, 60,440,606 shares of our common stock were outstanding and there were a total of 6,198,720 shares of our common stock issuable upon exercise of outstanding options and warrants. The issuance of additional shares of our common stock upon the exercise of outstanding options or warrants or the issuance of restricted stock grants could 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.

Because they own approximately 68% of our common stock, five stockholders could significantly influence our affairs, which may preclude other stockholders from being able to influence stockholder votes or corporate actions.

Five of our stockholders (together with their affiliates), who were former members of IdentiPHI, LLC, beneficially own approximately 68% of our outstanding common stock as of August 12, 2008. Given this substantial ownership, if they decided to act together, they would be able to significantly influence the vote on those corporate matters to be decided by our stockholders.

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 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 period may not be indicative of future revenue.

Two customers accounted for 62% and 14%, respectively, of our revenue for the six months ended June 30, 2008, while the same customer who accounted for 62% of our revenue during that period accounted for 71% of our revenue for the six months ended June 30, 2007. 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.

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.

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.

If third parties, on whom we partly depend for our product distribution, do not promote our products, our ability to generate revenue may be limited and our business and financial condition could suffer.

We utilize third parties such as resellers, distributors and other technology manufacturers to augment our full-time sales staff in promoting sales of our products. If these third parties do not actively promote our products, our ability to generate revenue may be limited. We cannot control the amount and timing of resources that these third parties devote to marketing activities on our behalf. Some of these business relationships are formalized in agreements that can be terminated with little or no notice, which may further decrease the willingness of such third parties to act on our behalf. We also may not be able to negotiate acceptable distribution relationships in the future and cannot predict whether current or future distribution relationships will be successful.

Our reliance on third party technologies for some specific technology elements of our products and our reliance on third parties for manufacturing may delay product launch, impair our ability to develop and deliver products or hurt our ability to compete in the market.

Our ability to license new technologies from third parties will be critical to our ability to offer a complete suite of products that meets customer needs and technological requirements. Some of our licenses do not run for the full duration of the third party’s patent for the licensed technology. We may not be able to renew our existing licenses on favorable terms, or at all. If we lose the rights to a patented technology, we may need to stop selling or may need to redesign our products that incorporate that technology, and we may lose a competitive advantage. In addition, competitors could obtain licenses for technologies for which we are unable to obtain licenses, and third parties may develop or enable others to develop a similar solution to digital communication security issues, either of which events could erode our market share. Also, dependence on the patent protection of third parties may not afford us any control over the protection of the technologies upon which we rely. If the patent protection of any of these third parties were compromised, our ability to compete in the market also would be impaired.

The anticipated benefits of our recently completed merger may not be realized fully or at all or may take longer to realize than anticipated.

Our recently completed merger involved the integration of two companies that had previously operated independently with principal offices in two distinct locations. We must now devote significant management attention and resources to integrating the two companies. Delays in this process could adversely affect our business, operations, financial results, financial condition and stock price.

Even if we are able to integrate the two companies there can be no assurance that this integration will result in the realization of the full benefits of synergies, cost savings, innovation and operational efficiencies that we had anticipated from the merger or that these benefits will be achieved within a reasonable period of time.

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.

We face intense competition and pricing pressures from a number of sources, which may reduce our average selling prices and gross margins.

The markets where we offer our products and services are intensely competitive. As a result, we face significant competition from a number of sources. We may be unable to compete successfully because many of our competitors are more established, benefit from greater name recognition and have substantially greater financial, technical and marketing resources than we have. In addition, there are several smaller and start-up companies with which we compete from time to time. We expect competition to increase as a result of consolidation in the information security technology industry.

The average selling prices for our products may decline as a result of competitive pricing pressures, promotional programs and customers who negotiate price reductions in exchange for longer-term purchase commitments. The pricing of products depends on the specific features and functions of the products, purchase volumes and the level of sales and service support required. As we experience pricing pressure, the average selling prices and gross margins for our products may decrease over product lifecycles. These same competitive pressures may require us to write down the carrying value of any inventory on hand, which would adversely affect our operating results and adversely affect our earnings per share.

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;

•

unforeseen legal expenses, including litigation costs;

•

expenses related to acquisitions;

•

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 unable to keep pace with rapid technological change in network operating environments, which could lead to an increase in our costs, a loss of customers or a delay in market acceptance of our products.

Network operating environments are characterized by rapid development and technological improvements. Because of these changes, our success will depend in part on our ability to keep pace with a changing marketplace, integrate new technology into our core software and hardware and introduce new products and product enhancements that build off of our existing technologies to address the changing needs of the marketplace. Various technical problems and resource constraints may impede the development, production, distribution and marketing of our products and services. In addition, laws, rules, regulations or industry standards may be adopted in response to these technological changes, which in turn, could materially and adversely affect how we will do business.

Our future success will also depend upon our ability to develop and introduce a variety of new products and services, and enhancements to these new products and services, to address the changing and sophisticated needs of the marketplace. Frequently, technical development programs in the biometric and smart card industry require assessments to be made of the future directions of technology and technology markets generally, which are inherently risky and difficult to predict. Delays in introducing new products, services and enhancements, the failure to choose correctly among technical alternatives or the failure to offer innovative products and services at competitive prices may cause customers to forego purchases of our products and services and purchase those of our competitors.

Our continued participation in the market for governmental agencies may require the investment of our resources in upgrading our products and technology for us to compete and to meet regulatory and statutory standards. We may not have adequate resources available to us or may not adequately keep pace with appropriate requirements to compete effectively in the marketplace.

Our efforts to expand our international operations are subject to a number of risks, including our potential inability to obtain government authorization regarding exports of our products, any of which could adversely affect our future international sales.

We must comply with U.S. laws regulating the export of our products in order to ship internationally. In some cases, authorization from the U.S. government may be needed in order to export our products. The export regimes applicable to our business are subject to frequent changes, as are the governing policies. Although we have obtained approvals to export certain of our products, we cannot assure you that such authorizations to export will be available to us or for our products in the future. If we cannot obtain the required government approvals under these regulations, we may not be able to sell products abroad or make products available for sale internationally.

Additionally, our international operations could be subject to a number of risks, any of which could adversely affect our future international sales, including:

•

increased collection risks;

•

trade restrictions;

•

export duties and tariffs;

•

uncertain political, regulatory and economic developments; and

•

inability to protect our intellectual property rights.

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 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 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

We have not announced any authorization to repurchase shares of our common stock. However, from time to time we repurchase shares of unvested restricted stock from directors, employees or consultants who cease providing service to us before such shares vest. These shares are repurchased pursuant to the terms of our equity incentive plan. In addition, the terms of restricted stock awards granted under our equity incentive plan allows participants to surrender or deliver to us a portion of the newly vested

shares of our common stock to satisfy tax withholding obligations that arise in connection with the vesting of those awards. These shares are repurchased at fair value market value. The following table summarizes repurchases of our common stock during the second quarter of fiscal 2008:

ISSUER PURCHASES OF EQUITY SECURITIES


Period	Total Number of Shares Purchased		Average Price Paid Per Share			Total Number of Shares Purchased as Part of Publicly Announced Plan	Maximum Number of shares that May Yet Be Purchase Under Plan or Program
April 1 – April 30	—			—		N/A	N/A
May 1 – May 31	—			—		N/A	N/A
June 1 – June 30	100,819	(1)	$	0.42	(2)	N/A	N/A

Total	100,819		$	0.42		N/A	N/A

(1)	Represents the surrender of newly vested shares to us to satisfy tax withholding obligations that arose in connection with the vesting of restricted stock awards.

(2)	For purposes of this table, the “price paid per share” is determined by reference to the closing sales price per share of our common stock as reported on the OTC Bulletin Board on the date of such surrender (or on the last date preceding such surrender for which such reported price exists).

ITEM 5.

OTHER INFORMATION

Entry into a Material Definitive Agreement

On August 12, 2008, we amended the terms of our secured promissory note held by Key Ovation, LLC, a Texas limited liability company. The promissory note, which we issued to Zaychan Pty Limited on March 12, 2008, was assigned to Key Ovation on June 30, 2008, and has an aggregate principal amount of $1.7 million (including accrued interest through June 30, 2008). Under the terms of the amendment, the maturity date of the principal and accrued but unpaid interest under the promissory note has been extended from August 31, 2008, and now becomes due and payable on the earlier of October 31, 2008, or upon the closing of an equity financing of at least $5.0 million. Our obligations under the promissory note continue to be secured by all of our assets. Chris Linegar, a beneficial owner of more than 10% of our common stock, is the principal member of Key Ovation. Peter A. Gilbert, our Vice Chairman and Senior Vice President of Sales and Marketing, and Mark A. Norwalk, our Chief Technology Officer, are minority members of Key Ovation.

Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers

On August 12, 2008, we appointed Christer Bergman, a current member of our board of directors, as our Chief Executive Officer and entered into an employment agreement with Mr. Bergman. Mr. Bergman has been serving as our Interim Chief Executive Officer since July 21, 2008 and has served as a member of our board of directors since February 2008. From 2001 through 2006, Mr. Bergman was President and CEO of Precise Biometrics AB, a publicly traded innovative security company that supplies world-leading systems for fingerprint and smart card-based authentication. Mr. Bergman founded NOVEXUS, LLC in 1999, a consulting firm through which Mr. Bergman advises biometric, smart card and authentication companies. Mr. Bergman received as M.S. degree from the Lund Institute of Technology and an M.S. degree from the University of California, Berkley.

Mr. Bergman’s employment agreement provides that he will serve as our Chief Executive Officer for an initial term of two years and automatically renews for subsequent one year terms unless either party provides 45 days’ advance written notice that it does not wish to renew the agreement. We paid Mr. Bergman a $50,000 signing bonus and agreed to pay Mr. Bergman an annual base salary of $300,000. For the first and second year of the employment agreement, Mr. Bergman’s annual corporate performance bonus must entitle him to the opportunity to receive at least 50% of his base salary under our management incentive plan. Mr. Bergman may terminate his agreement upon 30 days’ written notice without being entitled to further compensation, expect for unpaid base salary and other benefits already earned. We may terminate Mr. Bergman’s agreement for “cause” without notice or compensation to

Mr. Bergman, except for unpaid base salary and other benefits already earned. If we terminate Mr. Bergman’s agreement without “cause” in connection with a change in control, or if Mr. Bergman terminates his agreement for “good reason” following a change in control, we have agreed to pay Mr. Bergman an amount equal to his base salary and annual corporate performance bonus during the previous twelve months in accordance with our regular payroll cycle for a period of twelve months following the termination. In addition, Mr. Bergman will receive accelerated vesting of any unvested equity incentive awards and continued medical coverage at our expense for up to one year. Mr. Bergman also agreed not to solicit our customers and not to compete with us for one year following the termination of his employment.

Pursuant to the terms of the employment agreement, we granted Mr. Bergman an option to purchase 2,000,000 shares of our common stock and a stock award of 2,000,000 shares of our common stock. The option has an exercise price of $0.15 per share and vests in equal quarterly installments over a period of two years. The stock award consists of 1,000,000 shares of stock and 1,000,000 restricted stock units. The restricted stock units vest with respect to 500,000 shares upon our achievement of an average market capitalization equal to or greater than $50 million during any period of twenty (20) consecutive trading days after the date of grant and with respect to the remaining 500,000 shares upon our achievement of an average market capitalization equal to or greater than $75 million during any period of twenty (20) consecutive trading days after the date of grant.

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

Renewal, Modification and Extension of Promissory Note Agreement, dated June 30, 2008, by and between IdentiPHI, Inc. and Key Ovation, LLC

10.2

Security Agreement, dated June 30, 2008, by and between IdentiPHI, Inc. and Key Ovation, LLC

10.3

Amendments of Secured Promissory Note, dated July 21, 2008 and August 12, 2008, by and between IdentiPHI, Inc. and Key Ovation, LLC

10.4

Separation Agreement and Release of All Claims, dated July 21, 2008, by and between IdentiPHI, Inc. and Steven M. Oyer*

31.1

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

*	Management contract or compensatory plan or arrangement

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.


	IdentiPHI, Inc.

DATE: August 14, 2008	By:	/s/ JEFFREY T. DICK
		Jeffrey T. Dick
		Chief Financial Officer
		(Principal Financial Officer and
		Principal Accounting Officer)

Exhibit Index

Exhibit No.

Description

Form

Incorporated by Reference

Filed
Herewith

Exhibit No.

File No.

Filing
Date

10.1

Renewal, Modification and Extension of Promissory Note Agreement, dated June 30, 2008, by and between IdentiPHI, Inc. and Key Ovation, LLC

10.2

Security Agreement, dated June 30, 2008, by and between IdentiPHI, Inc. and Key Ovation, LLC

10.3

Amendments of Secured Promissory Note, dated July 21, 2008 and August 12, 2008, by and between IdentiPHI, Inc. and Key Ovation, LLC

10.4

Separation Agreement and Release of All Claims, dated July 21, 2008, by and between IdentiPHI, Inc. and Steven M. Oyer*

31.1

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

*	Management contract or compensatory plan or arrangement

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. junior Avg

Identiphi (IDPIQ) Inactive 10-Q2008 Q2 Quarterly report

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