IMAGEWARE SYSTEMS INC (Form: 10-K, Received: 02/24/2010 14:29:01)

5. Investments

In conjunction with the sale of the Company’s wholly-owned subsidiary, Digital Imaging Asia Pacific, as more fully described in Note 7 to these consolidated financial statements, in March 2005, the Company and Argus Solutions Ltd each agreed to purchase $250,000 of each others common stock at a per share price equal to 108% of the closing price of each others’ stock as determined by the American Stock Exchange and Australian Stock Exchange, respectively. As legal consideration, each Company paid the other cash of $250,000. The Company and Argus consummated the transaction through the exchange of common shares. The Company exchanged 71,225 shares of its common stock for 1,929,914 shares of common stock of Argus Solutions Ltd., which represents approximately one percent of the voting equity of Argus. In accordance with Statement of Financial Accounting Standards No. 153, “Exchange of Nonmonetary Assets, an amendment of APB Opinion No. 29”, the Company recorded this transaction as a nonmonetary exchange based on the fair value of the shares exchanged as determined by the closing price of the Company’s shares on the American Stock Exchange on the transaction date of $3.25 or $231,000.

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities” and based on the Company’s intentions regarding these instruments, they were classified as marketable equity securities into trading or available-for-sale categories. Marketable securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and are reported at fair value, with unrealized gains and losses recognized in earnings. Marketable securities not classified as trading are classified as available-for-sale and are carried at fair market value, with the unrealized gains and losses, net of tax, included in the determination of comprehensive income and reported in shareholders’ equity. Marketable equity securities are included in other non-current assets. The Company reviews its marketable equity holdings in publicly-traded companies on a regular basis to determine if any security has experienced an other-than-temporary decline in fair value. The Company considers the investee company’s cash position, earnings and revenue outlook, and stock price performance, among other factors, in its review. If it is determined that an other-than-temporary decline exists in a marketable equity security, the Company writes down the investment to its market value and records the related write-down as an investment loss in its Statement of Operations.

At December 31, 2007, the Company wrote off its remaining investment in Argus common stock as the market value of the common stock was determined to be $0. The write-down amounted to $39,000 and was due to a decline in the fair value of the equity security which, in the opinion of management, was considered to be other than temporary. The write-down is included in the caption Other income, net in the accompanying consolidated Statement of Operations for the twelve months ended December 31, 2007.

6. Acquisition

In December 2007, the Company entered into an agreement for the purchase of certain assets of Sol Logic, Inc. (“Sol Logic”) pursuant to an Asset Purchase Agreement (the “Asset Purchase Agreement”). The assets acquired include certain customer contracts, software licenses and intellectual property (collectively, the “Acquired Assets”). As a result of this asset acquisition, the Company integrated real-time voice recognition, multiple language translation and voice analytic capabilities into its biometric offerings. The Asset Purchase Agreement contained various customary representations and warranties on behalf of Sol Logic.

In consideration for the acquisition of the Acquired Assets, the Company: (1) issued to Sol Logic on December 19, 2007 (the “Closing”) 935,089 shares of restricted common stock of the Company (the “Initial Shares”), and (2) on June 19, 2008 (the “Additional Issuance Date”) was required to issue to Sol Logic that number of shares of restricted common stock (the “Additional Shares” and collectively with the Initial Shares, the “Shares”) equal to the quotient obtained by dividing $1,502,000 by the greater of (A) $1.633 and (B) the volume weighted average closing price of the Company’s common stock over the 20 trading-day period ending on June 18, 2008, as reported on the Over-the-Counter Bullet Board (“OTCBB”). Fifty percent of the Initial Shares and ten percent of the Additional Shares were held in escrow until the one-year anniversary of the Closing. The Company recorded the obligation to issue the required number of shares on the Additional Issuance Date as a current liability in the accompanying Consolidated Balance Sheet as of December 31, 2007 under the caption “Acquisition related obligation”.

On March 28, 2008, the Company entered into Amendment No. 1 to Asset Purchase Agreement (the “Purchase Agreement Amendment”) to amend the Purchase Agreement. The Purchase Agreement Amendment provided that in consideration for the Acquired Assets, the Company issue to Sol Logic an aggregate of 677,940 shares of restricted Common Stock (the “Initial Shares”). Of these shares, 467,545 were issued to Sol Logic on December 19, 2007, the date of the Purchase Agreement. The remaining 210,395 shares were issued to Sol Logic upon execution of the Purchase Agreement Amendment. In conjunction with these issuances, the Company simultaneously rescinded the issuance of 257,149 common shares originally placed into escrow on December 19, 2007.

In the event the Company’s revenues on certain specified products set forth in the Purchase Agreement Amendment either equal or exceed $3,000,000 for the six-month period commencing on March 6, 2008 and ending on September 6, 2008 or equal or exceed $5,000,000 for the eighteen-month period commencing on March 6, 2008 and ending on September 6, 2009, the Company was obligated to issue that number of additional shares of Common Stock (the “Additional Shares” and together with the Initial Shares, the “Shares”) obtained by dividing $1,921,924 by the greater of $1.10 or the volume weighted average closing price of the Company’s common stock over the 20 trading-day period immediately prior to the date the Additional Shares are issued, subject to the terms of the escrow described below. Pursuant to the Purchase Agreement Amendment, the maximum number of Additional Shares that may be issued is 1,747,204. The Company did not attain the specified revenue levels required pursuant to the terms of the Purchase Agreement Amendment and on September 6, 2009, the contingent consideration provision contained in the Purchase Agreement Amendment expired with no additional consideration due.

Concurrently with the execution of the Purchase Agreement Amendment, the Company entered into Amendment No. 1 to Registration Rights Agreement (the “Rights Agreement Amendment”) to amend the Rights Agreement. Under the terms of the Rights Agreement Amendment, the Company was required to register an additional 371,755 of the Initial Shares, for a total of 677,940 shares of Common Stock, for resale by Sol Logic.

As a result of recording the terms of the Purchase Agreement Amendment, the aggregate purchase price, not including direct transaction costs of approximately $274,000 was approximately $1,019,000. The value of the 677,940 common shares issued was determined based on the average market price of the Company’s common stock over the 2-day period before and after the terms of the Purchase Agreement Amendment were consummated on March 6, 2008 in accordance with EITF 99-12, “Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination’. As of December 31, 2008, the Company had incurred approximately $131,000 in expenses related to the issuance and registration of the Company’s equity securities issued pursuant to the Sol Logic asset purchase. Such issuance and registration costs have been recognized as a reduction of the fair value of the Company’s common stock in accordance with FASB Statement of Financial Accounting Standards No 141, “Business Combinations” (“FAS 141”).

In connection the Purchase Agreement Amendment, the Company agreed to pay additional consideration in future periods, based upon the attainment of certain revenue levels on certain specified products. FAS 141 requires, in situations involving a contingent consideration agreement that might result in the recognition of an additional element of cost when the contingency is resolved, the recognition of a purchase accounting liability in an amount equal to the lesser of the maximum amount of contingent consideration or the excess (the amount by which the amounts assigned to the assets acquired exceeds the cost of the acquired entity). Accordingly, the Company, upon execution of the Purchase Agreement Amendment, recorded a purchase accounting liability of approximately $1,060,000 as a current liability. When the contingency is resolved and the consideration is issued or becomes issuable, any excess of the fair value of the contingent consideration issued or issuable over the amount that was recognized as a liability shall be recognized as an additional cost of the acquisition. Any such additional cost would result in increases in goodwill. If the amount initially recognized as a liability exceeds the fair value of the consideration issued or issuable, that excess shall be allocated as a pro rata reduction of the amounts assigned to the acquired assets. As more fully described in Note 4 to these consolidated financial statements, the Company determined that the intangible assets acquired in the Sol Logic acquisition were impaired at December 31, 2008 as the carrying value of these assets exceeded their estimated fair value determined by the assets’ future discounted cash flows. The Company did not attain the specified revenue levels required pursuant to the terms of the Purchase Agreement Amendment and on September 6, 2009, the contingent consideration provision contained in the Purchase Agreement Amendment expired with no additional consideration due. The Company has recorded the resolution of the purchase accounting contingency as a recognized subsequent event and has allocated the excess of the contingent liability of $1,060,000 as a pro rata reduction of the amounts assigned to the acquired assets prior to the recording of an impairment charge of approximately $742,000.

The following table presents the allocation of the acquisition cost, including professional fees and other related acquisition costs, to the assets acquired and liabilities assumed, based on their fair values:

($ in thousands)	As recorded per Dec. 19, 2007 Asset Purchase Agreement			As adjusted per Mar. 6, 2008 Purchase Agreement Amendment

Fixed assets, net	$	42		$	42
Covenant not to compete		200			200
Customer base		93			93
Developed technology		2,018			2,018
Goodwill		1,036			—
Total assets acquired	$	3,389		$	2,353

Cash and direct transaction costs	$	(410	)	$	(466	)
Acquisition liability		(1,502	)		(1,060	)
Common stock		(9	)		(7	)
Additional paid in capital		(1,468	)		(820	)
Total consideration issued and liabilities incurred	$	(3,389	)	$	(2,353	)

Number of shares issued		935,089			677,940

The following (unaudited) pro forma consolidated results of operations have been prepared as if the acquisition of Sol Logic, Inc. had occurred at January 1, 2007:

($ in thousands)	Twelve Months Ended December 31, 2007
	(unaudited)
Sales	$	8,902
Net loss available to common shareholders	$	(6,690	)
Net loss per share available to common shareholders	$	(0.44	)

The pro forma information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.

7. Sale of Businesses and Discontinued Operations

On November 30, 2006, the Company completed the sale of its entire Digital Photography (“PDI”) product line and inventory (the “PDI Products”) to an unaffiliated third party for a total of $400,000, including an initial cash payment of $25,000. The purchaser is required to pay up to the full remaining amount of $375,000 in a series of quarterly installments equal to 12.5% of all newly acquired sales and license revenues relating to the PDI product line (the “Percentage Payments”). Until such time when the Company has received the full purchase price of $400,000, during any 12-month period during which the aggregate Percentage Payments to the Company are less than $50,000, the purchaser will pay the Company the difference between the Percentage Payments and $50,000. This component of the Company’s business was previously classified as the Company’s Digital Photography segment.

The Company decided to sell this component because it has incurred significant operating losses in each of the last five years and has lost significant market share in the last three years. The assets sold consisted primarily of a suite of software and related inventory including source, copyrights, trademarks, documentation and client base.

In 2007, the Company recognized a gain of approximately $50,000 from the disposal of this component representing the cash proceeds received less the value of net assets sold. At December 31, 2007, the Company has recorded the fair value of the remaining amount due of $325,000 offset by a full valuation allowance due to the uncertainty of the ultimate collectability of such amounts. This determination was based upon the maximum repayment period of 6.5 years of amounts owing the Company combined with the purchaser operating in a highly competitive business environment evidenced by rapid technological change. Accordingly, the Company has deferred any remaining gain from the disposal of this component until such time as the Company determines that the realization of the remaining amounts owed is reasonably assured.

In 2008, the Company recognized a gain of approximately $18,000 from the disposal of this component representing the cash proceeds received less the value of net assets sold. At December 31, 2008, the Company has continued to record the fair value of the remaining amount due of $307,000 offset by a full valuation allowance due to the uncertainty of the ultimate collectability of such amounts. This determination was based upon the maximum repayment period of 5.5 years of amounts owing the Company combined with the purchaser operating in a highly competitive business environment evidenced by rapid technological change. Accordingly, the Company has deferred any remaining gain from the disposal of this component until such time as the Company determines that the realization of the remaining amounts owed is reasonably assured.

8. Related Parties

As more fully described in Note 13 to these consolidated financial statements, on November 14, 2008, the Company entered in to a series of convertible promissory notes (the” Convertible Notes”), aggregating $110,000 with certain officers and members of the Company’s Board of Directors. The Convertible Notes bear interest at 7.0% per annum and were originally due February 14, 2009 for which a forbearance waiver was obtained which is more fully described in Notes 13.

In conjunction with the issuance of the Convertible Notes, the Company issued an aggregate of 149,996 warrants to the note holders to purchase Common Stock of the Company. The warrants have an exercise price $0.55 per share and may be exercised at any time from November 14, 2008 until November 14, 2013.

9. Inventory

Inventories at December 31, 2008 were comprised of work in process of $9,000 representing direct labor costs on in-process projects and finished goods of $10,000 net of reserves for obsolete and slow-moving items of $93,000. Inventories at December 31, 2007 were comprised of work in process of $29,000 representing direct labor costs on in-process projects and finished goods of $101,000 net of reserves for obsolete and slow-moving items of $16,000. Appropriate consideration is given to obsolescence, excessive levels, deterioration, and other factors in evaluating net realizable value and required reserve levels.

10. Property and Equipment

Property and equipment at December 31, 2008 and 2007, consists of:

($ in thousands)	2008			2007

Equipment	$	1,397		$	1,411
Leasehold improvements		31			149
Furniture		162			162
		1,590			1,722
Less accumulated depreciation		(1,482	)		(1,434	)
	$	108		$	288

Total depreciation expense for the years ended December 31, 2008 and 2007 was approximately $247,000 and $242,000, respectively.

11. Costs and Estimated Earnings on Uncompleted Contracts

The Company recognizes sales and cost of sales on long-term, fixed price contracts involving significant amounts of customization using the percentage of completion method based on costs incurred to date compared to total estimated costs at completion. Such amounts are included in the accompanying consolidated Balance Sheets at December 31, 2008 and December 31, 2007 under the caption “Billings in excess of costs and estimated earnings on uncompleted contract”.

Costs and estimated earnings on uncompleted contracts and related amounts billed under contract provisions as of December 31, 2008 and December 31, 2007 are as follows:

($ in thousands)	December 31, 2008			December 31, 2007

Costs incurred on uncompleted contract	$	108		$	—
Estimated earnings		397			—
		505			—

Less: Billings to date		(784	)		—
Billings in excess of costs and estimated earnings on uncompleted contract	$	(279	)	$	—

12. Accrued Liabilities

Principal components of accrued liabilities consist of:

($ in thousands)	2008		2007

Compensated absences	$	230	$	215
Wages and sales commissions		128		113
Customer deposits		336		267
Liquidated damages		280		280
Royalties		251		251
Professional fees		28		73
Employee benefit plans		113		10
Other		164		132
		1,530	$	1,341

13. Notes Payable and Line of Credit

Notes payable consist of the following:

($ in thousands)	2008		2007
Notes payable to related parties:
Convertible promissory notes to accrue interest at 7%. Face value of note $110, net of unamortized discount on note at December 31, 2008 of $12. Note due January 31, 2010		98	$	—
Total notes payable to related parties		98		—

Total notes payable		98	$	—
Less current portion		—		—
Long-term notes payable		98	$	—

Future maturities of long-term debt are as follows as of December 31, 2008:

($ in thousands)
2009	$	—
2010	$	98
2011	$	—
2012	$	—
2013	$	—
	$	98

On November 14, 2008, the Company entered in to a series of convertible promissory notes (the” Convertible Notes”), aggregating $110,000 with certain officers and members of the Company’s Board of Directors. The Convertible Notes bear interest at 7.0% per annum and were originally due February 14, 2009 for which a forbearance waiver was obtained. The principal amount of the Convertible Notes plus accrued but unpaid interest is convertible at the option of the holder into Common Stock of the Company. The number of shares into which the Convertible Notes are convertible shall be calculated by dividing the outstanding principal and accrued but unpaid interest by $0.55 (the “Conversion Price”).

The Company initially recorded the convertible notes net of a discount equal to the fair value allocated to the warrants using the relative fair value method of approximately $13,000. The Company estimated the fair value of the warrants using the Black-Scholes option pricing model and the following assumptions: term of 5 years, a risk free interest rate of 2.53%, a dividend yield of 0%, and volatility of 96%. The convertible notes also contained a beneficial conversion feature, which resulted in additional debt discount of $12,000. The beneficial conversion amount was measured using the accounting intrinsic value, i.e. the excess of the aggregate fair value of the common stock into which the debt is convertible over the proceeds allocated to the security. The Company is accreting the beneficial conversion feature over the life of the note. For the twelve months ended December 31, 2008 the Company recorded $12,000 as interest expense from the amortization of the discount related to the fair value of the warrants and from the accretion of the beneficial conversion feature.

In August 2009, the Company received from the Convertible Note holders a waiver of default and extension to January 31, 2010 of the maturity date of the Convertible Notes. As consideration for the waiver and note extension, the Company issued to the Convertible Note holders an aggregate of 150,000 warrants to purchase shares of the Company’s common stock. The warrants have an exercise price of $0.54 per share and expire on August 25, 2014. The Company is currently seeking an additional waiver of default from the holders of the Convertible Notes.

14. Income Taxes

The significant components of the income tax provision (benefit) are as follows:

($ in thousands)	December 31,
	2008		2007
Current
Federal	$	—	$	—
State		—		—
Foreign		—		—

Deferred
Federal		—		—
State		—		—
Foreign		—		—

	$	—	$	—

The principal components of the Company’s deferred tax assets (liabilities) at December 31, 2008 and 2007 are as follows:

($ in thousands)	2008			2007

Net operating loss carryforwards	$	17,306		$	16,118
Intangible assets		784			713
Impairment loss on intangible assets		296			-
Stock based compensation		552			426
Reserves and accrued expenses		37			(4	)
Other		(46	)		(46	)
		18,929			17,207
Less valuation allowance		(18,929	)		(17,207	)

Net deferred tax assets	$	—		$	—

A reconciliation of the provision (benefit) for income taxes to the amount computed by applying the statutory income tax rates to loss before income taxes is as follows:

	2008			2007

Amounts computed at statutory rates	$	(1,944	)	$	(1,593	)
State income tax, net of federal benefit		(190	)		(125	)
Expiration of net operating loss carryforwards		418			485
Federal research and development credit		—			—
Other		(5	)		6
Net change in valuation allowance		1,721			1,227

	$	—		$	—

The Company has established a valuation allowance against its deferred tax asset due to the uncertainty surrounding the realization of such asset. Management periodically evaluates the recoverability of the deferred tax asset. At such time as it is determined that is more likely than not that deferred tax assets are realizable, the valuation allowance will be reduced.

At December 31, 2008 and 2007, the Company had federal net operating loss carryforwards of approximately $45,490,000 and $42,330,000, respectively, state net operating loss carryforwards of approximately $31,514,000 and $29,576,000, respectively, which may be available to offset future taxable income for tax purposes. The federal net operating loss carryforwards expire at various dates from 2009 through 2028. The state net operating loss carryforwards expire at various dates from 2009 through 2018.

The Internal Revenue Code (“the Code”) limits the availability of certain tax credits that arose prior to certain cumulative changes in a corporation’s ownership resulting in a change of control of the Company. The Company has reduced its deferred tax assets to zero relating to its federal and state research credits because of such limitations.

The Code also limits the availability of net operating losses that arose prior to certain cumulative changes in a corporation’s ownership resulting in a change of control of the Company. The Company’s use of its net operating loss carryforwards and tax credit carryforwards will be significantly limited because the Company underwent “ownership changes” in 1991, 1995, 2000, 2003 and 2004.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements. The interpretation prescribes a recognition threshold and measurement attribute criteria for the financial statement recognition and measurement of an uncertain tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

The Company adopted the provisions of FIN 48 on January 1, 2007. The implementation of FIN 48 did not have a material impact on the Company’s financial statements. At the adoption date on January 1, 2007, and as of December 31, 2007 and 2008, the Company recorded no cumulative effect adjustments related to the adoption of FIN 48.

Upon adoption of FIN 48 on January 1, 2007, and as of December 31, 2007, the Company had no unrecognized tax benefits or accruals for the potential payment of interest and penalties. For the twelve months ended December 31, 2007 and 2008, no interest or penalties were recorded.

The Company files tax returns in the U.S. federal jurisdiction, and in various states and foreign jurisdictions. The Company is not aware of any jurisdictions currently under examination by tax authorities.

15. Commitments and Contingencies

Employment Agreements

The Company has employment agreements with its Chief Executive Officer and Senior Vice President of Administration and Chief Financial Officer. The Company may terminate the agreements with or without cause. Subject to the conditions and other limitations set forth in each respective employment agreement, each executive will be entitled to the following severance benefits if the Company terminates the executive’s employment without cause or in the event of an involuntary termination (as defined in the employment agreements) by the Company or by the executive: (i) a lump sum cash payment equal to between six months and twenty-four months of base salary, based upon specific agreements; (ii) continuation of the executive’s fringe benefits and medical insurance for a period of three years; and (iii) immediate vesting of 50% of each executive’s outstanding restricted stock awards and stock options. In the event that the executive’s employment is terminated within the six months prior to or the thirteen months following a change of control (as defined in the employment agreements), the executive is entitled to the severance benefits described above, except that 100% of each executive’s restricted stock awards outstanding and stock options will immediately vest. Each executive’s eligibility to receive any severance payments or other benefits upon his termination is conditioned upon him executing a general release of liability.

Litigation

The Company is involved in certain legal proceedings generally incidental to its normal business activities. While the outcome of such proceedings cannot be accurately predicted, the Company does not believe the ultimate resolution of any such existing matters should have a material effect on its financial position, results of operations or cash flows.

Leases

The Company currently leases office and research and development space under operating leases which expire at various dates through December 2013 .

At December 31, 2008, future minimum lease payments are as follows:

($ in thousands)
2009	$	251
2010	$	161
2011	$	164
2012	$	164
2013	$	108
	$	848

Rental expense from continuing operations incurred under operating leases for the years ended December 31, 2008 and 2007 was approximately $545,000 and $579,000, respectively.

16.

Equity

The Company’s Articles of Incorporation were amended effective August 31, 1994 and authorize the issuance of two classes of stock to be designated “Common Stock” and “Preferred Stock,” provide that both Common and Preferred Stock shall have a par value of $.01 per share and authorize the Company to issue 50,000,000 shares of Common Stock and 4,000,000 shares of Preferred Stock. The Preferred Stock may be divided into such number of series and with the rights, preferences, privileges and restrictions as the Board of Directors may determine.

Series B Convertible, Redeemable Preferred Stock

In April 1995, the Company’s Articles of Incorporation were amended to authorize 750,000 shares of Series B Convertible Redeemable Preferred Stock (“Series B”). Each 5.275 shares of Series B are convertible into one share of the Company’s common stock.

The holders of Series B are entitled to cumulative preferred dividends payable at the rate of $.2125 per share per annum commencing April 30, 1996, subject to legally available funds. The Series B plus accrued but unpaid dividends are convertible at the option of the holder into shares of common stock at a conversion price equal to the original Series B issue price as adjusted to prevent dilution. The Series B will automatically be converted into shares of common stock upon the closing of an underwritten public offering at a price per common share of not less than $31.65. If the public offering price is less than $31.65 but at least $21.10 per share, the conversion shall still be automatic upon written consent of a majority of the then outstanding shareholders of Series B.

The holders of Series B, on an as-converted basis, have the same voting rights per share as the Company’s common shares; provided, that the holders of Series B has a special right to elect one director if the Company defaults in the payment of any dividend to the holders of Series B. The holders of Series B are entitled to initial distributions of $2.50 per share of Series B outstanding, upon liquidation and in preference to common shares and any other series of preferred stock plus all accrued but unpaid dividends.

Any time after December 31, 2000, the Company has the right to redeem all or some of the outstanding shares of Series B at a price equal to the original issue price, plus all accrued but unpaid dividends.

The Company had 239,400 shares of Series B outstanding as of December 31, 2008 and 2007. At December 31, 2008 and 2007, the Company had cumulative undeclared dividends of approximately $34,000 and $9,000 respectively.

Series C Convertible Preferred Stock

In November 2006, the Company’s Articles of Incorporation were amended to authorize 3,500 shares of Series C Convertible Preferred Stock (“Series C”). Each share of Series C Preferred Stock is convertible at any time at the option of the holder into a number of shares of common stock equal to the stated value (initially $1,000 per share, subject to adjustment), plus any accrued and unpaid dividends, divided by the conversion price (initially $1.50 per share, subsequently adjusted to $0.50 per share and subject to further adjustment). Subject to certain limitations, the conversion price per share shall be adjusted in the event of certain subsequent stock dividends, splits, reclassifications, dilutive issuances, rights offerings, and reclassifications. Certain activities may not be undertaken by the Company without the affirmative vote of a majority of the holders of the outstanding shares of Series C Preferred Stock. The Series C preferred stock does not have voting rights and is not redeemable except at liquidation. The Company may be subject to losses arising from non-delivery of shares within a specified period of time under the “buy in” provision. At January 1, 2007, the Company had issued a total of 2,500 shares of Series C Convertible Preferred Stock.

The holders of Series C are entitled to receive cumulative dividends, at the option of the Company, (i) in common stock upon conversion of the Series C preferred stock, or (ii) in cash after the payment of cash dividends to the holders of Series B Preferred Stock at the rate per share (as a percentage of the stated value per share) of 8% per annum.

The holders of Series C are entitled to initial distributions of $1,000 per share of Series C outstanding, upon liquidation and in preference to common shares and any other series of preferred stock with the exception of Series B Preferred Stock, plus all accrued but unpaid dividends.

The Company had 2,200 shares of Series C outstanding as of December 31, 2008 and 2007. At December 31, 2008 and 2007, the Company had cumulative undeclared dividends of approximately $404,000 and $234,000.

During the twelve months ended December 31, 2007, 300 shares of Series C were converted into 206,778 shares of the Company’s common stock. There were no conversions during the corresponding period in 2008.

Series D Convertible Preferred Stock

In March 2007, the Company’s Articles of Incorporation were amended to authorize 2,000 shares of Series D 8% Convertible Preferred Stock (“Series D Preferred Stock”). In August 2008, the Company’s Articles of Incorporation were further amended to increase the number of authorized shares of Series D Preferred Stock from 2,000 to 3,000. Each share of Series D Preferred Stock is convertible at any time at the option of the holder into a number of shares of common stock equal to the stated value (initially $1,000 per share, subject to adjustment), plus any accrued and unpaid dividends, divided by the conversion price (initially $1.90 per share, subsequently adjusted to 0.50 per share and subject to further adjustment). Subject to certain limitations, the conversion price per share shall be adjusted in the event of certain subsequent stock dividends, splits, reclassifications, dilutive issuances, rights offerings, and reclassifications. Certain activities may not be undertaken by the Company without the affirmative vote of a majority of the holders of the outstanding shares of Series D Preferred Stock. The Series D Preferred Stock does not have voting rights and is not redeemable except at liquidation. The Company may be subject to losses arising from non-delivery of shares within a specified period of time under the “buy in” provision.

The Company had 2,198 and 1388 shares of Series D outstanding as of December 31, 2008 and 2007, respectively. At December 31, 2008 and 2007, the Company had cumulative undeclared dividends of approximately $230,000 and $98,000.

During March 2007, the Company issued a total of 1,500 shares of Series D Preferred Stock and generated gross proceeds of $1.5 million. During the twelve months ended December 31, 2007, 112 shares of Series D were converted into 79,248 shares of the Company’s common stock.

In conjunction with the March 2007 issuance of the Series D Preferred Stock, the Company issued warrants to the holders of the Series D Preferred Stock to purchase 59,207 shares of the Company’s common stock at $2.33 per share. These warrants have been classified as equity instruments on the balance sheet. The proceeds from the Series D Preferred Stock financing were allocated to the warrants and the Series D Preferred Stock based on the relative fair value of each on the date of issuance. This allocation process resulted in the initial recognition of a discount attributable to an embedded beneficial conversion feature of approximately $344,000. The discount was amortized over the minimum period from the date of issuance to the date at which the preferred shareholders are permitted to convert as a dividend to the Series D Preferred Stock shareholders.

The issuance of common stock and warrants pursuant to the Common Stock Financing triggered certain antidilution clauses in the Company’s Series D Preferred Stock agreement. As a result of these antidilution clauses, the Company was required to adjust the conversion price of the Series D Preferred Stock from $1.90 per share to $1.50 per share. This antidilution feature will cause an additional 210,528 common shares to be issued upon conversion of the Series D Preferred Stock into common stock. In accordance with EITF Issue 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments”, this antidilution feature resulted in the additional recognition of a discount attributable to an embedded beneficial conversion feature of approximately $470,000. This discount was amortized over the minimum period from the date of the conversion price adjustment to the date at which the preferred shareholders are permitted to convert as a dividend to the Series D Preferred Stock shareholders.

Commencing in August 2008 and ending in September 2008, (the”2008 Series D Preferred Stock Financing”), the Company issued to certain investors 810 shares of Series D Preferred Stock for aggregate gross proceeds of $810,000. In conjunction with the 2008 Series D Preferred Stock Financing, the Company issued warrants to the investors of the Series D Preferred Stock to purchase 1,620,000 shares of the Company’s common stock at $0.50 per share. These warrants have been classified as equity instruments on the Company’s Consolidated Balance Sheet at December 31, 2008. The proceeds from the 2008 Series D Preferred Stock Financing were allocated to the warrants and the Series D Preferred Stock based on the relative fair value of each on the date of issuance. This allocation process resulted in the initial recognition of a discount attributable to an embedded beneficial conversion feature of approximately $186,000. This discount was amortized over the minimum period from date of issuance to the date at which the preferred shareholders are permitted to convert as a dividend to the Series D Preferred Stock shareholders.

The issuance of the Series D Preferred Stock and warrants pursuant to the 2008 Series D Preferred Stock Financing triggered certain antidilution clauses in the Company’s Series C and previously issued Series D Preferred Stock agreements. As a result of these antidilution clauses, the Company was required to adjust the conversion price of the Series C and Series D Preferred Stocks from $1.00 to $0.50 per share. This antidilution feature will cause an additional 3,588,000 common shares to be issued upon conversion of the Series C and Series D Preferred Stocks into common stock. In accordance with EITF Issue 00-27,”Application of Issue 98-5 to Certain Convertible Instruments”, this antidilution feature resulted in the additional recognition of a discount attributable to an embedded beneficial conversion feature of approximately $3,588,000. This discount was amortized over the minimum period from date of issuance to the date at which the preferred shareholders are permitted to convert as a dividend to the Series D Preferred Stock shareholders.

As compensation to the placement agent for the 2008 Series D Preferred Stock Financing, the Company agreed to pay approximately $33,000 in cash. The cash payment has been recorded as an adjustment to additional paid in capital as a reduction of net proceeds.

Common Stock

On March 12, 2008, the Company received $541,666 from the exercise of 541,666 warrants to purchase shares of the Company’s common stock, par value $0.01 per share (the “Warrant Financing”). The warrants were originally issued in connection with a private placement of Common Stock to certain accredited investors (the “Investors”). The Financing was previously reported in a Current Report on Form 8-K filed on September 26, 2007. The Company agreed to reprice all warrants issued in the Financing, which originally had an exercise price of $1.67 per share, to an exercise price of $1.00 per share, in consideration for their immediate exercise (the “Warrant Repricing”) by the Investors who participated in the Warrant Repricing or their transferees, as applicable (the “Participating Investors”).

In connection with the Warrant Repricing, the Company also issued to the Participating Investors new warrants (the “Warrants”) to purchase up to an aggregate of 270,833 shares of Common Stock with an exercise price of $1.20 per share. The Warrants may be exercised at any time from March 12, 2008 until March 12, 2013. In addition, if the shares of Common Stock issuable upon exercise of the Warrants are not registered for resale with the Securities and Exchange Commission on or before the later of September 12, 2008 or the end of the applicable holding period for resales of securities by non-affiliates under Rule 144 of the Securities Act, but in any event no later than March 12, 2009, the Warrants may be exercised by the Participating Investors by “cashless” exercise.

As more fully disclosed in Note 6 to these condensed consolidated financial statements, in March 2008 the Company amended the Asset Purchase Agreement relating to the purchase of certain assets of Sol Logic, Inc. As a result of amending the Asset Purchase Agreement, the Company rescinded the issuance of 257,149 shares of common stock originally issued to Sol Logic and placed into escrow on December 19, 2007.

In 2008 and 2007, the Company issued 81,144 and 63,240 shares of common stock, respectively, pursuant to stock-based compensation agreements with certain employees.

The issuance of common stock and warrants in March 2008 pursuant to the Warrant Financing triggered certain antidilution clauses in the Company’s Series C and Series D Preferred Stock agreements. As a result of these antidilution clauses, the Company was required to adjust the conversion price of the Series C and Series D Preferred Stock from $1.50 per share to $1.00 per share. This antidilution feature will cause an additional 733,335 common shares to be issued upon conversion of the Series C Preferred Stock into common stock and an additional 462,669 common shares to be issued upon conversion of the Series D Preferred Stock into common stock. In accordance with EITF Issue 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments”, this antidilution feature resulted in the additional recognition of a discount attributable to an embedded beneficial conversion feature of approximately $1,100,000 related to Series C Preferred Stock and $694,000 related to Series D Preferred Stock. This discount was amortized over the minimum period from the date of the conversion price adjustment to the date at which the preferred shareholders are permitted to convert as a dividend to the Series C and Series D Preferred Stock shareholders.

On September 25, 2007, the Company sold to certain accredited investors a total of 2,016,666 shares of the Company’s common stock, par value $0.01 per share, at a purchase price of $1.50 per share for aggregate gross proceeds of $3,025,003 (the “Common Stock Financing”).

In conjunction with the issuance of the common stock, the Company issued to the investors warrants (the “Investor Warrants”) to purchase up to an aggregate of 1,008,333 shares of Common Stock with an exercise price of $1.67 per share. The Investor Warrants have been classified as equity instruments on the balance sheet in accordance with the provisions of Emerging Issues Task Force (“EITF”) Issue 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”.

The issuance of common stock and warrants pursuant to the Common Stock Financing triggered certain antidilution and exercise price reduction clauses in existing warrant agreements. As a result of these modifications, the Company was required to issue an additional 113,834 warrants and reduce the exercise price of certain previously issued warrants. As these warrants were classified as permanent equity, and the adjustment was related to antidilution features within these financial instruments, this increase in warrants and reduction of exercise price resulted in no adjustments to the financial statements.

As compensation to the placement agent for the Common Stock Financing, the Company paid approximately $212,000 in placement agent fees and agreed to reimburse up to $25,000 of placement agent legal expense incurred in connection with this financing. In addition, the Company issued the placement agent for the financing, and certain of its affiliates, a 5.5 year warrant (the “Placement Agent Warrants”) to purchase up to an aggregate of 151,249 shares of Common Stock on the same terms and conditions included in the Investor Warrants. The cash payment has been recorded as adjustment to additional paid in capital as a reduction of net proceeds. The Placement Agent Warrants have been classified as equity instruments on the balance sheet.

During the twelve months ended December 31, 2007 the Company issued 206,778 shares of its common stock pursuant to the conversion of 300 shares of Series C Preferred Stock and issued 79,248 shares of its common stock pursuant to the conversion of 112 shares of Series D Preferred Stock.

During the twelve months ended December 31, 2007, the Company issued 795,956 shares of its common stock pursuant to the exercise of common stock purchase warrants. The Company received gross proceeds of approximately $1,121,000 from these warrant exercises.

In December 2007, the Company issued 935,089 shares of its common stock pursuant to its acquisition of substantially all the assets of Sol Logic, Inc.

During the twelve months ended December 31, 2007, 300 shares of Series C were converted into 206,778 shares of the Company’s common stock. During the twelve months ended December 31, 2007, 112 shares of Series D were converted into 79,248 shares of the Company’s common stock.

Warrants

As of December 31, 2008, warrants to purchase 10,471,167 shares of common stock at prices ranging from $0.50 to $5.48 were outstanding. All warrants are exercisable as of December 31, 2008, and expire at various dates through March 2013.

The following table summarizes warrant activity for the following periods:

	Warrants			Weighted- Average Exercise Price

Balance at December 31, 2006		5,821,149		$	2.37
Granted		1,286,776		$	1.34
Expired / Canceled		(224,998	)	$	3.16
Exercised		(927,097	)	$	1.59
Balance at December 31, 2007		5,955,830		$	2.24
Granted		6,251,984		$	0.53
Expired / Canceled		(1,194,981	)	$	2.39
Exercised		(541,666	)	$	1.00
Balance at December 31, 2008		10,471,167		$	1.00

The following table summarized information about warrants outstanding and exercisable at December 31, 2008:

Exercise Price		Number Outstanding	Weighted—Average Remaining Life (Years)	Weighted—Average Exercise Price

$	.50	8,124,138	2.0	$	.50

$	.55	149,996	4.9	$	.55

$	1.20	270,833	4.2	$	1.20

$	1.43	75,149	5.0	$	1.43

$	1.67	617,916	4.24	$	1.67

$	2.14	34,600	0.9	$	2.14

$	2.68	635,767	1.56	$	2.68

$	4.66	63,012	0.1	$	4.66

$	5.48	499,756	0.1	$	5.48

		10,471,167

In conjunction with the issuance of the Series D Preferred Stock, the Company issued warrants to the holders of the Series D Preferred Stock to purchase 1,620,000 of the Company’s common stock at $0.50 per share. These warrants have been classified as equity instruments on the balance sheet.

As partial compensation to the placement agent for the Preferred Stock Financing, the Company issued the placement agent for the financing, and certain of its affiliates, a 5 year warrant (the “Placement Agent Warrants”) to purchase up to an aggregate of 65,600 shares of Common Stock on the same terms and conditions included in the Investor Warrants. The cash payment has been recorded as adjustment to additional paid in capital as a reduction of net proceeds. The Placement Agent Warrants have been classified as equity instruments on the balance sheet.

The issuance of common stock and warrants pursuant to the Common Stock Financing triggered certain antidilution and exercise price reduction clauses in existing warrant agreements. As a result of these modifications, the Company was required to issue an additional 4,145,555 warrants and reduce the exercise price of certain previously issued warrants. As these warrants were classified as permanent equity and their anti-dilution rights were likewise classified as equity, the adjustment was related to the execution of an existing warrant features within these financial instruments rather than an actual modification and this increase in warrants and reduction of exercise price resulted in no adjustment to the financial statements .

17.	Stock Option Plans

On August 31, 1994, the directors of the Company adopted the Company’s 1994 Employee Stock Option Plan (the “1994 Plan”) and the 1994 Nonqualified Stock Option Plan (the “Nonqualified Plan”). The 1992 Stock Option Plan and options previously granted were cancelled by the Board of Directors.

The 1994 Plan originally provided for officers and other key employees to receive nontransferable incentive stock options to purchase up to 170,616 shares of the Company’s common stock. The number of stock options issued and outstanding and the number of stock options remaining available for future issuance are shown in the table below. The option price per share must be at least equal to 100% of the market value of the Company’s common stock on the date of grant and the term may not exceed ten years.

The Nonqualified Plan originally provided for directors and consultants to receive nontransferable options to purchase up to 18,957 shares of the Company’s common stock. The number of options issued and outstanding and the number of options remaining available for future issuance are shown in the table below. The option price per share must be at least equal to 85% of the market value of the Company’s common stock on the date of grant and the term may not exceed five years.

Both the 1994 Plan and the Nonqualified Plan are administered by the Board of Directors or a Committee of the Board which determines the employees, directors or consultants which will be granted options and the terms of the options, including vesting provisions which to date has been over a three year period. Both the 1994 Plan and the Nonqualified Plan expired on August 31, 2004.

On December 17, 1999, the Company’s Board of Directors adopted the ImageWare Systems, Inc. Amended and Restated 1999 Stock Option Plan (the “1999 Plan”). Under the terms of the 1999 Plan, the Company could, originally, issue up to 350,000 non-qualified or incentive stock options to purchase common stock of the Company. The number of options issued and outstanding and the number of options remaining available for future issuance are shown in the table below. The 1999 Plan has substantially the same terms as the 1994 Employee Stock Option Plan and the 1994 Nonqualified Stock Option Plan and expires on December 17, 2009.

We increased the share reserve of the amended and restated 1999 plan by 883,000 shares of our common stock. This number consists of an increase in the share reserve of 800,000 of our shares of common stock and 83,000 shares of our common stock that were reserved and available for grants under the 2001 Equity Incentive Plan, which we refer to as the 2001 plan. Prior to amendment, the 1999 plan had 350,000 shares reserved for issuance under the 1999 plan.

·	Any shares not issued in connection with awards outstanding under the 2001 plan or the 1994 Employee Stock Option Plan (which we refer to as the 1994 plan) on June 7, 2005, will become available for issuance under the amended and restated 1999 plan.

·	Any shares not issued in connection with awards granted under the 1999 plan, will become available for issuance under the amended and restated 1999 plan.

·	The amended and restated 1999 plan prohibits the grant of stock option or stock appreciation right awards with an exercise price less than fair market value of Common Stock on the date of grant.

·	The amended and restated 1999 plan also generally prohibits the “re-pricing” of stock options or stock appreciation rights, although awards may be bought out for a payment in cash or our stock.

·	The amended and restated 1999 plan permits the grant of stock based awards other than stock options, including the grant of “full value” awards such as restricted stock, stock units and performance shares .

·	The amended and restated 1999 plan permits the qualification of awards under the plan (payable in either stock or cash) as “performance-based compensation” within the meaning of Section 162(m) of the Internal Revenue Code.

On September 12, 2001, the Company’s Board of Directors approved adoption of the 2001 Equity Incentive Plan (the “2001 Plan”). Under the terms of the 2001 Plan, the Company may issue stock awards to employees, directors and consultants of the Company, and such stock awards may be given for non-statutory stock options (options not intended to qualify as an “incentive stock option” within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended), stock bonuses, and rights to acquire restricted stock. The Company originally reserved 1,000,000 shares of its common stock for issuance under the 2001 Plan. The number of options issued and outstanding and the number of options remaining available for future issuance are shown in the table below.

The 2001 Plan is administered by the Board of Directors or a Committee of the Board as provided in the 2001 Plan. Options granted under the 2001 Plan shall not be less than 85% of the market value of the Company’s common stock on the date of the grant, and, in some cases, may not be less than 110% of such fair market value. The term of options granted under the 2001 Plan as well as their vesting are determined by the Board and to date, options have been granted with a ten year term and vesting over a three year period. While the Board may suspend or terminate the 2001 Plan at any time, if not terminated earlier, it will terminate on the day before its tenth anniversary of the date of adoption.

On November 9, 2007, the Company’s Board of Directors approved an amendment to the 1999 Plan, subject to shareholder approval, pursuant to which an additional 1,000,000 shares would be reserved for issuance under the plan. In December 2007, the Company’s shareholders approved this amendment resulting in 1,000,000 shares being added to the 1999 Plan.

Stock Option Plans

As of December 31, 2008

	Number of securities to be issued upon exercise of outstanding options (a)		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
1994 Plan		20,250		-0-
1999 Plan		1,773,047		653,089
2001 Plan		256,017		-0-
Total		2,049,314		653,089

The following table summarizes employee stock option activity since December 31, 2006 :

	Options			Weighted- Average Exercise Price

Balance at December 31, 2006		1,603,164		$	2.45
Granted		165,250		$	2.38
Expired/canceled		(103,206	)	$	2.58
Exercised		—		$	—

Balance at December 31, 2007		1,665,208		$	2.44
Granted		821,221		$	0.89
Expired/canceled		(437,115	)	$	2.19
Exercised		—		$

Balance at December 31, 2008		2,049,314		$	1.87

At December 31, 2008, a total of 1,239,422 options were exercisable at a weighted average price of $2.42 per share. At December 31, 2007, a total of 1,212,753 options were exercisable at a weighted average price of $2.50 per share. At December 31, 2006, a total of 810,527 options were exercisable at a weighted average price of $2.66 per share.

The intrinsic value of options exercised during the twelve months ended December 31, 2008, 2007 and 2006 was $0. The intrinsic value of options exercisable at December 31, 2008, 2007 and 2006 was $0.

The following table summarizes information about employee stock options outstanding and exercisable at December 31, 2008:

		Options Outstanding				Options Exercisable
Exercise Price		Number Outstanding	Weighted- Average Remaining Life (Years)	Weighted- Average Exercise Price		Number Exercisable	Weighted- Average Exercise Price

$	.17 – .52	321,221	9.8	$	.20	0	$	0
$	.58 - 1.04	96,000	9.3	$	.92	0	$	0
$	1.45 - 1.71	455,672	8.4	$	1.52	126,531	$	1.64
$	1.97 – 2.15	157,336	5.4	$	2.01	150,255	$	1.97
$	2.20 – 2.49	552,318	6.5	$	2.39	495,869	$	2.31
$	2.62 – 2.74	276,000	6.6	$	2.63	276,000	$	2.63
$	3.00 – 6.51	190,767	3.5	$	3.28	190,767	$	3.28
Total		2,049,314				1,239,422

The weighted-average grant-date fair value per share of options granted to employees during the years ended December 31, 2008 and 2007 was $0.54 and $1.48, respectively.

18. Employee Benefit Plan

During 1995, the Company adopted a defined contribution 401(k) retirement plan (the “Plan”). All U.S. based employees aged 21 years and older are eligible to become participants after the completion of 60 days employment. The Plan provides for annual contributions by the Company of 50% of employee contributions not to exceed 8% of employee compensation. Participants may contribute up to 100% of the annual contribution limitations determined by the Internal Revenue Service.

Employees are fully vested in their share of the Company’s contributions after the completion of five years of service. In 2007, the Company made contributions of approximately $28,000 for the 2006 plan year and made contributions of approximately $75,000 for the 2007 plan year and has accrued a contribution of approximately $6,000 for the 2007 plan year which was paid in January 2008. In 2008, the Company has accrued a contribution of approximately $108,000 for the 2008 plan year which was paid in 2009.

19. Pension Plan

One of the Company’s foreign subsidiaries maintains a defined benefit pension plan that provides benefits based on length of service and final average earnings. The following table sets forth the benefit obligation, fair value of plan assets, and the funded status of the Company’s plan; amounts recognized in the Company’s consolidated financial statements; and the assumptions used in determining the actuarial present value of the benefit obligations as of December 31:

($ in thousands)	2008			2007
Change in benefit obligation:
Benefit obligation at beginning of year	$	1,636		$	1,457
Service cost		2			2
Interest cost		84			76
Actuarial gain (loss)		(9	)		(8	)
Effect of exchange rate changes		(54	)		109
Effect of curtailment		—			—
Benefits paid		—			—
Benefit obligation at end of year		1,659			1,636

Change in plan assets
Fair value of plan assets at beginning of year		497			441
Actual return of plan assets		14			11
Company contributions		47			45
Benefits paid		—			—
Fair value of plan assets at end of year		558			497

Funded status		(1,101	)		(1,139	)
Unrecognized actuarial loss (gain)		363			342
Unrecognized prior service (benefit) cost		—			—
Additional minimum liability		(363	)		(342	)
Unrecognized transition (asset) liability		—			—
Net amount recognized		(1,101	)	$	(1,139	)

The weighted average assumptions used to determine benefit obligations for the years ended December 31 were:
Discount rate		4.60	%		4.60	%
Expected return on plan assets		4.00	%		4.00	%
Rate of compensation increase		N/A			N/A

Plan Assets
Pension plan assets were comprised of the following asset categories at December 31,
Equity securities		4.60	%		6.90	%
Debt securities		92.00	%		89.50	%
Other		3.40	%		3.60	%
Total		100	%		100	%

Components of net periodic benefit cost are as follows:
Service cost		2			2
Interest cost on projected benefit obligations		84			76
Expected return on plan assets		—			—
Amortization of prior service costs		—			—
Amortization of actuarial loss		—			—
Net periodic benefit costs		86			78

The weighted average assumptions used to determine net periodic benefit cost for the years ended December 31, were
Discount rate		4.60	%		4.60	%
Expected return on plan assets		4.00	%		4.00	%
Rate of compensation increase		N/A			N/A
The following discloses information about our defined benefit pension plan that had an accumulated benefit obligation in excess of plan assets as of December 31,
Projected benefit obligation		1,659			1,636
Accumulated benefit obligation		1,659			1,636
Fair value of plan assets		558			497

The following benefit payments are expected to be paid as follows:

2009			—
2010			—
2011			—
2012			—
2013			—
2014 — 2018			126

The Company made contributions to the plan of approximately $40,289 during 2010.

The investment objectives for the plan are the preservation of capital, current income and long-term growth of capital. All plan assets are managed in a policyholder pool in Germany by outside investment managers. The measurement date used to determine the benefit information of the plan was January 1, 2009.

20. SUBSEQUENT EVENTS

In February 2009, the Company entered in to a secured promissory note (the ‘Note”), for Five Million Dollars ($5,000,000) with a third-party lender (“the Lender”). The Note secures a credit facility for a total of up to Five Million Dollars ($5,000,000). The initial advance under the Note was One Million Dollars ($1,000,000). Subsequent advances shall be in increments of $1,000,000 and are subject to the discretion of the Lender. The Note shall bear interest at 5.0% per annum on the outstanding principal. Principal and interest was originally due June 30, 2010. The Company will also pay the Lender additional interest on the maturity date or such earlier date as may be required under the terms of the Note equal to the greater of Four Hundred Thousand Dollars ($400,000) or an amount equal to 2,000,000 multiplied by the average of the Closing prices for the Common Stock of the Company for the ten (10) trading day period immediately preceding the date of the payment of such interest payment.

The Note is secured by all of the assets of the Company. Under the terms of the Note, the entire outstanding balance together with all accrued interest shall be payable on (i) the maturity date (June 30, 2010), (ii) a change of control transaction, (iii) receipt by the Company of proceeds from the sale of equity or equity linked securities of the Company in excess of $2,500,000, (iv) receipt by the Company of proceeds from the issuance by the Company of any type of additional debt instruments, or upon the occurrence of an event of default under the terms of the Note.

In conjunction with the issuance of the Note, the Company issued a warrant to purchase 4,500,000 shares of Common Stock of the Company. The warrant has an exercise price $0.50 per share and may be exercised at any time from February 12, 2009 until February 12, 2014. Additionally, the Company entered into a Registration Rights Agreement requiring the Company to provide certain registration rights to the Lender relative to the 4,500,000 shares of Common Stock of the Company issuable pursuant to the warrant.

The Company intends to use the proceeds from the Note for general working capital purposes.

On May 19, 2009, ImageWare Systems, Inc. formed a wholly owned subsidiary in Mexico in order to support the Company’s efforts to develop new business and service existing contracts to provide products and service in Mexico. The Mexican subsidiary, ImageWare Mexico, S. DE R.L., is located in Mexico City and has one employee.

In June 2009, the Lender and the Company agreed to amend the Note (“Amendment No.1”) whereby the Company received a waiver of default and extension of certain date sensitive covenants contained in the Note. As consideration for the waiver and extension, the Company issued to the Lender warrants to purchase 1,000,000 shares of Common Stock of the Company at an exercise price of $0.50 per share. Such warrants may be exercised at any time from June 9, 2009 until June 9, 2014. In conjunction with the June 2009 waiver and extension, the interest rate on the Note was changed to 9% per annum, retroactive to February 2009.

In June 2009, the Lender and the Company further amended the Note (“Amendment No.2”) whereby the Lender advanced the Company an additional $350,000 and amended certain terms of the Note. As consideration for the additional advance, the Company issued to the Lender warrants to purchase 700,000 shares of Common Stock of the Company at an exercise price of $0.50 per share. Such warrants may be exercised at any time from June 22, 2009 until June 22, 2014.

In July and August 2009, the Company undertook a series of warrant financings whereby the Company issued 2,401,075 warrants with an exercise price of $0.50 per share to incentivize certain warrant holders to exercise their existing warrant of cash. Pursuant to this series of warrant financings, the Company issued an aggregate of 2,741,075 shares of common stock and raised approximately $1,371,000 in cash.

In July and August 2009, holders of existing warrants exercised 929,395 of their warrants pursuant to cashless exercise provisions and received 353,702 shares of common stock.

In October 2009, the Lender and the Company amended the Note (“Amendment No. 3”) whereby the Lender agreed to make additional advances in an aggregate amount up to One Million Dollars ($1,000,000) to only be used for the purpose of compromising certain of the Company’s outstanding vendor payables or for paying the audit of the Company’s financial statements. The amendment calls for the Company to repay the lender in full the amount of any and all Third Amendment Advances, together with all accrued and unpaid interest thereon, on or before January 31, 2010 . On October 5, 2009, the Lender made an advance of $300,000 to the Company pursuant to these provisions. As consideration for the additional advance, the Company issued to the Lender warrants to purchase 200,000 shares of Common Stock of the Company at an exercise price of $0.60 per share. Such warrants may be exercised at any time from October 5, 2009 until October 5, 2014. As additional consideration, the Company assigned certain patents related to discontinued product lines to the Lender with the condition that the Company would participate in future proceeds generated from efforts by the Lender to monetize the patents.

On November 4, 2009, the Lender and the Company amended the Note (“Amendment No. 4”) whereby the Lender made an additional $350,000 advance (the “Additional Advance”) under the Note. As consideration for the Additional Advance, the Company executed an assignment of all accounts receivable (the”Assignment of Receivables”) whereby the Company assigned to the Lender all of the Company’s rights, title and interest in all accounts receivable as of the date of Amendment No. 4. In December 2009, the Company paid back the $350,000 advance plus accrued interest.

In December 2009, the Lender advanced an additional $325,000 under Amendment No.3.

In January of 2010, holders of existing warrants exercised 13,120 of their warrants pursuant to cashless exercise provisions and received 5,665 shares of common stock.

In January of 2010, the Company issued 847,258 shares of restricted stock to members of management and the Board. These shares will vest quarterly over a three year period. The restricted shares were issued as compensation for the cancellation of 1,412,096 warrants held by members of management and the Board.

In February 2010, the Lender and the Company amended the Note “(Amendment No. 5”) whereby the Lender extended the due date of amounts due on January 31, 2010 to March 15, 2010.

SECURITIES PURCHASE AGREEMENT

This Securities Purchase Agreement (this “ Agreement ”) is dated as of August 29, 2008, among ImageWare Systems, Inc., a Delaware corporation (the “ Company ”), and each purchaser identified on the signature pages hereto (each, including its successors and assigns, a “ Purchaser ” and collectively the “ Purchasers ”).

WHEREAS, subject to the terms and conditions set forth in this Agreement and pursuant to Section 4(2) of the Securities Act of 1933, as amended (the “ Securities Act ”), and Rule 506 promulgated thereunder, the Company desires to issue and sell to each Purchaser, and each Purchaser, severally and not jointly, desires to purchase from the Company, securities of the Company as more fully described in this Agreement.

NOW, THEREFORE, IN CONSIDERATION of the mutual covenants contained in this Agreement, and for other good and valuable consideration the receipt and adequacy of which are hereby acknowledged, the Company and each Purchaser agree as follows:

ARTICLE I

DEFINITIONS

1.1 Definitions . In addition to the terms defined elsewhere in this Agreement: (a) capitalized terms that are not otherwise defined herein have the meanings given to such terms in the Certificate of Designation (as defined herein), and (b) the following terms have the meanings set forth in this Section 1.1:

“ Action ” shall have the meaning ascribed to such term in Section 3.1(j).

“ Affiliate ” means any Person that, directly or indirectly through one or more intermediaries, controls or is controlled by or is under common control with a Person, as such terms are used in and construed under Rule 144 under the Securities Act. With respect to a Purchaser, any investment fund or managed account that is managed on a discretionary basis by the same investment manager as such Purchaser will be deemed to be an Affiliate of such Purchaser.

“ Business Day ” means any day except Saturday, Sunday, any day which shall be a federal legal holiday in the United States or any day on which banking institutions in the State of New York are authorized or required by law or other governmental action to close.

“ Certificate of Designation ” means the Certificate of Designation to be filed prior to the Closing by the Company with the Secretary of State of Delaware, in the form of Exhibit A attached hereto.

“ Closing ” means the closing of the purchase and sale of the Securities pursuant to Section 2.1.

“ Closing Date ” means the Trading Day when all of the Transaction Documents have been executed and delivered by the applicable parties thereto, and all conditions precedent to (i) the Purchasers’ obligations to pay the Subscription Amount and (ii) the Company’s obligations to deliver the Securities have been satisfied or waived.

“ Closing Price ” means on any particular date (a) the last reported closing bid price per share of Common Stock on such date on the Trading Market (as reported by Bloomberg L.P. at 4:15 p.m. (New York City time)), or (b) if there is no such price on such date, then the closing bid price on the Trading Market on the date nearest preceding such date (as reported by Bloomberg L.P. at 4:15 p.m. (New York City time)), or (c) if the Common Stock is not then listed or quoted on the Trading Market and if prices for the Common Stock are then reported in the “pink sheets” published by Pink Sheets LLC (or a similar organization or agency succeeding to its functions of reporting prices), the most recent bid price per share of the Common Stock so reported, or (d) if the shares of Common Stock are not then publicly traded the fair market value of a share of Common Stock as determined by an appraiser selected in good faith by the Purchasers of a majority in interest of the Shares then outstanding.

“ Commission ” means the Securities and Exchange Commission.

“ Common Stock ” means the common stock of the Company, par value $0.01 per share, and any other class of securities into which such securities may hereafter be reclassified or changed into.

“ Common Stock Equivalents ” means any securities of the Company or the Subsidiaries which would entitle the holder thereof to acquire at any time Common Stock, including, without limitation, any debt, preferred stock, rights, options, warrants or other instrument that is at any time convertible into or exercisable or exchangeable for, or otherwise entitles the holder thereof to receive, Common Stock.

“ Company Counsel ” means Paul Hastings Janofsky & Walker, LLP with offices located at 3579 Valley Centre Drive, San Diego, California 92130.

“ Conversion Price ” shall have the meaning ascribed to such term in the Certificate of Designation.

“ Disclosure Schedules ” shall have the meaning ascribed to such term in Section 3.1.

“ Effective Date ” means the date that any Registration Statement filed by the Company covering the Underlying Shares is first declared effective by the Commission.

“ Evaluation Date ” shall have the meaning ascribed to such term in Section 3.1(r).

“ Exchange Act ” means the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder.

“ Exempt Issuance ” means the issuance of (a) shares of Common Stock or options to employees, officers or directors of the Company pursuant to any stock or option plan duly adopted for such purpose by a majority of the non-employee members of the Board of Directors of the Company or a majority of the members of a committee of non-employee directors established, (b) securities upon the exercise or exchange of or conversion of any Securities issued hereunder and/or other securities exercisable or exchangeable for or convertible into shares of Common Stock issued and outstanding on the date of this Agreement, provided that such securities have not been amended since the date of this Agreement to increase the number of such securities or to decrease the exercise, exchange or conversion price of such securities, and (c) securities issued pursuant to acquisitions or strategic transactions approved by a majority of the disinterested directors of the Company, provided any such issuance shall only be to a Person which is, itself or through its subsidiaries, an operating company in a business synergistic with the business of the Company and in which the Company receives benefits in addition to the investment of funds, but shall not include a transaction in which the Company is issuing securities primarily for the purpose of raising capital or to an entity whose primary business is investing in securities.

“ GAAP ” shall have the meaning ascribed to such term in Section 3.1(h).

“ Indebtedness ” shall have the meaning ascribed to such term in Section 3.1(bb).

“ Intellectual Property Rights ” shall have the meaning ascribed to such term in Section 3.1(o).

“ Legend Removal Date ” shall have the meaning ascribed to such term in Section 4.1(c).

“ Liens ” means a lien, charge, security interest, encumbrance, right of first refusal, preemptive right or other restriction.

“ Material Adverse Effect ” shall have the meaning assigned to such term in Section 3.1(b).

“ Material Permits ” shall have the meaning ascribed to such term in Section 3.1(m).

“ Maximum Rate ” shall have the meaning ascribed to such term in Section 5.17.

“ Participation Maximum ” shall have the meaning ascribed to such term in Section 4.13.

“ Person ” means an individual or corporation, partnership, trust, incorporated or unincorporated association, joint venture, limited liability company, joint stock company, government (or an agency or subdivision thereof) or other entity of any kind.

“ Preferred Stock ” means up to 1,500 shares of the Company’s Series D 8% Convertible Preferred Stock issued hereunder, having the rights, preferences and privileges set forth in the Certificate of Designation as amended, in the form of Exhibit A hereto.

“ Pre-Notice ” shall have the meaning ascribed to such term in Section 4.13.

“ Proceeding ” means an action, claim, suit, investigation or proceeding (including, without limitation, an investigation or partial proceeding, such as a deposition), whether commenced or threatened.

“ Purchaser Party ” shall have the meaning ascribed to such term in Section 4.11.

“ Registration Statement ” means a registration statement covering the resale of the Underlying Shares by each Purchaser.

“ Required Approvals ” shall have the meaning ascribed to such term in Section 3.1(e).

“ Required Minimum ” means, as of any date, the maximum aggregate number of shares of Common Stock then issued or potentially issuable in the future pursuant to the Transaction Documents, including any Underlying Shares issuable upon exercise or conversion in full of all Warrants and all shares of Preferred Stock, ignoring any conversion or exercise limits set forth therein, and assuming that any previously unconverted shares of Preferred Stock are held until the third anniversary of the Closing Date and all dividends are paid in shares of Common Stock until such third anniversary.

“ Rule 144 ” means Rule 144 promulgated by the Commission pursuant to the Securities Act, as such Rule may be amended from time to time, or any similar rule or regulation hereafter adopted by the Commission having substantially the same effect as such Rule.

“ SEC Reports ” shall have the meaning ascribed to such term in Section 3.1(h).

“ Securities ” means the Preferred Stock, the Warrants, the Warrant Shares and the Underlying Shares.

“ Securities Act ” means the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder.

“ Shareholder Approval ” means such approval as may be required by the applicable rules and regulations of the American Stock Exchange (or any successor entity) from the shareholders of the Company with respect to the transactions contemplated by the Transaction Documents, including the issuance of all of the Underlying Shares in excess of 19.99% of the issued and outstanding Common Stock on the Closing Date.

“ Short Sales ” means all “short sales” as defined in Rule 200 of Regulation SHO under the Exchange Act (but shall not be deemed to include the location and/or reservation of borrowable shares of Common Stock).

“ Stated Value ” means $1,000 per share of Preferred Stock.

“ Subscription Amount ” means, as to each Purchaser, the aggregate amount to be paid for the Preferred Stock purchased hereunder as specified below such Purchaser’s name on the signature page of this Agreement and next to the heading “Subscription Amount”, in United States dollars and in immediately available funds.

“ Subsequent Financing ” shall have the meaning ascribed to such term in Section 4.13.

“ Subsequent Financing Notice ” shall have the meaning ascribed to such term in Section 4.13.

“ Subsidiary ” shall have the meaning ascribed to such term in Section 3.1(a).

“ Trading Day ” means a day on which the Common Stock is traded on a Trading Market.

“ Trading Market ” means the following markets or exchanges on which the Common Stock is listed or quoted for trading on the date in question: the American Stock Exchange, the Nasdaq Capital Market, the Nasdaq Global Market, the Nasdaq Global Select Market, the New York Stock Exchange or the OTC Bulletin Board.

“ Transaction Documents ” means this Agreement, the Certificate of Designation, the Warrants and any other documents or agreements executed in connection with the transactions contemplated hereunder.

“ Transfer Agent ” means ComputerShare Trust Company, N.A., with a mailing address of 250 Royall Street, Canton, Massachusetts 02021 and a facsimile number of (617) 575-2549, and any successor transfer agent of the Company.

“ Underlying Shares ” means the shares of Common Stock issued and issuable upon conversion of the Preferred Stock, upon exercise of the Warrants and issued and issuable in lieu of the cash payment of dividends on the Preferred Stock in accordance with the terms of the Certificate of Designation.

“ VWAP ” means, for any date, the price determined by the first of the following clauses that applies: (a) if the Common Stock is then listed or quoted on a Trading Market, the daily volume weighted average price of the Common Stock for such date (or the nearest preceding date) on the Trading Market on which the Common Stock is then listed or quoted as reported by Bloomberg L.P. (based on a Trading Day from 9:30 a.m. (New York City time) to 4:02 p.m. (New York City time); (b) if the OTC Bulletin Board is not a Trading Market, the volume weighted average price of the Common Stock for such date (or the nearest preceding date) on the OTC Bulletin Board; (c) if the Common Stock is not then quoted for trading on the OTC Bulletin Board and if prices for the Common Stock are then reported in the “Pink Sheets” published by Pink Sheets, LLC (or a similar organization or agency succeeding to its functions of reporting prices), the most recent bid price per share of the Common Stock so reported; or (d) in all other cases, the fair market value of a share of Common Stock as determined by an independent appraiser selected in good faith by the Holder and reasonably acceptable to the Company.

“ Warrants ” means collectively the Common Stock purchase warrants delivered to the Purchasers at the Closing in accordance with Section 2.2(a) hereof, which Warrants shall be exercisable immediately and have a term of exercise equal to 5 years, in the form of Exhibit C attached hereto.

“ Warrant Shares ” means the shares of Common Stock issuable upon exercise of the Warrants.

ARTICLE II

PURCHASE AND SALE

2.1 Closing . On the Closing Date, upon the terms and subject to the conditions set forth herein, substantially concurrent with the execution and delivery of this Agreement by the parties hereto, the Company agrees to sell, and each Purchaser, severally and not jointly, agrees to purchase an aggregate of, up to $1,500,000 of shares of Preferred Stock with an aggregate Stated Value equal to such Purchaser’s Subscription Amount and Warrants as determined pursuant to Section 2.2(a). The aggregate number of shares of Preferred Stock sold hereunder shall be up to 1,500. Each Purchaser shall deliver to the Company via wire transfer or a certified check immediately available funds equal to its Subscription Amount and the Company shall deliver to each Purchaser its respective shares of Preferred Stock and Warrants as determined pursuant to Section 2.2(a) and the other items set forth in Section 2.2 issuable at the Closing. Upon satisfaction of the conditions set forth in Sections 2.2 and 2.3, the Closing shall occur at the offices of Company Counsel or such other location as the parties shall mutually agree.

2.2 Deliveries .

(a) On the Closing Date, the Company shall deliver or cause to be delivered to each Purchaser the following:

(i) this Agreement duly executed by the Company;

(ii) certified resolutions of the Board of Directors of the Company authorizing the transactions contemplated by the Transaction Documents;

(iii) a certificate evidencing a number of shares of Preferred Stock equal to such Purchaser’s Subscription Amount divided by the Stated Value, registered in the name of such Purchaser;

(iv) a Warrant registered in the name of each Purchaser to purchase the Purchaser’s pro-rata share of up to 3,000,000 shares of Common Stock, with an exercise price equal to $0.50, subject to adjustment therein.

(b) On the Closing Date, each Purchaser shall deliver or cause to be delivered to the Company the following:

(i) this Agreement duly executed by such Purchaser;

(ii) such Purchaser’s Subscription Amount by wire transfer to the account as specified in writing by the Company.

2.3 Subsequent Closings . At any time on or before the 15th day following the Closing, the Company may sell up to the balance of the authorized shares of Preferred Stock and Warrants not sold at the Closing to such persons as may be approved by the Company (the “ Additional Purchasers ”). All such sales made at any additional closings (each an “ Additional Closing ”), (i) shall be made on the terms and conditions set forth in this Agreement, (ii) the representations and warranties of the Company set forth in Section 3.1, and the Disclosure Schedules, shall speak as of the Closing and the Company shall have no obligation to update any such disclosure, and (iii) the representations and warranties of the Additional Purchasers in Section 3.2 shall speak as of such Additional Closing. This Agreement, including without limitation, the Disclosure Schedules, may be amended without the consent of the Purchasers to include any Additional Purchasers. Any shares of Preferred Stock or Warrants sold pursuant to this Section 2.3 shall be deemed to be “Securities” for all purposes under this Agreement and any Additional Purchasers shall be deemed to be “Purchasers” for all purposes under this Agreement.

2.4 Closing Conditions .

(a) The obligations of the Company hereunder in connection with the Closing are subject to the following conditions being met:

(i) the accuracy in all material respects when made and on the Closing Date of the representations and warranties of the Purchasers contained herein;

(ii) all obligations, covenants and agreements of the Purchasers required to be performed at or prior to the Closing Date shall have been performed; and

(iii) the delivery by the Purchasers of the items set forth in Section 2.2(b) of this Agreement.

(b) The respective obligations of the Purchasers hereunder in connection with the Closing are subject to the following conditions being met:

(i) the accuracy in all material respects when made and on the Closing Date of the representations and warranties of the Company contained herein;

(ii) all obligations, covenants and agreements of the Company required to be performed at or prior to the Closing Date shall have been performed;

(iii) the delivery by the Company of the items set forth in Section 2.2(a) of this Agreement;

(iv) there shall have been no Material Adverse Effect with respect to the Company since the date hereof; and

(v) from the date hereof to the Closing Date, trading in the Common Stock shall not have been suspended by the Commission or the Company’s principal Trading Market (except for any suspension of trading of limited duration agreed to by the Company, which suspension shall be terminated prior to the Closing), and, at any time prior to the Closing Date, trading in securities generally as reported by Bloomberg L.P. shall not have been suspended or limited, or minimum prices shall not have been established on securities whose trades are reported by such service, or on any Trading Market, nor shall a banking moratorium have been declared either by the United States or New York State authorities nor shall there have occurred any material outbreak or escalation of hostilities or other national or international calamity of such magnitude in its effect on, or any material adverse change in, any financial market which, in each case, in the reasonable judgment of each Purchaser, makes it impracticable or inadvisable to purchase the Preferred Stock at the Closing.

ARTICLE III

REPRESENTATIONS AND WARRANTIES

3.1 Representations and Warranties of the Company . Except as set forth under the corresponding section of the disclosure schedules delivered to the Purchasers concurrently herewith (the “ Disclosure Schedules ”), which Disclosure Schedules shall be deemed a part hereof and to qualify any representation or warranty otherwise made herein to the extent of such disclosure, and except as disclosed in the Company’s SEC Reports, the Company hereby makes the following representations and warranties to each Purchaser:

(a) Subsidiaries . The Company owns, directly or indirectly, all of the capital stock or other equity interests of each subsidiary listed in the Company’s SEC Reports (each, a “ Subsidiary ”) free and clear of any Liens, and all of the issued and outstanding shares of capital stock of each Subsidiary are validly issued and are fully paid, non-assessable and free of preemptive and similar rights to subscribe for or purchase securities. If the Company has no subsidiaries, all other references to the Subsidiaries or any of them in the Transaction Documents shall be disregarded.

(b) Organization and Qualification . The Company and each of the Subsidiaries is an entity duly incorporated or otherwise organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or organization (as applicable), with the requisite power and authority to own and use its properties and assets and to carry on its business as currently conducted. Neither the Company nor any Subsidiary is in violation or default of any of the provisions of its respective certificate or articles of incorporation, bylaws or other organizational or charter documents. Each of the Company and the Subsidiaries is duly qualified to conduct business and is in good standing as a foreign corporation or other entity in each jurisdiction in which the nature of the business conducted or property owned by it makes such qualification necessary, except where the failure to be so qualified or in good standing, as the case may be, could not have or reasonably be expected to result in (i) a material adverse effect on the legality, validity or enforceability of any Transaction Document, (ii) a material adverse effect on the results of operations, assets, business, prospects or condition (financial or otherwise) of the Company and the Subsidiaries, taken as a whole, or (iii) a material adverse effect on the Company’s ability to perform in any material respect on a timely basis its obligations under any Transaction Document (any of (i), (ii) or (iii), a “ Material Adverse Effect ”) and no Proceeding has been instituted in any such jurisdiction revoking, limiting or curtailing or seeking to revoke, limit or curtail such power and authority or qualification.

(c) Authorization; Enforcement . The Company has the requisite corporate power and authority to enter into and to consummate the transactions contemplated by each of the Transaction Documents and otherwise to carry out its obligations hereunder and thereunder. The execution and delivery of each of the Transaction Documents by the Company and the consummation by it of the transactions contemplated hereby and thereby have been duly authorized by all necessary action on the part of the Company and no further action is required by the Company, its board of directors or its stockholders in connection therewith other than in connection with the Required Approvals. Each Transaction Document has been (or upon delivery will have been) duly executed by the Company and, when delivered in accordance with the terms hereof and thereof, will constitute the valid and binding obligation of the Company enforceable against the Company in accordance with its terms except (i) as limited by general equitable principles and applicable bankruptcy, insolvency, reorganization, moratorium and other laws of general application affecting enforcement of creditors’ rights generally, (ii) as limited by laws relating to the availability of specific performance, injunctive relief or other equitable remedies and (iii) insofar as indemnification and contribution provisions may be limited by applicable law.

(d) No Conflicts . The execution, delivery and performance of the Transaction Documents by the Company and the consummation by the Company of the other transactions contemplated hereby and thereby do not and will not: (i) conflict with or violate any provision of the Company’s or any Subsidiary’s certificate or articles of incorporation, bylaws or other organizational or charter documents, or (ii) conflict with, or constitute a default (or an event that with notice or lapse of time or both would become a default) under, result in the creation of any Lien upon any of the properties or assets of the Company or any Subsidiary, or give to others any rights of termination, amendment, acceleration or cancellation (with or without notice, lapse of time or both) of, any agreement, credit facility, debt or other instrument (evidencing a Company or Subsidiary debt or otherwise) or other understanding to which the Company or any Subsidiary is a party or by which any property or asset of the Company or any Subsidiary is bound or affected, or (iii) subject to the Required Approvals, conflict with or result in a violation of any law, rule, regulation, order, judgment, injunction, decree or other restriction of any court or governmental authority to which the Company or a Subsidiary is subject (including federal and state securities laws and regulations), or by which any property or asset of the Company or a Subsidiary is bound or affected; except in the case of each of clauses (ii) and (iii), such as could not have or reasonably be expected to result in a Material Adverse Effect.

(e) Filings, Consents and Approvals . The Company is not required to obtain any consent, waiver, authorization or order of, give any notice to, or make any filing or registration with, any court or other federal, state, local or other governmental authority or other Person in connection with the execution, delivery and performance by the Company of the Transaction Documents, other than (i) filings required pursuant to Section 4.6, (ii) the notice and/or application(s) to each applicable Trading Market for the issuance and sale of the Securities and the listing of the Underlying Shares for trading thereon in the time and manner required thereby, (iii) the filing of Form D with the Commission and such filings as are required to be made under applicable state securities laws and (iv) Shareholder Approval (collectively, the “ Required Approvals ”).

(f) Issuance of the Securities . The Securities are duly authorized and, when issued and paid for in accordance with the applicable Transaction Documents, will be duly and validly issued, fully paid and nonassessable, free and clear of all Liens imposed by the Company other than restrictions on transfer provided for in the Transaction Documents. The Underlying Shares, when issued in accordance with the terms of the Transaction Documents, will be validly issued, fully paid and nonassessable, free and clear of all Liens imposed by the Company. The Company has reserved from its duly authorized capital stock a number of shares of Common Stock for issuance of the Underlying Shares at least equal to the Required Minimum on the date hereof.

(g) Capitalization . As of the date hereof (and prior to the Closing), the Company has authorized for issuance 50,000,000 shares of Common Stock, par value $ 0.01 per share (the “Common Stock”), and 4,000,000 shares of preferred stock, par value $0.01 per share. As of the date hereof (and prior to the Closing), there are 18,143,259 shares of Common Stock issued and outstanding, 239,400 shares of Series B Preferred Stock, par value $0.01 per share (the “Series B Preferred Stock”), issued and outstanding, and 2,200 shares of Series C 8% Convertible Preferred Stock, par value $0.01 per share (the “Series C Preferred Stock”), issued and outstanding and 1,388 shares of Series D 8% Convertible Preferred Stock, par value $0.01 per share issued and outstanding. As of the date hereof (and prior to the Closing), there are issued and outstanding warrants to purchase 6,721,389 shares of Common Stock, stock options to purchase 2,121,517 shares of Common Stock and restricted stock grants totaling 13,524 shares of Common Stock. The Company has not issued any capital stock since its most recently filed periodic report under the Exchange Act, other than pursuant to the exercise of employee stock options under the Company’s stock option plans, the issuance of shares of Common Stock to employees pursuant to the Company’s employee stock purchase plan and pursuant to the conversion or exercise of Common Stock Equivalents outstanding as of the date of the most recently filed periodic report under the Exchange Act. No Person has any right of first refusal, preemptive right, right of participation, or any similar right to participate in the transactions contemplated by the Transaction Documents. Except as a result of the purchase and sale of the Securities, there are no outstanding options, warrants, script rights to subscribe to, calls or commitments of any character whatsoever relating to, or securities, rights or obligations convertible into or exercisable or exchangeable for, or giving any Person any right to subscribe for or acquire, any shares of Common Stock, or contracts, commitments, understandings or arrangements by which the Company or any Subsidiary is or may become bound to issue additional shares of Common Stock or Common Stock Equivalents. The issuance and sale of the Securities will not obligate the Company to issue shares of Common Stock or other securities to any Person (other than the Purchasers) and will not result in a right of any holder of Company securities to adjust the exercise, conversion, exchange or reset price under any of such securities. All of the outstanding shares of capital stock of the Company are validly issued, fully paid and nonassessable, have been issued in compliance with all federal and state securities laws, and none of such outstanding shares was issued in violation of any preemptive rights or similar rights to subscribe for or purchase securities. No further approval or authorization of any stockholder, the Board of Directors of the Company or others is required for the issuance and sale of the Securities. There are no stockholders agreements, voting agreements or other similar agreements with respect to the Company’s capital stock to which the Company is a party or, to the knowledge of the Company, between or among any of the Company’s stockholders.

(h) SEC Reports; Financial Statements . The Company has filed all reports, schedules, forms, statements and other documents required to be filed by the Company under the Securities Act and the Exchange Act, including pursuant to Section 13(a) or 15(d) thereof, for the two years preceding the date hereof (or such shorter period as the Company was required by law or regulation to file such material) (the foregoing materials, including the exhibits thereto and documents incorporated by reference therein, being collectively referred to herein as the “ SEC Reports ”) on a timely basis or has received a valid extension of such time of filing and has filed any such SEC Reports prior to the expiration of any such extension. As of their respective dates, the SEC Reports complied in all material respects with the requirements of the Securities Act and the Exchange Act, as applicable, and none of the SEC Reports, when filed, contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. The financial statements of the Company included in the SEC Reports comply in all material respects with applicable accounting requirements and the rules and regulations of the Commission with respect thereto as in effect at the time of filing. Such financial statements have been prepared in accordance with United States generally accepted accounting principles applied on a consistent basis during the periods involved (“ GAAP ”), except as may be otherwise specified in such financial statements or the notes thereto and except that unaudited financial statements may not contain all footnotes required by GAAP, and fairly present in all material respects the financial position of the Company and its consolidated Subsidiaries as of and for the dates thereof and the results of operations and cash flows for the periods then ended, subject, in the case of unaudited statements, to normal, immaterial, year-end audit adjustments.

(i) Material Changes; Undisclosed Events, Liabilities or Developments . Since the date of the latest audited financial statements included within the SEC Reports, except as specifically disclosed in a subsequent SEC Report filed prior to the date hereof, (i) there has been no event, occurrence or development that has had or that could reasonably be expected to result in a Material Adverse Effect, (ii) the Company has not incurred any liabilities (contingent or otherwise) other than (A) trade payables and accrued expenses incurred in the ordinary course of business consistent with past practice and (B) liabilities not required to be reflected in the Company’s financial statements pursuant to GAAP or disclosed in filings made with the Commission, (iii) the Company has not altered its method of accounting, (iv) the Company has not declared or made any dividend or distribution of cash or other property to its stockholders or purchased, redeemed or made any agreements to purchase or redeem any shares of its capital stock and (v) the Company has not issued any equity securities to any officer, director or Affiliate, except pursuant to existing Company stock option plans. The Company does not have pending before the Commission any request for confidential treatment of information. Except for the issuance of the Securities contemplated by this Agreement or as set forth on Schedule 3.1(i) , no event, liability or development has occurred or exists with respect to the Company or its Subsidiaries or their respective business, properties, operations or financial condition, that would be required to be disclosed by the Company under applicable securities laws at the time this representation is made that has not been publicly disclosed at least 1 Trading Day prior to the date that this representation is made.

(j) Litigation . There is no action, suit, inquiry, notice of violation, proceeding or investigation pending or, to the knowledge of the Company, threatened against or affecting the Company, any Subsidiary or any of their respective properties before or by any court, arbitrator, governmental or administrative agency or regulatory authority (federal, state, county, local or foreign) (collectively, an “ Action ”) which (i) adversely affects or challenges the legality, validity or enforceability of any of the Transaction Documents or the Securities or (ii) could, if there were an unfavorable decision, have or reasonably be expected to result in a Material Adverse Effect. Neither the Company nor any Subsidiary, nor any director or officer thereof, is or has been the subject of any Action involving a claim of violation of or liability under federal or state securities laws or a claim of breach of fiduciary duty. There has not been, and to the knowledge of the Company, there is not pending or contemplated, any investigation by the Commission involving the Company or any current or former director or officer of the Company. The Commission has not issued any stop order or other order suspending the effectiveness of any registration statement filed by the Company or any Subsidiary under the Exchange Act or the Securities Act.

(k) Labor Relations . No material labor dispute exists or, to the knowledge of the Company, is imminent with respect to any of the employees of the Company which could reasonably be expected to result in a Material Adverse Effect. None of the Company’s or its Subsidiaries’ employees is a member of a union that relates to such employee’s relationship with the Company, and neither the Company or any of its Subsidiaries is a party to a collective bargaining agreement, and the Company and its Subsidiaries believe that their relationships with their employees are good. No executive officer, to the knowledge of the Company, is, or is now expected to be, in violation of any material term of any employment contract, confidentiality, disclosure or proprietary information agreement or non-competition agreement, or any other contract or agreement or any restrictive covenant, and to the knowledge of the Company, the continued employment of each such executive officer does not subject the Company or any of its Subsidiaries to any liability with respect to any of the foregoing matters. The Company and its Subsidiaries are in compliance with all U.S. federal, state, local and foreign laws and regulations relating to employment and employment practices, terms and conditions of employment and wages and hours, except where the failure to be in compliance could not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect.

(l) Compliance . Neither the Company nor any Subsidiary (i) is in default under or in violation of (and no event has occurred that has not been waived that, with notice or lapse of time or both, would result in a default by the Company or any Subsidiary under), nor has the Company or any Subsidiary received notice of a claim that it is in default under or that it is in violation of, any indenture, loan or credit agreement or any other agreement or instrument to which it is a party or by which it or any of its properties is bound (whether or not such default or violation has been waived), (ii) is in violation of any order of any court, arbitrator or governmental body, or (iii) is or has been in violation of any statute, rule or regulation of any governmental authority, including without limitation all foreign, federal, state and local laws applicable to its business and all such laws that affect the environment, except in each case as could not have or reasonably be expected to result in a Material Adverse Effect.

(m) Regulatory Permits . The Company and the Subsidiaries possess all certificates, authorizations and permits issued by the appropriate federal, state, local or foreign regulatory authorities necessary to conduct their respective businesses as described in the SEC Reports, except where the failure to possess such permits could not have or reasonably be expected to result in a Material Adverse Effect (“ Material Permits ”), and neither the Company nor any Subsidiary has received any notice of proceedings relating to the revocation or modification of any Material Permit.

(n) Title to Assets . The Company and the Subsidiaries have good and marketable title in fee simple to all real property owned by them that is material to the business of the Company and the Subsidiaries and good and marketable title in all personal property owned by them that is material to the business of the Company and the Subsidiaries, in each case free and clear of all Liens, except for Liens as do not materially affect the value of such property and do not materially interfere with the use made and proposed to be made of such property by the Company and the Subsidiaries and Liens for the payment of federal, state or other taxes, the payment of which is neither delinquent nor subject to penalties. Any real property and facilities held under lease by the Company and the Subsidiaries are held by them under valid, subsisting and enforceable leases with which the Company and the Subsidiaries are in compliance.

(o) Patents and Trademarks . The Company and the Subsidiaries have, or have rights to use, all patents, patent applications, trademarks, trademark applications, service marks, trade names, trade secrets, inventions, copyrights, licenses and other intellectual property rights and similar rights necessary or material for use in connection with their respective businesses as described in the SEC Reports and which the failure to so have could have a Material Adverse Effect (collectively, the “ Intellectual Property Rights ”). Neither the Company nor any Subsidiary has received a notice (written or otherwise) that the Intellectual Property Rights used by the Company or any Subsidiary violates or infringes upon the rights of any Person. To the knowledge of the Company, all such Intellectual Property Rights are enforceable and there is no existing infringement by another Person of any of the Intellectual Property Rights. The Company and its Subsidiaries have taken reasonable security measures to protect the secrecy, confidentiality and value of all of their intellectual properties, except where failure to do so could not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect.

(p) Insurance . The Company and the Subsidiaries have in place the insurance coverage set forth on Schedule 3.1(p) . Neither the Company nor any Subsidiary has any reason to believe that it will not be able to renew its existing insurance coverage as and when such coverage expires or to obtain similar coverage from similar insurers as may be necessary to continue its business without a significant increase in cost.

(q) Transactions With Affiliates and Employees . None of the officers or directors of the Company and, to the knowledge of the Company, none of the employees of the Company is presently a party to any transaction with the Company or any Subsidiary (other than for services as employees, officers and directors), including any contract, agreement or other arrangement providing for the furnishing of services to or by, providing for rental of real or personal property to or from, or otherwise requiring payments to or from any officer, director or such employee or, to the knowledge of the Company, any entity in which any officer, director, or any such employee has a substantial interest or is an officer, director, trustee or partner, in each case in excess of $60,000 other than (i) for payment of salary or consulting fees for services rendered, (ii) reimbursement for expenses incurred on behalf of the Company and (iii) for other employee benefits, including stock option agreements under any stock option plan of the Company.

(r) Sarbanes-Oxley; Internal Accounting Controls . The Company is in material compliance with all provisions of the Sarbanes-Oxley Act of 2002 which are applicable to it as of the Closing Date. The Company and the Subsidiaries maintain a system of internal accounting controls sufficient to provide reasonable assurance that (i) transactions are executed in accordance with management’s general or specific authorizations, (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP and to maintain asset accountability, (iii) access to assets is permitted only in accordance with management’s general or specific authorization, and (iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences. The Company has established disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Company and designed such disclosure controls and procedures to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. The Company’s certifying officers have evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by the Company’s most recently filed periodic report under the Exchange Act (such date, the “ Evaluation Date ”). The Company presented in its most recently filed periodic report under the Exchange Act the conclusions of the certifying officers about the effectiveness of the disclosure controls and procedures based on their evaluations as of the Evaluation Date. Since the Evaluation Date, there have been no changes in the Company’s internal control over financial reporting (as such term is defined in the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

(s) Certain Fees . No brokerage or finder’s fees or commissions are or will be payable by the Company to any broker, financial advisor or consultant, finder, placement agent, investment banker, bank or other Person with respect to the transactions contemplated by the Transaction Documents. The Purchasers shall have no obligation with respect to any fees or with respect to any claims made against the Company by or on behalf of other Persons for fees of a type contemplated in this Section that may be due in connection with the transactions contemplated by the Transaction Documents.

(t) Private Placement . Assuming the accuracy of the Purchasers representations and warranties set forth in Section 3.2, no registration under the Securities Act is required for the offer and sale of the Securities by the Company to the Purchasers as contemplated hereby. The issuance and sale of the Securities hereunder does not contravene the rules and regulations of the Trading Market.

(u) Investment Company. The Company is not, and is not an Affiliate of, and immediately after receipt of payment for the Securities, will not be or be an Affiliate of, an “investment company” within the meaning of the Investment Company Act of 1940, as amended. The Company shall conduct its business in a manner so that it will not become subject to the Investment Company Act of 1940, as amended.

(v) Listing and Maintenance Requirements . The Company’s Common Stock is registered pursuant to Section 12(b) or 12(g) of the Exchange Act, and the Company has taken no action designed to, or which to its knowledge is likely to have the effect of, terminating the registration of the Common Stock under the Exchange Act nor has the Company received any notification that the Commission is contemplating terminating such registration. The Company has not, in the 12 months preceding the date hereof, received notice from any Trading Market on which the Common Stock is or has been listed or quoted to the effect that the Company is not in compliance with the listing or maintenance requirements of such Trading Market. The Company is, and has no reason to believe that it will not in the foreseeable future continue to be, in compliance with all such listing and maintenance requirements.

(w) Application of Takeover Protections . The Company and its Board of Directors have taken all necessary action, if any, in order to render inapplicable any control share acquisition, business combination, poison pill (including any distribution under a rights agreement) or other similar anti-takeover provision under the Company’s Certificate of Incorporation (or similar charter documents) or the laws of its state of incorporation that is or could become applicable to the Purchasers as a result of the Purchasers and the Company fulfilling their obligations or exercising their rights under the Transaction Documents, including without limitation as a result of the Company’s issuance of the Securities and the Purchasers’ ownership of the Securities.

(x) Disclosure . Except with respect to the material terms and conditions of the transactions contemplated by the Transaction Documents, the Company confirms that neither it nor any other Person acting on its behalf has provided any of the Purchasers or their agents or counsel with any information that it believes constitutes or might constitute material, nonpublic information. The Company understands and confirms that the Purchasers will rely on the foregoing representation in effecting transactions in securities of the Company. All disclosure furnished by or on behalf of the Company to the Purchasers regarding the Company, its business and the transactions contemplated hereby, including the Disclosure Schedules to this Agreement, is true and correct and does not contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made therein, in light of the circumstances under which they were made, not misleading. The press releases disseminated by the Company during the twelve months preceding the date of this Agreement taken as a whole do not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements, in light of the circumstances under which they were made and when made, not misleading. The Company acknowledges and agrees that no Purchaser makes or has made any representations or warranties with respect to the transactions contemplated hereby other than those specifically set forth in Section 3.2 hereof.

(y) No Integrated Offering . Assuming the accuracy of the Purchasers’ representations and warranties set forth in Section 3.2, neither the Company, nor any of its Affiliates, nor any Person acting on its or their behalf has, directly or indirectly, made any offers or sales of any security or solicited any offers to buy any security, under circumstances that would cause this offering of the Securities to be integrated with prior offerings by the Company for purposes of the Securities Act or any applicable shareholder approval provision of any Trading Market on which any of the securities of the Company are listed or designated.

(z) Tax Status . Except for matters that would not, individually or in the aggregate, have or reasonably be expected to result in a Material Adverse Effect, the Company and each Subsidiary has filed all necessary federal, state and foreign income and franchise tax returns and has paid or accrued all taxes shown as due thereon, and the Company has no knowledge of a tax deficiency which has been asserted or threatened against the Company or any Subsidiary.

(aa) No General Solicitation . Neither the Company nor any person acting on behalf of the Company has offered or sold any of the Securities by any form of general solicitation or general advertising. The Company has offered the Securities for sale only to the Purchasers and certain other “accredited investors” within the meaning of Rule 501 under the Securities Act.

(bb) Foreign Corrupt Practices. Neither the Company, nor to the knowledge of the Company, any agent or other person acting on behalf of the Company, has (i) directly or indirectly, used any funds for unlawful contributions, gifts, entertainment or other unlawful expenses related to foreign or domestic political activity, (ii) made any unlawful payment to foreign or domestic government officials or employees or to any foreign or domestic political parties or campaigns from corporate funds, (iii) failed to disclose fully any contribution made by the Company (or made by any person acting on its behalf of which the Company is aware) which is in violation of law, or (iv) violated in any material respect any provision of the Foreign Corrupt Practices Act of 1977, as amended.

(cc) Accountants . The Company’s accounting firm is Stonefield Josephson, LLP. To the knowledge of the Company, such accounting firm (i) is a registered public accounting firm as required by the Exchange Act and (ii) shall express its opinion with respect to the financial statements to be included in the Company’s Annual Report on Form 10-KSB for the year ending December 31, 2008.

(dd) Seniority . As of the Closing Date, no Indebtedness or other claim against the Company is senior to the Preferred Stock in right of payment, whether with respect to interest or upon liquidation or dissolution, or otherwise, other than indebtedness secured by purchase money security interests (which is senior only as to underlying assets covered thereby), capital lease obligations (which is senior only as to the property covered thereby), the Series B Preferred Stock and the Series C Preferred Stock (which are senior only as to dividend and liquidation preferences).

(ee) No Disagreements with Accountants and Lawyers. There are no disagreements of any kind presently existing, or reasonably anticipated by the Company to arise, between the Company and the accountants and lawyers formerly or presently employed by the Company and the Company is current with respect to any fees owed to its accountants and lawyers.

(ff) Acknowledgment Regarding Purchasers’ Purchase of Securities . The Company acknowledges and agrees that each of the Purchasers is acting solely in the capacity of an arm’s length purchaser with respect to the Transaction Documents and the transactions contemplated thereby. The Company further acknowledges that no Purchaser is acting as a financial advisor or fiduciary of the Company (or in any similar capacity) with respect to the Transaction Documents and the transactions contemplated thereby and any advice given by any Purchaser or any of their respective representatives or agents in connection with the Transaction Documents and the transactions contemplated thereby is merely incidental to the Purchasers’ purchase of the Securities. The Company further represents to each Purchaser that the Company’s decision to enter into this Agreement and the other Transaction Documents has been based solely on the independent evaluation of the transactions contemplated hereby by the Company and its representatives.

(gg) Acknowledgement Regarding Purchasers’ Trading Activity . Anything in this Agreement or elsewhere herein to the contrary notwithstanding (except for Sections 3.2(f) and 4.16 hereof), it is understood and acknowledged by the Company (i) that past or future open market or other transactions by any Purchaser, including Short Sales, and specifically including, without limitation, Short Sales or “derivative” transactions, before or after the closing of this or future private placement transactions, may negatively impact the market price of the Company’s publicly-traded securities; and (iii) that any Purchaser, and counter-parties in “derivative” transactions to which any such Purchaser is a party, directly or indirectly, presently may have a “short” position in the Common Stock. The Company further understands and acknowledges that (a) one or more Purchasers may engage in hedging activities at various times during the period that the Securities are outstanding, including, without limitation, during the periods that the value of the Underlying Shares deliverable with respect to Securities are being determined and (b) such hedging activities (if any) could reduce the value of the existing stockholders' equity interests in the Company at and after the time that the hedging activities are being conducted.

(hh) Regulation M Compliance . The Company has not, and to its knowledge no one acting on its behalf has, (i) taken, directly or indirectly, any action designed to cause or to result in the stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of any of the Securities, (ii) sold, bid for, purchased, or paid any compensation for soliciting purchases of, any of the securities of the Company, or (iii) paid or agreed to pay to any Person any compensation for soliciting another to purchase any other securities of the Company, other than, in the case of clauses (ii) and (iii), compensation paid to the Company’s placement agent in connection with the placement of the Securities.

(ii) Form S-3 Eligibility . The Company is not eligible to register the resale of the Underlying Shares for resale by the Purchaser on Form S-3 promulgated under the Securities Act.

3.2 Representations and Warranties of the Purchasers . Each Purchaser hereby, for itself and for no other Purchaser, represents and warrants as of the date hereof and as of the Closing Date to the Company as follows:

(a) Organization; Authority . Such Purchaser is an entity duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization with full right, corporate or partnership power and authority to enter into and to consummate the transactions contemplated by the Transaction Documents and otherwise to carry out its obligations hereunder and thereunder. The execution, delivery and performance by such Purchaser of the transactions contemplated by this Agreement have been duly authorized by all necessary corporate or similar action on the part of such Purchaser. Each Transaction Document to which it is a party has been duly executed by such Purchaser, and when delivered by such Purchaser in accordance with the terms hereof, will constitute the valid and legally binding obligation of such Purchaser, enforceable against it in accordance with its terms, except (i) as limited by general equitable principles and applicable bankruptcy, insolvency, reorganization, moratorium and other laws of general application affecting enforcement of creditors’ rights generally, (ii) as limited by laws relating to the availability of specific performance, injunctive relief or other equitable remedies and (iii) insofar as indemnification and contribution provisions may be limited by applicable law.

(b) Own Account . Such Purchaser understands that the Securities are “restricted securities” and have not been registered under the Securities Act or any applicable state securities law and is acquiring the Securities as principal for its own account and not with a view to or for distributing or reselling such Securities or any part thereof in violation of the Securities Act or any applicable state securities law, has no present intention of distributing any of such Securities in violation of the Securities Act or any applicable state securities law and has no direct or indirect arrangement or understandings with any other persons to distribute or regarding the distribution of such Securities (this representation and warranty not limiting such Purchaser’s right to sell the Securities pursuant to the Registration Statement or otherwise in compliance with applicable federal and state securities laws) in violation of the Securities Act or any applicable state securities law. Such Purchaser is acquiring the Securities hereunder in the ordinary course of its business.

(c) Purchaser Status . At the time such Purchaser was offered the Securities, it was, and at the date hereof it is, and on each date on which it converts any shares of Preferred Stock or exercises any Warrants, it will be either: (i) an “accredited investor” as defined in Rule 501(a)(1), (a)(2), (a)(3), (a)(7) or (a)(8) under the Securities Act or (ii) a “qualified institutional buyer” as defined in Rule 144A(a) under the Securities Act. Such Purchaser is not required to be registered as a broker-dealer under Section 15 of the Exchange Act.

(d) Experience of Such Purchaser . Such Purchaser, either alone or together with its representatives, has such knowledge, sophistication and experience in business and financial matters so as to be capable of evaluating the merits and risks of the prospective investment in the Securities, and has so evaluated the merits and risks of such investment. Such Purchaser is able to bear the economic risk of an investment in the Securities and, at the present time, is able to afford a complete loss of such investment.

(e) General Solicitation . Such Purchaser is not purchasing the Securities as a result of any advertisement, article, notice or other communication regarding the Securities published in any newspaper, magazine or similar media or broadcast over television or radio or presented at any seminar or any other general solicitation or general advertisement.

(f) Short Sales and Confidentiality Prior To The Date Hereof . Other than the transaction contemplated hereunder, such Purchaser has not, nor has any Person acting on behalf of or pursuant to any understanding with such Purchaser, directly or indirectly executed any transaction, including Short Sales, in the securities of the Company during the period commencing from the time that such Purchaser first received a term sheet (written or oral) from the Company or any other Person setting forth the material terms of the transactions contemplated hereunder until the date hereof (“ Discussion Time ”). Notwithstanding the foregoing, in the case of a Purchaser that is a multi-managed investment vehicle whereby separate portfolio managers manage separate portions of such Purchaser's assets and the portfolio managers have no direct knowledge of the investment decisions made by the portfolio managers managing other portions of such Purchaser's assets, the representation set forth above shall only apply with respect to the portion of assets managed by the portfolio manager that made the investment decision to purchase the Securities covered by this Agreement. Other than to other Persons party to this Agreement, such Purchaser has maintained the confidentiality of all disclosures made to it in connection with this transaction (including the existence and terms of this transaction).

ARTICLE IV

OTHER AGREEMENTS OF THE PARTIES

4.1 Transfer Restrictions .

(a) The Securities may only be disposed of in compliance with state and federal securities laws. In connection with any transfer of Securities other than pursuant to an effective registration statement or Rule 144, to the Company or to an Affiliate of a Purchaser or in connection with a pledge as contemplated in Section 4.1(b), the Company may require the transferor thereof to provide to the Company an opinion of counsel selected by the transferor and reasonably acceptable to the Company, the form and substance of which opinion shall be reasonably satisfactory to the Company, to the effect that such transfer does not require registration of such transferred Securities under the Securities Act. As a condition of transfer, any such transferee shall agree in writing to be bound by the terms of this Agreement and shall have the rights of a Purchaser under this Agreement.

(b) The Purchasers agree to the imprinting, so long as is required by this Section 4.1, of a legend on any of the Securities (as applicable) in the following form:

[NEITHER] THIS SECURITY [NOR THE SECURITIES INTO WHICH THIS SECURITY IS [EXERCISABLE] [CONVERTIBLE]] HAS BEEN REGISTERED WITH THE SECURITIES AND EXCHANGE COMMISSION OR THE SECURITIES COMMISSION OF ANY STATE IN RELIANCE UPON AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES ACT”), AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR PURSUANT TO AN AVAILABLE EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH APPLICABLE STATE SECURITIES LAWS AS EVIDENCED BY A LEGAL OPINION OF COUNSEL TO THE TRANSFEROR TO SUCH EFFECT, THE SUBSTANCE OF WHICH SHALL BE REASONABLY ACCEPTABLE TO THE COMPANY. THIS SECURITY AND THE SECURITIES ISSUABLE UPON [EXERCISE] [CONVERSION] OF THIS SECURITY MAY BE PLEDGED IN CONNECTION WITH A BONA FIDE MARGIN ACCOUNT OR OTHER LOAN SECURED BY SUCH SECURITIES.

The Company acknowledges and agrees that a Purchaser may from time to time pledge pursuant to a bona fide margin agreement with a registered broker-dealer or grant a security interest in some or all of the Securities to a financial institution that is an “accredited investor” as defined in Rule 501(a) under the Securities Act and who agrees to be bound by the provisions of this Agreement and, if required under the terms of such arrangement, such Purchaser may transfer pledged or secured Securities to the pledgees or secured parties. Such a pledge or transfer would not be subject to approval of the Company and no legal opinion of legal counsel of the pledgee, secured party or pledgor shall be required in connection therewith. Further, no notice shall be required of such pledge. At the appropriate Purchaser’s expense, the Company will execute and deliver such reasonable documentation as a pledgee or secured party of Securities may reasonably request in connection with a pledge or transfer of the Securities.

(c) Certificates evidencing the Underlying Shares shall not contain any legend (including the legend set forth in Section 4.1(b) hereof): (i) while a registration statement (including the Registration Statement) covering the resale of such security is effective under the Securities Act, or (ii) following any sale of such Underlying Shares pursuant to Rule 144, or (iii) if such Underlying Shares are eligible for sale under Rule 144(k), or (iv) if such legend is not required under applicable requirements of the Securities Act (including judicial interpretations and pronouncements issued by the staff of the Commission). The Company shall cause its counsel to issue a legal opinion to the Transfer Agent promptly after the Effective Date if required by the Transfer Agent to effect the removal of the legend hereunder. If all or any shares of Preferred Stock or any portion of a Warrant is converted or exercised (as applicable) at a time when there is an effective registration statement to cover the resale of the Underlying Shares, or if such Underlying Shares may be sold under Rule 144(k) or if such legend is not otherwise required under applicable requirements of the Securities Act (including judicial interpretations and pronouncements issued by the staff of the Commission) then such Underlying Shares shall be issued free of all legends. The Company agrees that following the Effective Date or at such time as such legend is no longer required under this Section 4.1(c), it will, no later than three Trading Days following the delivery by a Purchaser to the Company or the Transfer Agent of a certificate representing Underlying Shares, as applicable, issued with a restrictive legend (such third Trading Day, the “ Legend Removal Date ”), deliver or cause to be delivered to such Purchaser a certificate representing such shares that is free from all restrictive and other legends. The Company may not make any notation on its records or give instructions to any transfer agent of the Company that enlarge the restrictions on transfer set forth in this Section. Certificates for Underlying Shares subject to legend removal hereunder shall be transmitted by the Transfer Agent to the Purchasers by crediting the account of the Purchaser’s prime broker with the Depository Trust Company System.

(d) [RESERVED]

(e) Each Purchaser, severally and not jointly with the other Purchasers, agrees that the removal of the restrictive legend from certificates representing Securities as set forth in this Section 4.1 is predicated upon the Company’s reliance that the Purchaser will sell any Securities pursuant to either the registration requirements of the Securities Act, including any applicable prospectus delivery requirements, or an exemption therefrom, and that if Securities are sold pursuant to a Registration Statement, they will be sold in compliance with the plan of distribution set forth therein.

4.2 Acknowledgment of Dilution . The Company acknowledges that the issuance of the Securities may result in dilution of the outstanding shares of Common Stock, which dilution may be substantial under certain market conditions. The Company further acknowledges that its obligations under the Transaction Documents, including without limitation its obligation to issue the Underlying Shares pursuant to the Transaction Documents, are unconditional and absolute and not subject to any right of set off, counterclaim, delay or reduction, regardless of the effect of any such dilution or any claim the Company may have against any Purchaser and regardless of the dilutive effect that such issuance may have on the ownership of the other stockholders of the Company.

4.3 Furnishing of Information . As long as any Purchaser owns Securities, the Company covenants to timely file (or obtain extensions in respect thereof and file within the applicable grace period) all reports required to be filed by the Company after the date hereof pursuant to the Exchange Act. As long as any Purchaser owns Securities, if the Company is not required to file reports pursuant to the Exchange Act, it will prepare and furnish to the Purchasers and make publicly available in accordance with Rule 144(c) such information as is required for the Purchasers to sell the Securities under Rule 144. The Company further covenants that it will take such further action as any holder of Securities may reasonably request, to the extent required from time to time to enable such Person to sell such Securities without registration under the Securities Act within the requirements of the exemption provided by Rule 144.

4.4 Integration . The Company shall not sell, offer for sale or solicit offers to buy or otherwise negotiate in respect of any security (as defined in Section 2 of the Securities Act) that would be integrated with the offer or sale of the Securities in a manner that would require the registration under the Securities Act of the sale of the Securities to the Purchasers or that would be integrated with the offer or sale of the Securities for purposes of the rules and regulations of any Trading Market.

4.5 Conversion and Exercise Procedures . The form of Notice of Exercise included in the Warrants and the form of Notice of Conversion included in the Certificate of Designation set forth the totality of the procedures required of the Purchasers in order to exercise the Warrants or convert the Preferred Stock. No additional legal opinion or other information or instructions shall be required of the Purchasers to exercise their Warrants or convert their Preferred Stock. The Company shall honor exercises of the Warrants and conversions of the Preferred Stock and shall deliver Underlying Shares in accordance with the terms, conditions and time periods set forth in the Transaction Documents.

4.6 Securities Laws Disclosure ; Publicity . The Company shall within the time period required by the Exchange Act, issue a Current Report on Form 8-K, disclosing the material terms of the transactions contemplated hereby and filing the Transaction Documents as exhibits thereto. The Company and each Purchaser shall consult with each other in issuing any other press releases with respect to the transactions contemplated hereby, and neither the Company nor any Purchaser shall issue any such press release or otherwise make any such public statement without the prior consent of the Company, with respect to any press release of any Purchaser, or without the prior consent of each Purchaser, with respect to any press release of the Company, which consent shall not unreasonably be withheld or delayed, except if such disclosure is required by law, in which case the disclosing party shall promptly provide the other party with prior notice of such public statement or communication. Notwithstanding the foregoing, the Company shall not publicly disclose the name of any Purchaser, or include the name of any Purchaser in any filing with the Commission or any regulatory agency or Trading Market, without the prior written consent of such Purchaser, except (i) as required by federal securities law in connection with (A) any registration statement contemplated by the Company and (B) the filing of final Transaction Documents (including signature pages thereto) with the Commission and (ii) to the extent such disclosure is required by law or Trading Market regulations, in which case the Company shall provide the Purchasers with prior notice of such disclosure permitted under this subclause (ii).

4.7 Shareholder Rights Plan . No claim will be made or enforced by the Company or, with the consent of the Company, any other Person, that any Purchaser is an “Acquiring Person” under any control share acquisition, business combination, poison pill (including any distribution under a rights agreement) or similar anti-takeover plan or arrangement in effect or hereafter adopted by the Company, or that any Purchaser could be deemed to trigger the provisions of any such plan or arrangement, solely by virtue of receiving Securities under the Transaction Documents.

4.8 Non-Public Information . Except with respect to the material terms and conditions of the transactions contemplated by the Transaction Documents, the Company covenants and agrees that neither it nor any other Person acting on its behalf will provide any Purchaser or its agents or counsel with any information that the Company believes constitutes material non-public information, unless prior thereto such Purchaser shall have executed a written agreement regarding the confidentiality and use of such information. The Company understands and confirms that each Purchaser shall be relying on the foregoing representations in effecting transactions in securities of the Company.

4.9 Use of Proceeds . Except as set forth on Schedule 4.9 attached hereto, the Company shall use the net proceeds from the sale of the Securities hereunder for working capital purposes, and shall not use such proceeds to redeem any Common Stock, or Common Stock Equivalents or to settle any outstanding litigation.

4.10 [RESERVED]

4.11 Indemnification of Purchasers . Subject to the provisions of this Section 4.11, the Company will indemnify and hold each Purchaser and its directors, officers, shareholders, members, partners, employees and agents (and any other Persons with a functionally equivalent role of a Person holding such titles notwithstanding a lack of such title or any other title), each Person who controls such Purchaser (within the meaning of Section 15 of the Securities Act and Section 20 of the Exchange Act), and the directors, officers, shareholders, agents, members, partners or employees (and any other Persons with a functionally equivalent role of a Person holding such titles notwithstanding a lack of such title or any other title) of such controlling persons (each, a “ Purchaser Party ”) harmless from any and all losses, liabilities, obligations, claims, contingencies, damages, costs and expenses, including all judgments, amounts paid in settlements, court costs and reasonable attorneys’ fees and costs of investigation that any such Purchaser Party may suffer or incur as a result of or relating to (a) any breach of any of the representations, warranties, covenants or agreements made by the Company in this Agreement or in the other Transaction Documents or (b) any action instituted against a Purchaser, or any of them or their respective Affiliates, by any stockholder of the Company who is not an Affiliate of such Purchaser, with respect to any of the transactions contemplated by the Transaction Documents (unless such action is based upon a breach of such Purchaser’s representations, warranties or covenants under the Transaction Documents or any agreements or understandings such Purchaser may have with any such stockholder or any violations by the Purchaser of state or federal securities laws or any conduct by such Purchaser which constitutes fraud, gross negligence, willful misconduct or malfeasance). If any action shall be brought against any Purchaser Party in respect of which indemnity may be sought pursuant to this Agreement, such Purchaser Party shall promptly notify the Company in writing, and the Company shall have the right to assume the defense thereof with counsel of its own choosing reasonably acceptable to the Purchaser Party. Any Purchaser Party shall have the right to employ separate counsel in any such action and participate in the defense thereof, but the fees and expenses of such counsel shall be at the expense of such Purchaser Party except to the extent that (i) the employment thereof has been specifically authorized by the Company in writing, (ii) the Company has failed after a reasonable period of time to assume such defense and to employ counsel or (iii) in such action there is, in the reasonable opinion of such separate counsel, a material conflict on any material issue between the position of the Company and the position of such Purchaser Party, in which case the Company shall be responsible for the reasonable fees and expenses of no more than one such separate counsel. The Company will not be liable to any Purchaser Party under this Agreement (i) for any settlement by a Purchaser Party effected without the Company’s prior written consent, which shall not be unreasonably withheld or delayed; or (ii) to the extent, but only to the extent that a loss, claim, damage or liability is attributable to any Purchaser Party’s breach of any of the representations, warranties, covenants or agreements made by such Purchaser Party in this Agreement or in the other Transaction Documents.

4.12 Reservation and Listing of Securities.

(a) The Company shall maintain a reserve from its duly authorized shares of Common Stock for issuance pursuant to the Transaction Documents in such amount as may be required to fulfill its obligations in full under the Transaction Documents.

(b) The Company shall, if applicable: (i) in the time and manner required by the principal Trading Market, prepare and file with such Trading Market an additional shares listing application covering a number of shares of Common Stock at least equal to the Required Minimum on the date of such application, (ii) take all steps necessary to cause such shares of Common Stock to be approved for listing on such Trading Market as soon as possible thereafter, (iii) provide to the Purchasers evidence of such listing, and (iv) maintain the listing of such Common Stock on any date at least equal to the Required Minimum on such date on such Trading Market or another Trading Market.

4.13 [RESERVED]

4.14 [RESERVED]

4.15 Equal Treatment of Purchasers . No consideration shall be offered or paid to any Person to amend or consent to a waiver or modification of any provision of any of the Transaction Documents unless the same consideration is also offered to all of the parties to the Transaction Documents. For clarification purposes, this provision constitutes a separate right granted to each Purchaser by the Company and negotiated separately by each Purchaser, and is intended for the Company to treat the Purchasers as a class and shall not in any way be construed as the Purchasers acting in concert or as a group with respect to the purchase, disposition or voting of Securities or otherwise.

4.16 Short Sales and Confidentiality After The Date Hereof . Each Purchaser severally and not jointly with the other Purchasers covenants that neither it nor any Affiliate acting on its behalf or pursuant to any understanding with it will execute any Short Sales during the period commencing at the Discussion Time and ending at the time that the transactions contemplated by this Agreement are first publicly announced as described in Section 4.6. Each Purchaser, severally and not jointly with the other Purchasers, covenants that until such time as the transactions contemplated by this Agreement are publicly disclosed by the Company as described in Section 4.6, such Purchaser will maintain the confidentiality of all disclosures made to it in connection with this transaction (including the existence and terms of this transaction). Each Purchaser understands and acknowledges, severally and not jointly with any other Purchaser, that the Commission currently takes the position that coverage of short sales of shares of the Common Stock “against the box” prior to the Effective Date of the Registration Statement with the Securities is a violation of Section 5 of the Securities Act, as set forth in Item 65, Section A, of the Manual of Publicly Available Telephone Interpretations, dated July 1997, compiled by the Office of Chief Counsel, Division of Corporation Finance. Notwithstanding the foregoing, no Purchaser makes any representation, warranty or covenant hereby that it will not engage in Short Sales in the securities of the Company after the time that the transactions contemplated by this Agreement are first publicly announced as described in Section 4.6. Notwithstanding the foregoing, in the case of a Purchaser that is a multi-managed investment vehicle whereby separate portfolio managers manage separate portions of such Purchaser's assets and the portfolio managers have no direct knowledge of the investment decisions made by the portfolio managers managing other portions of such Purchaser's assets, the covenant set forth above shall only apply with respect to the portion of assets managed by the portfolio manager that made the investment decision to purchase the Securities covered by this Agreement.

4.17 Form D; Blue Sky Filings . The Company agrees to timely file a Form D with respect to the Securities as required under Regulation D and to provide a copy thereof, promptly upon request of any Purchaser. The Company shall take such action as the Company shall reasonably determine is necessary in order to obtain an exemption for, or to qualify the Securities for, sale to the Purchasers at the Closing under applicable securities or “Blue Sky” laws of the states of the United States, and shall provide evidence of such actions promptly upon request of any Purchaser.

ARTICLE V

MISCELLANEOUS

5.1 Termination . This Agreement may be terminated by any Purchaser, as to such Purchaser’s obligations hereunder only and without any effect whatsoever on the obligations between the Company and the other Purchasers, by written notice to the other parties, if the Closing has not been consummated on or before September 15, 2008; provided , however , that no such termination will affect the right of any party to sue for any breach by the other party (or parties). The Agreement may be terminated by the Company at any time and with respect to one or more Purchasers at any time and without any obligation to any Purchaser at any time prior to the Closing Date.

5.2 Fees and Expenses . The Company shall deliver to each Purchaser, prior to the Closing, a completed and executed copy of the Closing Statement, attached hereto as Annex A . Except as expressly set forth in the Transaction Documents to the contrary, each party shall pay the fees and expenses of its advisers, counsel, accountants and other experts, if any, and all other expenses incurred by such party incident to the negotiation, preparation, execution, delivery and performance of this Agreement. The Company shall pay all Transfer Agent fees, stamp taxes and other taxes and duties levied in connection with the delivery of any Securities to the Purchasers.

5.3 Entire Agreement . The Transaction Documents, together with the exhibits and schedules thereto, contain the entire understanding of the parties with respect to the subject matter hereof and supersede all prior agreements and understandings, oral or written, with respect to such matters, which the parties acknowledge have been merged into such documents, exhibits and schedules.

5.4 Notices . Any and all notices or other communications or deliveries required or permitted to be provided hereunder shall be in writing and shall be deemed given and effective on the earliest of (a) the date of transmission, if such notice or communication is delivered via facsimile at the facsimile number set forth on the signature pages attached hereto prior to 5:30 p.m. (New York City time) on a Trading Day, (b) the next Trading Day after the date of transmission, if such notice or communication is delivered via facsimile at the facsimile number set forth on the signature pages attached hereto on a day that is not a Trading Day or later than 5:30 p.m. (New York City time) on any Trading Day, (c) the 2 nd Trading Day following the date of mailing, if sent by U.S. nationally recognized overnight courier service, or (d) upon actual receipt by the party to whom such notice is required to be given. The address for such notices and communications shall be as set forth on the signature pages attached hereto.

5.5 Amendments; Waivers . No provision of this Agreement may be waived, modified, supplemented or amended except in a written instrument signed, in the case of an amendment, by the Company and each Purchaser or, in the case of a waiver, by the party against whom enforcement of any such waived provision is sought. No waiver of any default with respect to any provision, condition or requirement of this Agreement shall be deemed to be a continuing waiver in the future or a waiver of any subsequent default or a waiver of any other provision, condition or requirement hereof, nor shall any delay or omission of any party to exercise any right hereunder in any manner impair the exercise of any such right.

5.6 Headings . The headings herein are for convenience only, do not constitute a part of this Agreement and shall not be deemed to limit or affect any of the provisions hereof.

5.7 Successors and Assigns . This Agreement shall be binding upon and inure to the benefit of the parties and their successors and permitted assigns. The Company may not assign this Agreement or any rights or obligations hereunder without the prior written consent of each Purchaser (other than by merger). Any Purchaser may assign any or all of its rights under this Agreement to any Person to whom such Purchaser assigns or transfers any Securities, provided such transferee agrees in writing to be bound, with respect to the transferred Securities, by the provisions of the Transaction Documents that apply to the “Purchasers”.

5.8 No Third-Party Beneficiaries . This Agreement is intended for the benefit of the parties hereto and their respective successors and permitted assigns and is not for the benefit of, nor may any provision hereof be enforced by, any other Person, except as otherwise set forth in Section 4.11.

5.9 Governing Law . All questions concerning the construction, validity, enforcement and interpretation of the Transaction Documents shall be governed by and construed and enforced in accordance with the internal laws of the State of California, without regard to the principles of conflicts of law thereof. Each party agrees that all legal proceedings concerning the interpretations, enforcement and defense of the transactions contemplated by this Agreement and any other Transaction Documents (whether brought against a party hereto or its respective affiliates, directors, officers, shareholders, employees or agents) shall be commenced exclusively in the state and federal courts sitting in the City of San Diego. Each party hereby irrevocably submits to the exclusive jurisdiction of the state and federal courts sitting in the City of San Diego for the adjudication of any dispute hereunder or in connection herewith or with any transaction contemplated hereby or discussed herein (including with respect to the enforcement of any of the Transaction Documents), and hereby irrevocably waives, and agrees not to assert in any suit, action or proceeding, any claim that it is not personally subject to the jurisdiction of any such court, that such suit, action or proceeding is improper or is an inconvenient venue for such proceeding. Each party hereby irrevocably waives personal service of process and consents to process being served in any such suit, action or proceeding by mailing a copy thereof via registered or certified mail or overnight delivery (with evidence of delivery) to such party at the address in effect for notices to it under this Agreement and agrees that such service shall constitute good and sufficient service of process and notice thereof. Nothing contained herein shall be deemed to limit in any way any right to serve process in any other manner permitted by law. The parties hereby waive all rights to a trial by jury. If either party shall commence an action or proceeding to enforce any provisions of the Transaction Documents, then the prevailing party in such action or proceeding shall be reimbursed by the other party for its reasonable attorneys’ fees and other costs and expenses incurred with the investigation, preparation and prosecution of such action or proceeding.

5.10 Survival . The representations and warranties contained herein shall survive the Closing and the delivery of Securities for the applicable statue of limitations.

5.11 Execution . This Agreement may be executed in two or more counterparts, all of which when taken together shall be considered one and the same agreement and shall become effective when counterparts have been signed by each party and delivered to the other party, it being understood that both parties need not sign the same counterpart. In the event that any signature is delivered by facsimile transmission or by e-mail delivery of a “.pdf” format data file, such signature shall create a valid and binding obligation of the party executing (or on whose behalf such signature is executed) with the same force and effect as if such facsimile or “.pdf” signature page were an original thereof.

5.12 Severability . If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction to be invalid, illegal, void or unenforceable, the remainder of the terms, provisions, covenants and restrictions set forth herein shall remain in full force and effect and shall in no way be affected, impaired or invalidated, and the parties hereto shall use their commercially reasonable efforts to find and employ an alternative means to achieve the same or substantially the same result as that contemplated by such term, provision, covenant or restriction. It is hereby stipulated and declared to be the intention of the parties that they would have executed the remaining terms, provisions, covenants and restrictions without including any of such that may be hereafter declared invalid, illegal, void or unenforceable.

5.13 Rescission and Withdrawal Right . Notwithstanding anything to the contrary contained in (and without limiting any similar provisions of) any of the other Transaction Documents, whenever any Purchaser exercises a right, election, demand or option under a Transaction Document and the Company does not timely perform its related obligations within the periods therein provided, then such Purchaser may rescind or withdraw, in its sole discretion from time to time upon written notice to the Company, any relevant notice, demand or election in whole or in part without prejudice to its future actions and rights; provided , however , in the case of a rescission of a conversion of the Preferred Stock or exercise of a Warrant, the Purchaser shall be required to return any shares of Common Stock subject to any such rescinded conversion or exercise notice.

5.14 Replacement of Securities . If any certificate or instrument evidencing any Securities is mutilated, lost, stolen or destroyed, the Company shall issue or cause to be issued in exchange and substitution for and upon cancellation thereof (in the case of mutilation), or in lieu of and substitution therefor, a new certificate or instrument, but only upon receipt of evidence reasonably satisfactory to the Company of such loss, theft or destruction. The applicant for a new certificate or instrument under such circumstances shall also pay any reasonable third-party costs (including customary indemnity) associated with the issuance of such replacement Securities.

5.15 Remedies . In addition to being entitled to exercise all rights provided herein or granted by law, including recovery of damages, each of the Purchasers and the Company will be entitled to specific performance under the Transaction Documents. The parties agree that monetary damages may not be adequate compensation for any loss incurred by reason of any breach of obligations contained in the Transaction Documents and hereby agrees to waive and not to assert in any action for specific performance of any such obligation the defense that a remedy at law would be adequate.

5.16 Usury . To the extent it may lawfully do so, the Company hereby agrees not to insist upon or plead or in any manner whatsoever claim, and will resist any and all efforts to be compelled to take the benefit or advantage of, usury laws wherever enacted, now or at any time hereafter in force, in connection with any claim, action or proceeding that may be brought by any Purchaser in order to enforce any right or remedy under any Transaction Document. Notwithstanding any provision to the contrary contained in any Transaction Document, it is expressly agreed and provided that the total liability of the Company under the Transaction Documents for payments in the nature of interest shall not exceed the maximum lawful rate authorized under applicable law (the “ Maximum Rate ”), and, without limiting the foregoing, in no event shall any rate of interest or default interest, or both of them, when aggregated with any other sums in the nature of interest that the Company may be obligated to pay under the Transaction Documents exceed such Maximum Rate. It is agreed that if the maximum contract rate of interest allowed by law and applicable to the Transaction Documents is increased or decreased by statute or any official governmental action subsequent to the date hereof, the new maximum contract rate of interest allowed by law will be the Maximum Rate applicable to the Transaction Documents from the effective date forward, unless such application is precluded by applicable law.

5.17 Independent Nature of Purchasers’ Obligations and Rights . The obligations of each Purchaser under any Transaction Document are several and not joint with the obligations of any other Purchaser, and no Purchaser shall be responsible in any way for the performance or non-performance of the obligations of any other Purchaser under any Transaction Document. Nothing contained herein or in any other Transaction Document, and no action taken by any Purchaser pursuant thereto, shall be deemed to constitute the Purchasers as a partnership, an association, a joint venture or any other kind of entity, or create a presumption that the Purchasers are in any way acting in concert or as a group with respect to such obligations or the transactions contemplated by the Transaction Documents. Each Purchaser shall be entitled to independently protect and enforce its rights, including without limitation, the rights arising out of this Agreement or out of the other Transaction Documents, and it shall not be necessary for any other Purchaser to be joined as an additional party in any proceeding for such purpose. Each Purchaser has been represented by, or had the opportunity to consult with, its own separate legal counsel in their review and negotiation of the Transaction Documents. The Company has elected to provide all Purchasers with the same terms and Transaction Documents for the convenience of the Company and not because it was required or requested to do so by the Purchasers.

5.18 Liquidated Damages . The Company’s obligations to pay any partial liquidated damages or other amounts owing under the Transaction Documents is a continuing obligation of the Company and shall not terminate until all unpaid partial liquidated damages and other amounts have been paid notwithstanding the fact that the instrument or security pursuant to which such partial liquidated damages or other amounts are due and payable shall have been canceled.

5.19 Construction . The parties agree that each of them and/or their respective counsel has reviewed and had an opportunity to revise the Transaction Documents and, therefore, the normal rule of construction to the effect that any ambiguities are to be resolved against the drafting party shall not be employed in the interpretation of the Transaction Documents or any amendments hereto.

[SIGNATURE PAGES FOLLOWS]

IN WITNESS WHEREOF, the parties hereto have caused this Securities Purchase Agreement to be duly executed by their respective authorized signatories as of the date first indicated above.

IMAGEWARE SYSTEMS, INC.	Address for Notice :
By:__________________________________________ Name: Title:	10883 Thornmint Road San Diego, CA 92127 Facsimile: 858 673 0291 Attention: Wayne Wetherell

[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK

SIGNATURE PAGE FOR PURCHASER FOLLOWS]

[PURCHASER SIGNATURE PAGES TO IW SECURITIES PURCHASE AGREEMENT]

IN WITNESS WHEREOF, the undersigned have caused this Securities Purchase Agreement to be duly executed by their respective authorized signatories as of the date first indicated above.

Name of Purchaser: ____________________________________________________

Signature of Authorized Signatory of Purchaser : __________________________

Name of Authorized Signatory: ____________________________________

Title of Authorized Signatory: _____________________________________

Email Address of Authorized Signatory: ___________________________________________

Fax Number of Authorized Signatory: _________________________________________

Address for Notice of Purchaser:

Address for Delivery of Securities for Purchaser (if not same as above):

Subscription Amount: $____________

Shares of Preferred Stock: ____________

Warrant Shares: ________________

EIN Number:

[SIGNATURE PAGES CONTINUE]

Annex A

CLOSING STATEMENT

Pursuant to the attached Securities Purchase Agreement, dated as of the date hereto, the purchasers shall purchase up to $1,500,000 of Preferred Stock and Warrants from ImageWare Systems, Inc., a Delaware corporation (the “ Company ”). All funds will be wired directly to the Company. All funds will be disbursed in accordance with this Closing Statement.

Disbursement Date: August _____ , 2008

I. PURCHASE PRICE
	Gross Proceeds to be Received in Trust	$

II. DISBURSEMENTS
		$
		$
		$
		$
		$

Total Amount Disbursed:		$



WIRE INSTRUCTIONS :
To: _____________________________________
To: _____________________________________

Delaware		33-0224167
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

10883 Thornmint Road, San Diego, California		92127
(Address of Principal Executive Offices)		(Zip Code)

Title of Each Class		Name of Each Exchange on Which Registered
Common Stock, $0.01 par value		N/A
Warrants to Purchase Common Stock		N/A

PART I		3

Item 1.	Business	3

Item 1A.	Risk Factors	14

Item 1B.	Unresolved Staff Comments	22

Item 2.	Properties	22

Item 3.	Legal Proceedings	22

Item 4.	Submission of Matters to a Vote of Security Holders	22

PART II		22

Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	22

Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24

Item 8.	Consolidated Financial Statements and Supplementary Data	34

Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	34

Item 9A.	Controls and Procedures	34

Item 9B.	Other Information	35

PART III		36

Item 10.	Directors, Executive Officers and Corporate Governance	36

Item 11.	Executive Compensation	38

Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	48

Item 13.	Certain Relationships and Related Transactions	50

Item 14.	Principal Accountant Fees and Services	52

PART IV		53

Item 15.	Exhibits and Financial Statement Schedules	53

Exhibit Index		54

Signatures		57

Index to Consolidated Financial Statements		58

2008 Fiscal Quarters	High		Low
First Quarter	$	1.610	$	0.950
Second Quarter	$	1.150	$	0.250
Third Quarter	$	0.800	$	0.340
Fourth Quarter	$	0.480	$	0.050

2007 Fiscal Quarters	High		Low
First Quarter	$	2.810	$	1.450
Second Quarter	$	2.740	$	1.450
Third Quarter	$	2.180	$	1.400
Fourth Quarter	$	2.000	$	1.400

	TWELVE MONTHS ENDED
	DECEMBER 31,
($ in thousands)	2008			Change		2007

Product revenues:
Software and Royalties	$	2,362		-52	%	$	4,966
Percentage of total net product revenue	64		%	-24	%	88		%
Hardware and consumables	$	171		-51	%	$	350
Percentage of total net product revenue	5		%	-2	%	6		%
Services	$	1,174		250	%	$	336
Percentage of total net product revenue	31		%	25	%	6		%
Total net product revenues	$	3,707		-34	%	$	5,652

Name	Age	Principal Occupation/Position Held With the Company
Mr. S. James Miller, Jr.	56	Chief Executive Officer and Chairman of the Board of Directors
Mr. John Callan	63	Director
Mr. David Carey	65	Director
Mr. Guy Steven Hamm	62	Director
Mr. John Holleran	83	Director
Mr. David Loesch	65	Director

Name	Age	Principal Position(s) Held With the Company
Mr. Wayne Wetherell	57	Sr. Vice President, Administration, Chief Financial Officer, Secretary and Treasurer
Mr. Charles AuBuchon	66	Vice President, Business Development
Mr. David Harding	40	Vice President and Chief Technical Officer

				Stock			Option			All Other
Name and Principal Position	Year	Salary		Awards			Awards(1)(2)			Compensation			Total

S. James Miller, Jr. Chairman of the Board and Chief Executive Officer	2008	$	308,988	$	64,718	(3)	$	109,026	(5)	$	12,448	(4)	$	495,180
	2007		314,791		126,119	(3)		52,325	(5)		12,244	(6)		505,479

Wayne G. Wetherell Senior Vice President Administration, Chief Financial Officer, Secretary, and Treasurer	2008		183,160		31,032	(7)		62,966	(5)		10,324	(8)		287,482
	2007		186,631		67,136	(7)		35,588	(5)		10,019	(9)		299,374

Charles AuBuchon Vice President Business Development	2008		152,600		—			89,603	(5)		—			242,203
	2007		155,581		—			62,439	(5)		—			218,020

David Harding Vice President and Chief Technical Officer	2008		185,029		—			62,482	(5)		—			248,511
	2007		182,132		—			48,251	(5)		—			230,383

(1)		All option awards were granted under the 1999 Plan.

(2)		The amounts reflect the dollar amount recognized for financial statement reporting purposes for the fiscal year ended December 31, 2008, in accordance with the provisions of SFAS 123R and thus may include amounts from awards granted prior to 2008. We have elected to use the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life, and interest rates. We are required to make various assumptions in the application of the Black-Scholes option pricing model and have determined that the best measure of expected volatility is based on the historical weekly volatility of our common stock. Historical volatility factors utilized in our Black-Scholes computations range from 64.4% to 98.5%. We have elected to estimate the expected life of an award based upon the SEC approved “simplified method” noted under the provisions of Staff Accounting Bulletin No. 107. Under this formula, the expected term is equal to: ((weighted-average vesting term + original contractual term)/2). The expected term used by us as computed by this method ranges from 3.5 years to 6.1 years. The interest rate used is the risk free interest rate and is based upon U.S. Treasury rates appropriate for the expected term. Interest rates used in our Black-Scholes calculations range from 2.7% to 4.6%. Dividend yield is zero as we do not expect to declare any dividends on our common shares in the foreseeable future. In addition to the key assumptions used in the Black-Scholes model, the estimated forfeiture rate at the time of valuation is a critical assumption. We have estimated an annualized forfeiture rate of 10% for corporate officers, 4% for members of the Board of Directors and 24% for all other employees. We review the expected forfeiture rate annually to determine if that percent is still reasonable based on historical experience.

(3)		Represents the quarterly vesting of 124,162 restricted shares granted on March 30, 2004, and the vesting of 109,700 restricted shares granted on September 27, 2005 for Mr. Miller. The restricted shares granted in September 2005 vest one-third after one year with the remainder vesting ratably on a quarterly basis over two years ending September 27, 2008.

(4)		Consists of $9,200 in 401(K) matching contributions, $1,248 in life insurance premiums and $2,000 in club membership.

(5)		The amounts reflect the dollar amount recognized for financial statement reporting purposes for the fiscal year ended December 31, 2007, in accordance with the provisions of SFAS 123R and thus may include amounts from awards granted prior to 2007. Assumptions used in the calculation of these amounts are included in Notes to the Consolidated Financial Statements for the fiscal year ended December 31, 2007, included in our annual report on Form 10-K filed with the SEC on April 15, 2008.

(6)		Consists of $9,000 in 401(K) matching contributions, $1,244 in life insurance premiums and $2,000 in club membership.

(7)		Represents the quarterly vesting of 80,281 restricted shares granted on March 30, 2004 and the vesting of 52,600 restricted shares granted on September 27, 2005. The restricted shares granted in September 2005 vest one-third after one year with the remainder vesting ratably on a quarterly basis over two years ending September 27, 2008.

(8)		Consists of $7,466 in 401(K) matching contributions, $858 in life insurance premiums and $2,000 in club membership.

(9)		Consists of $7,221 in 401(K) matching contributions, $798 in life insurance premiums and $2,000 in club membership.

	Option Awards
	Number of			Number of
	Securities			Securities
	Underlying			Underlying
	Unexercised			Unexercised
	Unearned			Unearned		Option
	Options:			Options:		Exercise		Option
	#			#		Price		Expiration
Name	Exercisable			Unexercisable		($)		Date
S. James Miller, Jr.		75,000			—	$	3.00	9/12/2011
		25,000			—	$	1.97	5/28/2013
		100,000			—	$	2.40	10/28/2014
		100,000			—	$	2.62	8/16/2015
		109,700			—	$	2.36	9/27/2015
		9,000	(1)		9,000	$	2.49	4/3/2017
		—	(4)		100,000	$	1.45	1/2/2018

Wayne G. Wetherell		25,000			—	$	3.00	9/12/2011
		10,000			—	$	1.97	5/28/2013
		50,000			—	$	2.40	10/28/2014
		60,000			—	$	2.62	8/16/2015
		52,600			—	$	2.36	9/27/2015
		7,500	(1)		7,500	$	2.49	4/3/2017
		—	(4)		60,000	$	1.45	1/2/2018

Charles AuBuchon		10,000			—	$	3.00	9/12/2011
		40,000			—	$	2.30	10/15/2014
		30,000			—	$	3.19	4/1/2015
		60,000			—	$	2.62	8/16/2015
		55,000	(2)		5,000	$	1.99	1/13/2016
		5,002	(1)		4,998	$	2.49	4/3/2017
		—	(4)		50,000	$	1.45	1/2/2018

David Harding		91,675	(3)		8,325	$	1.65	1/31/2016
		12,550	(1)		12,450	$	2.49	4/3/2017
		—	(4)		50,000	$	1.45	1/2/2018

(1)		These options vest over three years with one third vesting 4/2/2008 and the remainder vesting in equal quarterly installments thereafter.
(2)		These options vest over three years with one third vesting 1/13/2007 and the remainder vesting in equal quarterly installments thereafter.
(3)		These options vest over three years with one third vesting 1/31/2007 and the remainder vesting in equal quarterly installments thereafter.
(4)		These options vest over three years with one third vesting 1/02/2009 and the remainder vesting in equal quarterly installments thereafter.

	Stock Awards
	Number of
	Shares		Value
	Acquired on		Realized
Name	Vesting		on Vesting

S. James Miller, Jr.(1)		27,423	$	21,299

Wayne G. Wetherell(2)		13,149		10,212

(1)		Represents the quarterly vesting of 109,700 restricted shares granted on September 27, 2005. The restricted shares granted in September 2005 vest one-third after one year with the remainder vesting ratably on a quarterly basis over two years ending September 27, 2008.

(2)		Represents the quarterly vesting of 52,600 restricted shares granted on September 27, 2005. The restricted shares granted in September 2005 vest one-third after one year with the remainder vesting ratably on a quarterly basis over two years ending September 27, 2008.

			Involuntary
Executive Benefits and Payments	Voluntary		Not for Cause			Change in
Upon Termination(1)	Termination		Termination			Control

Cash	$	—	$	662,856	(2)	$	662,856	(2)
Equity	$	—	$	—	(3)(4)	$	—	(3)(4)
Fringe Benefits	$	—	$	72,634	(5)	$	72,634	(5)

(1)		For purposes of this analysis, we assumed Mr. Miller’s compensation is based on his current base salary of $331,428.

(2)		Mr. Miller’s cash severance benefit under an involuntary, good reason termination or a termination due to a change in control is equal to two times annual compensation.

(3)		Mr. Miller’s equity severance benefit under an involuntary or good reason termination is the immediate vesting of 50% of Mr. Miller’s outstanding stock options and restricted stock awards. In the event that Mr. Miller’s employment is terminated within six months prior to or thirteen months following a change in control, Mr. Miller is entitled to the immediate vesting of 100% of Mr. Miller’s outstanding stock options and restricted stock awards.

(4)		This amount was calculated from the unexercisable stock options and unvested stock awards held by Mr. Miller on December 31, 2008. The stock option award amount was calculated by multiplying the number of securities underlying the unexercisable options by the difference between the option price and the price per share of common stock on the date of termination. The unvested stock award amount was calculated by multiplying the number of unvested shares of stock by the price per share on the date of termination.

(5)		Mr. Miller’s fringe benefits consist of medical and life insurance for a period of three years.

(1)		For purposes of this analysis, we assumed Mr. Wetherell’s compensation is based on his current base salary of $198,291.

(2)		Mr. Wetherell’s cash severance benefit under an involuntary, good reason termination or a termination due to a change in control is equal to the amount of his annual compensation.

(3)		Mr. Wetherell’s equity severance benefit under an involuntary or good reason termination is the immediate vesting of 50% of Mr. Wetherell’s outstanding stock options and restricted stock awards. In the event that Mr. Wetherell’s employment is terminated within six months prior to or thirteen months following a change in control, Mr. Wetherell is entitled to the immediate vesting of 100% of Mr. Wetherell’s outstanding stock options and restricted stock awards.

(4)		This amount was calculated from the unexercisable stock options and unvested stock awards held by Mr. Wetherell on December 31, 2008. The stock option award amount was calculated by multiplying the number of securities underlying the unexercisable options by the difference between the option price and the price per share of common stock on the date of termination. The unvested stock award amount was calculated by multiplying the number of unvested shares of stock by the price per share on the date of termination.

(5)		Mr. Wetherell’s fringe benefits consist of medical and life insurance for a period of three years.

(1)		For purposes of this analysis, we assumed Mr. AuBuchon’s compensation is based on his current base salary of $165,000.

(2)		Mr. AuBuchon’s cash severance benefit under an involuntary, good reason termination or a termination due to a change in control is equal to six months of annual compensation.

(3)		Mr. AuBuchon’s fringe benefits consist of medical and life insurance for a period of six months.

(1)		For purposes of this analysis, we assumed Mr. Harding’s compensation is based on his current base salary of $191,000.

(2)		Mr. Harding’s cash severance benefit under an involuntary, good reason termination or a termination due to a change in control is equal to six months of annual compensation.

(3)		Mr. Harding’s fringe benefits consist of medical and life insurance for a period of six months.

Name (1)	Option Awards (number of shares)		Exercise Price Per Share		Fair Market Value on Option Grant Date (2)

John Callan		5,000	$	1.45	$	1.45

John Holleran		5,000		1.45		1.45

David Loesch		5,000		1.45		1.45

Guy Steve Hamm		5,000		1.45		1.45

David Carey		5,000		1.45		1.45

(1)		As of December 31, 2008, no options had been exercised by non-employee directors under any plans maintained by us.

(2)		The fair market value of the common stock underlying such options on the date of grant is based on the closing sales price reported for the date of each such grant.

Name and Principal Position	Fees Earned or Paid in Cash		Option Awards(1)(2)(3)		Total

John Callan	$	28,250	$	11,749	$	39,999

John Holleran		29,450		11,749		41,199

David Loesch		28,875		12,882		41,757

Guy Steven Hamm		31,125		6,609		37,734

David Carey		27,625		13,044		40,669

(1)		The grant date per share fair value of options issued to Messrs. Callan, Downs, Holleran, Loesch, Hamm and Carey in 2008 was $.94.

(2)		The amounts reflect the dollar amount recognized for financial statement reporting purposes for the fiscal year ended December 31, 2008, in accordance with the provisions of SFAS 123R and thus may include amounts from awards granted prior to 2008. We have elected to use the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life, and interest rates. We are required to make various assumptions in the application of the Black-Scholes option pricing model and have determined that the best measure of expected volatility is based on the historical weekly volatility of our common stock. Historical volatility factors utilized in our Black-Scholes computations range from 64.4% to 98.5%. We have elected to estimate the expected life of an award based upon the SEC approved “simplified method” noted under the provisions of Staff Accounting Bulletin No. 107. Under this formula, the expected term is equal to: ((weighted-average vesting term + original contractual term)/2). The expected term used by us as computed by this method ranges from 3.5 years to 6.1 years. The interest rate used is the risk free interest rate and is based upon U.S. Treasury rates appropriate for the expected term. Interest rates used in our Black-Scholes calculations range from 2.7% to 4.6%. Dividend yield is zero as we do not expect to declare any dividends on our common shares in the foreseeable future. In addition to the key assumptions used in the Black-Scholes model, the estimated forfeiture rate at the time of valuation is a critical assumption. We have estimated an annualized forfeiture rate of 10% for corporate officers, 4% for members of the Board of Directors and 24% for all other employees. We review the expected forfeiture rate annually to determine if that percent is still reasonable based on historical experience.

(3)		The aggregate number of stock option awards outstanding at the end of fiscal 2008 for each director was as follows: John Callan (42,535); John Holleran (40,261); David Loesch (47,000); Guy Steven Hamm (27,000); and David Carey (20,000).


Beneficial Ownership(1)
Name and Address of Beneficial Owner	Number of Shares		Percent of Class (2)
Directors and Named Executive Officers:
S. James Miller, Jr.(3)		913,150		4.1
John Callan(4)		77,193		*
David Carey(5)		33,672		*
G. Steve Hamm(6)		65,072		*
John Holleran(7)		26,491		*
David Loesch(8)		93,072		*
Wayne Wetherell(9)		346,200		1.6
Charles AuBuchon(10)		440,078		2.8
David Harding (11)		121,672		**
Total Shares Held By Directors and Executive Officers		2,116,600		9.3
5% Stockholders:
Gruber & McBaine Capital Management LLC 50 Osgood Place San Francisco, CA(12)		10,941,260		36.5
Bruce Toll (13)		8,539,851		27.9
Goldman Capital (14)		3,400,121		14.2

Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted- average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
	(a)		(b)		(c)
Equity compensation plans approved by security holders:
1994 Employee Stock Option Plan		24,250	$	2.15		—
1999 Stock Award Plan amended and restated as of June 7, 2005		1,378,495	$	2.19		1,035,208
Equity compensation plans not approved by security holders:
2001 Equity Incentive Plan		345,654	$	2.89		—
Total		1,748,399	$	2.33		1,035,208

	Fiscal Year Ended
	2008		2007
Audit Fees	$	195,642	$	150,892

Audit-Related Fees		11,422		28,682

Tax Fees		—		—

All Other Fees		26,224		22,821
Total Fees	$	233,288	$	202,395

Exhibit Number		Description
2.1		Stock Purchase Agreement, dated March 1, 2005, between the Registrant and Argus Solutions Ltd. (incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K, filed March 9, 2005).
2.2		Agreement and Plan of Merger, dated October 27, 2005 (incorporated by reference to Annex A to the Registrant’s Definitive Proxy Statement on Schedule 14A, filed November 15, 2005).
3.1		Certificate of Incorporation (incorporated by reference to Annex B to the Registrant’s Definitive Proxy Statement on Schedule 14A, filed November 15, 2005).
3.2		Bylaws (incorporated by reference to Annex C to the Registrant’s Definitive Proxy Statement on Schedule 14A, filed November 15, 2005).
3.3		Certificate of Designations of Preferences, Rights and Limitations of Series C 8% Convertible Preferred Stock dated November 2, 2006, as amended (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K, filed November 20, 2006).
3.4		Certificate of Designations of Preferences, Rights and Limitations of Series D 8% Convertible Preferred Stock dated March 8, 2007 (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K, filed March 15, 2007).
4.1		Warrant to Purchase Common Stock in favor of Imperial Bank, dated January 15, 1998 (incorporated by reference to Exhibit 10.42 to the Registrant’s Registration Statement on Form SB-2 (No. 333-93131), filed December 20, 1999, as amended).
4.2		Registration Rights Agreement, dated May 22, 2002, by and between the Registrant and Perseus 2000 L.L.C. (incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed May 24, 2002).
4.3		Warrant to Purchase Common Stock, dated June 13, 2003, issued by the Registrant to L.F. Global Holdings, LLC (incorporated by reference to Exhibit 10.5 to the Registrant’s Current Report on Form 8-K, filed June 20, 2003).
4.4		Form of Warrant dated November 24, 2003 (incorporated by reference to Exhibit 99.2 to the Registrant’s Current Report on Form 8-K, filed February 9, 2004).
4.5		Form of Registration Rights Agreement dated November 24, 2003 (incorporated by reference to Exhibit 99.3 to the Registrant’s Current Report on Form 8-K, filed February 9, 2004).
4.6		Form of Registration Rights Agreement dated March 13, 2003 (incorporated by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-QSB, filed May 15, 2003).
4.7		Form of Warrant dated January 29, 2004 (incorporated by reference to Exhibit 99.5 to the Registrant’s Current Report on Form 8-K, filed February 9, 2004).
4.8		Form of Registration Rights Agreement dated January 29, 2004 (incorporated by reference to Exhibit 99.8 to the Registrant’s Current Report on Form 8-K, filed February 9, 2004).
4.9		Form of Warrant dated July 22, 2005 and dated July 28, 2005 (incorporated by reference to Exhibit A to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed July 26, 2005).
4.10		Form of Warrant dated March 17, 2006 (incorporated by reference to Exhibit 4.1 to the Registrant’s Quarterly Report on Form 10-Q, filed May 22, 2006).
4.11		Registration Rights Agreement, dated November 14, 2006 by and among the Registrant and certain investors (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed November 20, 2006).
4.12		Form of Warrant to Purchase Common Stock dated November 14, 2006 (incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed November 20, 2006).
4.13		Registration Rights Agreement, dated March 9, 2007, by and among the Registrant and certain accredited investors (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed March 15, 2007).
4.14		Form of Warrant to Purchase Common Stock dated March 9, 2007 (incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed March 15, 2007).
4.15		Registration Rights Agreement, dated September 25, 2007, by and among the Registrant and certain accredited investors (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed September 26, 2007).
4.16		Form of Warrant to Purchase Common Stock dated September 25, 2007 (incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed September 26, 2007).

4.17		Registration Rights Agreement, dated December 19, 2007, by and among the Registrant, Sol Logic, and Wink Jones, as the representative of Sol Logic (incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K, filed December 21, 2007).
4.18		Amendment No. 1 to Registration Rights Agreement, dated March 28, 2008, by and among the Registrant, Sol Logic, and Wink Jones, as the representative of Sol Logic, and Wink Jones, as the representative of Sol Logic (incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K, filed April 1, 2008).
4.19		Form of Warrant to Purchase Common Stock dated September 5, 2008.
4.20		Form of Warrant to Purchase Common Stock dated November 14, 2008.
4.21		Registration Rights Agreement, dated February 12, 2009, between the Registrant and BET Funding, LLC.
4.22		Warrant to Purchase Common Stock, dated February 12, 2009, issued by the Registrant to BET Funding, LLC.
4.23		Warrant to Purchase Common Stock, dated June 9, 2009, issued by the Registrant to BET Funding, LLC.
4.24		Warrant to Purchase Common Stock, dated June 22 2009, issued by the Registrant to BET Funding, LLC.
4.25		Warrant to Purchase Common Stock, dated October 5 2009, issued by the Registrant to BET Funding, LLC.
10.1		Employment Agreement, dated September 27, 2005, between the Registrant and S. James Miller (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed September 30, 2005).
10.2		Employment Agreement, dated September 27, 2005, between the Registrant and Wayne G. Wetherell (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed September 30, 2005).
10.3		Change of Control and Severance Benefits Agreement, dated October 31, 2005, between Registrant and Charles Aubuchon (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed November 3, 2005).
10.4		Offer of Employment Letter Agreement, dated December 19, 2007, between the Registrant and Frank Mitchell (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed December 21, 2007).
10.5		Form of Indemnification Agreement entered into by the Registrant with its directors and executive officers (incorporated by reference to Exhibit 10.4 to the Registrant’s Registration Statement on Form SB-2 (No. 333-93131), filed December 20, 1999, as amended).
10.6		1994 Employee Stock Option Plan (incorporated by reference to Exhibit 10.6 to the Registrant’s Registration Statement on Form SB-2 (No. 333-93131), filed December 20, 1999, as amended).
10.7		1994 Nonqualified Stock Option Plan (incorporated by reference to Exhibit 10.7 to the Registrant’s Registration Statement on Form SB-2 (No. 333-93131), filed December 20, 1999, as amended).
10.8		Amended and Restated 1999 Stock Plan Award (incorporated by reference to Appendix B of the Registrant’s Definitive Proxy Statement on Schedule 14A, filed November 21, 2007).
10.9		Form of Stock Option Agreement (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed July 14, 2005).
10.10		2001 Equity Incentive Plan (incorporated by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-QSB, filed November 14, 2001).
10.11		Form of Restricted Stock Bonus Agreement (incorporated by reference to Exhibit 99.3 to the Registrant’s Registration Statement on Form S-8, filed November 27, 2001).
10.12		Form of Stock Option Agreement (incorporated by reference to Exhibit 99.2 to the Registrant’s Registration Statement on Form S-8, filed November 27, 2001).
10.13		Note and Warrant Purchase Agreement, dated May 22, 2002, by and between the Registrant and Perseus (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed May 24, 2002).
10.14		Form of Securities Purchase Agreement dated November 14, 2003 (incorporated by reference to Exhibit 99.1 to the Registrant’s Current Report on Form 8-K, filed February 9, 2004).
10.15		Form of Securities Purchase Agreement dated January 29, 2004 (incorporated by reference to Exhibit 99.4 to the Registrant’s Current Report on Form 8-K, filed February 9, 2004).
10.16		Offer of Restricted Stock in Exchange for Certain Stock Options Previously Granted — Offer Made to James Miller (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-QSB, filed August 16, 2004).
10.17		Offer of Restricted Stock in Exchange for Certain Stock Options Previously Granted — Offer Made to Wayne Wetherell, dated March 30, 2004 (incorporated by reference to Exhibit 10.3 to the Registrant’s Quarterly Report on Form 10-QSB, filed August 16, 2004).
10.18		Form of Securities Purchase Agreement dated July 22, 2005 and July 28, 2005 (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed July 26, 2005).
10.19		Securities Purchase Agreement, dated November 14, 2006 by and among the Registrant and certain accredited investors (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed November 20, 2006).
10.20		Securities Purchase Agreement, dated March 9, 2007, by and among the Registrant and certain accredited investors (incorporated by reference to Exhibit 10.1 to the Registrant Current Report on Form 8-K, filed March 15, 2007).
10.21		Securities Purchase Agreement, dated September 25, 2007, by and among the Registrant and certain accredited investors (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed September 26, 2007).
10.22		Asset Purchase Agreement and Plan of Reorganization, among Sol Logic, Frank Mitchell, as shareholder of Sol Logic, and Wink Jones, as the representative of Sol Logic (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed December 21, 2007).

10.23		Amendment No. 1 to Asset Purchase and Plan of Reorganization, by and between the Registrant and Wink Jones, as the representative of Sol Logic (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed April 1, 2008).
10.24		Product Line Purchase Agreement, dated November 30, 2006, by and between the Registrant and PhotoLynx, Inc. (incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed December 26, 2006).
10.25		Standard Commercial Lease, dated September 26, 2003, by and between Thornmint I and the Registrant (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-QSB, filed November 14, 2003).
10.26		Amendment to Office Lease, dated June 12, 2006, by and between Thornmint I and the Registrant (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q, filed August 14, 2006).
10.27		Office Lease, dated September 7, 2006, by and between Union Bank of California as Trustee for Quest Group Trust VII and the Registrant (incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q, filed November 20, 2006).
10.38		Office Space Lease between I.W. Systems Canada Registrant and Dundeal Canada (GP) Inc. dated June 1, 2006 (incorporated by reference to Exhibit 10.40 to the Registrant’s Annual Report on Form 10-K, filed April 17, 2007).
10.39		Office Space Lease between I.W. Systems Canada Registrant and GE Canada Real Estate Equity dated July 25, 2008).
10.40		Form of Securities Purchase Agreement, dated August 29, 2008 by and among the Registrant and certain accredited investors.
10.41		Change of Control and Severance Benefits Agreement, dated September 27, 2008, between Registrant and Charles Aubuchon.
10.42		Change of Control and Severance Benefits Agreement, dated September 27, 2008, between Registrant and David Harding.
10.43		First Amendment to Employment Agreement, dated September 27, 2008, between the Registrant and S. James Miller.
10.44		First Amendment to Employment Agreement, dated September 27, 2008, between the Registrant and Wayne Wetherell.
10.45		Form of Convertible Note dated November 14, 2008.
10.46		Secured Note Agreement, dated February 12, 2009, by and between the Registrant and BET Funding, LLC.
10.47		Security Agreement, dated February 12, 2009, by and between the Registrant and BET Funding, LLC
10.48		Second Amendment to Change of Control and Severance Benefits Agreement, dated April 6, 2009, between Registrant and Charles Aubuchon.
10.49		Second Amendment to Change of Control and Severance Benefits Agreement, dated April 6, 2009, between Registrant and David Harding.
10.50		Second Amendment to Employment Agreement, dated April 6, 2009, between the Registrant and S. James Miller.
10.51		Second Amendment to Employment Agreement, dated April 6, 2009, between the Registrant and Wayne Wetherell.
10.52		Waiver and Amendment Agreement to Secured Note Agreement, dated June 9, 2009 between the Registrant and BET Funding, LLC
10.53		Second Amendment to Secured Note Agreement, dated June 22, 2009 between the Registrant and BET Funding, LLC.
10.54		Office Space Lease between the Registrant and Allen W. Wooddell, dated July 25, 2008.
10.55		Third Amendment to Secured Note Agreement, dated October 5, 2009 between the Registrant and BET Funding, LLC.
10.56		Fourth Amendment to Secured Note Agreement, dated November 11, 2009 between the Registrant and BET Funding, LLC.
10.57		Assignment of Receivable dated November 11, 2009 between the Registrant and BET Funding, LLC.
10.58		Third Amendment to Change of Control and Severance Benefits Agreement, dated December 10, 2009, between Registrant and Charles Aubuchon.
10.59		Third Amendment to Change of Control and Severance Benefits Agreement, dated December 10, 2009, between Registrant and David Harding.
10.60		Third Amendment to Employment Agreement, dated December 10, 2009, between the Registrant and S. James Miller.
10.61		Third Amendment to Employment Agreement, dated December 10, 2009, between the Registrant and Wayne Wetherell.
21.1		Subsidiaries of the Registrant
31.1		Certification of the Principal Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a)
31.2		Certification of the Principal Financial and Accounting Officer pursuant to Rule 13a-14(a) and 15d-14(a)
32.1		Certification by the Principal Executive Officer and Principal Financial and Accounting Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

	IMAGEWARE SYSTEMS, INC.


February 23, 2010	By:	/s/ S. JAMES MILLER, JR.
		S. James Miller, Jr.
		Chief Executive Officer and Chairman of the Board of Directors

Signature	Title	Date

/s/ S. JAMES MILLER, JR.	Chief Executive Officer and Chairman of the Board of Directors	February 24, 2010
S. James Miller, Jr.	(Principal Executive Officer)

/s/ WAYNE G. WETHERELL	Senior Vice President of Administration and Chief Financial Officer	February 24, 2010
Wayne G. Wetherell	(Principal Financial and Accounting Officer)

/s/ JOHN CALLAN	Director	February 24, 2010
John Callan

/s/ JOHN L. HOLLERAN	Director	February 24, 2010
John L. Holleran

/s/ DAVID LOESCH	Director	February 24, 2010
David Loesch

/s/ STEVE HAMM	Director	February 24, 2010
Steve Hamm

/s/ DAVID CAREY	Director	February 24, 2010
David Carey

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	59

CONSOLIDATED FINANCIAL STATEMENTS:

CONSOLIDATED BALANCE SHEETS	60

CONSOLIDATED STATEMENTS OF OPERATIONS	61

CONSOLIDATED STATEMENTS OF CASH FLOW	62

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS	64

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)	65

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS	67

	December 31, 2008			December 31, 2007
ASSETS

Current Assets:
Cash and cash equivalents	$	171		$	1,044
Accounts receivable, net of allowance for doubtful accounts of $28 and $0
at December 31, 2008 and 2007, respectively		503			425
Inventories, net		19			130
Other current assets		191			441
Total Current Assets		884			2,040

Property and equipment, net		108			288
Other assets		37			24
Pension assets		682			694
Intangible assets, net		110			2,437
Goodwill		3,416			4,452
Total Assets	$	5,237		$	9,935

LIABILITIES AND SHAREHOLDERS’ (DEFICIT) EQUITY

Current Liabilities:
Accounts payable	$	2,388		$	1,415
Deferred revenue		872			1,011
Billings in excess of costs and estimated earnings on uncompleted contracts		279			—
Accrued expenses		1,530			1,341
Acquisition related obligation		—			1,502
Total Current Liabilities		5,069			5,269

Notes payable to related parties		98			—
Pension obligation		1,102			1,139
Total Liabilities		6,269			6,408

Commitments and contingencies		—			—

Shareholders’ equity
Preferred stock, authorized 4,000,000 shares:

Series B convertible preferred stock, designated 750,000 shares,
389,400 shares issued, and 239,400 shares outstanding at December 31, 2008
and 2007, liquidation preference $632 at December 31, 2008 and $607 at December 31, 2007		2			2

Series C convertible preferred stock, designated 3,500 shares,
2,500 shares issued, and 2,200 shares outstanding at December 31, 2008
and 2007, liquidation preference of $2,604 at December 31, 2008 and $2,434 at December 31, 2007		—			—

Series D convertible preferred stock, designated 3,000 shares,
2,310 and 1,500 shares issued at December 31, 2008 and 2007, respectively, and
2,198 and 1,388 shares outstanding at December 31, 2008 and 2007, respectively,
liquidation preference $2,428 and $1,486 at December 31, 2008 and 2007, respectively		—			—

Common stock, $.01 par value, 50,000,000 shares authorized, 18,163,487 and
17,797,826 shares issued at December 31, 2008 and 2007, respectively,
18,156,783 and 17,791,122 shares outstanding at December 31, 2008
and 2007, respectively		180			177

Additional paid in capital		86,007			79,294
Treasury stock, at cost - 6,704 shares		(64	)		(64	)
Accumulated other comprehensive income		44			7
Accumulated deficit		(87,201	)		(75,889	)
Total shareholders’ (deficit) equity		(1,032	)		3,527

Total Liabilities and Shareholders’ (Deficit)Equity	$	5,237		$	9,935

	Twelve Months Ended December 31,			Twelve Months Ended December 31,

	2008			2007

Revenues:
Product	$	3,707		$	5,652
Maintenance		2,808			2,836
		6,515			8,488
Cost of revenues:
Product		1,062			1,380
Maintenance		1,146			1,166

Gross profit		4,307			5,942

Operating expenses:
General and administrative		3,553			3,865
Sales and marketing		2,111			2,647
Research and development		2,956			3,669
Impairment of intangible assets		742			—
Depreciation and amortization		772			258
		10,134			10,439

Loss from operations		(5,827	)		(4,497	)

Interest (income) expense, net		19			215

Other (income) expense, net		(110	)		23

Loss from continuing operations before income taxes		(5,736	)		(4,735	)

Income tax benefit (expense)		—			—

Loss from continuing operations		(5,736	)		(4,735	)

Discontinued operations:
Gain from operations of discontinued Digital Photography Component	$	18		$	50
Income tax benefit (expense)		—			—
Gain (loss) on discontinued operations		18			50

Net loss		(5,718	)		(4,685	)
Preferred dividends		(5,928	)		(1,171	)
Net loss available to common shareholders	$	(11,646	)	$	(5,856	)

Basic and diluted loss per common share - see Note 2
Continuing operations	$	(0.32	)	$	(0.31	)
Discontinued operations		—			—
Preferred dividends		(0.33	)		(0.08	)
Basic and diluted loss per common available to common shareholders	$	(0.65	)	$	(0.39	)

Weighted-average shares outstanding (basic and diluted)		18,056,026			15,070,308