Actividentity 10-Q 2009 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

Form 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2009
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to

Commission File Number 001-34137

ActivIdentity Corporation

(Exact name of Registrant as specified in its charter)

Delaware	45-0485038
(State or other jurisdiction of incorporation or organization)	(I.R.S. employer identification no.)
6623 Dumbarton Circle, Fremont, CA	94555
(Address of principal executive offices)	(Zip Code)

(510) 574-0100

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No o

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

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

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

As of July 31, 2009, the Registrant had outstanding 45,839,860 shares of Common Stock.

ACTIVIDENTITY CORPORATION

INDEX TO QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2009

		Page
PART I - FINANCIAL INFORMATION
ITEM 1.	CONSOLIDATED FINANCIAL STATEMENTS	3
	CONDENSED CONSOLIDATED BALANCE SHEETS	3
	CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)	4
	CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS	5
	NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS	6
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	17
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK	31
ITEM 4.	CONTROLS AND PROCEDURES	32
PART II - OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	33
ITEM 1A.	RISK FACTORS	33
ITEM 2	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	33
ITEM 3	DEFAULT OF SENIOR SECURITIES	33
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	33
ITEM 5	OTHER INFORMATION	33
ITEM 6.	EXHIBITS	34
	SIGNATURE	35

2

PART I.  FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

ACTIVIDENTITY CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands except per share data)

	June 30, 2009			September 30, 2008
	(Unaudited)			(1)
ASSETS
Current assets:
Cash and cash equivalents	$	75,392		$	70,173
Short-term investments	3,454			9,656
Accounts receivable, net of allowance for doubtful accounts of $288 and $317	10,092			11,792
Inventories, net	990			1,760
Prepaid and other current assets	2,517			1,696
Total current assets	92,445			95,077
Restricted cash	1,610			—
Investments	11,752			11,752
Property and equipment, net	1,953			2,877
Other intangible assets, net	2,248			4,150
Other long-term assets	848			3,745
Total assets	$	110,856		$	117,601
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	812		$	1,652
Accrued compensation and related benefits	5,095			5,935
Current portion of accrued restructuring liability	634			616
Accrued and other current liabilities	3,869			3,682
Current portion of deferred revenue	10,637			11,024
Total current liabilities	21,047			22,909
Deferred revenue, net of current portion	826			1,125
Accrued restructuring liability, net of current portion	490			962
Long-term deferred rent	208			430
Other long-term liabilities	571			2,517
Total liabilities	23,142			27,943
Minority interest	312			304
Commitments and contingencies (Note 10)	—			—
Stockholders’ equity:
Preferred stock, $0.001 par value: 10,000 shares authorized, none issued and outstanding	—			—
Common stock, $0.001 par value: 75,000 shares authorized, 45,840 and 45,786 issued and outstanding	46			46
Additional paid-in capital	428,183			426,141
Accumulated deficit	(328,285		)	(323,053		)
Accumulated other comprehensive loss	(12,542		)	(13,780		)
Total stockholders’ equity	87,402			89,354
Total liabilities and stockholders’ equity	$	110,856		$	117,601

(1)Derived from Audited Consolidated Financial Statements

See accompanying notes to consolidated financial statements

3

ACTIVIDENTITY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(In thousands, except per share data, unaudited)

	Three Months Ended						Nine Months Ended
	June 30,						June 30,
	2009			2008			2009			2008
Revenue:
Software	$	6,888		$	5,024		$	18,405		$	13,961
Hardware	3,245			3,175			12,196			11,090
Service	5,236			6,099			17,199			18,311
Total revenue	15,369			14,298			47,800			43,362
Cost of revenue:
Software	1,046			530			3,227			829
Hardware	1,675			2,071			6,234			6,819
Service	1,716			2,596			5,699			8,035
Amortization of acquired developed technology and patents	593			592			1,779			1,787
Total cost of revenue	5,030			5,789			16,939			17,470
Gross profit	10,339			8,509			30,861			25,892
Operating expenses:
Sales and marketing	4,868			5,827			15,172			19,548
Research and development	3,398			4,676			11,690			14,092
General and administration	3,101			2,626			9,732			8,267
Restructuring expense (net of adjustments)	—			3			—			(70		)
Amortization of acquired intangible assets	41			42			123			124
Impairment of goodwill	—			—			—			35,874
Total operating expenses	11,408			13,174			36,717			77,835
Income (Loss) from operations	(1,069		)	(4,665		)	(5,856		)	(51,943		)
Other income (expense):
Interest income, net	285			845			1,465			3,772
Other income (expense), net	2,108			(2,927		)	(1,053		)	(4,977		)
Total other income (expense), net	2,393			(2,082		)	412			(1,205		)
Income (loss) before income tax and minority interest	1,324			(6,747		)	(5,444		)	(53,148		)
Income tax benefit (provision)	766			(250		)	113			(280		)
Minority interest	(5		)	14			99			32
Net Income (loss)	$	2,085		$	(6,983	)	$	(5,232	)	$	(53,396	)
Net income (loss) per share: Basic	0.05			(0.15		)	$	(0.11	)	(1.17		)
Diluted	0.05			(0.15		)	(0.11		)	(1.17		)
Shares used to compute net income (loss) per share: Basic	45,817			45,778			45,800			45,764
Diluted	46,309			45,778			45,800			45,764
Other comprehensive income (loss):
Net income (loss)	$	2,085		$	(6,983	)	$	(5,232	)	$	(53,396	)
Unrealized (loss) gain on short-term investment, net	—			(78		)	152			(911		)
Reclassification of unrealized income (loss) on short-term investments	—			—			—			945
Foreign currency translation gain (loss)	(1,678		)	(372		)	1,086			(1,213		)
Reclassification of currency translation loss on liquidation of investment in foreign entity	—			1,946			—			1,946
Comprehensive income (loss)	$	407		$	(5,487	)	$	(3,994	)	$	(52,629	)

See accompanying notes to consolidated financial statements.

4

ACTIVIDENTITY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands, unaudited)

	Nine Months Ended June 30,
	2009			2008
Cash flows from operating activities:
Net loss	$	(5,232	)	$	(53,396	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation of property, plant, and equipment	973			1,225
Amortization of acquired developed technology and patents	1,779			1,787
Unrealized foreign exchange (gain) loss	717			(1,470		)
Amortization of acquired intangible assets	123			124
Stock-based compensation expense	2,152			2,127
Loss on disposal of property and equipment	43			20
Currency translation loss on liquidation of investment in foreign entity	—			1,946
Goodwill impairment charge	—			35,874
Investment impairment charge	—			3,812
Minority interest in ActivIdentity Europe S.A.	(99		)	(32		)
Changes in:
Accounts receivable	1,872			6,339
Inventories	731			22
Prepaid and other current assets	(505		)	593
Long-term income taxes receivable	2,719			—
Accounts payable	(809		)	(192		)
Accrued compensation and related benefits	(761		)	(714		)
Accrued restructuring liability	(454		)	(581		)
Accrued and other liabilities	(2,029		)	666
Deferred revenue	(759		)	(1,396		)
Net cash provided by (used in) operating activities	461			(3,246		)
Cash flows from investing activities:
Purchases of property and equipment, net	(135		)	(264		)
Purchases of short-term investments	—			(37,245		)
Proceeds from sales and maturities of short-term investments	6,184			78,215
Restricted cash	(1,396		)	—
Other long-term assets	7			63
Net cash provided by investing activities	4,660			40,643
Cash flows from financing activities:
Proceeds from exercise of options, rights and warrants	—			25
Net cash provided by financing activities	—			25
Effect of exchange rate changes on cash and cash equivalents	98			257
Net increase in cash and cash equivalents	5,219			37,679
Cash and cash equivalents, beginning of period	$	70,173		$	30,639
Cash and cash equivalents, end of period	$	75,392		$	68,318
Supplemental disclosures:
Cash paid (refund received) for income taxes	35			$	(11	)

See accompanying notes to consolidated financial statements.

5

ACTIVIDENTITY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2009

1. Basis of Presentation

The accompanying condensed consolidated financial statements include the accounts of ActivIdentity Corporation (the “Company”) and its subsidiaries. The Company has subsidiaries in Asia, Australia, Canada, Europe, and South Africa.

The accompanying condensed balance sheet as of September 30, 2008 which has been derived from audited financial statements, and the unaudited interim condensed consolidated balance sheet as of June 30, 2009, and statements of operations and comprehensive income (losses) and cash flows for the three and nine months ended June 30, 2009 and 2008, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the rules and regulations of the Securities and Exchange Commission (SEC) for interim financial statements.  In the opinion of management, the unaudited condensed consolidated financial statements include all adjustments that management considers necessary for a fair presentation of the Company’s financial position, operating results, and cash flows for the interim periods presented. All inter-company accounts and transactions have been eliminated in consolidation. Operating results and cash flows for interim periods are not necessarily indicative of results to be expected for the entire fiscal year ending September 30, 2009.

These interim condensed consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2008.  There have been no significant changes in the Company’s critical accounting policies from those that were disclosed in the Annual Report on Form 10-K for the fiscal year ended September 30, 2008, other than as described below.

Fair Value Measurements

Effective October 1, 2008, the Company adopted Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, and SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which affected the Company’s accounting for financial assets and liabilities (see Note 3 — Fair Value Measurements).

At June 30, 2009, non-SFAS-157 financial instruments, for which the fair value is the same as carrying value due to the short-term nature of the instruments, include cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities. Accounts receivable and other investments are financial assets with carrying values that approximate the fair value. Accounts payable and other accrued expenses are financial liabilities with carrying values that approximate the fair value. In the absence of quoted prices in active markets, considerable judgment is required in developing estimates of fair value. Estimates are not necessarily indicative of the amounts the company could realize in a current market transaction.

Restricted Cash

Under the terms of a software development contract with a customer, the Company provides a performance guarantee in the form of a financial security agreement that extends through September 30, 2011.  At June 30, 2009, restricted cash, classified as non-current, included $1.6 million of financial guarantees secured by a term deposit.

Reclassifications

Certain reclassifications of previously reported information have been made to conform to current period presentation.

Professional services revenue, and related costs of revenue, that are not essential to the functionality of software have been reclassified from software revenue and combined with maintenance and support revenue to create a new caption of service revenue, and related costs of revenue, on the consolidated statement of operations, effective the quarter ended September 30, 2008. This reclassification had no net effect on gross revenues, gross costs of revenue, or gross profit. For comparative purposes, $1.0 million and $3.1 million of revenues and $0.6 million and $2.0 million of costs of revenue have been reclassified for the three and nine months ended June 30, 2008, to conform to the revised presentation.

6

Subsequent Events

In accordance with SFAS No. 165, Subsequent Events, we have evaluated subsequent events through August 10, 2009, the date of issuance of the unaudited condensed consolidated financial statements. During this period we did not have any material recognizable subsequent events. We did, however, have a non-recognizable subsequent event by entering into a new three year lease agreement in Europe commencing on July 1, 2009. See Note 12 to the condensed consolidated financial statements for additional discussion on the lease agreement.

2. Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.  SFAS No. 157 replaces the different definitions of fair value in the accounting literature with a single definition.  It defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  The Company adopted SFAS No. 157 on October 1, 2008, for financial assets and liabilities (see Note 3 — Fair Value Measurements).  The Company has elected to adopt SFAS No. 157 for non-financial assets and liabilities beginning on October 1, 2009, in accordance with FASB Staff Position (FSP) No. 157-2.  The Company is currently evaluating the impact of applying the deferred portion of SFAS No. 157 to the nonrecurring fair value measurements of its nonfinancial assets and liabilities.

In April 2009, the FASB issued FSP SFAS No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. FSP SFAS No. 157-4 provides guidelines for making fair value measurements more consistent with the principles presented in SFAS No. 157, Fair Value Measurements. The FSP relates to determining fair values when there is no active market or where the price inputs being used represent distressed sales. It reaffirms what SFAS No. 157 states the objective of fair value measurement—to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements under current market conditions. Specifically, it reaffirms the need to use judgment to ascertain if a forme rly active market has become inactive and in determining fair values when markets have become inactive. The provisions of FSP 157-4 are effective for the Company’s interim reporting for the period ending on June 30, 2009. The Company has adopted this FSP in the quarter ended June 30, 2009, and there was no material impact on the consolidated financial statements.

In April 2009, the FASB issued FSP SFAS No. 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments. FSP SFAS No. 107-1 and APB 28-1 enhances consistency in financial reporting by increasing the frequency of fair value disclosures. The FSP relates to fair value disclosures for any financial instruments that are not currently reflected within a compan y’s balance sheet at fair value. Prior to the effective date of this FSP, fair values for these assets and liabilities have only been disclosed once a year. The FSP will now require these disclosures on a quarterly basis, providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value. The disclosure requirements under this FSP are effective for the company’s interim reporting period ending on June 30, 2009.  The Company adopted this FSP in the quarter ended June 30, 2009. There was no impact on the consolidated financial statements as it relates only to additional disclosures. The required disclosures are included in Note 1 “Basis of Presentation” on page 6.

In April 2009, the FASB issued FSP SFAS No. 115-2 and SFAS No. 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. FSP SFAS No. 115-2 and SFAS No. 124-2 amends the other-than-temporary impairment guidance in U.S. GAAP for debt securities and provides additional guidance designed to create greater clarity and consistency in accounting and presenting impairment losses on securities. The FSP is intended to bring greater consistency to the timing of impairment recognition, and provide greater clarity to investors about the credit and noncredit components of impaired debt securities that are not expected to be sold. The measure of impairment in comprehensive income remains fair value. The FSP also requires increased and timelier disclosures regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. The FSP is effective for the Company’s interim reporting for the period ending on June 30, 2 009. The Company adopted this FSP for the quarter ended June 30, 2009, and there was no material impact on the Consolidated Financial Statements.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events.  This Statement sets forth: 1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; 2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and 3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. This Statement is effective for interim and annual periods ending after June 15, 2009. The Company adopted this Statement in the quarter ended June 30, 2009. This Statement did not impact the consolidated financial results.

7

In December 2007, the FASB issued SFAS No. 141 (revised), Business Combinations. The standard changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs, and the recognition of changes in the acquirer’s income tax valuation allowance. Statement 141(R) is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. The Company will evaluate the impact the provisions of SFAS No. 160 and will adopt this standard on October 1, 2009.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51. The standard changes the accounting for noncontrolling (minority) interests in consolidated financial statements including the requirements to classify noncontrolling interests as a component of consolidated stockholders’ equity, and the elimination of “minority interest” accounting in results of operations with earnings attributable to noncontrolling interests reported as part of consolidated earnings. Additionally, SFAS No. 160 revises the accounting for both increases and decreases in a parent’s controlling ownership interest. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. The Company will evaluate the impact the provisions of SFAS No. 160 and will adopt this standard on October 1, 2009.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities. The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company will evaluate the impact of the provisions of SFAS No. 161 and will adopt this standard on October 1, 2009.

In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 168, The FASB Accounting Standards Codification TM and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162 (the Codification). The Codification, which was launched on July 1, 2009, became the single source of authoritative nongovernmental U.S. GAAP, superseding existing FASB, American Institute of Certified Public Accountants (AICPA), Emerging Issues Task Force (EITF) and related literature. The Codification eliminates the GAAP hierarchy contained in SFAS No. 162 and establishes one level of authoritative GAAP. All other literature is considered non-authoritative. This Statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Company will adopt this Statement for its fiscal year ending September 30, 2009. There will be no change to the Company’s consolidated financial statements due to the implementation of this Statement.

3. Fair Value Measurements

Effective October 1, 2008, the Company adopted the fair value measurement and disclosure provisions of SFAS No. 157, Fair Value Measurements, which establishes specific criteria for the fair value measurements of financial and nonfinancial assets and liabilities that are already subject to fair value measurements under current accounting rules.  SFAS No. 157 also requires expanded disclosures related to fair value measurements.  In February 2008, the FASB approved FSP No. 157-2, Effective Date of FASB Statement No. 157, which allows companies to elect a one-year delay in applying SFAS No. 157 to certain fair value measurements, primarily related to nonfinancial instruments.  The Company elected the delayed adoption for the portions of SFAS No. 157 impacted by FSP No. 157-2.  The partial adoption of SFAS No. 157 was prospective and did not have a significant effect on the Company’s condensed consolidated financial statements.

In October 2008, the FASB issued FSP No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.  FSP No. 157-3 clarifies the application of SFAS No. 157, which the Company adopted as of October 1, 2008, in situations where the market is not active.  The Company has considered the guidance provided by FSP No. 157-3 in its determination of estimated fair values as of June 30, 2009, and the impact was not material.

Concurrently with the adoption of SFAS No. 157, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which permits entities to elect, at specified election dates, to measure eligible financial instruments at fair value.  As of June 30, 2009, the Company did not elect the fair value option under SFAS No. 159 for any financial assets and liabilities that were not previously measured at fair value.

8

Fair Value Hierarchy

SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value.  The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).  The three levels of the fair value hierarchy under SFAS No. 157 are described below:

Level 1	Valuations based on quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
Level 2	Valuations based on quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities.
Level 3	Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

Most of the Company’s financial instruments are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency.  The types of instruments valued based on quoted market prices in active markets include cash, term deposits, money market funds, and U.S. Treasury securities which are classified within Level 1 of the fair value hierarchy.

Financial instruments valued based on unobservable inputs include auction rate securities (ARS).  Such instruments are classified within Level 3 of the fair value hierarchy.  The Company estimates the fair value of these ARS using a discounted cash flow model incorporating assumptions regarding expected cash flows; liquidity risk, default risk, recovery risk, and interest rate risk (see Note 4 — Investments for additional discussion).

Financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2009, as presented on the Company’s condensed consolidated balance sheet were as follows (in thousands):

At June 30, 2009	Quoted Prices in  Active Markets for  Identical Assets  (Level 1)		Significant Other Observable Inputs (Level 2)	Significant  Unobservable  Inputs (Level 3)		Total
Cash and cash equivalents:
Short-term:
Cash	$	9,876	—	$	—	$	9,876
Money market funds / U.S. Treasuries	65,516		—	—		65,516
Total short-term cash and cash equivalents	75,392		—	—		75,392
Long-term restricted cash (term deposits)	1,610		—	—		1,610
Short-term investments:
Corporate notes and bonds	—		—	—		—
Auction rate securities	—		—	3,454		3,454
Total short-term investments	—		—	3,454		3,454
Long-term investments:
Auction rate securities	—		—	11,752		11,752
Total financial assets under SFAS No. 157	$	77,002	—	$	15,206	$	92,208

At September 30, 2008	Quoted Prices in  Active Markets for  Identical Assets  (Level 1)		Significant Other Observable Inputs (Level 2)		Significant  Unobservable  Inputs (Level 3)		Total
Cash and cash equivalents:
Short-term:
Cash	$	6,952	—		$	—	$	6,952
Money market funds / U.S. Treasuries	63,221		—		—		63,221
Total short-term cash and cash equivalents	70,173		—		—		70,173
Long-term restricted cash (term deposits)	—		—		—		—
Short-term investments:
Corporate notes and bonds	—		5,970		—		5,970
Auction rate securities	—		—		3,686		3,686
Total short-term investments	—		5,970		3,686		9,656
Long-term investments:
Auction rate securities	—		—		11,752		11,752
Total financial assets under SFAS No. 157	$	70,173	$	5,970	$	15,438	$	91,581

9

At June 30, 2009, the Company did not have any financial assets or financial liabilities measured at fair value on a recurring basis using significant other observable inputs (Level 2) in the balance sheet.

Changes in the Company’s Level 3 assets for the nine months ended June 30, 2009 were as follows (in thousands):

	Level 3
Aggregate estimated fair value of Level 3 securities at September 30, 2008	$	15,438
Total realized and unrealized gain (loss):
Included in earnings	—
Included in other comprehensive income	—
Settlements	(133		)
Transfers in (out) of Level 3	—
Aggregate estimated fair value of Level 3 securities at December 31, 2008	$	15,305
Total realized and unrealized gain (loss):
Included in earnings	—
Included in other comprehensive income	—
Settlements	—
Transfers in (out) of Level 3	(26		)
Aggregate estimated fair value of Level 3 securities at March 31, 2009	$	15,279
Total realized and unrealized gain (loss):
Included in earnings	—
Included in other comprehensive income	—
Settlements	(50		)
Transfers in (out) of Level 3	(23		)
Aggregate estimated fair value of Level 3 securities at June 30, 2009	$	15,206

4. Investments

During fiscal 2008, the Company reclassified $33.0 million at cost of investments in certain ARS from short-term to long-term investments and recorded an other-than-temporary impairment on these holdings of $21.2 million, resulting in a carrying value of $11.8 million at September 30, 2008. Based on a review of the underlying valuation assumptions for the period ended June 30, 2009, no change in the fair value of long-term ARS was recorded during the period and only negligible amounts of settlement activity occurred on the underlying holdings.  At June 30, 2009, the carrying value remained $11.8 million.  Contractual maturity for these investments range from 2025 to 2052 and these investments are presently not liquid. The Company also holds $3.5 million of Closed-end Mutual Fund ARS which remain valued at par and are classified as short-term investments. The Company has not reclassified these investments since $12.4 million of ARS, representing formerly held Closed-end Mutual Fund and Taxable Municipal ARS investments, were called at par during the last twenty-one months.  Based on this recent evidence of liquidity, the Company continues to classify the remaining $3.5 million Closed-end Mutual Fund ARS investments as short-term. However, future changes in the market regarding these securities may result in reclassifications in future periods.

ARS are structured to provide liquidity through a Dutch auction process that resets the interest rates paid at pre-determined intervals, generally every 28 days. The auctions have historically provided a liquid market for these securities. The Company’s investments in ARS represent interests in Collateralized Debt Obligations (CDO), Closed-end Mutual Funds, Derivative Product Companies, and Student Loans. Uncertainty in the financial markets has affected the liquidity of the Company’s ARS holdings and has resulted in a significant increase in the risks related to the ARS investments classified as long-term.

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Historically, the fair value of ARS approximated par value due to the frequent auction events. However, failed auctions since August of 2007 have, in most cases, resulted in revised estimates of fair value that are less than par. The Company has reviewed those investments classified as long-term and has valued the holdings accordingly using a discounted cash flow methodology.

The Company reviews its impairments in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and related guidance issued by the FASB and SEC in order to determine the classification of the impairment as either “temporary” or “other-than-temporary.” A temporary impairment charge results in an unrealized loss being recorded in the other comprehensive income (loss) section of stockholders equity in the balance sheet. This type of unrealized loss does not affect net income (loss) for the applicable accounting period. However, an other-than-temporary impairment charge is recorded as a realized loss in the consolidated statement of operations. The differentiating factors between temporary and other-than-temporary impairment are primarily the length of time and the extent to which the market value has been less than cost and the term of the illiquid position. In addition, the financial condition and near-term prospects of the issuer, the composition of any underlying assets in the holdings, and the Company’s intent and ability to hold the investment for a period of time that would allow for a liquidity event to take place are also factors taken into consideration in the Company’s valuation analysis.

The Company uses a discounted cash flow analysis technique in modeling and valuing these securities. Probabilities of an eventual cleared auction or a par recovery through the issuer refinancing the holding, as well as probabilities of default and potential levels of recovery in default were all taken into consideration as well as the probability of the issuer to continue paying penalty interest payments while the instrument remains in an illiquid condition. These various considerations were applied to each projected cash flow through maturity of each instrument to derive an expected cash flow at each relevant period. This cash flow was then discounted to the present by using a discount rate derived from an evaluation of multiple sources including credit default swap spreads on securities with similar credit ratings as well as overall spreads on corporate debt.

While the Company has used what it believes to be an appropriate valuation model for these securities and has fully attempted to incorporate all known and significant risk factors into the analysis, the Company makes many estimates and assumptions when assessing the value of these securities. Accordingly, assumptions regarding expected cash flows, liquidity risk, default risk and related recovery risk, interest rate risk, and other risk factors are all considerations in the analysis and valuation of the Company’s ARS holdings. These estimates are also based on market and economic conditions, which are currently in a state of crisis and heightened uncertainty. As a result, there is much independent judgment required in deriving these valuation conclusions.

The Company believes it has made reasonable judgments in its valuation exercise. However, if the relevant assumptions, estimates, or the related analyses prove incorrect or, if due to additional information received in the future, management’s conclusions would change, the Company may be required to change the recorded value of these securities, or other securities that make up the investment portfolio.

5. Stock-Based Compensation

Equity Compensation Plans

Warrants

Warrant issued to service provider:  In August 2004, the Company issued a warrant to purchase 50,000 shares at an exercise price of $6.60 to a service provider. The warrant was fully vested and exercisable upon issuance and expires in August 2010. No other warrants were granted during periods presented nor do any other warrants remain outstanding.

Stock Option Plans

The Company has several stockholder approved stock option plans under which it grants or has granted options to purchase shares of its common stock to employees. As of June 30, 2009, it had one plan under which it continues to grant awards, the 2004 Equity Incentive Plan (2004 Plan). As of June 30, 2009, the Company had an aggregate of 12.6 million shares of its common stock reserved for issuance under various equity plans approved by the stockholders, of which 8.5 million shares were subject to outstanding awards and 4.1 million shares were available for future grants under the 2004 Plan.

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Stock option plans prior to 2002 were established by ActivIdentity Europe S.A. (formerly known as ActivCard Europe S.A. and ActivCard S.A.) under the laws of France. Options granted under these plans vested over four years and have a maximum term of seven years. For these option plans, the Board of Directors established the exercise price as the weighted average closing price quoted on Nasdaq Europe during the twenty trading days prior to the date of grant. The Company has made no grants under the stock options plans established prior to 2002 during any of the periods presented.

In August 2002, the Company’s stockholders approved the 2002 Stock Option Plan (2002 Plan) and reserved 8.6 million shares for issuance under the plan. Options granted under the 2002 Plan vest over four years and have a maximum term of 10 years. The Board of Directors establishes the exercise price as the closing price quoted on the NASDAQ Global Market on the date of grant.  In August 2004, the Company’s stockholders approved the 2004 Plan. The 2004 Plan replaced the 2002 Plan with substantially the same terms as the 2002 Plan. The remaining share reserve from the 2002 Plan was transferred to the 2004 Plan. In addition to stock options, the 2004 Plan allows for the grant of restricted stock, restricted stock units, stock appreciation rights, and cash awards.  In February 2007, the Company’s stockholders approved an amendment to the 2004 Plan, increasing the number of shares reserved for issuance by 4.0 million shares.

For options granted in 2000 and later, the option plans prohibit residents of France employed by the Company from selling their shares prior to the fourth anniversary from the date of grant.

Periodically, the Company has issued equity inducement grants as permitted under the NASDAQ Marketplace Rules to certain officers under a plan that has not been presented to the Company’s stockholders for approval.  Although the options were granted outside of the 2004 Plan, they are governed in all respects by the terms and conditions of that plan as if granted thereunder.

Activity under the Company’s stock equity plans, including the inducement grants and excluding any current period modifications of previously issued awards, was as follows:

Stock options	Number of Options		Weighted Average Exercise Price		Aggregate Intrinsic Value (in thousands)
Outstanding at 9/30/2008	10,948,100		$	3.93	$	160
Granted	976,000		1.58
Exercised	—		—
Forfeited	(910,076	)	5.26
Outstanding at 12/31/2008	11,014,024		$	3.61	$	227
Granted	199,000		2.13
Exercised	—		—
Forfeited	(399,020	)	3.78
Outstanding at 3/31/2009	10,814,004		$	3.58	$	475
Granted	125,000		2.10
Exercised	—		—
Forfeited	(771,037	)	4.28
Outstanding at 6/30/2009	10,167,967		$	3.50	$	1,813
Exercisable at 6/30/2009	3,247,793		$	5.33	$	102

Stock options outstanding and exercisable as of June 30, 2009, were as follows:

	Options Outstanding				Options Exercisable
Range of Exercise Prices	Number	Weighted Average Remaining Contractual Term (in Years)	Weighted Average Exercise Price		Number	Weighted Average Exercise Price
$1.45 - $2.18	3,151,000	6.05	$	1.98	291,666	$	2.18
$2.19 - $2.92	3,066,500	6.10	2.52		24,315	2.87
$2.93 - $4.35	1,371,624	5.08	3.90		993,034	3.90
$4.36 - $6.42	1,089,935	4.86	4.81		594,190	4.93
$6.43 - $9.99	1,488,908	4.23	7.45		1,344,558	7.29
	10,167,967	5.54	$	3.50	3,247,793	$	5.33

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Restricted Stock and Restricted Stock Units

The Company periodically grants awards of restricted stock, which are issued but subject to vesting requirements, and restricted stock units, which result in the issuance of shares without an exercise price only upon the satisfaction of vesting requirements. Vesting may be time-based, performance-based or a combination of the two. Compensation expense is generally recorded on a straight-line basis over the vesting period of the award.

Activity for the Company’s restricted stock and restricted stock units, excluding any effects of grant modifications, was as follows:

Unvested Restricted Stock and Restricted Stock Units	Number of Shares		Weighted Average Grant-Date Fair Value
Unvested at September 30, 2008	136,723		$	4.00
Granted	—		—
Vested	(60,899	)	3.87
Cancelled	—		—
Unvested at December 31, 2008	75,824		$	4.11
Granted	—		—
Vested	(30,000	)	2.90
Cancelled	—		—
Unvested at March 31, 2009	45,824		$	4.91
Granted	210,000		2.38
Vested	(50,000	)	2.38
Cancelled	—		—
Unvested at June 30, 2009	205,824		$	2.45

Valuation and Expense Information under SFAS 123(R)

The Company bases its weighted-average fair value of stock-based compensation to employees generally on the single option valuation approach. Forfeitures are estimated and the Company assumes no dividends will be declared. The Company generally amortizes estimated fair value of stock-based compensation awards to employees using the straight-line method over the vesting period of the options. Below are the ranges of assumptions used for new grants during the respective quarters (data excludes assumptions for the revaluation of modified grants of previously issued awards):

	Three Months Ended		Nine Months Ended
	June 30,		June 30,
	2009	2008	2009	2008
Risk-free interest rate	2.4%	2.9% - 3.4%	1.5% – 2.8%	2.4% - 4.2%
Expected life (years)	4.2 – 5.8	4.8 – 5.4	4.2 – 6.1	4.8 – 5.4
Dividend yield	0.0%	0.0%	0.0%	0.0%
Expected volatility	54.0%	40.5% - 41.4%	42.2% – 54.0%	39.7% - 41.4%
Weighted average expected volatility	54.0%	41.3%	44.8%	40.9%
Weighted average estimated forfeiture rate	26.3%	40.0%	30.3%	39.5%

The following table summarizes stock-based compensation expense related to employee stock options, warrants, restricted stock, and restricted stock units under SFAS 123(R) for the three and nine months ended June 30, 2009 and 2008, which was allocated as follows (in thousands):

	Three Months Ended				Nine Months Ended
	June 30,				June 30,
	2009		2008		2009		2008
Cost of sales—Hardware	$	2	$	16	$	13	$	50
Cost of sales—Service*	12		46		95		145
Stock-based compensation expense included in cost of sales	14		62		108		195
Research and development	34		219		490		628
Sales and marketing	148		155		465		486
General and administrative	325		324		1,089		818
Stock-based compensation expense included in operating expenses	507		698		2,044		1,932
Stock-based compensation expense related to employee stock options	$	521	760		2,152		2,127

*Certain amounts have been reclassified in prior years from cost of sales—software to conform to the current year’s presentation.

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As of June 30, 2009, total unrecognized compensation costs related to unvested stock options, restricted stock, and restricted stock units was $4.1 million, which will be recognized as an expense over a weighted average vesting period of approximately 2.3 years. The weighted average grant date fair value of options newly granted during the three and nine months ended June 30, 2009 was $0.98 and $0.73, respectively, and for the three and nine months ended June 30, 2008 was $1.02 and $1.16, respectively.

6. Accounts Receivable and Customer Concentration

Accounts receivable from significant customers in excess of 10% of total account receivable for the respective periods are summarized as follows:

	June 30,		September 30,
Accounts Receivable concentration	2009		2008
Customer A	12	%	*
Customer B	*		11	%
Customer D	14	%	*

* Customer accounted for less than 10%

Revenue from significant customers representing revenue in excess of 10% of total revenue for the respective periods is summarized as follows:

	Three Months Ended				Nine Months Ended
	June 30,				June 30,
Revenue concentration	2009		2008		2009		2008
Customer C	15	%	13	%	10	%	13	%

7. Inventories, net

Inventories consist of the following (in thousands):

	June 30,			September 30
	2009			2008
Components, gross	$	929		$	1,184
Reserve for excess and obsolete	(364		)	(438		)
Components, net	565			746
Finished goods, gross	640			1,271
Reserve for excess and obsolete	(215		)	(257		)
Finished goods, net	425			1,014
Total inventory, net	$	990		$	1,760

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8. Other Intangible Assets

Other intangible assets consist of the following (in thousands):

	September 30, 2008			Additions			June 30, 2009
Gross carrying amount:
Acquired developed technology and patents	$	15,294		$	—		$	15,294
Customer relationships	2,028			—			2,028
Patents	3,999			—			3,999
Other intangible assets at cost	21,321						21,321
Accumulated amortization
Acquired developed technology	(13,793		)	(1,278		)	(15,071		)
Customer relationships	(1,887		)	(123		)	(2,010		)
Patents	(1,491		)	(501		)	(1,992		)
Total accumulated amortization	(17,171		)	$	(1,902	)	(19,073		)
Other intangible assets, net	$	4,150					$	2,248

Intangible assets with finite lives are amortized over their estimated economic or estimated useful lives and are reviewed for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable.  Based on a review of events and circumstances at June 30, 2009, no indicators of impairment were identified. The Company will continue to evaluate its intangible assets when events and changes in circumstances indicate that there may be a potential impairment.

Estimated future amortization of other intangible assets is as follows (in thousands):

Fiscal years ending September 30,	Acquired developed technology and patents		Customer relationships
2009 (remaining 3 months)	$	388	$	18
2010	666
2011	666
2012	510
	$	2,230	18

9. Net Income (Loss) Per Share

The following is a reconciliation of the numerator and denominator used to determine basic and diluted net income or net loss per share (in thousands, except per share amounts):

	Three Months Ended					Nine Months Ended
	June 30,					June 30,
	2009		2008			2009			2008
Numerator:
Net income (loss)	$	2,085	$	(6,983	)	$	(5,232	)	$	(53,396	)
Denominator:
Weighted average number of shares outstanding: Basic	45,817		45,778			45,800			45,764
Diluted	46,309		45,778			45,800			45,764
Basic net income (loss) per share	$	0.05	$	(0.15	)	$	(0.11	)	$	(1.17	)
Diluted net income (loss) per share	$	0.05	$	(0.15	)	$	(0.11	)	$	(1.17	)

	Three Months Ended
	June 30
	2009	2008
Weighted average number of shares — Basic	45,817	45,778
Common stock equivalents	492	—
Weighted number of shares diluted	46,309	45,778

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For the above periods, the Company had securities outstanding which were excluded from the computation of diluted net loss per share in the periods presented as their impact would have been anti-dilutive, but could potentially dilute basic earnings per share in the future. For the three and nine months ended June 30, 2009 and 2008, approximately 10.6 million and 8.2 million potential shares of common stock (prior to application of treasury method), respectively, consisting of options, restricted stock units, and warrants, were considered in the determination of diluted net income and net loss per share. After the application of the treasury method for the nine months ended June 30, 2009, the additional shares were neither dilutive nor anti-dilutive and had no impact to earning per share.

10. Commitments and Contingencies

Operating leases

The Company has entered into various non-cancelable operating leases for office space with original terms that range from three to ten years.

Future minimum lease payments under these leases are as follows (in thousands):

Fiscal Year Ending September 30,	Payments
2009 (remaining 3 months)	$	743
2010	2,815
2011	1,121
	$	4,679

The future minimum lease payments above include amounts related to non-cancelable operating leases that were included in the charge for restructuring expenses.

Gross rent expense under all operating leases was $0.7 and $2.1 million and $0.8 and $2.3 million, respectively, for the three and nine months ended June 30, 2009 and 2008.

Contingencies

From time to time, the Company has been named as a defendant in legal actions arising from its normal business activities, which the Company believes will not have a material adverse effect on it or its business.

The Company enters into standard indemnification agreements with many of its customers and certain other business partners in the ordinary course of business. These agreements include provisions for indemnifying the customer against any claim brought by a third-party to the extent any such claim alleges that an ActivIdentity product infringes a patent, copyright or trademark, or violates any other proprietary rights of that third-party. It is not possible to estimate the maximum potential amount of future payments the Company could be required to make under these indemnification agreements. To date, the Company has not incurred any costs to defend lawsuits or settle claims related to these indemnification agreements. No liability for these indemnification agreements was recorded at June 30, 2009 or September 30, 2008.

As permitted under Delaware law, the Company has agreements indemnifying its executive officers and directors for certain events and occurrences while the officer or director is, or was, serving at the Company’s request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is not estimable. The Company maintains directors and officers’ liability insurance designed to enable it to recover a portion of any future amounts paid. No liability for these indemnification agreements was recorded at June 30, 2009 or September 30, 2008.

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11. Segment Information

The Company operates in one segment, Digital Identity Solutions. Accordingly, the Company is disclosing geographic information only. Transfers between geographic areas are eliminated in the consolidated financial statements. Geographic revenue information is determined primarily by the customers’ receiving locations. The following is a summary of operations by geographic region (in thousands):

	North America		Europe		Asia Pacific		Total
Three months ended June 30, 2009
Total revenue	$	7,073	$	6,489	$	1,807	$	15,369
Capital expenditures	2		25		—		27
Depreciation of fixed assets	203		76		3		282
Nine months ended June 30, 2009
Total revenue	$	21,831	$	20,679	$	5,290	$	47,800
Capital expenditures	78		57		—		135
Depreciation of fixed assets	643		236		94		973
Three months ended June 30, 2008
Total revenue	$	6,572	$	6,448	$	1,278	$	14,298
Capital expenditures	19		34		8		61
Depreciation of fixed assets	216		104		14		334
Nine months ended June 30, 2008
Total revenue	$	18,402	$	21,144	$	3,816	$	43,362
Capital expenditures	80		138		46		264
Depreciation of fixed assets	680		317		228		1,225
June 30, 2009
Long-lived assets	$	3,714	$	619	$	716	$	5,049
Total assets	92,088		11,332		7,435		110,856
September 30, 2008
Long-lived assets	$	5,221	$	3,680	$	1,871	$	10,772
Total assets	98,986		14,215		4,400		117,601

For the three months ended June 30, 2009, sales to customers in the United States, France, and United Kingdom accounted for 44%, 5%, and 18% of the Company’s total revenue, respectively.  For the three months ended June 30, 2008, sales to customers in the United States, France, and the United Kingdom accounted for 43%, 14%, and 9%, respectively, of the Company’s total revenue. For the nine months ended June 30, 2009, sales to customers in the United States, France, and United Kingdom accounted for 43%, 9%, and 12%, respectively. For the nine months ended June 30, 2008, the United States, France, and the United Kingdom accounted for 36%, 15%, and 11%. No other individual country accounted for 10% or more of the Company’s total net revenue for the periods presented.

12. Subsequent Events

On July 1, 2009, management entered into a three year lease agreement in Europe commencing on July 1, 2009. The lease commitment for the first, second, and third year, which is denominated in Euros, translated into US dollars is $0.4 million, $0.7 million, and $0.7 million respectively.

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

This Quarterly Report on Form 10-Q contains forward-looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. All statements included in this Quarterly Report on Form 10-Q, other than statements that are purely historical, are forward-looking statements. Words such as “anticipates”, “expects”, “intends”, “plans”, “believes”, “seeks”, “estimates”, and similar expressions also identify forward-looking statements. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements. Forward-looking statements in this Quarterly Report on Form 10-Q include, without limitation, statements regarding operating results, product development, marketing initiatives, business plans, and anticipated trends. The forward-looking statements in this Quarterly Report on Form 10-Q are subject to additional risks and uncertainties further discussed under Part II Item 1A “Risk Factors” below and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended September 30, 2008.  We assume no obligation to update any forward-looking statements. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q.

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The following discussion of our financial condition and results of operations should be read in conjunction with our Condensed Consolidated Financial Statements and related notes included in “Item 1. Financial Statements” in this Quarterly Report on Form 10-Q.

OVERVIEW

ActivIdentity Corporation (ActivIdentity, the “Company”, “we”, or “us”) is a global leader in credential management and strong authentication, providing solutions to confidently establish a person’s identity when interacting digitally. For more than two decades the Company’s experience has been leveraged by security-minded organizations in large scale deployments such as the U.S. Department of Defense, Nissan, and Saudi Aramco. The Company’s customers have issued over 100 million credentials, securing the holder’s digital identity. ActivIdentity solutions include a fully integrated platform, enabling organizations to issue, manage and use identity devices and credentials for secure access, secure communications, legally binding digital transactions, and intelligent citizen services.

ActivIdentity provides key building blocks for securing IT infrastructures and digital transactions to defend against security threats and identity fraud while optimizing your organization’s resource utilization, improving productivity, and maximizing return on investment.

ActivIdentity offers four product lines, which are the foundation for its Employer-to-Employee, Business-to-Customer, and Government-to-Citizen solutions:

Credential Management

ActivIdentity Credential Management products enable organizations to securely deploy and manage smart cards and USB tokens containing a variety of credentials, including public key infrastructure (PKI) certificates, one-time passwords, static passwords, biometrics, demographic data, and virtually any other application. The ActivIdentity ActivID™ Card Management System is a reliable, proven, and extensible solution that enables organizations to securely issue and manage digital credentials on devices, as well as securely update applications and credentials on devices after they have been issued to end users. For organizations deploying large quantities of smart cards, ActivIdentity bundles three add-on modules into its Advanced Edition of ActivIdentity ActivID Card Management System.  ActivIdentity ActivID™ Batch Management System enables communication with a service bureau for personalization and encoding of smart cards in centralized high-volume card production environments. ActivIdentity ActivID™ Inventory and Logistics System enables advanced card stock management. ActivIdentity ActivID™ Key Management System enables complete life cycle management of the cryptographic keys that protect access to the content of the authentication device keys and the hardware security modules that hold those keys. Together with its Security Client software, Strong Authentication platform, and Authentication Device offering, ActivIdentity can provide organizations with a complete “Smart Employee ID Solution” that can be leveraged for both physical and logical access control.

Strong Authentication

Prominently featured in several Gartner research reports (e.g., “MarketScope for Enterprise Broad-Portfolio Authentication Vendors,” published in April 2009; and “Market Overview: Authentication,” published in September 2008), ActivIdentity offers two distinct strong authentication platforms for organizations that are seeking to implement a cost-effective, flexible, and scalable solution. ActivIdentity 4TRESS™ AAA Server for Remote Access addresses the security risks associated with a mobile workforce accessing systems and data remotely. ActivIdentity 4TRESS™ Authentication Server offers support for many authentication methods (e.g., user name and password, knowledge-based authentication, one-time password, PKI certificates) and diverse audiences across a variety of service channels, making it the preferred versatile authentication platform for customer-facing transactions.

Security Clients

ActivIdentity Security Clients protect against unauthorized access by providing easy-to-manage enterprise single sign-on capabilities, strong authentication, and an enforcement point for corporate security policy. Using the proven, market-leading ActivIdentity Security Clients, organizations not only can address regulatory requirements by replacing static passwords with two-factor authentication, but also eliminate the need for users to remember multiple static passwords.

Whether using ActivIdentity ActivClient™ to secure workstations with smart cards and smart USB tokens, ActivIdentity ActivClient™ for Common Access Card to do the same in the U.S. federal government, ActivIdentity SecureLogin™ Single Sign-On to provide comprehensive enterprise single sign-on and password management capabilities, or ActivIdentity™ Authentication Client to offer additional authentication, user, and management services, ActivIdentity delivers a complete solution to meet the requirements of any organization.

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Authentication Devices

Rounding out the ActivIdentity product portfolio, ActivIdentity Authentication Devices provide organizations with a one-stop shop experience. ActivIdentity Authentication Devices range from Smart Cards, Smart Card Readers, Smart USB Tokens, OTP Tokens, DisplayCard Tokens, and Soft Tokens to Hardware Security Modules. ActivIdentity Authentication Devices provide the flexibility to deploy any combination of devices to best meet an organization’s specific business needs, security requirements, and budget.

Our Strategy:  In 2009, management started to implement a multi-pronged business transformation plan. Management is realigning the Company to increase the organizational and operational efficiencies through its initiatives to optimize cost and improve key operation processes that are expected to create a foundation for future growth strategies. This plan is expected to deliver modest revenue growth and reduced operational expenses. Management has initiated global growth strategy that is intended to capture a global market leadership position for ActivIdentity by leveraging the Company’s existing core assets and customer base to issue and manage identity credentials (and devices), authenticate using these credentials, enforce access control rules and enable the credential usage. As part of this strategy, ActivIdentity intends to realign its products and solutions to better address customer requirements, and to create and penetrate new and existing markets.

Industry Outlook:  We believe that the identity management market (covering credential management solutions and strong authentication) is a rapidly emerging global industry that despite the economic downturn offers opportunity for growth. Main business drivers are tightening of government regulations, growing awareness of the risks of identity theft (especially in light of the increased internal threat from disgruntled ex-employees), and the growth in electronic commerce. While the industry is still in the early stage of development, industry-wide standards are evolving. Combining the essential back-end infrastructure components (a versatile strong authentication platform and a credential management system) of an identity management system with a variety of authentication devices as well as security clients to enable a secure, end-to-end solution is essential for protecting an organization’s assets, including network infrastructures, employees, customers, and confidential data. Issues driving industry growth and standardization are often unique across our target customer base, especially in international locations. We continue to monitor the evolution of the digital identity market and adapt products and services to best position the Company to realize competitive advantages. Additional challenges and risks that our product lines face include, but are not limited to: price and product feature competition, evolving technological change in the network security market, and risk of bugs and other errors in the software.

Financial Performance Indicators:  We have a long and often complicated sales cycle and are dependent on a relatively small number of large deals, which can result in significant revenue fluctuations between periods. The typical sales cycle is six to nine months for an enterprise customer and over 12 months for a network service provider or government agency. As a result, in addition to monitoring financial performance based on reported revenues, management analyzes the probability of future transactions in the open deal pipeline when assessing financial condition and operating performance. Trends in deferred revenues, maintenance renewal contracts, and customer, geographic, or product mix are also integral to management’s decision making process.

Strategic Initiatives: We are currently realigning our product and solutions strategy to address current and future market trends. As part of these efforts, we are conducting market studies to analyze vertical market segments in which the information technology (“IT”) spending and adoption rates favor strong authentication and credential management system solutions. These verticals include, but are not limited to the Banking and Financial Services Industry (BFSI), Government, Enterprise (especially high-tech and pharmaceuticals), as well as Aerospace and Defense. We are also developing financial performance benchmarks to quantify the financial impacts of the revised strategic alignment and provide additional tools to assist management in assessing our financial condition. Restructuring and related cost cutting plans implemented to date have helped to streamline the Company and management will continue to identify areas for strategic improvement, in both revenue growth and cost containment.

SIGNIFICANT EVENTS

During the quarter ended June 30, 2009, the following items impacted our net income:

·Foreign exchange gains: For the quarter ended June 30, 2009, we recorded a gain on foreign exchange of $2.1 million through our consolidated statement of operations.  The gains primarily occurred from the revaluation of assets and liabilities denominated in non-functional currencies on the balance sheets of various legal entities.  The largest percentage gains during the three months ended June 30, 2009 against the US dollar were seen in the British pound and Australian dollar of 14% and 15% respectively.

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RESULTS OF OPERATIONS

Certain prior periods’ revenue and cost of revenue have been reclassified to conform to the current period’s presentation. See further discussion of reclassified amounts in Note 1 — Basis of Presentation to the consolidated financial statements.

REVENUE

Revenue by Product Type

Total revenue, period-over-period changes and mix by product type were as follows (dollars in thousands):

	Three Months Ended											Nine Months Ended
	June 30,						Increase			Percentage		June 30,						Increase			Percentage
	2009			2008			(Decrease)			Change		2009			2008			(Decrease)			Change
Software	$	6,888		$	5,024		$	1,864		37	%	$	18,405		$	13,961		$	4,444		32	%
Hardware	3,245			3,175			70			2	%	12,196			11,090			1,106			10	%
Service	5,236			6,099			(863		)	-14	%	17,199			18,311			(1,112		)	-6	%
Total revenue	15,369			$	14,298		$	1,071		7	%	$	47,800		$	43,362		$	4,438		10	%
Product Mix:
Software	45		%	35		%						38		%	32		%
Hardware	21		%	22		%						26		%	26		%
Service	34		%	43		%						36		%	42		%
	100		%	100		%						100		%	100		%

Our business has varying revenue streams, each of which has different characteristics including its recurring nature, transactional pricing, and volume characteristics. Software revenue is driven by irregularly occurring and unpredictable orders of significant size that are dependent on the closing of the transactions and can result in significant variances period over period. As hardware revenue is generally coincident with the sale of software products, the variability in software revenue is the driving factor in the fluctuations of hardware revenue, although timing of hardware sales may lag the initial sale of related software. Maintenance revenue, the most significant component of service revenue, is tied directly to the installed base of customers, which fluctuates with the timing of new customer aquisition and the level of renewal activity with existing customers. The timing of closure of software transactions in the pipeline is the single most relevant factor in the Company’s recorded revenue.

Our software revenue is comprised of software license revenue and professional services revenue essential to the functionality of our software. The $1.9 million and $4.4 million increase, year-over-year, in software revenue for the three and nine months ended June 30, 2009, was primarily driven by software customization, sales of our ActivClient™  software linked to PIV (personal identity verification) and PIVi Card rollouts, as well as sales of our authentication products.

Hardware revenue is comprised of tokens, readers, smart cards, and related equipment, generally to complement sales of related software products. Hardware sales for the three months ended June 30, 2009 was flat year-over-year. Hardware revenue for the nine months ended June 30, 2009 increased $1.1 million year-over-year primarily driven by increases in token sales in the Europe and Asia Pacific banking sectors.

Service revenue is comprised of post-contract customer support and professional services not essential to the functionality of software, including installation, training, and consulting.   Service revenue decreased by 14% and 6%, respectively for the three and nine months ended June 30, 2009 resulting from fewer maintenance contracts which was partially offset by higher training revenue.

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Revenue by Geography

Period-over-period changes in revenue by geography and as a percentage of total revenue, was as follows (dollars in thousands):

	Three Months Ended										Nine Months Ended
	June 30,						Increase		Percentage		June 30,						Increase			Percentage
	2009			2008			(Decrease)		Change		2009			2008			(Decrease)			Change
North America	$	7,073		$	6,572		$	501	8	%	$	21,831		$	18,402		$	3,429		19	%
Europe	6,489			6,448			41		1	%	20,679			21,144			(465		)	-2	%
Asia Pacific	1,807			1,278			529		41	%	5,290			3,816			1,474			39	%
Total revenue	$	15,369		$	14,298		$	1,071	7	%	$	47,800		$	43,362		$	4,438		10	%
Geographic Mix:
North America	46		%	46		%					46		%	42		%
Europe	42		%	45		%					43		%	49		%
Asia Pacific	12		%	9		%					11		%	9		%
	100		%	100		%					100		%	100		%

North America revenue increased $0.5 million and $3.4 million for the three and nine months ended June 30, 2009, year-over-year. North America software sales for the three and nine months ended June 30, 2009 increased 40% and 92% year-over-year, respectively. Hardware sales in North America decreased year over year for the three and nine months ended June 30, 2009 by 26% and 19% respectively.

Europe revenue was flat for the three and nine months ended June 30, 2009, year-over-year. For the three months ended June 30, 2009 increasing software sales were offset by decreasing service revenues. For the nine months ended June 30, 2009, softening software sales in Europe were offset by increasing hardware sales. Hardware sales for the Europe region for the three and nine months ended June 30, 2009 increased 7% and 23% respectively.

Asia Pacific revenue for the three and nine months ended June 30, 2009  increased $0.5 million and $1.5 million, year-over-year, due primarily to the smart card driver’s license contract in Queensland, Australia.  Strengthening software and hardware sales were the primary drivers for the increased revenues.

COST OF REVENUE

Total cost of revenue, costs as a percentage of corresponding revenue, and period-over-period changes were as follows (dollars in thousands)

	Three Months Ended June 30,						Increase			Percentage		Nine Months Ended June 30,						Increase			Percentage
	2009			2008			(Decrease)			Change		2009			2008			(Decrease)			Change
Software	$	1,046		$	530		$	516		97	%	$	3,227		$	829		$	2,398		289	%
As a % of software revenue	15		%	11		%						18		%	6		%
Hardware	$	1,675		$	2,071		$	(396	)	-19	%	$	6,234		$	6,819		$	(585	)	-9	%
As a % of hardware revenue	52		%	65		%						51		%	61		%
Service	$	1,716		$	2,596		$	(880	)	-34	%	$	5,699		$	8,035		$	(2,336	)	-29	%
As a % of service revenue	33		%	43		%						33		%	44		%
Amortization of acquired dev. technology & patents	$	593		$	592		$	1		0	%	$	1,779		$	1,787		$	(8	)	-1	%
Total cost of revenue	$	5,030		$	5,789		$	(759	)	-13	%	$	16,939		$	17,470		$	(531	)	-3	%

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Cost of Software Revenue

Cost of software revenue includes the cost of professional services associated with customization essential to the functionality of software. The $0.5 million and $2.4 million increase, year-over-year, in software cost of revenue for the three and nine months ended June 30, 2009, was primarily driven by increased engineering service costs incurred on a large software customization project for the issuance of smart card driver’s licenses.  Margins were adversely impacted as professional services revenue has significantly more direct costs than traditional product software sales.

Cost of Hardware Revenue

Cost of hardware revenue includes costs associated with the manufacturing and shipping of product, logistics, operations, warranty costs and charges related to excess and obsolete inventory. Hardware product margins are influenced by numerous factors including hardware product mix, inventory adjustments, pricing, geographic mix and foreign currency exchange rates. Many of these factors influence, or are interrelated with, other factors. As a result, it is difficult to precisely quantify the impact of each item individually to our hardware margins. The majority of our smart card and reader revenue reflects products manufactured for us by original equipment manufacturers that accordingly have lower margins compared to tokens, which are manufactured for us by contract manufacturers and yield higher gross margins.

Hardware margins improved for the three and nine months ended June 30, 2009 year-over-year, due to the increase in token sales which generally have higher margins than readers and smart cards. Cost reduction programs are reducing logistic and operational expenses.

Cost of Service Revenue

Cost of service revenue consists of personnel costs and expenses incurred in providing post-contract customer support and professional services not essential to software such as installation, training, and consulting.  Cost of service revenue decreased for the three and nine months ended June 30, 2009 year-over-year, as we revised downward our overhead allocation rates to maintenance and professional services during our annual budgeting review process.  The lower allocation rates are in line with our cost reduction strategies that are intended to reduce overhead expenses as we realign our business model.  In addition, a greater percentage of total professional service hours were allocated to software cost of revenue as the hours were incurred on the development of customized software projects.  Service margins improved as less overhead expenses were absorbed into cost of revenue based on the revised allocation rates.

Cost of service revenue decreased for the three and nine months ended June 30, 2009 by 0.9 million and $2.3 million as resources during the current year were reallocated to software contracts as well as a decline in service revenues.

Amortization of Acquired Developed Technology and Patents

Amortization of acquired developed technology and patents includes amortization of technology capitalized in our acquisitions and purchase of certain patents and related intellectual property from third parties.  Current period amortization variances are insignificant and consistent with our scheduled amortization.

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OPERATING EXPENSES

A substantial proportion of our operating expenses are fixed. Accordingly, a small variation in the timing of revenue recognition can cause significant variations in operating results across periods.

Sales and marketing

Sales and marketing expenses and period-over-period changes were as follows (dollars in thousands):

	Three Months Ended June 30,						Nine Months Ended June 30,
	2009			2008			2009			2008
Sales and marketing	$	4,868		$	5,827		$	15,172		$	19,548
Percentage change from comparable prior period	-16		%				-22		%
As a percentage of net revenue	32		%	41		%	32		%	45		%
Headcount, end of period	91			99

Sales and marketing expenses consist primarily of salaries and other payroll expenses such as commissions and travel, depreciation, costs associated with marketing programs, promotions, trade shows, and allocations of facilities and information technology costs.

Sales and marketing expenses for the three and nine ended June 30, 2009 decreased 16% and 22% respectively, year-over-year on reduced compensation costs associated with the headcount reductions and cost reduction programs.

Research and development

Research and development expenses and period-over-period changes were as follows (dollars in thousands):

	Three Months Ended June 30,						Nine Months Ended June 30,
	2009			2008			2009			2008
Research and development, net	$	3,398		$	4,676		$	11,690		$	14,092
Percentage change from comparable prior period	-27		%				-17		%
As a percentage of net revenue	22		%	33		%	24		%	32		%
Headcount, end of period	98			116

Research and development expenses consist primarily of salaries, costs of components used in research and development activities, travel, depreciation, and allocations of facilities and information technology costs.

Research and development expenses were reduced $1.3 million and $2.4 million for the three and nine months ended June 30, 2009, year-over-year as compensation costs associated with headcount reductions, decreased severance expense and overhead allocation reductions from cost reduction programs continue.

General and administration

General and administration expense and period-over-period changes were as follows (dollars in thousands):

	Three Months Ended June 30,						Nine Months Ended June 30,
	2009			2008			2009			2008
General and administration	$	3,101		$	2,626		$	9,732		$	8,267
Percentage change from comparable prior period	18		%				18		%
As a percentage of net revenue	20		%	18		%	20		%	19		%
Headcount, end of period	38			42

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General and administration expenses consist primarily of personnel costs for administration, finance, human resources, and legal, as well as professional fees related to legal, audit and accounting, costs associated with Sarbanes-Oxley Act compliance, and allocations of facilities and information technology costs.

General and administration expenses increased $0.5 million and $1.5 million for the three and nine months ended June 30, 2009 over the same period in the prior year primarily as a result of a change in the manner that executive officer and board of directors’ costs were allocated. All amounts were allocated to general and administration instead of other cost centers during fiscal 2009.  Management believes these costs are properly reported as general and administration expenses.

INTEREST INCOME

Interest income and period-over-period changes were as follows (dollars in thousands):

	Three Months Ended June 30,						Nine Months Ended June 30,
	2009			2008			2009			2008
Interest income	$	285		$	845		$	1,465		$	3,772
Percentage change from comparable prior period	-66		%				-61		%
As a percentage of net revenue	2		%	6		%	3		%	9		%

Interest income consists of interest on our cash, cash equivalents, restricted cash, and investments.  Since the quarter ended September 30, 2007, we have transferred a significant portion of our investment portfolio into cash and cash equivalents.  The decrease in interest income for the three and nine ended June 30, 2009 year-over-year was attributable to a migration of the portfolio to lower yielding investments, decreases in market interest rates over the prior year, and the overall reduction in the cash, equivalents, and investments portfolio.

OTHER INCOME (EXPENSE), NET

Other income (expense) and period-over-period changes were as follows (dollars in thousands):

	Three Months Ended June 30,						Nine Months Ended June 30,
	2009			2008			2009			2008
Other income (expense)	$	2,108		$	(2,927	)	$	(1,053	)	$	(4,977	)
Percentage change from comparable prior period	-172		%				-79		%
As a percentage of net revenue	14		%	20		%	2		%	11		%

Other income (expense), net, consists of foreign exchange gains and losses, primarily caused by the revaluation of intercompany balances, impairment of investments, and other income and expenses.  For the three months ended June 30, 2009, the U.S. dollar weakened against the Euro, British pound, and Australian dollar, resulting in foreign exchange gains of $2.1 million dollars for the period which represented a 172% change from the same period in 2008. The largest percentage gains during the three months ended June 30, 2009 against the US dollar were seen in the British pound and Australian dollar of 14% and 15% respectively. For the nine months ended June 30, 2009 the US dollar strengthened against the aforementioned currencies and resulted in a $1.1 million year-to-date loss on the revaluation of assets and liabilities denominated in non-functional currencies on the balance sheets of our foreign entities.

INCOME TAXES

We account for income taxes under the liability method in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109), and FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109 (FIN 48). Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax reporting bases of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. Realization of deferred tax assets is dependent upon future earnings, the timing and amount of which are uncertain.

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As of June 30, 2009, we continue to provide a full valuation allowance for substantially all of our net deferred tax assets.  As of June 30, 2009 some deferred tax assets and liabilities in foreign jurisdictions have been benefitted.  The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income and the reversal of deductible and taxable temporary differences.  We consider, among other available information, historical earnings, scheduled reversals of temporary differences, projected future taxable income, prudent and feasible tax planning strategies and other matters in making this assessment.

We have recorded an income tax benefit for the three months and nine months ended June 30, 2009 of $0.8 million and $0.1 million, respectively. The income tax benefit was primarily related to timing differences associated with unrealized gains on foreign exchange and refundable credits earned in France.

The Company or its subsidiaries files income tax returns in the U.S. and California, as well as various other foreign and domestic jurisdictions. The French tax authority is currently examining the fiscal 2005, 2006, and 2007 income tax returns.  The Company is currently not the subject of any additional income tax examinations.  In general, the earliest open year subject to examination in a major tax jurisdiction is the year ended December 31, 2003, although depending upon jurisdiction, earlier tax years may remain open subject to limitations.

MINORITY INTEREST

Minority interest represents the minority interest share in the consolidated net income or loss of ActivIdentity Europe S.A.

LIQUIDITY AND CAPITAL RESOURCES

The following sections discuss the effect of changes in our balance sheet and cash flows and contractual obligations on our liquidity and capital resources.

CASH, CASH EQUIVALENTS, RESTRICTED CASH, AND INVESTMENTS

The following table summarizes our cash, cash equivalents, restricted cash, and investments (dollars in thousands):

	June 30, 2009		September 30, 2008		Increase (Decrease)
Cash and cash equivalents	$	75,392	$	70,173	$	5,219
Short-term investments	3,454		9,656		(6,202		)
Long-term restricted cash	1,610		—		1,610
Long-term investments	11,752		11,752		—
	$	92,208	$	91,581	$	627

The portfolio of cash, cash equivalents, restricted cash, and marketable securities is managed by several financial institutions.  The increase of $0.6 million was attributable primarily to $0.5 million of cash provided by operating activities in the current quarter. Proceeds from the sale of short-term investments constituted a cash transfer to support operations in the beginning of the fiscal year.

We believe that our cash, cash equivalents, and short-term investments will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures for at least the next 12 months.  From time to time, in the ordinary course of business, we may evaluate potential acquisitions of businesses, products, or technologies.  A portion of our cash may be used to acquire or invest in complementary businesses, or to acquire products or to obtain the right to use complementary technologies.

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The following table summarizes cash inflows / outflows by category (dollars in thousands):

	Nine Months Ended June 30,
	2009		2008			Increase (Decrease)
Net cash provided by (used in) operating activities	$	461	$	(3,246	)	$	3,707
Net cash provided by (used in) investing activities	4,660		40,643			(35,983		)
Net cash provided by financing activities	—		25			(25		)

Operating Activities

For the nine months ended June 30, 2009, our net cash provided by operating activities increased $0.5 million resulting in positive net cash provided by operations, year-over-year due to improved operating activities and expense reduction programs.

Investing Activities

For the nine months ended June 30, 2009, net cash provided by investing activities decreased $36.0 million year-over-year as net proceeds from the purchasing and sale of short-term investments decreased. Cash provided by investing activities of $4.7 million was the result of sales of short-term securities at the beginning of the fiscal year of $6.2 million that were offset by $1.4 million of cash moved to restricted cash. Due to movements in foreign exchange rates since the initial transfer to restricted cash, this balance was valued at $1.6 million as of June 30, 2009.

ACCOUNTS RECEIVABLE, NET

The following table summarizes our accounts receivable, net (in thousands):

	June 30, 2009		September 30, 2008		Increase (Decrease)
Accounts receivable, net	$	10,092	$	11,792	$	(1,700	)

Net Accounts receivable decreased $1.7 million or 14% at June 30, 2009 from September 30, 2008, primarily as a result of the timing of invoices.  Collection activity improved during the nine months ended June 30, 2009 as days sales outstanding (“DSO”) decreased from 66 days at September 30, 2008 to 62 days by June 30, 2009.

DEFERRED REVENUE, NET

The following table summarizes our deferred revenue (in thousands):

	June 30, 2009		September 30, 2008		Increase (Decrease)
Service	$	8,224	$	9,589	$	(1,365	)
Product	3,239		2,560		679
Total	$	11,463	$	12,149	$	(686	)
Reported as:
Current	$	10,637	$	11,024	$	(387	)
Noncurrent	826		1,125		(299		)
Total	$	11,463	$	12,149	$	(686	)

Deferred product revenue increased $0.7 million at June 30, 2009, primarily driven by sales of new licenses that took place during the quarter for which not all revenue recognition criteria under SOP 97-2 were met to allow revenue recognition prior to June 30, 2009.

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CONTRACTUAL OBLIGATIONS

The following summarizes our contractual obligations under facility leases which are inclusive of amounts identified as part of our restructuring plans and exclusive of expected sublease income, at June 30, 2009, and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands):

	Total		Less than 1 Year (1)		1 to 3 Years		3 to 5 Years		More than 5 years
Operating leases (2)	$	4,679	$	743	$	3,936	$	—	$	—

(1)	Represents remaining three months of the 2009 fiscal year.
(2)	Operating leases include amounts related to non-cancelable operating leases that are included in the charge for restructuring expenses exclusive of expected sublease income of approximately $0.5 million.

RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.  SFAS No. 157 replaces the different definitions of fair value in the accounting literature with a single definition.  It defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  We adopted SFAS No. 157 on October 1, 2008, for financial assets and liabilities.  We have elected to adopt SFAS No. 157 for non-financial assets and liabilities on October 1, 2009, in accordance with FASB Staff Position (FSP) No. 157-2.  We are currently evaluating the impact of applying the deferred portion of SFAS No. 157 to the nonrecurring fair value measurements of its nonfinancial assets and liabilities.

In April 2009, the FASB issued FSP SFAS No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. FSP SFAS No. 157-4 provides guidelines for making fair value measurements more consistent with the principles presented in SFAS No. 157, Fair Value Measurements. The FSP relates to determining fair values when there is no active market or where the price inputs being used represent distressed sales. It reaffirms what SFAS No. 157 states the objective of fair value measurement—to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements under current market conditions. Specifically, it reaffirms the need to use judgment to ascertain if a fo rmerly active market has become inactive and in determining fair values when markets have become inactive. The provisions of FSP 157-4 are effective for the Company’s interim reporting for the period ending on June 30, 2009. The Company has adopted this FSP in the quarter ended June 30, 2009, and there was no material impact on the consolidated financial statements.

In April 2009, the FASB issued FSP SFAS No. 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments. FSP SFAS No. 107-1 and APB 28-1 enhances consistency in financial reporting by increasing the frequency of fair value disclosures. The FSP relates to fair value disclosures for any financial instruments that are not currently reflected within a Company’s balance sheet at fair value. Prior to the effective date of this FSP, fair values for these assets and liabilities have only been disclosed once a year. The FSP will now require these disclosures on a quarterly basis, providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value. The disclosure requirements under this FSP are effective for the Company’s interim reporting period ending on June 30, 2009.  The Company adopted this FSP in the quarter ended June 30, 2009. There was no impact on the consolidated financial statements as it relates only to additional disclosures. The required disclosures are included in Note 1 “Basis of Presentation”.

In April 2009, the FASB issued FSP SFAS No. 115-2 and SFAS No. 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. FSP SFAS No. 115-2 and SFAS No. 124-2 amends the other-than-temporary impairment guidance in U.S. GAAP for debt securities and provides additional guidance designed to create greater clarity and consistency in accounting and presenting impairment losses on securities. The FSP is intended to bring greater consistency to the timing of impairment recognition, and provide greater clarity to investors about the credit and noncredit components of impaired debt securities that are not expected to be sold. The measure of impairment in comprehensive income remains fair value. The FSP also requires increased and timelier disclosures regarding expected cash flows, credit losses, and an aging of securities with unrealized losse s. The FSP is effective for the Company’s interim reporting for the period ending on June 30, 2009. The Company adopted this FSP for the quarter ended June 30, 2009, and there was no material impact on the consolidated financial statements.

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In December 2007, the FASB issued SFAS No. 141 (revised), Business Combinations. The standard changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. We will evaluate the impact of the provisions of SFAS No. 141(R) and will adopt this standard on October 1, 2009.

In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51. The standard changes the accounting for noncontrolling (minority) interests in consolidated financial statements including the requirements to classify noncontrolling interests as a component of consolidated stockholders’ equity, and the elimination of “minority interest” accounting in results of operations with earnings attributable to non-controlling interests reported as part of consolidated earnings. Additionally, SFAS No. 160 revises the accounting for both increases and decreases in a parent’s controlling ownership interest. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. We will evaluate the impact of the provisions of SFAS No. 160 and will adopt this standard on October 1, 2009.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities. The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. We will evaluate the impact of the provisions of SFAS No. 161 and will adopt this standard on October 1, 2009.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events.  This Statement sets forth: 1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; 2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and 3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. This Statement is effective for interim and annual periods ending after June 15, 2009. The Company adopted this Statement in the quarter ended June 30, 2009. This Statement did not impact the consolidated financial results.

In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification TM and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162 (the Codification). The Codification, which was launched on July 1, 2009, became the single source of authoritative nongovernmental U.S. GAAP, superseding existing FASB, American Institute of Certified Public Accountants (AICPA), Emerging Issues Task Force (EITF) and related literature. The Codification eliminates the GAAP hierarchy contained in SFAS No. 162 and establishes one level of authoritative GAAP. All other literature is considered non-authoritative. This Statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Company will adopt this Statement for its fiscal year ending September 30, 2009. There will be no change to the Company’s Consolidated Financial Statements due to the implementation of this Statement.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Basis of Presentation

The above discussion and analysis of the financial condition and results of operations are based on the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of SEC Regulation S-X.  We believe there are several accounting policies that are critical to understanding the consolidated financial statements, as these policies affect the reported amounts of revenue and expenses and involve management’s judgment regarding significant estimates.  We have reviewed the critical accounting policies and their application in the preparation of the financial statements and related disclosures with the Audit Committee of the Board of Directors. The critical accounting policies and estimates are described below. The results for the interim periods presented are not necessarily indicative of the results expected for any future period.  The following information should be read in conjunction with the audited financial statements and notes thereto included in the Annual Report on Form 10-K for the year ended September 30, 2008.

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Revenue Recognition

We recognize revenue in accordance with accounting principles generally accepted in the U.S., as set forth in American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions, Accounting Research Bulletin No. 45 (ARB 45), Long-Term Construction-Type Contracts, SOP 81-1, Accounting for Performance of Construction Type and Certain Production Type Contracts, SEC Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition, Emerging Issues Task Force Issue No. (EITF) 00-21, Revenue Arrangements with Multiple Deliverables, and EITF 03-05, Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software. The application of the appropriate accounting principles to revenue is dependent upon the specific transaction and whether the sale includes hardware products, software products, post contract customer support (PCS), other professional services, or a combination of some or all of these products and/or services.

Subject to the additional conditions described below, the Company did not recognize revenue until: (1) persuasive evidence of an arrangement exists; (2) the fee is fixed or determinable; (3) delivery has occurred; and (4) collection of the corresponding receivable is reasonably assured.

For multiple element arrangements that contain one or more deliverables for which the functionality is not dependent on the software, the arrangement fee is allocated between the “non-software” and software deliverables in accordance with EITF 00-21 when the following criteria are met:

·     The delivered item has stand alone value;

·     There is objective and reliable evidence of the fair value of the undelivered elements as demonstrated by vendor specific objective evidence (VSOE) or third party evidence; and

·     If the arrangement includes a general return right relative to the delivered item, delivery or performance of the undelivered item is considered probable and substantially in the control of the vendor.

If the above criteria are met, we allocate the arrangement fee to the delivered items using the residual value method. Revenue for the elements whose functionality is not dependent upon the delivered software is recognized in accordance with SAB 104, and revenue for software elements is recognized in accordance with SOP 97-2. If the above criteria are not met, all deliverables are considered a single unit of accounting and revenue is recognized in accordance with SOP 97-2 upon delivery of all elements of the arrangement.

For multiple element arrangements that contain one or more deliverables for which the functionality is dependent on the software, the arrangement fee is subject to the provisions of SOP 97-2, and is allocated among each element, based on VSOE of fair value of each element if VSOE of each element exists. We determine VSOE of an element based on the price charged when the same element is sold separately. For an element not yet sold separately, VSOE may be established by management having the relevant authority as long as it is probable that the price, once established, will not change before separate introduction of the element in the marketplace. When arrangements contain multiple elements and VSOE exists for all undelivered elements only, we recognize revenue for the delivered elements based on the residual value method. For arrangements containing multiple elements wherein VSOE does not exist for all undelivered elements, revenue for the delivered and undelivered elements is deferred until VSOE exists or all elements have been delivered. Additionally, where VSOE does not exist to allocate the fee to the separate elements and the only undelivered element is PCS, the entire arrangement fee is recognized ratably over the contractual PCS period. For all other transactions not involving software, fair value is determined using the price when sold separately or other methods allowable under EITF 00-21.

Professional service revenue is recognized separately from the software element when the services are performed and when VSOE exists to allocate the revenue to the various elements in a multi-element arrangement, the services are not essential to the functionality of any other element of the arrangement, and the total price of the contract would vary with the inclusion or exclusion of the services. Revenue under these arrangements is presented as a component of service revenue on the statement of operations.

PCS contracts are typically priced as a percentage of the product license fee and generally have a one-year term. Services provided to customers under PCS contracts include technical product support and unspecified product upgrades, on a when and if available basis. Revenues from advance payments for PCS contracts are recognized on a straight-line basis over the term of the contract and are classified as service revenue.

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Even though delivery of PCS and services has started, while all of the criteria in SOP 97-2 for revenue recognition have not yet been met, PCS and service revenue recognition may not commence. At the time all the criteria in SOP 97-2 are met, the portion of the deferred amount based on the proportion of the service period that has already expired to the total service period is immediately recognized and the residual amount is recognized ratably over the longer of the remaining PCS or service period.

Except in arrangements where acceptance is considered perfunctory, where we have provided acceptance rights to certain customers, no products or services revenue is recognized until the earlier of the customer formal acceptance or the expiration of the acceptance period granted to the customer.

For arrangements that involve some customization, modification or production services that are considered essential to the functionality of the software element, and separate accounting for these services is not permitted, revenue from the license and professional services essential to the functionality of the software is recognized using the percentage-of-completion method in accordance with SOP 81-1. The percentage-of-completion method is applied when we have the ability to make reasonably dependable estimates of the total cost of effort required for completion using the cost of labor hours incurred as the measure of progress towards completion. The progress toward completion is measured based on the date when the essential product functionality has been delivered or the application enters into a production environment or the point at which no significant additional professional service resources are required for the functionality of the software. Estimates are subject to revisions as the contract progresses to completion and these changes are accounted for as changes in accounting estimates when the information becomes known. Revenue under these arrangements is presented as a component of software revenue on the statement of operations as the related project revenues, including both the license and service components, are less than 10% of total net revenues.  Where VSOE exists for professional services not essential to the functionality of the software, revenue is recorded as service revenue.  Forecasted losses on contracts are accrued to cost of revenue in the period in which a forecasted loss is deemed probable and estimable.  Amounts billed in excess of revenue recognized are recorded as deferred revenue in the consolidated balance sheets. Unbilled work-in-process is recorded as a receivable in the consolidated balance sheets. At June 30, 2009 and September 30, 2008, the balances of unbilled work-in-process were $0.9 million and $0.4 million, respectively.

We had one ongoing reseller arrangement under which we received a fixed percentage of license and service revenue earned by the reseller. For this arrangement, we have no control over the pricing established by the reseller, including what is charged for service renewals. Since we cannot determine if sufficient amounts of PCS renewals are priced at consistent percentages of license fees, we are unable to establish VSOE for service renewals in this arrangement. Accordingly, for the bundled sales of license and service, the Company recognizes revenue on a straight-line basis over the term of the service period. For statement of operations presentation purposes only, we allocate revenue for this arrangement between software and PCS in a ratio consistent with our standard end-user pricing model. For the year ended September 30, 2008, $3.5 million or 18% of total software revenue and $4.0 million, or 16% of total service revenue, was allocated for this arrangement. We modified this ongoing customer arrangement in February 2009 and all future revenues will recognized as software revenue through the remainder of this arrangement.

For single element arrangements, revenue from stand alone product sales is recognized upon shipment (unless shipping terms determine otherwise), net of estimated returns and/or certain estimated future price changes. Our practice is not to ship product to a reseller or distributor unless the reseller or distributor has a history of selling the products or the end-user is known and has been qualified. In certain specific and limited circumstances, we provide product return and price protection rights to certain distributors and resellers. We have established a reasonable basis through historical experience for estimating future returns and price changes. Actual returns and price protection claims have not been material to date.

Loss Contingencies

We record loss contingencies in accordance with SFAS No. 5, Accounting for Contingencies. SFAS No. 5 establishes standards of financial accounting and reporting for loss contingencies. It requires accrual by a charge to profit and loss and disclosure for an estimated loss from a loss contingency if two conditions are met: (a) information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements, and (b) the amount of loss can be reasonably estimated. Accruals for general or unspecified business risks (“reserves for general contingencies”) are not permitted.

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Restricted Cash

Under the terms of a software development contract with a customer, we provide a performance guarantee in the form of a financial security agreement that extends through September 30, 2011.  At June 30, 2009, restricted cash, classified as non-current, included $1.6 million of financial guarantees secured by a term deposit.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. We base our estimates and judgments on historical experience and on various assumptions that we believe are reasonable under current circumstances. Future events, however, are subject to change and estimates and judgments routinely require adjustments, actual results could therefore differ from our current estimates. Significant estimates made in the accompanying financial statements include:

·Fair Value Measurements

·Allowance for Doubtful Accounts

·Inventory Valuation

·Long-lived Assets

·Other Intangible Assets

·Goodwill

·Restructuring Expense

·Hardware Sales Warranty Reserve

·Provision for Income Taxes

·Stock-based compensation

Off-Balance Sheet Arrangements

As of June 30, 2009 the Company had no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our consolidated financial condition, changes in our consolidated financial condition, revenues or expenses, consolidated results of operations, liquidity, capital expenditures or capital resources.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Exchange Rate Sensitivity

The Company is exposed to currency exchange fluctuations as it sells products and incurs expenses globally. The Company manages the sensitivity of international sales by denominating transactions in U.S. dollars, Euros, Australian dollars and British pounds.  A natural hedge exists in some local currencies, to a limited extent, as local currency denominated revenue offsets some of the local currency denominated operating expenses. The fluctuation of foreign currencies amounted to a gain of $2.1 million and loss of $1.1 million in the three and nine months ended June 30, 2009, respectively, as compared to a loss of $0.2 million and a gain of $0.8 million for the three and nine months ended June 30, 2008, respectively.

During the three and nine months ended June 30, 2009, of total sales, approximately 56% and 65% respectively were invoiced in U.S. dollars.  Although the Company purchases many components in U.S. dollars, approximately 46% and 54% of its expenses for the three and nine months ended June 30, 2009 were denominated in other currencies, primarily in Euros, Australian dollars and British pounds.  Because more revenue is U.S. dollar-denominated than expenses, a decline in the value of the U.S. dollar could adversely affect operating results.

Interest Rate Sensitivity

The Company is exposed to interest rate risk as a result of significant cash, cash equivalents, and investment holdings. The rate of return that the Company may be able to obtain on investment securities will depend on market conditions at the time these investments are made and may differ from the rates secured in the past.

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At June 30, 2009, the Company held $75.4 million of cash and cash equivalents, $3.5 million in short-term investments, $1.6 million in long-term restricted cash, and $11.8 million in long-term investments for a total of approximately $92.2 million.  Cash and cash equivalents consist primarily of cash, money-market funds, and U.S. Treasuries.  Short-term investments are primarily comprised of ARS associated with Closed-end Mutual Funds.  Long-term restricted cash consists of term deposits.  Long-term investments consist of ARS, associated with CDOs Derivative Product Companies, and Student Loans.  Based on the cash, cash equivalents, restricted cash, and investments at June 30, 2009, a hypothetical 10% increase or decrease in interest rates would increase or decrease annual interest income and cash flows by approximately $0.1 million.

Concentration of Credit Risk

Financial instruments that potentially expose the Company to a concentration of credit risk consist primarily of cash, cash equivalents, restricted cash, investments, and accounts receivable. The Company maintains cash, cash equivalents, and restricted cash with high credit quality financial institutions and investments consist of U.S. government and government agency securities, term deposits, corporate notes and bonds, and ARS.

The Company regularly maintains cash and cash equivalent balances that may exceed the amounts insured by the Federal Deposit Insurance Company (FDIC). The Company has not suffered any losses on its deposits of cash or cash equivalents.

See Note 4 — Investments, in Part 1 — Item 1, Consolidated Financial Statements and Liquidity and Capital Resources for a description of recent market events that may affect the value of the investments in our portfolio and the liquidity of certain ARS that we held as of June 30, 2009.  The Company believes it has made reasonable judgments in its valuation of investments. However, if the relevant assumptions, estimates, or the related analyses prove incorrect or, if due to additional information received in the future, management’s conclusions would change, the Company may be required to change the recorded value of the securities that make up the investment portfolio.

The Company sells the majority of its products and services to a limited number of customers. If the financial conditions or results of operations of any one of the large customers deteriorate substantially, operating results could be adversely affected. To reduce credit risk, management performs ongoing credit evaluations of the financial condition of significant customers. The Company does not generally require collateral and maintains reserves for estimated credit losses on customer accounts when considered necessary.

ITEM 4. CONTROLS AND PROCEDURES

(a) Management’s Evaluation of Disclosure Controls and Procedures:  The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s Securities Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management including its Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow timely decisions regarding required financial disclosure.

The Company’s CEO and CFO evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) during and as of the end of the period covered by this report.  Based on this evaluation, the CEO and CFO concluded that the disclosure controls and procedures were not operating effectively because the material weakness in internal controls over financial reporting as discussed below for the year ended September 30, 2008, had not been fully remediated as of June 30, 2009.  In light of the material weakness, the Company performed analysis and other post-closing procedures to ensure that the consolidated financial statements were prepared in accordance with generally accepted accounting principles.  Accordingly, management believes the financial statements included in this report fairly present in all material respects the Company’s financial condition, results of operations, and cash flows for the periods presented.

A material weakness is a control deficiency, or a combination of control deficiencies, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected.  Management determined that, pursuant to this definition, a material weakness existed in the Company’s internal control over financial reporting at September 30, 2008 and June 30, 2009, as follows:

·Revenue Recognition - The Company has controls in place to review significant revenue transactions and ensure revenue accounting is in accordance with the Company’s revenue recognition policy.  These controls were not effective during the year ended September 30, 2008, as their operation failed to ensure that all conditions required for revenue recognition were met.  During fiscal 2008, material revenue adjustments were required after the accounting close to properly defer revenue transactions in accordance with the Company’s revenue recognition policies.  In all cases, the adjustments were identified post-close and adjusting entries were recorded prior to issuance of the quarterly or annual reports.

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Since September 30, 2008, management has undertaken further steps to remediate the above identified material weaknesses, including a reorganization of the revenue accounting and order management departments to consolidate related operations under a newly created Director of Sales Management and Analysis. In addition, a new Revenue Recognition Manager with extensive software industry background was hired. During fiscal year 2009, the Company intends to revise the order to cash process to streamline data flows and enhance the review and approval process for sales transactions.  The material weakness in internal control identified as of September 30, 2008 will not be considered effectively remediated until management completes its internal control assessment as of September 30, 2009.

(b) Changes in Internal Control over Financial Reporting: There was no change in internal control over financial reporting (as defined in Rules 13a—15(f) and 15(d)—15(f) under the Exchange Act) that occurred during the period covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting, other than those activities described above.

PART II.  OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

From time to time, we are involved in disputes or regulatory inquiries that arise in the ordinary course of business. Any claims or regulatory actions against us, whether valid or not, could be time consuming, result in costly litigation, require significant amounts of management time, and result in the diversion of significant operational resources.

ITEM 1A.  RISK FACTORS

Risk factors as discussed in Part I - Item 1A Risk Factors in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2008, have not materially changed.  The risks discussed in the Annual Report on Form 10-K could materially affect the Company’s business, financial condition and future results. The risks described in the Annual Report on Form 10-K are not the only risks facing the Company.  Additional risks and uncertainties not currently known or that are currently deemed to be insignificant also may materially and adversely affect the Company’s business, financial condition or operating results.

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

None

ITEM 3. DEFAULT OF SENIOR SECURITIES

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5. OTHER INFORMATION

None

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ITEM 6. EXHIBITS

ExhibitNumber	Description
31.1	Certification of Chief Executive Officer Pursuant to Section 302(a) of The Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer Pursuant to Section 302(a) of The Sarbanes-Oxley Act of 2002
32.1	Certification of the Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, ActivIdentity Corporation has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Fremont, State of California, on the 10th day of August 2009.

ActivIdentity Corporation
By:	/s/  JACQUES KERREST
	Jacques Kerrest
	Chief Financial Officer

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