PART I FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

ACTIVIDENTITY CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

	June 30,			September 30,
	2008			2007 (1)
	(Unaudited)
ASSETS

Current assets:
Cash and cash equivalents	$	68,318		$	30,639
Short-term investments	16,836			91,084
Accounts receivable, net of allowance for doubtful accounts	8,820			14,566
Inventories, net	2,336			2,146
Prepaid and other current assets	2,026			2,077
Total current assets	98,336			140,512

Investments	29,148			—
Property and equipment, net	3,390			4,267
Other intangible assets, net	4,784			6,695
Other long-term assets	1,098			1,104
Goodwill	—			35,874
Total assets	$	136,756		$	188,452

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	2,023		$	2,116
Accrued compensation and related benefits	6,597			6,942
Current portion of accrual for restructuring liability	611			733
Accrued and other current liabilities	4,178			3,484
Current portion of deferred revenue	9,478			10,349
Total current liabilities	22,887			23,624

Deferred revenue, net of current portion	2,582			2,752
Accrual for restructuring liability, net of current portion	1,118			1,574
Long-term deferred rent	496			705
Other long-term liabilities	479			—
Total liabilities	27,562			28,655
Minority interest	323			354

Commitments and contingencies (Notes 11 and 13)

Stockholders’ equity:
Preferred stock, $0.001 par value:
10,000,000 shares authorized, none issued and outstanding	—			—
Common stock, $0.001 par value:
75,000,000 shares authorized, 45,786,184 and 45,732,623 issued and outstanding at June 30, 2008 and September 30, 2007, respectively	46			46
Additional paid-in capital	425,394			423,242
Accumulated deficit	(299,992		)	(246,501		)
Accumulated other comprehensive loss	(16,577		)	(17,344		)
Total stockholders’ equity	108,871			159,443
Total liabilities and stockholders’ equity	$	136,756		$	188,452

(1) Derived from audited consolidated financial statements.

See accompanying notes to consolidated financial statements.

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ACTIVIDENTITY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except per share data, unaudited)

	Three Months Ended June 30,						Nine Months Ended June 30,
	2008			2007			2008			2007

Revenue:
Software	$	5,983		$	4,923		$	17,017		$	17,540
Hardware	3,175			5,670			11,090			13,778
Maintenance and support	5,140			5,691			15,255			14,465
Total revenue	14,298			16,284			43,362			45,783

Cost of revenue:
Software	1,086			1,344			2,772			2,930
Hardware	2,071			2,733			6,819			7,536
Maintenance and support	2,040			1,194			6,092			3,406
Amortization of acquired developed technology and patents	592			747			1,787			2,331
Total cost of revenue	5,789			6,018			17,470			16,203
Gross profit	8,509			10,266			25,892			29,580

Operating expenses:
Sales and marketing	5,827			6,127			19,548			19,053
Research and development	4,676			5,060			14,092			14,913
General and administration	2,626			4,405			8,267			9,784
Restructuring expense (recovery)	3			—			(70		)	—
Amortization of acquired intangible assets	42			48			124			144
Impairment of goodwill	—			—			35,874			—
Total operating expenses	13,174			15,640			77,835			43,894
Loss from operations	(4,665		)	(5,374		)	(51,943		)	(14,314		)

Other income (expense):
Interest income, net	845			1,596			3,772			4,494
Other income (expense), net	(2,927		)	1,099			(4,977		)	2,431
Total other income (expense), net	(2,082		)	2,695			(1,205		)	6,925
Loss before income tax and minority interest	(6,747		)	(2,679		)	(53,148		)	(7,389		)
Income tax provision	(250		)	(41		)	(280		)	(155		)
Minority interest	14			(2		)	32			(8		)
Net loss	$	(6,983	)	$	(2,722	)	$	(53,396	)	$	(7,552	)
Basic and diluted net loss per share	$	(0.15	)	$	(0.06	)	$	(1.17	)	$	(0.17	)
Shares used to compute basic and diluted net loss per share	45,778			45,713			45,764			45,682

Other comprehensive income (loss):
Net Loss	$	(6,983	)	$	(2,722	)	$	(53,396	)	$	(7,552	)
Unrealized gain (loss) on short-term investment, net	(78		)	—			(911		)	364
Reclassification of unrealized loss on short-term investments	—			—			945			—
Foreign currency translation gain (loss)	(372		)	(1,133		)	(1,213		)	(2,390		)
Reclassification of currency translation loss on liquidation of investment in foreign entity	1,946			—			1,946			—
Comprehensive loss	$	(5,487	)	$	(3,855	)	$	(52,629	)	$	(9,578	)

See accompanying notes to consolidated financial statements.

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ACTIVIDENTITY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited in Thousands)

	Nine Months Ended June 30,
	2008			2007

Cash flows from operating activities:
Net loss	$	(53,396	)	$	(7,552	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization of fixed assets	1,225			1,157
Amortization of acquired developed technology and patents	1,787			2,331
Non-realized foreign exchange gain	(1,470		)	(2,394		)
Amortization of acquired intangible assets	124			144
Stock-based compensation expense	2,127			1,799
Loss on disposal of property and equipment	20			25
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	(32		)	8
Changes in:
Accounts receivable	6,339			7,839
Inventories	22			(519		)
Prepaid and other assets	593			(166		)
Accounts payable	(192		)	1,944
Accrued compensation and related benefits	(714		)	153
Accrual for restructuring liability	(581		)	(508		)
Accrued and other liabilities	666			453
Deferred revenue	(1,396		)	(2,310		)
Net cash provided by (used in) operating activities	(3,246		)	2,404

Cash flows from investing activities:
Purchases of property and equipment	(264		)	(1,815		)
Purchases of short-term investments	(37,245		)	(101,391		)
Proceeds from sales and maturities of short-term investments	78,215			113,337
Other long-term assets	(63		)	28
Net cash provided by investing activities	40,643			10,159

Cash flows from financing activities:
Proceeds from exercise of options, rights and warrants	25			191
Net cash provided by financing activities	25			191
Effect of exchange rate changes	257			482
Net increase in cash and cash equivalents	37,679			13,236
Cash and cash equivalents, beginning of period	30,639			11,477
Cash and cash equivalents, end of period	$	68,318		$	24,713

Supplemental disclosures:
Cash paid (refund received) for income taxes, net	$	(11	)	$	360

See accompanying notes to consolidated financial statements.

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1. Nature of Business

ActivIdentity Corporation (the Company) is a provider of digital identity assurance solutions for the enterprise, government, healthcare, and financial services markets worldwide for employer-to-employee, business-to-consumer and government-to-citizen solutions. Trusted identity is the core of the ActivIdentity platform enabling security for data, networks, applications, passwords and credentials, web, email and documents, transactions as well as converged security.

ActivIdentity® solutions support the convergence of physical and logical identity through strong authentication with smart card lifecycle management, enterprise single sign on, and data encryption and digital signature. 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, as well as intelligent citizen services.

ActivIdentity customers experience multiple benefits including increased network security, protection against identity theft and online fraud, enhanced workforce productivity, business process efficiencies, and regulatory compliance.

2. Basis of Presentation

The accompanying condensed consolidated financial statements include the accounts of 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, 2007, which has been derived from audited financial statements, and the unaudited interim condensed consolidated balance sheet as of June 30, 2008, and statements of operations and comprehensive losses and cash flows for the three and nine months ended June 30, 2008 and 2007, 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, 2008.

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, 2007. There have been no significant changes in the Company’s critical accounting policies that were disclosed in the Annual Report on Form 10-K for the fiscal year ended September 30, 2007, other than the impact of the adoption of Financial Accounting Standards Board (FASB) Financial Interpretation Number (FIN) 48, Accounting for Income Tax Uncertainties, which affected the Company’s accounting for income taxes (see Note 3).

3. Recent Accounting Pronouncements

In July 2006, the FASB issued FIN 48. FIN 48 defines the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authority. The recently issued literature provides guidance on the recognition, measurement and classification of income tax uncertainties, along with any related interest and penalties. FIN 48 includes guidance concerning accounting for income tax uncertainties in interim periods and increases the level of disclosures associated with any recorded income tax uncertainties. Any differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption are accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. In connection with the adoption of FIN 48 on October 1, 2007, the Company increased the liability for unrecognized tax benefits by approximately $95,000, which was accounted for as an increase to the October 1, 2007 balance of accumulated deficit. In addition, approximately $384,000 was reclassified from short-term to long-term income taxes payable. The total amount of gross unrecognized tax benefits as of the adoption was $479,000. The Company’s policy to include interest and penalties related to unrecognized tax benefits within the provision for (benefit from) income taxes did not change as a result of adopting the provisions of FIN 48.

In September 2006, the FASB issued Statement of Financial Accounting Standards (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. SFAS No. 157 is effective for fair-value measurements already required or permitted by other standards for

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financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. On November 14, 2007, the FASB agreed to partially defer the effective date of the standard for certain nonfinancial assets and liabilities. Management is currently in the process of determining the impact of adopting the provisions of SFAS No. 157 on its financial position, results of operations and cash flows, and will adopt this standard on October 1, 2008.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115. SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The provisions of SFAS No. 159 become effective for fiscal years beginning after November 15, 2007, and management will adopt this standard on October 1, 2008. Management believes that the adoption of SFAS No. 159 will not have a material effect on its financial statements.

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. Management 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, 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. Management 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. The Company will evaluate the impact of the provisions of SFAS No. 161 and will adopt this standard on October 1, 2009.

4. Stock-Based Compensation

Equity Compensation Plans

Warrants

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, 2008, it had one plan under which it continues to grant awards, the 2004 Equity Incentive Plan (2004 Plan). As of June 30, 2008, 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 8.0 million shares were subject to outstanding awards and 4.6 million shares were available for future grants under the 2004 Plan.

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.

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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.

In August 2004, the Company’s stockholders approved the 2004 Plan, which replaces 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 stock awards, 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.

The Company’s stock option activity is as follows:

Stock options	Number of Options		Weighted Average Exercise Price		Aggregate Intrinsic Value (in thousands)
Outstanding at 9/30/2007	7,226,603		$	5.75	$	3,879
Granted	428,000		4.12
Exercised	(4,781	)	3.77
Forfeited	(446,143	)	8.52
Outstanding at 12/31/2007	7,203,679		$	5.48	$	394
Granted	438,500		3.35
Exercised	—		—
Forfeited	(715,042	)	5.97
Outstanding at 3/31/2008	6,927,137		$	5.29	$	—
Granted	2,120,000		2.22
Exercised	—		—
Forfeited	(1,108,569	)	4.77
Outstanding at 6/30/2008	7,938,568		$	4.54	$	1,100
Exercisable at 6/30/2008	3,107,335		$	5.95	$	—

On April 23, 2008, two options were granted to the new Chief Executive Officer. The first option, which represents the right to acquire 1.0 million shares, will vest solely upon satisfaction of a time-based vesting condition and will vest with respect to one-quarter of the underlying shares on the first anniversary of the date of grant and then with respect to the remaining shares monthly thereafter ratably over the subsequent thirty-six months. The second option also represents the right to acquire 1.0 million shares and will vest only if the average closing stock price for the Company’s common stock over any given 90-day period within the first four years from the date of grant equals or exceeds $4.50 per share. Once this condition has been met, the option will vest with respect to 500,000 shares and then will vest monthly thereafter with respect to the remaining 500,000 shares ratably over the subsequent twelve months. Both options were granted outside of the 2004 Plan and as “inducement” awards as permitted under the NASDAQ Marketplace Rules. 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.

Stock options outstanding and exercisable as of June 30, 2008 are as follows:

		Options Outstanding
			Weighted
			Average
			Remaining			Options Exercisable
			Contractual	Weighted Average			Weighted Average
Range of Exercise Prices		Number	Term (in Years)	Exercise Price		Number	Exercise Price
$	2.18 - 4.23	3,130,076	6.94	$	2.63	467,413	$	3.46
	4.24 - 5.00	2,508,914	5.58	4.44		771,702	4.42
	5.01 - 6.82	912,003	5.61	6.19		742,335	6.36
	7.10 - 8.95	1,287,375	3.68	7.86		1,025,685	7.60
	9.04 - 11.18	100,200	3.69	9.43		100,200	9.43
		7,938,568	5.79	$	4.54	3,107,335	$	5.95

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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. During the first quarter of fiscal year 2008, 50,000 restricted stock units valued at a total of $206,000 were granted at no cost to non-employee directors. These awards will vest monthly over one year. During the quarter ended June 30, 2008, 120,000 restricted stock units valued at a total of $348,000 were granted at no cost to non-employee directors. These awards will vest monthly over one year, beginning on March 13, 2008, the date of the 2008 Annual Meeting of Stockholders, at which time these directors were elected.

Activity for the Company’s restricted stock and restricted stock units is as follows:

Nonvested Restricted Stock and Restricted Stock Units	Number of Shares		Weighted Average Grant-Date Fair Value
Nonvested at September 30, 2007	216,014		$	4.75
Granted	50,000		4.12
Vested	(21,319	)	4.96
Cancelled	—		—
Nonvested at December 31, 2007	244,695		$	4.60
Granted	—		—
Vested	(17,294	)	4.18
Cancelled	(18,752	)	4.12
Nonvested at March 31, 2008	208,649		$	4.68
Granted	120,000		2.90
Vested	(65,064	)	3.86
Cancelled	(90,612	)	4.57
Nonvested at June 30, 2008	172,973		$	3.82

Adoption of SFAS No. 123(R)

SFAS No. 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Consolidated Statement of Operations.

Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest. As stock-based compensation expense recognized in the Consolidated Statement of Operations for the three and nine months ended June 30, 2008 and 2007 is based on awards ultimately expected to vest, this expense has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company’s estimated forfeiture rates differ for executive and non-executive employees and for employees located in France.

SFAS No. 123(R) requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options to be classified as financing cash flows. Due to the Company’s loss position, there were no such tax benefits during the three and nine months ended June 30, 2008 and 2007.

The fair value of stock-based awards to employees that do not have a market or performance vesting condition is calculated using the Black-Scholes Merton option pricing model (the model). The model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which differ significantly from the Company’s stock options. The model also requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The risk-free rate is based on the U.S Treasury rates in effect during the corresponding period of grant. The expected volatility is based on the historical volatility of the Company’s stock price. These factors could change in the future, which would affect the stock-based compensation expense in future periods.

For restricted stock and restricted stock unit awards, compensation is based on the fair market value of the stock on the actual grant date.

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For awards that carry a market based vesting aspect, the fair value of the award is based on the results of a market simulation model (the simulation model) that evaluates the probability that the requisite market conditions needed for vesting will be achieved. The simulation model uses multiple iterations of simulated daily stock prices of the Company between the grant date and the future vesting date. The inputs to the simulation model include the Company’s stock price on the grant date, the historical volatility of the Company’s stock price over a period of time corresponding to the vesting period of the unit award as of the grant date, and the risk free interest rate, based on U.S. Treasury rates, as of the grant date whose applicable term also matches the vesting period. Based on whether the requisite market conditions are achieved during the multiple simulations the simulation model produces an expected future value of the stock on the vesting date. This future value is discounted back to the grant date and used as the requisite fair value of the unit award.

Valuation and Expense Information under SFAS No. 123(R)

The weighted-average fair value of stock-based compensation to employees that do not have a market based performance condition is based on the single option valuation approach. Forfeitures are estimated and it is assumed no dividends will be declared. The estimated fair value of stock-based compensation awards to employees is amortized using the straight-line method over the vesting period of the options. Below are the ranges of assumptions used:

	Three Months Ended		Nine Months Ended
	June 30,		June 30,
	2008	2007	2008	2007
Risk-free interest rate	2.9% - 3.4%	4.6% - 4.7%	2.4% - 4.2%	4.5% - 4.8%
Expected life (years)	4.8 – 5.4	4.8	4.8 – 5.4	4.8 – 6.1
Dividend Yield	0.0%	0.0%	0.0%	0.0%
Expected volatility	40.5% - 41.4%	41.1%	39.7% - 41.4%	41.1% - 55.0%
Weighted average expected volatility	41.3%	41.1%	40.9%	43.7%
Weighted average estimated forfeiture rate	40.0%	19.2%	39.5%	31.5%

Inputs to the simulation model did not differ significantly from the assumptions used in the single option valuation model. For the market based options granted to the CEO on April 23, 2008, the anticipated vesting period was derived from the output of the simulation model and was calculated as 2.3 years for the first 500,000 options, the median time to vest.

The following table summarizes stock-based compensation expense related to employee stock options, warrants, restricted stock, and restricted stock units under SFAS No. 123(R) for the three and nine months ended June 30, 2008 and 2007, which was allocated as follows (in thousands):

	Three Months Ended				Nine Months Ended
	June 30,				June 30,
	2008		2007		2008		2007
Cost of sales—software	$	32	$	34	$	97	$	74
Cost of sales—hardware	16		13		50		32
Cost of sales—support and maintenance	14		29		48		66
Stock-based compensation expense included in cost of sales	62		76		195		172
Research and development	219		226		628		446
Sales and marketing	155		162		486		422
General and administrative	324		285		818		759
Stock-based compensation expense included in operating expenses	698		673		1,932		1,627
Stock-based compensation expense related to employee stock options	$	760	$	749	$	2,127	$	1,799

As of June 30, 2008, total unrecognized compensation costs related to non-vested stock options, restricted stock, and restricted stock units was $5.6 million, which will be recognized as an expense over a weighted average vesting period of approximately 3.0 years. The weighted average grant date fair value of options granted during the three and nine months ended June 30, 2008 was $1.02 and $1.16, respectively, and $2.08 and $2.26, for the three and nine months ended June 30, 2007, respectively.

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5. Investments

Investments consist of corporate bonds and notes, commercial paper, certificates of deposit, and various auction rate securities (ARS). All investments are classified as available-for-sale and are recorded at market value.

As of June 30, 2008, the Company held a total of $38.0 million, at historical cost, invested in ARS. 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 historically have provided a liquid market for these securities. The Company’s investments in ARS represent interests in Collateralized Debt Obligations (CDO), Closed-end Mutual Funds, Taxable Municipals, Derivative Product Companies, and Student Loans.

Continued uncertainty in the credit markets has affected the Company’s holdings in ARS. During the quarters ended December 31, 2007, March 31, 2008, and June 30, 2008, $30.8 million, $41.9 million and $38.0 million, respectively, of ARS holdings at cost failed to settle at auction due to sell orders exceeding buy orders. As a result, the Company now earns a “penalty” interest rate, which is typically a higher rate than would be paid if the auctions were successful, but which may not fully compensate the Company for the loss of liquidity in the securities. Due to the failed auctions, the investments are currently considered illiquid until such time as auctions are again successful or these instruments are called or refinanced. The CDO’s and the Derivative Product Companies’ auctions began failing in August 2007. The Closed-end Mutual Funds, Taxable Municipals, and Student Loans failed initially in February 2008. At present, all ARS holdings of the Company have experienced failed auctions and are, therefore, presently illiquid as no viable trading market exists for these securities.

The CDO are insured by financial guarantors. At June 30, 2008, $11.5 million at cost of the CDO are guaranteed by Ambac and $14.5 million at cost are guaranteed by MBIA. As of June 30, 2008, Ambac was rated Aa3 by Moody’s and AA by Standard and Poor’s and MBIA was rated A2 by Moody’s and AA by Standard and Poor’s. Fitch has withdrawn rating coverage for the two financial guarantors effective June 26, 2008. Both insurers are reported to be experiencing financial difficulty, which could further negatively affect their ratings and thus the ratings of the Company’s ARS holdings.

During the quarter ended June 30, 2008, as a result of the downgrade on the financial guarantors, several of the ARS investments were downgraded by the rating agencies from the historical AAA rating. Following these downgrades of the guarantors, ratings of the ARS now range from AAA to AA by Standard and Poor’s and from Aaa to A2 by Moody’s. All investments are current on all obligations, and all continue to pay interest at the applicable penalty rates. Additionally, during the quarter ended June 30, 2008, $3.9 million at cost of the ARS holdings classified as short-term investments were called by the issuers at par, which provided the Company with liquidity on that portion of the ARS holdings without recognizing any loss on that portion of the Company’s investment. We currently expect that the Closed-end Mutual Funds and the Taxable Municipals will be called within the next 1 to 12 months at par. Based on this current expectation, these holdings are classified as short-term on the Company’s balance sheet as of June 30, 2008. Changes in future expectations regarding these securities may result in reclassifications of these holdings in future periods.

To reflect the lack of liquidity, $33.0 million at cost, representing an estimated $30.0 million at fair market value as of March 31, 2008, of these investments, specifically the CDO, the Derivative Product Companies, and the Student Loan holding, were reclassified as long-term investments on the Company’s balance sheet as of March 31, 2008. During the quarter ended June 30, 2008, none of the investments classified as long-term were liquidated and the Company currently has no short-term access to these funds. Given the Company’s current cash balances and forecasted operational cash requirements, the Company could hold these assets to maturity, if necessary.

Historically, the fair value of ARS approximated par value due to the frequent interest rate resets. However, the failed auctions have resulted, in most cases, in revised estimates of fair value that are less than par. Management has reviewed these investments and has valued the holdings accordingly using a discounted cash flow methodology.

The Company reduced the carrying value of certain ARS investments by $0.9 million as of December 31, 2007, through Other Comprehensive Income, so as to reflect the Company’s view at the time that the impairment was of a temporary nature. For the quarter ended March 31, 2008, the Company performed a valuation analysis, including reviews of the other-than-temporary impairment factors, and recorded an other-than-temporary impairment charge of $2.1 million to Other Income on the Consolidated Statement of Operations. Concurrently, the temporary impairment of $0.9 million recorded in the quarter ended December 31, 2007, was reclassified from Other Comprehensive Income to Other Income on the Consolidated Statement of Operations for the period ended March 31, 2008. For the quarter ended June 30, 2008, the Company recorded an additional other-than-temporary impairment charge of $0.8 million to Other Income on the Consolidated Statement of Operations, resulting in an estimated fair market valuation of $29.1 million for those ARS holdings classified as long-term as of June 30, 2008. The additional impairment was predominately driven by the downgrades on the financial guarantors and the resulting impact on the underlying ARS holdings. As a result of the downgrades, assumptions used in the valuation models changed, including an increase in the discount rates and a lengthening of certain expected terms. $5.0 million of ARS holdings are classified as short-term as of June 30, 2008, and are valued at par, based on the Company’s current expectations that these securities will be called by the issuers within the next twelve months.

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While the Company has used what it believes to be an appropriate valuation model for these securities and has attempted to incorporate all material identified risk factors into the analysis, the Company must make certain estimates and assumptions when assessing the value of the investment portfolio, including estimates of fair value and liquidity and estimates regarding the probability of redemption in certain time periods. These estimates are also based on market conditions, which are currently in a state of uncertainty. As a result, there is much independent judgment required in deriving these valuation conclusions. Accordingly, assumptions of expected terms, expected cash flows, and evaluations of liquidity, default and other risks were made as part of management’s analysis and valuation of its ARS investments as of the quarter ended June 30, 2008. While the Company believes that it has made reasonable judgments in its valuation exercise, 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 significantly change the recorded value of these securities, or other securities that make up the investment portfolio. Therefore, the company intends to monitor these securities and the ARS markets in general, on a continuing basis.

The Company reviews its investment impairments in accordance with Emerging Issues Task Force Issue No. (EITF) 03-1, The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments and SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Specifically, management analyzed the continued downward trend in the fair value of ARS holdings and concluded that the continuing uncertainty in these credit markets precluded classifying the impairment on ARS classified as long-term as temporary.

6. Accounts Receivable and Customer Concentration

Activity in the allowance for doubtful accounts is as follows (in thousands):

Balance, September 30, 2007	$	237
Amounts charged to expense (net of write-off)	(2		)
Recoveries / Adjustments to Provision	(80		)
Impact of exchange rate	(3		)
Balance, December 31, 2007	152
Amounts charged to expense (net of write-off)	5
Recoveries / Adjustments to Provision	77
Impact of exchange rate	22
Balance, March 31, 2008	256
Amounts charged to expense (net of write-off)	38
Recoveries / Adjustments to Provision	(142		)
Impact of exchange rate	12
Balance, June 30, 2008	$	164

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

	June 30,	September 30,
	2008	2007
Customer B	*	14	%
Customer C	*	18	%
	—	32	%

* Customer accounted for less than 10% of outstanding accounts receivable

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,
	2008		2007		2008		2007
Customer A	*		22	%	*		19	%
Customer C	13	%	10	%	13	%	11	%

* Customer accounted for less than 10% of revenue during the period

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7. Inventories, net

Inventories consist of the following (in thousands):

	June 30,			September 30,
	2008			2007
Components, gross	$	1,395		$	1,293
Reserve for excess and obsolete	(471		)	(319		)
Components, net	924			974
Finished Goods, gross	1,638			1,361
Reserve for excess and obsolete	(226		)	(189		)
Finished Goods, net	1,412			1,172
Total Inventory, net	$	2,336		$	2,146

8. Other Intangible Assets

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

	September 30, 2007			Additions			June 30, 2008
Gross Carrying Amount:
Acquired developed technology and patents	$	15,294		$	—		$	15,294
Customer relationships	2,028			—			2,028
Patents	4,659			—			4,659
Other intangible assets at cost	21,981			—			21,981
Accumulated Amortization:
Acquired developed technology	(12,078		)	(1,287		)	(13,365		)
Customer relationships	(1,722		)	(124		)	(1,846		)
Patents	(1,486		)	(500		)	(1,986		)
Total accumulated amortization	(15,286		)	$	(1,911	)	(17,197		)
Other intangible assets, net	$	6,695					$	4,784

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. At June 30, 2008, the Company performed a SFAS No. 144 impairment review of intangible assets. It was determined that no impairment of the carrying value of intangible assets of $4.8 million existed as of that date. 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
2008 (remaining 3 months)	$	593	$	41
2009	2,167		141
2010	666		—
2011	666		—
Thereafter	510		—
	$	4,602	$	182

9. Goodwill

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the Company tests recorded goodwill and intangibles with indefinite lives for impairment at least annually. At December 1, 2007, the Company performed the annual impairment review and determined that no impairment on the carrying values of goodwill of $35.9 million existed as of that date.

During the quarter ended March 31, 2008, the Company’s stock price declined approximately 36%, an event that indicated the potential impairment of the carrying value of goodwill. As a result, management undertook an impairment evaluation to estimate the fair value of the Company’s single reporting unit in relation to the book value of the Company (SFAS 142 - Step One Analysis). Fair value as used in SFAS 142 is defined as the amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in

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a current transaction between willing parties that is other than a forced or liquidation sale. Fair value was determined based on the market value of the Company’s stock at March 31, 2008. Based on the Step One Analysis results, potential impairment was indicated, as the carrying value of the Company exceeded the fair value. A SFAS 142 - Step Two Analysis was undertaken to quantify the impairment as of March 31, 2008. As a result of the analysis, the entire carrying value of goodwill was deemed fully impaired and written down to nil, as a non-cash charge to income.

Changes in goodwill are as follows (in thousands):

Balance, September 30, 2007	$	35,874
Goodwill impaired during the period	—
Balance, December 31, 2007	35,874
Goodwill impaired during the period	(35,874		)
Balance, March 31, 2008	$	—
Balance, June 30, 2008	$	—

10. Sales Warranty Reserve

Changes in sales warranty reserve are as follows (in thousands):

Balance, September 30, 2007	$	78
Warranty costs incurred	(3		)
Additions related to current period sales (net of adjustments)	19
Impact of exchange rates	—
Balance, December 31, 2007	$	94
Warranty costs incurred	(4		)
Additions related to current period sales (net of adjustments)	37
Impact of exchange rates	9
Balance, March 31, 2008	$	136
Warranty costs incurred	(4		)
Additions related to current period sales (net of adjustments)	22
Impact of exchange rates	—
Balance, June 30, 2008	$	154

For the three and nine months ended June 30, 2008, the Company recorded approximately $22,000 and $78,000 of new provision, respectively, and incurred approximately $4,000 and $11,000 of warranty costs, respectively. The sales warranty reserve is included in accrued and other current liabilities in the consolidated balance sheet.

11. Restructuring and Business Realignment Expenses

The Company has accounted for its 2002 restructuring under EITF 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity. Costs associated with restructuring activities initiated on or after January 1, 2003 are accounted for in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, and SFAS No. 112, Employer’s Accounting for Postemployment Benefits, when applicable. All restructurings subsequent to December 15, 2002 have been accounted for under SFAS No. 146 which requires that a liability for a cost associated with an exit or disposal activity be recognized when a liability is incurred rather than when an exit or disposal plan is approved. The following summarizes the restructuring activity (in thousands):

	2002 Restructuring			2004 Restructuring			2005 Restructuring
	Facility Exit Costs			Facility Exit Costs			Workforce Reduction			Total
Balances, September 30, 2006	$	2,744		$	190		$	65		$	2,999
Cash payments	(572		)	(138		)	—			(710		)
Impact of exchange rate changes	—			12			6			18
Balances, September 30, 2007	2,172			64			71			2,307
Adjustments to accruals for changes in estimates	—			—			(73		)	(73		)
Cash payments	(145		)	(7		)	—			(152		)
Impact of exchange rate changes	—			—			2			2
Balances, December 31, 2007	2,027			57			—			2,084
Cash payments	(145		)	(31		)	—			(176		)
Impact of exchange rate changes	—			(2		)	—			(2		)
Balances, March 31, 2008	1,882			24			—			1,906
Adjustments to accruals for changes in estimates	—			3			—			3
Cash payments	(153		)	(28		)	—			(181		)
Impact of exchange rate changes	—			1			—			1
Balances, June 30, 2008	1,729			—			—			1,729
Less current portion	(611		)	—			—			(611		)
Long-term portion	$	1,118		$	—		$	—		$	1,118

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12. Net Loss Per Share

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

	Three Months Ended						Nine Months Ended
	June 30,						June 30,
	2008			2007			2008			2007
Numerator:
Net loss	$	(6,983	)	$	(2,722	)	$	(53,396	)	$	(7,552	)
Denominator:
Weighted average number of shares outstanding	45,778			45,713			45,764			45,682
Basic net loss per share	$	(0.15	)	$	(0.06	)	$	(1.17	)	$	(0.17	)
Diluted net loss per share	$	(0.15	)	$	(0.06	)	$	(1.17	)	$	(0.17	)

For the above periods, the Company had securities outstanding that 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. At June 30, 2008 and 2007, approximately 8.2 million and 6.6 million potential shares of common stock (prior to application of treasury method), respectively, consisting of options, restricted stock units and warrants, were excluded from the determination of diluted net loss per share as the effect of such shares was anti-dilutive.

13. 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 all leases are as follows (in thousands):

Fiscal Year Ending September 30,
2008 (remaining 3 months)	$	1,064
2009	3,694
2010	2,807
2011	1,121
Thereafter	—
	$	8,686

The future minimum lease payments above include amounts related to non-cancelable operating leases that are included in the charge for restructuring expenses (see Note 11).

Gross rent expense under all operating leases was $0.8 million and $0.7 million, respectively, for the three months and $2.3 million and $2.2 million, respectively, for the nine months ended June 30, 2008 and 2007.

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 has been recorded at June 30, 2008 or September 30, 2007.

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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 has been recorded at June 30, 2008 or September 30, 2007.

14. Segment Information

The Company operates in one segment, Digital Identity Solutions and, accordingly, 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, 2008
Total revenue	$	6,572	$	6,448	$	1,278	$	14,298
Capital expenditures	19		34		8		61
Depreciation and amortization 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 and amortization of fixed assets	680		317		228		1,225

Three months ended June 30, 2007
Total revenue	$	6,077	$	9,492	$	715	$	16,284
Capital expenditures	383		180		56		619
Depreciation and amortization of fixed assets	188		128		83		399

Nine months ended June 30, 2007
Total revenue	$	17,824	$	25,827	$	2,132	$	45,783
Capital expenditures	1,249		459		107		1,815
Depreciation and amortization of fixed assets	599		337		221		1,157

June 30, 2008
Goodwill	$	—	$	—	$	—	$	—
Long-lived assets	5,892		976		2,404		9,272
Total assets	120,326		11,137		5,293		136,756

September 30, 2007
Goodwill	$	7,748	$	6,345	$	21,781	$	35,874
Long-lived assets	7,017		1,008		4,041		12,066
Total assets	143,346		17,098		28,008		188,452

For the three months ended June 30, 2008 and 2007, the United States, France, and the United Kingdom accounted for 43%, 14%, and 9% compared to 32%, 11%, and 24% respectively, of the Company’s total net revenue. For the nine months ended June 30, 2008 and 2007, the United States, France, and the United Kingdom accounted for 36%, 15%, and 11% compared to 35%, 14%, and 20% respectively, of the Company’s total net revenue. No other individual country accounted for 10% or more of the Company’s total net revenue for the periods presented.

15. Subsequent Events

Stockholder Rights Agreement

The Board of Directors of the Company authorized and declared a dividend distribution of one Preferred Stock Purchase Right (each a “Right” and collectively the “Rights”) for each outstanding share of Common Stock, $0.001 par value (“Common Stock”), of the Company outstanding as of July 25, 2008 (the “Record Date”). The description and terms of the Rights are set forth in the Stockholder Rights Agreement dated July 25, 2008 (the “Rights Agreement”), between the Company and American Stock

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Transfer & Trust Company (the “Rights Agent”). Additionally, for each share of Common Stock issued between the Record Date and the Distribution Date (as defined in the Rights Agreement), one Right will be issued. Each Right entitles the registered holder to purchase from the Company one ten-thousandth of a share of the Company’s Series A Junior Participating Cumulative Preferred Stock, $0.001 par value (the “Series A Preferred Stock”), at a price of $11.00 per unit (the “Exercise Price”). If any Acquiring Person (as defined in the Rights Agreement) acquires 20% or more of ActivIdentity’s Common Stock, there would be a triggering event causing significant dilution in the voting power of such person or group. Until there is a triggering event, the rights trade with the Company’s Common Stock. The Rights Plan will continue in effect until June 30, 2018, unless earlier redeemed or exchanged, as provided in the Rights Agreement.

New Chief Financial Officer / Chief Operating Officer

On August 1, 2008, the Company entered into an Employment Agreement with Jacques Kerrest to serve as the Chief Financial Officer and Chief Operating Officer of the Company. Mr. Kerrest will commence his duties on a part-time basis on August 4, 2008, and on a full-time basis on August 18, 2008. Mr. Kerrest will receive an annual salary of $325,000 with a target bonus of 65%, which amount will be pro rated for fiscal 2008 and which can be paid out at double that amount if so determined by the Compensation Committee. Mr. Kerrest will also receive two inducement options to purchase shares of the Company’s Common Stock. The first option, which represents the right to acquire up to 650,000 shares, will vest solely upon satisfaction of a time-based vesting condition and will vest with respect to one-quarter of the shares on August 4, 2009, and with respect to the remaining shares monthly thereafter over the subsequent 36 months. The second option represents the right to acquire up to 700,000 shares and will vest only if the average closing stock price for the Company’s Common Stock over any given 90-day period within the first four years from the date of grant equals or exceeds $4.50 per share. Once this condition has been met, the option will vest with respect to 350,000 shares and then will vest monthly thereafter with respect to the remaining 350,000 shares over the subsequent twelve months. Both options will vest immediately if following a Change of Control (as defined in the Employment Agreement), Mr. Kerrest is removed as Chief Financial Officer or Chief Operating Officer and such removal is other than for Cause (as defined in the Employment Agreement).

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, as well as future actions by third parties. 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 the Annual Report on Form 10-K for the fiscal year ended September 30, 2007 filed with the Securities and Exchange Commission. The Company assumes 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.

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

Overview

ActivIdentity® solutions support the convergence of physical and logical identity through strong authentication with smart card lifecycle management, adding enterprise single sign on, and data encryption and digital signature. 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, as well as intelligent citizen services.

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Company products enable strong authentication utilizing a range of security methods and devices such as Smart Employee ID, Enterprise Single Sign On (SSO), Strong Authentication, Secure Information and Transactions, and Smart Citizen ID. ActivIdentity products include SecureLogin ® SSO, ActivClient™ smart card middleware, ActivID™ Card Management System, 4TRESS™ AAA Server, one-time password (OTP) tokens, soft OTP tokens for mobile phone and personal digital assistants and ActivKey™ USB tokens. These devices enable organizations to address their security, compliance and auditing requirements by confirming identities before granting access to computer systems, networks, applications and physical locations.

More than 15 million users and 4,000 customers at businesses, government agencies, and financial institutions worldwide rely on solutions from ActivIdentity to safely and efficiently interact electronically.

Company Strategy: In March and April 2008, the Company experienced significant turnover among members of the Board of Directors and senior level officers. As a result of these changes, the Company essentially has a new Board and management team and they are currently assessing the strategic focus and priorities for the Company. In connection with this assessment, the Board is expected to consider a number of potential actions over the next 12 months, including a potential return of capital to stockholders, either through a stock repurchase plan or special dividend, acquisitions or divestitures of assets and product lines to reorganize the Company in line with its strategic focus and further restructurings of the Company and its operations. Any of these actions could significantly affect the Company’s operations, financial results, prospects and stock price.

Industry Outlook: The Company believes the digital identity market is a rapidly emerging global industry, driven by new government regulations, growing awareness of the risks of identity theft, and the growth in electronic commerce. While the industry is still in the early stage of development, industry-wide standards are evolving. The Company’s business model is premised on the smartcard becoming a common access platform protecting an organization’s assets, including network infrastructures, employees, customers, and confidential data. Issues driving industry growth and standardization are often unique across the Company’s target customer base, especially in international locations. The Company continues to monitor the evolution of the digital identity market and adapt products and services to best position the Company to realize competitive advantage. Additional challenges and risks that the Company’s 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: The Company has a long and often complicated sales cycle 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 twelve months for a network service provider or government. 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: The Company is currently aligning its business model to shadow customer markets more effectively, focusing product lines on employer-to-employee, government-to-citizen, and business-to-consumer strategic initiatives. The Company is also developing financial performance benchmarks to quantify the financial impacts of the revised strategic alignment and provide additional tools to assist management in assessing the Company’s 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.

Unusual Items: During the quarter ended June 30, 2008, the Company liquidated an inactive foreign subsidiary, ActivCard Developments Pty. Ltd. As a result of the liquidation, $1.9 million of accumulated translation adjustment was reclassified from the Accumulated Other Comprehensive Loss component of equity on the balance sheet to Other Expense on the Condensed Consolidated Statement of Operations. The accumulated losses resulted from the historic translation of the foreign entity’s Australian Dollar denominated local books in the Company’s consolidation process. In addition, ARS investments were marked to market resulting in an other-than-temporary impairment of $0.8 million for the quarter.

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Results of operations

Revenue

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

	Three Months Ended											Nine Months Ended
	June 30,						Increase			Percentage		June 30,						Increase			Percentage
	2008			2007			(Decrease)			Change		2008			2007			(Decrease)			Change
Software	$	5,983		$	4,923		$	1,060		22	%	$	17,017		$	17,540		$	(523	)	-3	%
Hardware	3,175			5,670			(2,495		)	-44	%	11,090			13,778			(2,688		)	-20	%
Maintenance and support	5,140			5,691			(551		)	-10	%	15,255			14,465			790			5	%
Total revenue	$	14,298		$	16,284		$	(1,986	)	-12	%	$	43,362		$	45,783		$	(2,421	)	-5	%
Product Mix:
Software	42		%	30		%						39		%	38		%
Hardware	22		%	35		%						26		%	30		%
Maintenance and support	36		%	35		%						35		%	32		%
	100		%	100		%						100		%	100		%

The business has varying revenue streams, each of which is unique in terms of its recurring nature, transactional pricing, and volume characteristics. Software revenues are driven by irregularly occurring and unpredictable orders of significant size that are dependent on the closing of the transactions for revenue recognition purposes and can result in significant variances period over period. As hardware revenues are generally derived from the sale of software products, the variability in software revenue is the driving factor in the fluctuations of this revenue stream, although timing of hardware sales may lag the initial sale of related software. Maintenance revenue is tied directly to the installed base of customers, which fluctuates with the ability to attract new customers and the level of renewal activity with existing customers. The timing of closure of software transactions in the pipeline is the single most relevant trend in the Company’s recorded revenue. The economic uncertainty that is currently affecting the global market has had an adverse impact on the Company’s ability to finalize sales transactions, especially large dollar deals.

Software revenue is comprised of sales of standard software and professional services associated with customization, installation, integration, and training. Client software revenue improved $0.5 million or 93% quarter-over-quarter, with a $0.3 million deal with a United States government agency driving the increase. Authentication software revenue increased $0.7 million or 112% quarter-over-quarter on a general increase in deal size. Year-to-date, the major drivers of the variance in software revenue included Card Management and Single Sign On software revenue decreases of $2.0 million and $1.2 million respectively, offset by increases in Authentication software revenue ($1.3 million increase) and Client software revenue ($0.8 million increase). The timing of deal closures continues to be the most relevant trend in the fluctuation of software revenue.

Hardware revenue is comprised of Tokens, Readers, Smartcards and related equipment, generally to support sales of related software products. Smartcard and Reader revenues were down $2.1 million quarter-over-quarter and $2.0 million year-over-year influenced by the $2.0 million decrease in Card Management software revenue for the nine months ended June 30, 2008. Token revenue decreased $0.4 million year-over-year as a result of losing a significant customer in 2007 as a result of consolidation in the European banking industry.

Maintenance revenue is comprised of software customer support agreements and is directly tied to the installed base of software customers. The decrease quarter-over-quarter in maintenance revenue was primarily timing related. During the quarter ended June 30, 2007, $0.4 million of maintenance revenue adjustments were recorded to recognize revenue on specific deferred transactions. Due to the recognition of these deferrals and other adjustments, maintenance revenue in the quarter ended June 30, 2007, was 18% above the quarterly average for fiscal year 2007 maintenance revenue. The increase in year-over-year maintenance revenue continues the trend noted in the previous quarter, which is driven by increases in the installed base of software customers.

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

	Three Months Ended											Nine Months Ended
	June 30,						Increase			Percentage		June 30,						Increase			Percentage
	2008			2007			(Decrease)			Change		2008			2007			(Decrease)			Change
North America	$	6,572		$	6,077		$	495		8	%	$	18,402		$	17,824		$	578		3	%
Europe	6,448			9,492			(3,044		)	-32	%	21,144			25,827			(4,683		)	-18	%
Asia Pacific	1,278			715			563			79	%	3,816			2,132			1,684			79	%
Total revenue	$	14,298		$	16,284		$	(1,986	)	-12	%	$	43,362		$	45,783		$	(2,421	)	-5	%
Geographic Mix:
North America	46		%	37		%						42		%	39		%
Europe	45		%	58		%						49		%	56		%
Asia Pacific	9		%	5		%						9		%	5		%
	100		%	100		%						100		%	100		%

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The increase quarter-over-quarter for North America revenue was driven by improved software sales of $1.1 million offset by a decrease of $0.6 million in maintenance and support revenue, primarily resulting from the recognition of previously deferred maintenance revenue in the quarter ended June 30, 2007.

The decrease quarter-over-quarter for Europe revenue was the result of a $2.6 million decrease in hardware revenue sales, driven in part by the decrease in year-over-year Card Management software revenue. Total software revenue in Europe was down quarter-over-quarter by $0.5 million. Year-over-year hardware revenue in Europe decreased $3.9 million. Reductions in total software revenue in Europe year-over-year ($2.0 million decrease) were partially offset by increases in maintenance and support revenue ($1.2 million increase). As noted in the prior quarter, the Company lost a significant European customer in 2007 due to consolidation in the banking industry.

Increases in Asia Pacific revenue remain strong as the Company improves market penetration and continues to close significant transactions. Quarter-over-quarter, software revenue increased $0.5 million. Year-over-year, software revenue increased $1.1 million and hardware revenue increased $0.7 million.

Period-over-period changes in hardware and software revenue by customer sector and as a percentage of total hardware and software revenue, is as follows (dollars in thousands):

	Three Months Ended											Nine Months Ended
	June 30,						Increase			Percentage		June 30,						Increase			Percentage
	2008			2007			(Decrease)			Change		2008			2007			(Decrease)			Change
Enterprise	$	6,006		$	4,831		$	1,175		24	%	$	17,451		$	15,364		$	2,087		14	%
Government	1,935			3,997			(2,062		)	-52	%	6,428			10,191			(3,763		)	-37	%
Financial	1,217			1,765			(548		)	-31	%	4,228			5,763			(1,535		)	-27	%
Total hardware and software revenue	$	9,158		$	10,593		$	(1,435	)	-14	%	$	28,107		$	31,318		$	(3,211	)	-10	%
Customer Sector Mix:
Enterprise	66		%	45		%						62		%	49		%
Government	21		%	38		%						23		%	33		%
Financial	13		%	17		%						15		%	18		%
	100		%	100		%						100		%	100		%

Enterprise sales improved quarter-over-quarter as $0.5 million of prior period deferred software revenue was recognized during the quarter ended June 30, 2008. In addition, software revenue for the enterprise sector increased $0.9 million (primarily attributable to increases in Authentication and Single Sign On product sales), offset by a decrease of $0.3 million in hardware revenue. Year-over-year, the increase in enterprise sector revenue was driven by a $1.4 million increase in hardware revenue on improved Token, Smartcard, and USB key sales driven in part by a $0.7 million increase in enterprise software sales.

Government sector revenue continues to suffer from general fiscal constraints on government spending under current economic conditions. The Company continues to pursue government sector sale; the rate of deal closure, however, has been trending down and the total time to close individual deals has been increasing. Year-over-year, hardware revenue decreased $2.3 million, software revenue decreased $1.1 million, and professional services revenue decreased $0.3 million.

Financial sector revenue decreased quarter-over-quarter due to a decrease in hardware revenues of $0.6 million. The decrease in financial sector revenue year-over-year is primarily attributable to the loss of a major customer during the quarter ended March 31, 2007, due to consolidation in the European banking industry. Year-over-year, decreases in hardware sales revenue were $1.7 million.

Cost of revenue

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

	Three Months Ended											Nine Months Ended
	June 30,						Increase			Percentage		June 30,						Increase			Percentage
	2008			2007			(Decrease)			Change		2008			2007			(Decrease)			Change
Software	$	1,086		$	1,344		$	(258	)	-19	%	$	2,772		$	2,930		$	(158	)	-5	%
As a % of software revenue	18		%	27		%						16		%	17		%
Hardware	$	2,071		$	2,733		$	(662	)	-24	%	$	6,819		$	7,536		$	(717	)	-10	%
As a % of hardware revenue	65		%	48		%						61		%	55		%
Maintenance and support	$	2,040		$	1,194		$	846		71	%	$	6,092		$	3,406		$	2,686		79	%
As a % of maintenance and support revenue	40		%	21		%						40		%	24		%
Amortization of acquired dev. technology & patents	$	592		$	747		$	(155	)	-21	%	$	1,787		$	2,331		$	(544	)	-23	%

Total cost of revenue	$	5,789		$	6,018		$	(229	)	-4	%	$	17,470		$	16,203		$	1,267		8	%

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Cost of software revenue includes the cost of professional services associated with the customization, installation and integration services. Software margins improved quarter-over-quarter due to an increase in stand-alone software sales. For the quarter ended June 30, 2008, stand-alone software sales represented 70% of total software sales compared to 64% of total software sales for the quarter ended June 30, 2007. Stand-alone software sales require less installation and customization expense per sale.

Cost of hardware revenue includes costs associated with the manufacturing and shipping of hardware products as well as logistics, operations, and adjustments to reserves for warranty and inventory. Hardware costs of revenue fell in absolute dollars on lower hardware revenue. The lower volumes negatively impacted margins, specifically for readers (margins decreased 10 percentage points quarter-over-quarter) and smartcards (margins decreased 18 percentage points quarter-over-quarter).

Cost of maintenance and support revenue consists primarily of personnel costs and expenses incurred in providing support and on-site consulting services, including absorbed research and development departmental costs such as sustaining engineering efforts. The trend identified originally in the quarter ended December 31, 2007, continued in the current quarter, specifically, an increase in sustaining engineering costs incurred by the development team on a larger installed base and a more detailed financial allocation of engineering activities during the period. In absolute dollars, the effect of the increase in absorbed Research and Development costs for the nine months ended June 30, 2008, compared to the same period in the prior year explains $2.7 million of the variance.

Amortization of acquired developed technology includes amortization of technology capitalized in the Company’s historical acquisitions and purchases of certain patents and related intellectual property from a third party. The variances are in line with the scheduled amortization of acquired intangibles, as certain items become fully amortized.

Operating expenses

A substantial proportion of operating expenses are comprised of personnel costs, facilities, and associated information technology costs to support Company personnel, which are generally fixed. Accordingly, a small variation in the timing of recognition of revenue can cause significant variations in operating results from quarter to quarter.

Sales and marketing

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

	Three Months Ended						Nine Months Ended
	June 30,						June 30,
	2008			2007			2008			2007
Sales and marketing	$	5,827		$	6,127		$	19,548		$	19,053
Percentage change from comparable prior period	-5		%				3		%
As a percentage of net revenue	41		%	38		%	45		%	42		%
Headcount, end of period	99			112

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. Expected savings associated with reduced headcount have not been realized to date due to severance expense recorded year to date associated with the December 2007 cost cutting plan and subsequent severance associated with the 2008 resignations of the Company’s CEO and CFO, portions of which are allocated to sales and marketing as a result of corporate allocation.

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Research and development

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

	Three Months Ended						Nine Months Ended
	June 30,						June 30,
	2008			2007			2008			2007
Research and development, net	$	4,676		$	5,060		$	14,092		$	14,913
Percentage change from comparable prior period	-8		%				-6		%
As a percentage of net revenue	33		%	31		%	32		%	33		%
Headcount, end of period	116			136

Research and development expenses consist primarily of salaries, costs of components used in research and development activities, travel, depreciation, and an allocation of facilities and information technology costs. The focus of research and development efforts is to bring new products, as well as new versions of existing products, to market, in order to address customer demand as well as to provide ongoing support to existing products. Significant research and development expenses are absorbed into maintenance and support cost of goods sold to reflect sustaining engineering efforts.

Decreases in research and development expenses, net, were the result of increased percentages of spend for support and sustaining engineering efforts made by the development team on a growing installed based that were absorbed into cost of revenues. Quarter-over-quarter, an additional $1.0 million was absorbed to cost of revenue. Year-over-year, an additional $2.7 million was absorbed to cost of revenue. Offsetting these decreases quarter-over-quarter were higher outsourcing costs of $0.3 million, and increased severance expense of $0.2 million. Year-over-year, outsourcing costs for offshore engineering increased $0.4 million, severance expense increased $0.8 million, and the weak United States dollar adversely impacted consolidated research and development expenses, as more than 50% of costs are incurred in foreign currencies. Savings associated with the reduced headcount have been offset by the impact of the weakening U.S. dollar over the prior year.

General and administrative

General and administrative expense and period-over-period changes are as follows (dollars in thousands):

	Three Months Ended						Nine Months Ended
	June 30,						June 30,
	2008			2007			2008			2007
General and administration	$	2,626		$	4,405		$	8,267		$	9,784
Percentage change from comparable prior period	-40		%				-16		%
As a percentage of net revenue	18		%	27		%	19		%	21		%
Headcount, end of period	42			50

General and administrative 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 an allocation of facilities and information technology costs.

General and administrative expenses were abnormally high in the quarter ended June 30, 2007, due to the recording of the Protocom earn-out provision settlement ($0.9 million) and the write-off of a sales tax receivable ($0.3 million). Bad debt expense quarter-over-quarter decreased $0.3 million. Year-over-year, bad debt expense decreased $0.4 million, primarily as a result of a $1.8 million lower trade accounts receivable balance. Year-over-year, cost savings associated with the headcount reduction have been offset by severance expense.

Restructuring expenses

Restructuring expenses consist of severance and other costs associated with the reduction of headcount and facility exit costs. Facility exit costs consist primarily of future minimum lease payments net of estimated sub-lease income, if any.

During the three months ended December 31, 2007, the Company reversed an accrual of $73,000 for a potential liability related to ongoing legal proceedings brought by a terminated employee in France. The court hearing the case ruled in favor of the Company. During the quarter ended June 30, 2008, an adjustment was recorded to the facility exit costs related to the 2004 Canada restructuring, resulting in $3,000 of additional expense.

Although the Company does not expect to incur any significant additional charges related to previous restructurings, a change in the estimated sublease income from, or time required to sublease exited facilities, or any other changes could result in future charges to the statement of operations.

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Amortization of acquired intangible assets

Amortization of acquired intangible assets includes amortization of customer relationships, trademark, and trade name intangibles capitalized in acquisitions.

Amortization of acquired intangibles and period-over-period changes are as follows (dollars in thousands):

	Three Months Ended						Nine Months Ended
	June 30,						June 30,
	2008			2007			2008			2007
Amortization of acquired intangible assets	$	42		$	48		$	124		$	144
Percentage change from comparable prior period	-13		%				-14		%
As a percentage of net revenue	0		%	0		%	0		%	0		%

Impairment of Goodwill

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the Company tests recorded goodwill and intangibles with indefinite lives for impairment at least annually. During the quarter ended March 31, 2008, based on indicators of potential impairment, the Company performed an impairment review of goodwill and determined the carrying value of goodwill of $35.9 million was fully impaired. As a result, goodwill of $35.9 million was written off as a non-cash charge to income during the second fiscal quarter. As of June 30, 2008, the Company has a nil balance for goodwill.

Interest income (expenses)

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

	Three Months Ended						Nine Months Ended
	June 30,						June 30,
	2008			2007			2008			2007
Interest income	$	845		$	1,596		$	3,772		$	4,494
Percentage change from comparable prior period	-47		%				-16		%
As a percentage of net revenue	6		%	10		%	9		%	10		%

Interest income (expense) consists of interest income on cash, cash equivalents, and investments.

Interest income, net, decreased quarter-over-quarter due to the combination of moving a significant portion of the investment portfolio principal from investments (net decrease of $59.1 million from June 30, 2007) into cash and cash equivalents that earn a lower rate of return, the continued usage of cash in the operations of the business, and the decrease in prevailing market interest rates earned on investments. Interest income has trended down throughout fiscal year 2008 as positions in ARS have been liquidated into cash and cash equivalents. The Company expects interest income to fluctuate in the future depending on interest rate variability and the composition of the investment portfolio.

Other income (expenses)

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

	Three Months Ended						Nine Months Ended
	June 30,						June 30,
	2008			2007			2008			2007
Other income (expense)	$	(2,927	)	$	1,099		$	(4,977	)	$	2,431
Percentage change from comparable prior period	-366		%				-305		%
As a percentage of net revenue	20		%	7		%	11		%	5		%

Other income (expense), net, is primarily comprised of foreign exchange gains or losses and other-than-temporary impairment of ARS holdings.

For the quarter ended June 30, 2008, the Company recorded an other-than-temporary impairment on ARS of $0.8 million a reclassification of accumulated translation adjustment losses on the liquidation of an inactive Australian subsidiary of $1.9 million, and a loss of $0.2 million on foreign exchange. Year-to-date, other-than-temporary impairment on ARS amounted to $3.8 million. Year-to-date foreign exchange gains amounted to $0.8 million, primarily resulting from the revaluation of intercompany balances denominated in other than functional currencies on local entities’ accounting books. Other income for the three and nine months ended June 30, 2007, are primarily related to foreign exchange gains based on a weakening United States dollar during the period.

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Income taxes

The income tax provision in all periods represents taxes payable in certain domestic and foreign jurisdictions based on estimates of annualized taxable income. The income tax provision, as adjusted for current period activity, was approximately $250,000 and $41,000 for the three months ended June 30, 2008 and 2007, respectively, and $280,000 and $155,000 for the nine months ended June 30, 2008 and 2007, respectively. The effective tax rate differs from the statutory rates as the Company has recorded a 100% valuation allowance related to the deferred tax assets and does not consider the generation of taxable income to realize these benefits to be more likely than not.

The Company adopted the provisions of FIN 48 on October 1, 2007. As a result of the adoption of FIN 48, the Company increased the liability for unrecognized tax benefits by approximately $95,000, which was accounted for as an increase to the October 1, 2007 balance of accumulated deficit. In addition, upon adoption of FIN 48, the Company also reclassified approximately $384,000 from short-term to long-term income tax payable. On October 1, 2007, the Company had approximately $479,000 of unrecognized tax benefits, which, if recognized, will be recorded as an income tax benefit in the consolidated statement of operations. Although it is possible that some of the unrecognized tax benefits could be settled within the next 12 months, the Company cannot reasonably estimate the outcome at this time. The Company’s policy to include interest and penalties related to unrecognized tax benefits with the provision for (benefit from) income taxes did not change as a result of adopting the provisions of FIN 48. At October 1, 2007, an insignificant amount of interest and penalties are included in long-term taxes payable.

The Company and/or its subsidiaries files income tax returns in the U.S. and various states, as well as various other foreign jurisdictions. The Company is currently not the subject of any income tax examinations. In general, the earliest open year subject to examination is the year ended December 31, 2002, although depending upon jurisdiction, 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 the balance sheet, cash flows, and contractual obligations on the liquidity and capital resources.

Balance Sheet and Cash Flows

Cash, Cash Equivalents, and Investments

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

	June 30, 2008		September 30, 2007		Increase (Decrease)
Cash and cash equivalents	$	68,318	$	30,639	$	37,679
Short-term investments	16,836		$	91,084	(74,248		)
Long-term investments	29,148		—		29,148
	$	114,302	$	121,723	$	(7,421	)

The portfolio of cash, cash equivalents, and marketable securities is managed by several financial institutions. Due to uncertainty in the investment market that has affected the liquidity of ARS holdings, the Company reclassified $30.0 million of investments at fair market value ($33.0 million at cost) to long-term as of March 31, 2008. During the quarter ended March 31, 2008, an other-than-temporary impairment charge of $3.0 million was recorded. During the quarter ended June 30, 2008, an additional other-than-temporary impairment of long-term investments reduced the balance an additional $0.8 million. As investments have matured or been liquidated, the proceeds are being held in cash and cash equivalents until the uncertainties in the credit markets improve. Total cash, cash equivalents, and investments were down $7.4 million from September 30, 2007, as a result of the investment impairments ($3.8 million year-to-date) combined with the operational usage of cash in the business ($3.3 million cash used in operating activities) and the purchase of $0.3 million of property and equipment.

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

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

	Nine Months Ended
	June 30, 2008			June 30, 2007		Increase (Decrease)
Net cash provided by (used in) operating activities	$	(3,246	)	$	2,404	$	(5,650	)
Net cash provided by investing activities	$	40,643		$	10,159	$	30,484
Net cash provided by (used in) financing activities	$	25		$	191	$	(166	)

Operating Activities

Net cash provided by operating activities decreased $5.7 million for the nine months ended June 30, 2008, as compared to the corresponding period in fiscal year 2007. Year-to-date compared to the prior year, increases in net loss after adjustment for non-cash charges resulted in a net usage of cash of $3.5 million. Benefits to cash from accounts receivable collections decreased $1.5 million year-over-year. Payments on outstanding trade payables and accrued compensation decreased cash balances by $3.0 million year-over-year. Reductions in outstanding deferred revenue liabilities were $0.9 million less in fiscal 2008, benefiting cash flows period-over-period. The timing of collection of interest on investments benefited cash year-over-year by driving a decrease in prepaid and other assets of $0.8 million. Inventory change in fiscal year 2008 was minimal compared to a sizable inventory build in fiscal 2007, resulting in a benefit to cash of $0.5 million year-over-year.

Investing Activities

Net cash provided by investing activities increased $30.5 million for the nine months ended June 30, 2008, as compared to the corresponding period in fiscal year 2007. The Company liquidated a net $29.0 million of short-term investments into cash and cash equivalents, year-over-year, combined with a $1.5 million decrease in property and equipment purchases, year-over-year.

Financing Activities

Net cash provided by financing activities decreased $0.2 million for the nine months ended June 30, 2008, as compared to the corresponding period in fiscal year 2007 due to a decrease in the exercise of stock options, rights, and warrants.

Accounts Receivable, net

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

	June 30,		September 30,
	2008		2007		Decrease
Accounts receivable, net	$	8,820	$	14,566	$	(5,746	)

The decrease in accounts receivable at June 30, 2008 compared to September 30, 2007, resulted from a combination of improved collections and a general decrease in bookings between periods. Days sales outstanding (DSO) in accounts receivable as of June 30, 2008, and September 30, 2007, were 53 days and 95 days, respectively.

Deferred Revenue, net

The following table summarizes deferred revenue (in thousands):

	June 30, 2008		September 30, 2007		Increase (Decrease)
Maintenance and support	$	9,057	$	10,893	$	(1,836	)
Product	3,003		2,208		795
Total	$	12,060	$	13,101	$	(1,041	)

Reported as:
Current	$	9,478	$	10,349	$	(871	)
Noncurrent	2,582		2,752		(170		)
Total	$	12,060	$	13,101	$	(1,041	)

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The $1.8 million decrease in maintenance and support deferred revenue is primarily attributable to timing of a large renewal maintenance contract that expired at June 30, 2008, for which the renewal support had not been invoiced at period end. Deferred maintenance associated with this contract was $1.5 million at September 30, 2007. The increase in deferred product revenue at June 30, 2008, was primarily attributable to the deferral of $0.7 million of software revenue on a transaction for which the Company did not have persuasive evidence of an arrangement at period end.

Contractual Obligations

The following summarizes contractual obligations at June 30, 2008, and the effect such obligations are expected to have on liquidity and cash flows 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)	$	8,686	$	1,064	$	6,501	$	1,121	$	—

(1) Represents the remaining three months of the 2008 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 $0.6 million.

Jason Hart resigned as Chief Executive Officer as of November 1, 2007. In connection with the termination of Mr. Hart’s employment, the Company agreed to pay Mr. Hart severance in an amount equal to one year of base salary, which is $290,000, and to provide for continued health insurance coverage for up to one year. As of June 30, 2008, Mr. Hart’s severance was paid in full. On March 10, 2008, Mark Lustig informed the Company of his intent to resign as Chief Financial Officer. Pursuant to a separation agreement, Mr. Lustig received a one-time separation payment of $85,937, which includes a pro rated 2008 bonus. As of June 30, 2008, Mr. Lustig’s separation payment was paid in full. Thomas Jahn resigned as Chief Executive Officer on April 11, 2008. In connection with the termination of Mr. Jahn’s employment, the Company agreed to pay Mr. Jahn severance in the amount of $400,000, provide up to eighteen months of benefits continuation under COBRA, accelerate the vesting of certain unvested restricted stock units, and extend the exercise period of outstanding vested stock options such that they remain exercisable for one year from the date of resignation. During the three months ended June 30, 2008, $110,000 was paid to Mr. Jahn and as of June 30, 2008, $290,000 remained to be paid.

On December 5, 2007, the Company announced a cost cutting plan to be implemented in the first and second quarters of fiscal 2008. The plan was implemented to reduce worldwide headcount and to consolidate certain business functions. During the quarter ended June 30, 2008, the severance costs estimate was revised downward by $300,000 to $1.0 million, of which all has been paid as of June 30, 2008. The final headcount reduction was 25.

Recent Accounting Pronouncements

In July 2006, the FASB issued FIN 48, Accounting for Income Tax Uncertainties. FIN 48 defines the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authority. The recently issued literature provides guidance on the recognition, measurement and classification of income tax uncertainties, along with any related interest and penalties. FIN 48 includes guidance concerning accounting for income tax uncertainties in interim periods and increases the level of disclosures associated with any recorded income tax uncertainties. Any differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption are accounted for as a cumulative-effect adjustment recorded to the beginning balance of retained earnings. In connection with the adoption of FIN 48 on October 1, 2007, the Company’s unrecognized tax benefits increased by approximately $95,000, which was accounted for as an increase to the October 1, 2007 balance of accumulated deficit. In addition, approximately $384,000 was reclassified from short-term to long-term income taxes payable. The total amount of gross unrecognized tax benefits as of the adoption was $479,000. The Company’s policy to include interest and penalties related to unrecognized tax benefits within the provision for (benefit from) income taxes did not change as a result of adopting the provisions of FIN 48.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS 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. SFAS 157 is effective for fair-value measurements already required or permitted by other standards for financial statements issued for fiscal years beginning

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after November 15, 2007 and interim periods within those fiscal years. On November 14, 2007, the FASB agreed to partially defer the effective date of the standard for certain nonfinancial assets and liabilities. The Company is currently in the process of determining the impact of adopting the provisions of SFAS 157 on its financial position, results of operations and cash flows.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115. SFAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The provisions of SFAS 159 become effective for fiscal years beginning after November 15, 2007. The Company believes that the adoption of SFAS 159 will not have a material effect on the financial statements.

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. 141(R) 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.

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 Securities and Exchange Commission, or SEC, Regulation S-X. The Company believes 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. The Company has 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, 2007.

Revenue Recognition

The Company recognizes revenue in accordance with accounting principles generally accepted in the United States, as set forth in American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue Recognition, 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 services, or a combination of these items.

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Subject to the additional conditions described below, revenue is not recognized until: (1) evidence of an arrangement exists; (2) the fee is fixed or determinable; (3) no significant obligations remain; 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 if 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, the Company allocates 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 the deliverables subject to SOP 97-2, as amended by SOP 98-9, the arrangement fee is allocated among each element, based on VSOE of fair value of each element if VSOE of each element exists. The Company determines VSOE of an element based on the price charged when the same element is sold separately. For an element not yet sold separately, VSOE is 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, the Company recognizes 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 for undelivered elements does not exist and where the only undelivered element is PCS, revenue for the delivered and undelivered elements is recognized on a straight-line basis over the life of the PCS contract. 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.

From time-to-time, the Company has provided acceptance rights to certain customers, which give the customer the right to accept or reject the software after it has been delivered, for customized or significantly modified software products developed under product development agreements, and on occasion, for hardware products and client/server software products. In instances where an acceptance clause exists, no revenue is recognized until the product is formally accepted by the customer or the acceptance period has expired.

Service revenue includes revenue from training, installation and consulting. From time-to-time, the Company develops and license software to customers that requires some customization, modification or production. Where the services are essential to the functionality of the software element of the arrangement and separate accounting for the services is not permitted, contract accounting is applied to both the software and service elements. For these projects, revenue is recognized in accordance with SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, typically on a percentage-of-completion basis as evidenced by labor hours incurred to estimated total labor hours. Revenues under these arrangements are presented as a component of software revenue on the income statement as the related project revenues, including both the license and service components, are less than 10% of total net revenues. Amounts billed in excess of revenue recognized are recorded as deferred revenue in the accompanying consolidated balance sheets. Unbilled work-in-process is recorded as a receivable in the accompanying consolidated balance sheets. At June 30, 2008 and September 30, 2007, the balances of unbilled work-in-process on the books were immaterial.

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 software revenue on the income statement as the related service revenues are less than 10% of total net revenues.

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The Company has one ongoing reseller arrangement in which the Company earns a fixed percentage of license and maintenance revenue earned by the reseller from the end-user. For this arrangement, the Company has no control over the pricing established by the reseller, including what is charged for maintenance renewals. Since the Company cannot determine if sufficient amounts of PCS renewals are priced at consistent percentages of license fees, the Company is unable to establish VSOE for maintenance renewals in this arrangement. Accordingly, for the bundled sales of license and maintenance, the Company recognizes revenue on a straight-line basis over the life of the maintenance contract in accordance with paragraph 12 of SOP 97-2. For income statement presentation purposes only, the Company allocates revenue for this arrangement between software and PCS in a ratio consistent with the Company’s standard end-user pricing model. For the year ended September 30, 2007, $3.6 million or 16% of total software revenue and $3.4 million or 17% of total maintenance revenue was allocated for this arrangement.

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. Revenues from advance payments for PCS contracts are recognized on a straight-line basis over the term of the contract.

Even though delivery of PCS and services has started, if all of the criteria in SOP 97-2 for revenue recognition are not 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 remaining PCS service period. In very limited and infrequent circumstances, the Company may provide PCS to customers without persuasive evidence of an arrangement. This typically occurs when a customer’s PCS renewal is due but the customer has not provided an appropriate purchase order in a timely manner.

Revenue from stand alone product sales is recognized upon shipment (unless shipping terms determine otherwise) to resellers, distributors and other indirect channels, net of estimated returns or estimated future price changes. The Company’s 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, the Company provides product return and price protection rights to certain distributors and resellers. The Company has 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

The Company records loss contingencies in accordance with SFAS No. 5, Accounting for Contingencies. This Statement establishes standards of financial accounting and reporting for loss contingencies. It requires accrual by a charge to income 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.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the Company 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. The Company bases its estimates and judgments on historical experience and on various assumptions that the Company believes 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 the current estimates. Significant estimates made in the accompanying financial statements are:

·	Allowance for Doubtful Accounts — The Company provides an allowance for doubtful accounts receivable based on account aging, historical bad debt experience, and customer creditworthiness. Changes in the allowance are included as a component of general and administrative expense in the consolidated statement of operations. If actual collections differ significantly from estimates, it may result in a decrease or increase in general and administrative expenses.

·	Inventory Valuation — The Company provides for slow moving and obsolete inventories based on historical experience and forecast of product demands. A change in the value of the inventory is included as a component of cost of hardware revenue. If sales of inventory on-hand are less than current projections or if there is a change in technology making current inventory obsolete, the Company may be required to record additional charges adversely affecting margins and results of operations.

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·	Long-Lived Assets — The Company performs an annual review of the valuation of long-lived assets, including property and equipment. The Company also assesses the recoverability of long-lived assets on an interim basis whenever events and circumstances indicate that the carrying value may not be recoverable based on an analysis of estimated expected future undiscounted net cash flows to be generated by the assets over their estimated useful lives. If the estimated future undiscounted net cash flows are insufficient to recover the carrying value of the assets over their estimated useful lives, the Company records an impairment charge in the amount by which the carrying value of the assets exceeds their fair value. Should conditions prove to be different than management’s current assessment, material write-downs of long-lived assets may be required, adversely affecting results of operations.

·	Other Intangible Assets — The Company generally records intangible assets when a company is acquired. The cost of the acquisition is allocated to the assets and liabilities acquired, including identifiable intangible assets. Certain identifiable intangible assets such as purchased technology, customer lists, trademarks, and trade names are amortized over time, while in-process research and development is recorded as a charge on the date of acquisition. Accordingly, the allocation of the acquisition cost to identifiable intangible assets has a significant impact on future operating results. The allocation process requires extensive use of estimates and assumptions, including estimates of future cash flows expected to be generated by the acquired assets. If impairment indicators are identified with respect to other intangible assets, the fair value of other intangible assets is re-assessed using valuation techniques that require significant management judgment. Should conditions prove to be different than the original assessment, material write-downs of the fair value of intangible assets may be required. The Company recorded such impairments in fiscal 2005 and 2004. The Company periodically reviews the estimated remaining useful lives of other intangible assets. A reduction in the estimate of remaining useful life could result in accelerated amortization or an impairment charge in future periods and may adversely affect results of operations.

·	Valuation of Investment Portfolio — The Company must make certain estimates and assumptions when assessing the value of the investment portfolio, including estimates of fair value and liquidity as well as estimates regarding future actions by third parties, such as the redemption of securities. Many of these estimates are based on market conditions, which are currently in a state of uncertainty. Accordingly, assumptions of expected terms, redemption expectations, expected cash flows, and evaluations of liquidity and default risk were made as part of management’s analysis and valuation of its ARS investments as of period-end. 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 significantly change the recorded value of these securities, or other securities that make up the investment portfolio.

·	Goodwill— In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the Company tests recorded goodwill and intangibles with indefinite lives for impairment at least annually. At December 1, 2007, the Company performed the annual impairment review and determined that no impairment on the carrying values of goodwill of $35.9 million existed as of that date.During the quarter ended March 31, 2008, the Company’s stock price declined approximately 36%, an event that indicated the potential impairment of the carrying value of goodwill. As a result, management undertook an impairment evaluation to estimate the fair value of the Company’s single reporting unit in relation to the book value of the Company (SFAS 142 — Step One Analysis). Based on the Step One Analysis results, potential impairment was indicated. A SFAS 142 - Step Two Analysis was undertaken to quantify the impairment as of March 31, 2008. As a result of the analysis, the entire carrying value of goodwill was deemed impaired and written down to nil, as a non-cash charge to income.

·	Restructuring Expense — In connection with the 2006, 2005, 2004, and 2002 restructurings, the Company accrued restructuring liabilities associated with costs of employee terminations, vacating facilities, write-off of assets that will no longer be used in operations, and costs for a terminated project based on estimates. Accrual of costs associated with terminations requires the Company to estimate severance payments. Recording of costs associated with vacating facilities require the Company to estimate future sub-lease income. If the actual future severance or lease payments, net of any sub-lease income, differ from estimates, it may result in an increase or decrease in restructuring charges, and could adversely affect the results of operations. In fiscal 2006 and 2005, the Company recorded additional charges associated with the change in estimates for future sublease income.

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·	Hardware Sales Warranty Reserve — The Company accrues expenses associated with potential warranty claims at the time of sale, based on warranty terms and historical experience. The warranty the Company provides is in excess of warranty coverage provided by product assembly contractors. The Company’s standard warranty period is ninety days for software products and one year for hardware products. Changes in the warranty reserve are included as a component of cost of hardware revenue. If actual returns under warranty differ significantly from estimates, it may result in a decrease or increase in the cost of hardware revenue.

·	Provision for Income Taxes — The provision for income taxes includes taxes currently payable and changes in deferred tax assets and liabilities. The Company records deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. If the Company does not generate sufficient taxable income, the realization of deferred tax assets could be impaired resulting in additional income tax expense. As a result, the Company records a valuation allowance to reduce net deferred tax assets to amounts that are more likely than not to be recognized. Deferred tax assets are principally the result of the tax benefit of disqualifying dispositions of stock options and net operating loss carry-forwards. The Company has established a valuation allowance to fully reserve these deferred tax assets due to uncertainty regarding their realization.

·	Share Based Payments - The Company estimates the value of employee stock options on the date of grant using the Black-Scholes Merton option pricing model. The determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The expected volatility is based on the historical volatility of the stock price.

Off-Balance Sheet Arrangements

The Company has 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 the Company 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 losses of $0.2 million and gains of $1.1 million for the quarters ended June 30, 2008 and 2007, respectively, as recorded in the consolidated statement of operations. For the nine months ended June 30, 2008 and 2007, the fluctuation of foreign currencies amounted to gains of $0.8 million and $2.4 million, respectively.

During the three and nine months ended June 30, 2008, of total sales, approximately 65% and 61%, respectively, were invoiced in U.S. Dollars. Although the Company purchases many components in U.S. Dollars, approximately half of expenses are 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 the Company makes these investments and may differ from the rates the Company has secured in the past.

At June 30, 2008, the Company held $68.3 million of cash and cash equivalents, $16.9 million in short-term investments, and $29.1 million in long-term investments for a total of $114.3 million. Cash and cash equivalents consist primarily of cash and money-market funds. Short-term investments are primarily comprised of U.S. government agency securities, corporate notes and bonds, certificates of deposit, and ARS. Long-term investments consist of ARS. Based on the cash, cash equivalents and investments at June 30, 2008, a hypothetical 10% increase or decrease in interest rates would increase or decrease annual interest income and cash flows by approximately $0.5 million.

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Concentration of Credit Risk

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

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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 acting 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 acting CFO concluded that the disclosure controls and procedures were not operating effectively because the material weakness discussed below for the quarter ended December 31, 2007 has not been fully remediated as of the quarter ended June 30, 2008. Further, an additional material error relating to revenue recognition and internal controls was identified during the third quarter close. 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 December 31, 2007, and June 30, 2008, as follows:

· Revenue Recognition - The Company had controls in place to review significant revenue transactions and ensure revenue accounting was in accordance with the Company’s revenue recognition policy. These controls were not effective during the quarter ended December 31, 2007, as their operation failed to ensure that all conditions required for revenue recognition were met. More specifically, the controls failed to identify outstanding obligations in relation to certain contracts and that persuasive evidence of an arrangement had not been obtained prior to period end for another contract. As a result, a material adjustment was recorded to defer hardware, license and maintenance revenue to future periods.

· Revenue Recognition - For the quarter ended June 30, 2008, another material revenue adjustment was recorded post accounting close to defer software revenue associated with two contracts for which persuasive evidence of an arrangement was not formally evidenced prior to period end. The adjustment has been recorded and is properly reflected in the financial statements included in this quarterly report on Form 10-Q for the period ended June 30, 2008.

(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 further below.

Since December 31, 2007, the Company has taken steps to modify existing controls and/or implement new internal controls to remediate the material weakness identified above. These steps included additional training, to enable financial personnel to perform the review and approval of revenue transactions and prevent or detect any similar revenue recognition issues. In addition, the Company initiated more timely and comprehensive communications between the revenue accounting, legal, and operations teams to ensure revenue agreements were properly reviewed and approved, including evidencing this approval more formally. As a result of the material weakness identified in the third quarter, management intends to initiate additional remediation to ensure the control is operating effectively in the fourth quarter. As of the date of this filing, the Company believes that it has made progress in the implementation of these corrective actions toward remediation of the material weakness.

PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, the Company is involved in disputes or regulatory inquiries that arise in the ordinary course of business. Any claims or regulatory actions against the Company, 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.

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ITEM 1A. RISK FACTORS

Risk Factors That May Affect Results of Operations and Financial Condition

A restated description of the risk factors associated with our business is set forth below. The description includes any material changes to and supersedes the description of the risk factors associated with our business previously disclosed in Part 1 of our Annual report on 10-K for the fiscal year ended September 30, 2007. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem less significant also may impair our business operations.

We have a history of losses and may experience losses in the foreseeable future.

We have not achieved profitability and may incur losses for the foreseeable future. During the three and nine months ended June 30, 2008, our net losses were $7.0 million and $53.4 million, respectively, and in fiscal year 2007, we incurred losses of approximately $9.3 million. As of June 30, 2008, our accumulated deficit was $300.0 million, which represents our net losses since inception. Although our cash balance is sizable, it may not last long enough for our operations to become profitable.

We will need to achieve incremental revenue growth and manage our costs to achieve profitability. Even if we do achieve profitability, we may be unable to sustain profitability on a quarterly or annual basis in the future. It is possible that our revenue will grow at a slower rate than we anticipate or that operating expenses will increase beyond our current run rate. Current concern over a potential global economic slowdown could slow customer orders, as well as anticipated revenue growth, and could further delay our prospects of operating profitability.

Our cost-reduction initiatives may not result in the anticipated savings or more efficient operations and may harm our long-term viability.

Over the past several years, we have implemented extensive cost cutting measures and have incurred significant restructuring charges as we have attempted to streamline operations, improve efficiency, and reduce costs. We expect that we will undertake further restructuring initiatives in the future as we realign our business around areas of strategic focus. Although we believe that it has been and will continue to be necessary to reduce the size and cost of our operations to improve our performance, the reduction in our operations may make it more difficult to develop and market new products and to compete successfully with other companies in our industry. In addition, many of the employees who have been terminated as part of our restructuring activities possessed specific knowledge or expertise that may prove to have been important to our operations and their absence may create significant difficulties. These efforts may not result in anticipated cost savings, making it difficult for us to achieve profitability. These cost reduction initiatives may also preclude us from making complementary acquisitions and/or other potentially significant expenditures that could improve our product offerings, competitiveness or long-term prospects.

We derive revenue from only a limited number of products and do not have a diversified product base.

Substantially all of our revenue is derived from the sale of our digital identity systems and products. We anticipate that substantially all of our future revenue, if any, will also be derived from these products. If for any reason our sale of these products is impeded or if we divest existing product lines as part of our strategic realignment, and we have not diversified our product offerings, our business and results of operations could be harmed. We have reduced our product offerings as part of our prior restructuring initiatives to focus on just our core products and do not expect to diversify our product offerings in the foreseeable future. By limiting our product offerings in the future, we will likely increase the risks associated with not having a more diversified product base.

Our customer base is highly concentrated and the loss of any one of these customers or delay in anticipated orders could adversely affect our business.

Our customers consist primarily of medium to large enterprises, governments, system integrators, resellers, distributors, and original equipment manufacturers. Historically, we have experienced a concentration of revenue through certain of our channel partners and customers. One customer (Novell) accounted for more than 10% of our total revenue during the nine months ended June 30, 2008. Two customers (EDS and Novell) each accounted for more than 10% of our total revenue during the nine months ended June 30, 2007. Additionally, a substantial portion of our total revenue is generated from the governmental sector. The government business accounted for 29% of total product revenue in fiscal year 2007 and 23% of total product revenue for the nine months ended June 30, 2008. We expect future potential revenue variability in this sector due to variable government ordering patterns and frequent delays associated with larger programs.

Our operating results could be adversely affected if any of the following events occur:

·		The loss of the above or other significant customers;
·		The failure of any of our significant channel partners to renew their contracts upon expiration;
·		The divestiture of products or product lines, which could cause the loss of that revenue and the further dependence on remaining customers; or
·		Delays in orders from governmental agencies.

We expect to continue to depend upon a small number of large customers for a substantial portion of our revenue and the occurrence of any of the above events could further extend our reliance on remaining customers.

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Our quarterly gross and net margins are difficult to predict, and if we miss quarterly financial expectations, our stock price could decline.

Our quarterly revenue, expense levels and operating results are difficult to predict and fluctuate from quarter to quarter. It is likely that our operating results in some periods will be below the guidance we have provided and not meet investor expectations. If this happens, the market price of our common stock is likely to decline. Fluctuations in our future quarterly operating results may be caused by many factors, including:

· The size and timing of customer orders, which are received unevenly and unpredictably throughout a fiscal year and may be subject to seasonality relating to the U.S. government’s fiscal year and related spending patterns;

· The mix of products licensed and types of license agreements;

· The effect of generally accepted accounting principles on the timing of revenue recognition;

· The timing of customer payments;

· The size and timing of revenue recognized in advance of actual customer billings and customers with installment payment schedules that may result in higher accounts receivable balances;

· Changes in financial markets, which could adversely affect the value of our assets and our liquidity;

· The relative mix of our license and services revenue, as well as the relative mix of product offerings, which could change in connection with strategic realignment initiatives; and

· The application of new accounting regulations that could negatively impact results.

We have a long and often complicated sales cycle, which can result in significant revenue fluctuations between periods.

The sales cycle for our products is typically long and subject to a number of significant risks over which we have little control. The typical sales cycle is six to nine months for an enterprise customer and over twelve months for a network service provider or government. As our operating expenses are based on anticipated revenue levels, a small fluctuation in the timing of sales can cause our operating results to vary significantly between periods. If revenue falls significantly below anticipated levels, our business would be negatively impacted.

Purchasing decisions for our products and systems may be subject to delay due to many factors that are outside of our control, such as:

· Political and economic uncertainties;

· Time required for a prospective customer to recognize the need for our products;

· Time and complexity for us to assess and determine a prospective customer’s IT environment;

· Customer’s requirements for customized features and functionalities;

· Turnover of key personnel at existing and prospective customers;

· Customer’s internal budgeting process; and

· Customer’s internal procedures for the approval of large purchases.

Furthermore, the implementation process is subject to delays resulting from concerns associated with incorporating new technologies into existing networks, deployment of a new network system or preservation of existing network infrastructure and data migration to the new system. Full deployment of our technology and products for such networks, servers, or other host systems can be

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scheduled to occur over an extended period and the licensing of systems and products, including client and server software, smartcards, readers, and tokens, and the recognition of maintenance revenues would also occur over this period, thereby negatively impacting the results of our operations in the near term, resulting in unanticipated fluctuations between periods.

We invest in securities that are subject to market risk and the recent problems in the financial markets could adversely affect the value of our assets.

As of June 30, 2008, we held a total of $38.0 million, at historical cost, invested in ARS. 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 historically have provided a liquid market for these securities. We investment in ARS represent interests in Collateralized Debt Obligations (CDO), Closed-end Mutual Funds, Taxable Municipals, Derivative Product Companies, and Student Loans.

Continued uncertainty in the credit markets has affected our holdings in ARS. During the quarters ended December 31, 2007, March 31, 2008, and June 30, 2008, $30.8 million, $41.9 million and $38.0 million, respectively, of ARS holdings at cost failed to settle at auction due to sell orders exceeding buy orders. As a result, we now earn a “penalty” interest rate, which is typically a higher rate than would be paid if the auctions were successful, but which may not fully compensate us for the loss of liquidity in the securities. Due to the failed auctions, the investments are currently considered illiquid until such time as auctions are again successful or these instruments are called or refinanced. The CDO’s and the Derivative Product Companies’ auctions began failing in August 2007. The Closed-end Mutual Funds, Taxable Municipals, and Student Loans failed initially in February 2008. At present, all of our ARS holdings have experienced failed auctions and are, therefore, presently illiquid as no viable trading market exists for these securities.

During the quarter ended June 30, 2008, as a result of the downgrade on the financial guarantors, several of the ARS investments were downgraded by the rating agencies from the historical AAA rating. Following these downgrades of the guarantors, ratings of the ARS now range from AAA to AA by Standard and Poor’s and from Aaa to A2 by Moody’s. All investments are current on all obligations, and all continue to pay interest at the applicable penalty rates. Additionally, during the quarter ended June 30, 2008, $3.9 million at cost of the ARS holdings classified as short-term investments were called by the issuers at par, which provided us with liquidity on that portion of the ARS holdings without recognizing any loss on that portion of our investment. We currently expect that the Closed-end Mutual Funds and the Taxable Municipals will be called within the next 1 to 12 months at par. Based on this current expectation, these holdings are classified as short-term on our balance sheet as of June 30, 2008. Changes in future expectations regarding these securities may result in reclassifications of these holdings in future periods.

To reflect the lack of liquidity, $33.0 million at cost, representing an estimated $30.0 million at fair market value as of March 31, 2008, of these investments, specifically the CDO, the Derivative Product Companies, and the Student Loan holding, were reclassified as long-term investments on our balance sheet as of March 31, 2008. During the quarter ended June 30, 2008, none of the investments classified as long-term were liquidated and we currently have no short-term access to these funds. Given our current cash balances and forecasted operational cash requirements, we could hold these assets to maturity, if necessary.

Historically, the fair value of ARS approximated par value due to the frequent interest rate resets. However, the failed auctions have resulted, in most cases, in revised estimates of fair value that are less than par. We have reviewed these investments and have valued the holdings accordingly using a discounted cash flow methodology.

We reduced the carrying value of certain ARS investments by $0.9 million as of December 31, 2007, through Other Comprehensive Income, so as to reflect our view at the time that the impairment was of a temporary nature. For the quarter ended March 31, 2008, we performed a valuation analysis, including reviews of the other-than-temporary impairment factors, and recorded an other-than-temporary impairment charge of $2.1 million to Other Income on the Consolidated Statement of Operations. Concurrently, the temporary impairment of $0.9 million recorded in the quarter ended December 31, 2007, was reclassified from Other Comprehensive Income to Other Income on the Consolidated Statement of Operations for the period ended March 31, 2008. For the quarter ended June 30, 2008, we recorded an additional other-than-temporary impairment charge of $0.8 million to Other Income on the Consolidated Statement of Operations, resulting in an estimated fair market valuation of $29.1 million for those ARS holdings classified as long-term as of June 30, 2008. The additional impairment was driven by the downgrades on the financial guarantors and the resulting impact on the underlying ARS holdings. As a result of the downgrades, assumptions used in the valuation models changed, including an increase in the discount rates and a lengthening of certain expected terms. $5.0 million of ARS holdings are classified as short-term as of June 30, 2008, and are valued at par, based on our current expectations that these securities will be called by the issuers within the next twelve months.

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While we have used what we believe to be an appropriate valuation model for these securities and have attempted to incorporate all material identified risk factors into the analysis, we must make certain estimates and assumptions when assessing the value of the investment portfolio, including estimates of fair value and liquidity and estimates regarding the probability of redemption in certain time periods. These estimates are also based on market conditions, which are currently in a state of uncertainty. As a result, there is much independent judgment required in deriving these valuation conclusions. Accordingly, assumptions of expected terms, expected cash flows, and evaluations of liquidity, default and other risks were made as part of management’s analysis and valuation of our ARS investments as of the quarter ended June 30, 2008. While we believe we have made reasonable judgments in our valuation exercise, 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, we may be required to significantly change the recorded value of these securities, or other securities that make up the investment portfolio. Therefore, we intend to monitor these securities and the ARS markets in general, on a continuing basis.

If a liquid market for these securities does not develop, the ARS holding may require us to recognize additional impairment charges. Any of these events could adversely affect our results of operations and our financial condition. A material change in these underlying estimates and assumptions could significantly change the reported value of the securities and could cause us to take significant charges for additional write-downs in value.

We rely on certain key employees and have faced challenges in the past with employee turnover in senior management. If we are not able to build and maintain a strong management team, our ability to manage and expand our business will be impacted.

We rely on certain key employees, including our Chief Executive Officer, President and Chief Financial Officer. In recent years, there has been significant and recurring turnover in all levels of management. In March 2008, our Chief Financial Officer, Mark Lustig, announced his resignation, effective in May 2008. In April 2008, Grant Evans became our Chief Executive Officer following the resignation of Thomas Jahn. In August 2008, we hired a new Chief Financial Officer / Chief Operating Officer, Jacques Kerrest. We may experience further turnover in management in the future and, as a result, we face challenges in effectively managing our operations during these periods of transition. If new key employees and other members of our senior management team cannot work together effectively, or if other members of our senior management team resign, our ability to manage our business effectively may be impacted.

The market for some of our products is still developing and if the industry adopts standards or a platform different from our platform, then our competitive position would be negatively affected.

The market for digital identity products is still emerging and is also experiencing consolidation. The evolution of the market is in a constant state of flux that may result in the development of different network computing platforms and industry standards that are not compatible with our current products or technologies.

We believe smartcards are an emerging platform for providing digital identity for network applications and for the procurement of services from private enterprise and government agencies. Our business model is premised on the smartcard becoming a common access platform for network computing in the future. Further, we have focused on developing our products for certain operating systems related to smartcard deployment and use. Should platforms or form factors other than the smartcard emerge as a preferred platform or should operating systems other than the specific systems we have focused on emerge as preferred operating systems, such as Microsoft’s recent introduction of Windows Vista, our current product offerings could be at a disadvantage. If this were to occur, our future growth and operating results could be negatively affected. Additionally, consolidation within this industry has created a more difficult competitive environment for us and may result in the broader adoption of competing platforms and systems.

In addition, the digital identity market has evolving industry-wide standards. While we are actively engaged in discussions with industry peers to define what these standards should be, it is possible that any standards eventually adopted could prove disadvantageous to or incompatible with our business model and product lines. Uncertainty surrounding the Homeland Security Presidential Directive No. 12 may affect sales of our products to government agencies. If our products do not comply with the requirements of Homeland Security Presidential Directive No. 12, we may not be able to sell to agencies that must comply with this Directive.

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We rely on strategic relationships with other companies to develop and market our products. If we are unable to enter into additional relationships, or if we lose an existing relationship, our business could be harmed.

Our success depends on establishing and maintaining strategic relationships with other companies to develop, market, and distribute our technology and products and, in some cases, to incorporate our technology into their products. Part of our business strategy has been to enter into strategic alliances and other cooperative arrangements with other companies in the industry. We are currently involved in cooperative efforts to incorporate our products into the products of others, to jointly engage in research and development efforts, and to jointly engage in marketing efforts and reseller arrangements. To date, none of these relationships is exclusive, and some of our strategic partners also have cooperative relationships with certain of our competitors.

If we are unable to enter into cooperative arrangements in the future or if we lose any of our current strategic or cooperative relationships, our business could be adversely affected. We do not control the time and resources devoted to such activities by parties with whom we have relationships. In addition, we may not have the resources available to satisfy our commitments, which may adversely affect these relationships. These relationships may not continue, may not be commercially successful, or may require the expenditure of significant financial, personnel, and administrative resources from time to time. Further, certain of our products and services compete with the products and services of our strategic partners, which may adversely affect our relationships with these partners, which could adversely affect our business.

Employee turnover could adversely impact our revenues, costs and productivity.

Partially due to our restructuring efforts over the past several years, we have become increasingly dependent on a smaller number of employees. If these key employees leave ActivIdentity, we suffer loss of productivity while new employees are hired or promoted into vacant positions. The departure of highly skilled key employees sometimes results in a loss of talent or knowledge that is difficult to replace. There are also costs of recruiting and relocating new employees if needed to fill these positions. For example, the recruiting market for experienced operations personnel is very competitive and we may be limited in our ability to attract and retain key operations talent as the need should arise. New employees must learn the ActivIdentity organization, products, and procedures. All of this takes time, reduces productivity and increases cost. The potential adverse impact of employee turnover is greater for situations involving senior positions in the Company and our turnover rate may be higher as a result of our restructuring activities where key employees decided to leave on their own accord. If turnover increases, the adverse impact of turnover could materially affect our costs, productivity or ability to respond quickly to the competitive environment.

We may be adversely affected by operating in international markets.

Our international operations subject us to risks associated with operating in foreign markets, including fluctuations in currency exchange rates that could adversely affect our results of operations and financial condition. International sales and expenses make up a substantial portion of our business. A severe economic decline in any of our major foreign markets could make it difficult for our customers to pay us on a timely basis. Any such failure to pay, or deferral of payment, could adversely affect our results of operations and financial condition. During the nine months ended June 30, 2008 and 2007, markets outside of North America accounted for 58% and 61% respectively, of total revenue.

We face a number of additional risks inherent in doing business in international markets, including among others:

· Unexpected changes in regulatory requirements;

· Potentially adverse tax consequences;

· Export controls relating to encryption technology;

· Tariffs and other trade barriers;

· Difficulties in staffing and managing international operations;

· Laws that restrict our ability, and make it costly, to reduce our workforce;

· Changing economic or political conditions;

· Exposures to different legal standards;

· Burden of complying with a variety of laws and legal systems;

· Fluctuations in currency exchange rates; and

· Fluctuations in business activity.

While we present our financial statements in U.S. Dollars, a significant portion of our business is conducted outside of the United States and we incur a significant portion of our expenses in Euros, Australian dollars and British Pounds. Some revenue transactions are denominated in foreign currencies as well. Significant fluctuations in exchange rates between the United States

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Dollar and foreign currencies may adversely affect our future operating results. The fluctuation of foreign currencies amounted to losses of $0.2 million and gains of $1.1 million for the quarters ended June 30, 2008 and 2007, respectively, as recorded in the consolidated statement of operations. For the nine months ended June 30, 2008 and 2007, the fluctuation of foreign currencies amounted to gains of $0.8 million and $2.4 million, respectively.

We have recorded significant write-downs in recent periods for impairment of acquired intangible assets and may have similar write-downs in future periods.

We recorded an impairment charge of $35.9 million to goodwill during the quarter ended March 31, 2008, and had previously recorded similar charges in 2005. Due to our declining stock price, we conducted a goodwill impairment analysis and determined the full carrying value of our goodwill was impaired. As of June 30, 2008, we have no goodwill on our balance sheet.

We may terminate additional non-core activities in the future or determine that our long-lived assets or acquired intangible assets have been impaired. Any future termination or impairment related charges could be significant and would have a material adverse effect on our financial position and results of operations.

As of June 30, 2008, we had $4.8 million of other intangible assets, representing approximately 3% of our total assets. If our estimates of future undiscounted cash flows to be derived from the use of our other intangible assets drop below the carrying value of such assets, an additional impairment charge may be required.

Our operating results could suffer if we are subject to intellectual property infringement claims.

We may face claims of infringement on proprietary rights of others that could subject us to costly litigation and possible restrictions on the use of such proprietary rights. There is a risk that our products infringe on the proprietary rights of third parties. While we currently do not believe that our products infringe on proprietary rights of third parties, infringement or invalidity claims may nevertheless be asserted or prosecuted against us and our products may be found to have infringed the rights of third parties. Such claims are costly to defend and could subject us to substantial litigation costs. If any claims or actions are asserted against us, we may be required to modify our products or may be forced to obtain a license for such intellectual property rights. However, we may not be able to modify our products or obtain a license on commercially reasonable terms, or at all.

In addition, despite precautions that we take, it may be possible for competitors to copy or reverse-engineer aspects of our current or future products, to independently develop similar or superior technology, or to design around the patents we own. Monitoring unauthorized use and transfer of our technology is difficult and technology piracy currently is and can be expected to continue to be a persistent problem. In addition, the laws of some foreign countries do not protect our intellectual property rights to the same extent as in the United States. It may be necessary to enforce our intellectual property rights through litigation, arbitration or other adversarial proceedings, which could be costly and distracting to management and which could put our rights at risk as others may seek to have our rights declared invalid. Additionally, there is no assurance that we would prevail in any such proceedings or that the recoveries from any such proceedings would exceed our enforcement costs.

We may have exposure to additional tax liabilities as a result of inter-company transfer pricing policies.

As a multinational organization, we conduct business and are subject to income taxes in both the United States and various foreign jurisdictions. Significant judgment is required in determining our worldwide income tax provision and related tax liabilities. In the ordinary course of a global business, inter-company transactions and calculations result in a variety of uncertain tax positions. Our inter-company pricing policies are subject to audits in the various foreign tax jurisdictions. Although we believe our tax estimates are reasonable, there is no assurance that the final determination of tax audits or potential tax disputes will not be different from what is reflected in our historical income tax provisions and accruals. During the fourth quarter of fiscal 2007, we recorded an additional $384,000 of tax liabilities with respect to our inter-company transfer pricing study. Additionally, in connection with the adoption of FIN 48 on October 1, 2007, we increased the liability for unrecognized tax benefits by approximately $95,000, which was accounted for as an increase to the October 1, 2007 balance of accumulated deficit.

It may be difficult for a third party to acquire the Company, which could affect the price of our common stock.

In July 2008, we adopted a stockholder rights agreement, which is sometimes also called a “poison pill.” This agreement has the effect of discouraging a stockholder from acquiring more than 20% of our issued and outstanding common stock without prior approval of our Board of Directors. We are also afforded the protections of Section 203 of the Delaware General Corporation Law, which will prevent us, for a period of three years, from engaging in a business combination with a person who acquires more than 15% of our common stock unless Board of Director or shareholder approval were obtained. Defensive measures such as the stockholder rights agreement and Section 203 are expected to have the effect of discouraging coercive hostile takeover attempts where the Board does not support the transaction. Any delay or prevention of a change of control transaction could deter potential acquirers or prevent the completion of a transaction in which our stockholders could receive a premium over the then current market price for their shares.

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

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable

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

None

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

Exhibit Number		Description

3.1		Amended and Restated Certificate of Incorporation of ActivCard Corp. (1)

3.2		Bylaws of ActivCard Corp. (2)

4.1		Stockholder Rights Agreement, dated as of July 25, 2008, by and between ActivIdentity Corporation and American Stock Transfer & Trust Company (3)

10.1		Employment Agreement between Jacques Kerrest and ActivIdentity dated August 1, 2008 (4)

31.1		Certification of Chief Executive Officer Pursuant to Section 302(a) of The Sarbanes-Oxley Act of 2002

31.2		Certification of Principal Financial Officer Pursuant to Section 302(a) of The Sarbanes-Oxley Act of 2002

32.1		Certification of the Chief Executive Officer and Principal Financial Officer Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002

(1)	Previously filed with the Company’s Registration Statement on Form S-4 (File No. 333-100067), filed September 25, 2002 and incorporated by reference herein.

(2)	Previously filed with the Company’s Registration Statement on Form S-4 (File No. 333-105558), filed May 23, 2003 and incorporated by reference herein.

(3)	Previously filed with the Company’s Registration Statement on Form 8-A (File No. 001-34137), filed July 25, 2008 and incorporated by reference herein.

(4)	Previously filed with the Company’s Registration Statement on Form 8-K (File No. 001-34137), filed August 4, 2008 and incorporated by reference herein

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)

	ActivIdentity Corporation

	By:	/s/ Jerome Pintar
	Jerome Pintar
	Vice President Finance (Principal Financial Officer)

		Page
PART I FINANCIAL INFORMATION

ITEM 1.	CONSOLIDATED FINANCIAL STATEMENTS	3
	CONDENSED CONSOLIDATED BALANCE SHEETS	3
	CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE 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	18
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK	32
ITEM 4.	CONTROLS AND PROCEDURES	35

PART II OTHER INFORMATION

ITEM 1.	LEGAL PROCEEDINGS	35
ITEM 1A.	RISK FACTORS	36
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	42
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	42
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	42
ITEM 5.	OTHER INFORMATION	42
ITEM 6.	EXHIBITS	42
	SIGNATURE	43