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

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

OVERVIEW

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

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

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

Credential Management

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

Strong Authentication

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

Security Clients

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

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

Authentication Devices

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

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

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

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

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

SIGNIFICANT EVENTS

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

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

RESULTS OF OPERATIONS

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

REVENUE



Revenue by Product Type



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



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

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

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

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

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

Revenue by Geography



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



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

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

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

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

COST OF REVENUE



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



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

Cost of Software Revenue

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

Cost of Hardware Revenue

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

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

Cost of Service Revenue

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

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

Amortization of Acquired Developed Technology and Patents

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

OPERATING EXPENSES

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

Sales and marketing

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

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

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

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

Research and development

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

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

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

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

General and administration

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

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

. . .