OPERATIONS

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

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 strong authentication and credential management, 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.

Our products enable solutions for strong authentication utilizing a range of security methods and devices such as Smart Employee ID, for Enterprise that 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; Smart Customer ID and Smart Citizen ID that supports Strong Authentication, Secure Information and Transactions.

ActivIdentity products include SecureLogin ® SSO, ActivClient™ smart card middleware, ActivID™ Credential Management System, 4TRESS™ Authentication and Provisioning Server, one-time password (OTP) tokens, soft OTP tokens for mobile phone and personal digital assistants and ActivKey™ USB tokens. These devices and software enable organizations to address their security, compliance and auditing requirements by confirming identities before granting access to computer systems, networks, applications and physical locations and ensure integrity of digital transactions.

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

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 is initiating a 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 strong authentication and credential management solutions) 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 March 31, 2009, the following items impacted our net loss:

† Severance expense: Continued business realignment in accordance with our revised strategic initiatives resulted in reducing net headcount during the quarter by nine employees or 4% to 236 at March 31, 2009. Severance expense for the quarter amounted to $0.6 million.

† Foreign exchange losses: For the quarter ended March 31, 2009, we recorded a loss on foreign exchange of $0.8 million through our consolidated statement of operations. The losses primarily occurred from the revaluation of assets and liabilities denominated in non-functional currencies on the balance sheets of local entities. The continued strengthening of the U.S. dollar, specifically against the Australian dollar and British pound, was the driving factor in the recorded losses.

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                                   Six Months Ended
                         March 31,           Increase     Percentage        March 31,          Increase     Percentage
                     2009         2008      (Decrease)      Change       2009        2008     (Decrease)      Change
Software          $    6,207    $   4,083   $     2,124           52 % $  11,517   $  8,937   $     2,580           29 %
Hardware               4,148        3,733           415           11 %     8,951      7,915         1,036           13 %
Service                5,775        5,815           (40 )         -1 %    11,963     12,212          (249 )         -2 %
Total revenue         16,130    $  13,631   $     2,499           18 % $  32,431   $ 29,064   $     3,367           12 %
Product Mix:
Software                  38 %         30 %                                   35 %       31 %
Hardware                  26 %         27 %                                   28 %       27 %
Service                   36 %         43 %                                   37 %       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 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 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 $2.1 million and $2.6 million increase, year-over-year, in software revenue for the three and six months ended March 31, 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 March 31, 2009 was flat year-over-year. Hardware revenue for the six months ended March 31, 2009 increased $1.0 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 slightly decreased by 1% and 2%, respectively for the three and six months ended March 31, 2009.

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                                  Six Months Ended
                        March 31,           Increase     Percentage        March 31,          Increase     Percentage
                     2009         2008     (Decrease)      Change       2009        2008     (Decrease)      Change
North America     $     7,371   $  5,420   $     1,951           36 % $  14,758   $ 11,830   $     2,928           25 %
Europe                  6,999      6,552           447            7 %    14,190     14,696          (506 )         -3 %
Asia Pacific            1,760      1,659           101            6 %     3,483      2,538           945           37 %
Total revenue     $    16,130   $ 13,631   $     2,499           18 % $  32,431   $ 29,064   $     3,367           12 %
Geographic Mix:
North America              46 %       40 %                                   45 %       41 %
Europe                     43 %       48 %                                   44 %       50 %
Asia Pacific               11 %       12 %                                   11 %        9 %
                          100 %      100 %                                  100 %      100 %

North America revenue increased $2.0 million and $2.9 million for the three and six months ended March 31, 2009, year-over-year, as a $2.0 million and $3.5 million increase in North American software and service revenue occurred, respectively. North America software sales for the three and six months ended March 31, 2009 were up 142% and 146% year-over-year, respectively. Hardware sales in North America were flat for the three months ended March 31, 2009, and declined 18% for the six months ended March 31, 2009.

Europe revenue was flat for the three and six months ended March 31, 2009, year-over-year. Softening software sales in Europe were offset by increasing hardware sales for the region. Hardware sales for the Europe region for the three and six months ended March 31, 2009 increased 22% and 31% respectively.

Asia Pacific revenue for the six months ended increased $0.9 million, year-over-year, due primarily to the smart card driver's license contract in Queensland, Australia. Asia Pacific region revenue was flat for the three months ended March 31, 2009.

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                                   Six Months Ended
                          March 31,           Increase     Percentage        March 31,           Increase     Percentage
                      2009         2008      (Decrease)      Change       2009        2008      (Decrease)      Change
Software           $    1,142    $      87   $     1,055        1,213 % $   2,181   $    299   $      1,882          629 %
As a % of
software revenue           18 %          2 %                                   19 %        3 %
Hardware           $    2,138    $   2,381   $      (243 )        -10 % $   4,559   $  4,748   $       (189 )         -4 %
As a % of
hardware revenue           52 %         64 %                                   51 %       60 %
Service            $    1,891    $   2,868   $      (977 )        -34 % $   3,983   $  5,439   $     (1,456 )        -27 %
As a % of
service revenue            30 %         49 %                                   33 %       45 %
Amortization of
acquired dev.
technology &
patents            $      593    $     593   $         0            0 % $   1,186   $  1,195   $         (9 )         -1 %
Total cost of
revenue            $    5,764    $   5,929   $      (165 )         -3 % $  11,909   $ 11,681   $        228            2 %

Cost of Software Revenue

Cost of software revenue includes the cost of professional services associated with customization essential to the functionality of software. The $1.1 million and $1.9 million increase, year-over-year, in software cost of revenue for the three and six months ended March 31, 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 six months ended March 31, 2009 year-over-year, due to the increase in token sales which generally have higher margins than readers and smart cards.

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 six months ended March 31, 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.

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              Six Months Ended
                                             March 31,                       March 31,
                                        2009            2008            2009           2008
Sales and marketing                 $      5,294    $      6,822    $     10,304    $    13,721
Percentage change from
comparable prior period                      -22 %                           -25 %
As a percentage of net revenue                33 %            50 %            32 %           47 %
Headcount, end of period                      81             110

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 six ended March 31, 2009, were down 22% and 25% 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              Six Months Ended
                                             March 31,                       March 31,
                                        2009            2008            2009           2008
Research and development, net       $      3,505    $      4,663    $      8,292    $     9,416
Percentage change from
comparable prior period                      -25 %                           -12 %
As a percentage of net revenue                22 %            34 %            26 %           32 %
Headcount, end of period                      99             121

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 $1.2 million and $1.1 million for the three and six months ended March 31, 2009, year-over-year as compensation costs associated with headcount reductions, decreased severance expense and overhead allocation reductions from cost reduction programs take effect.

General and administration

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

                                         Three Months Ended              Six Months Ended
                                             March 31,                       March 31,
                                        2009            2008            2009           2008
General and administration          $      3,204    $      2,527    $      6,631    $     5,641
Percentage change from
comparable prior period                       27 %                            18 %
As a percentage of net revenue                20 %            19 %            20 %           19 %
Headcount, end of period                      39              43

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

General and administration expenses increased $0.7 million and $1.0 million for the three and six months ended March 31, 2009 over the same quarter in the prior year primarily as a result of a change in the manner that executive officer and board of directors' costs for the three and six months ended March 31, 2009 were allocated. All amounts were allocated to general and administration instead of other cost centers during fiscal 2009. Management believes these costs are properly reported as general and administration expenses.

IMPAIRMENT OF GOODWILL

During the three months 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. Fair value was determined based on the market value of the Company's stock at March 31, 2008. Based on the SFAS
142 - 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 zero, as a non-cash charge to income.

                                        Three Months Ended                Six Months Ended
                                            March 31,                         March 31,
                                      2009             2008             2009            2008
Impairment of goodwill            $          -    $       35,874    $          -    $      35,874
Percentage change from
comparable prior period                   -100 %                            -100 %
As a percentage of net revenue                               263 %                            123 %

INTEREST INCOME



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



                                       Three Months Ended              Six Months Ended
                                           March 31,                       March 31,
                                      2009            2008            2009           2008
Interest income                   $        370    $      1,307    $      1,180    $     2,927
Percentage change from
comparable prior period                    -72 %                           -60 %
As a percentage of net revenue               2 %            10 %             4 %           10 %

Interest income consists of interest on our cash, cash equivalents, restricted cash, and investments. Since the quarter ended September 30, 2007, we have transferred a significant portion of our investment portfolio into cash and cash equivalents. The decrease in interest income for the three and six ended March 31, 2009 year-over-year was attributable to a migration of the portfolio to lower yielding investments, decreases in market interest rates over the prior year, and the overall reduction in the cash, equivalents, and investments portfolio.

OTHER INCOME (EXPENSE), NET



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



                                       Three Months Ended              Six Months Ended
. . .