Aeon Global Health Corp. - Quarter Report: 2005 September (Form 10-Q)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days.

Yes     No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes     No

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes     No

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d)of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

Yes     No

In the opinion of management the accompanying unaudited consolidated financial statements contain all adjustments, consisting of only normal, recurring adjustments, necessary for fair presentation. The consolidated financial statements include the accounts of Authentidate Holding Corp. (AHC) and its subsidiaries DJS Marketing Group, Inc. (DJS), Authentidate, Inc., Authentidate International AG (AG), Trac Medical Solutions, Inc. (Trac Med), and its Docstar Division, and are referred to as the Company. The results of operations for the three months ended September 30, 2005 are not necessarily indicative of the results to be expected for the full year. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These consolidated financial statements should be read in conjunction with the annual consolidated financial statements and notes thereto included in the Company’s Form 10-K for the fiscal year ended June 30, 2005.

The following represents the reconciliation of the basic and diluted loss per share amounts for the three months ended September 30, 2005 and 2004, respectively:

At September 30, 2005 the Company has an Employee Stock Option Plan and a Director Stock Option Plan. Prior to July 1, 2005 the Company applied APB Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for its stock option plans and, accordingly, no compensation cost has been recognized in the Company's financial statements for stock options under any of the stock option plans which on the date of the grant the exercise price per share was equal to or exceeded the fair value per share. Effective July 1, 2005, the Company adopted FAS No. 123R and began applying the provisions of the statement prospectively for any newly issued, modified or settled award after the date of initial adoption, as well as for any awards that were granted prior to the adoption date for which the requisite service has not been provided as of the adoption date. Results of prior periods have not been restated. The Company uses the Black Scholes option-pricing model to calculate total stock compensation expense.

The Black Scholes option-pricing model values options based on the stock price at the grant date, the expected life of the option, the estimated volatility, expected dividend payments and risk-free interest rates over the expected life of the options. For the three months ended September 30, 2005 the Company included $653,000 of stock option expense in its Statement of Operations. Had the Company continued to account for share-based compensation under APB Opinion No. 25, basic and diluted loss per common share would have been $.09 compared to $.11. No stock option expense was included in the Company's Statement of Operations for the three months ended September 30, 2004. Following is a table comparing the current year net loss to the prior year pro-forma net loss showing the effects of expensing stock options on a pro-forma basis for the three months ended September 30, 2004.

Prior to the adoption of FAS No. 123R, the Company presented cash flows resulting from the tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Statement of Cash Flows. FAS No. 123R requires cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. The Company did not realize any tax benefits from stock options during the three months ended September 30, 2005.

The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of FAS 123R to options granted under the Company’s stock option plans in all periods presented. For purposes of this pro forma disclosure, the value of the options is estimated using a Black Scholes option-pricing formula and amortized to expense over the options’ vesting periods.

The Company manages its business in three reportable segments: the Document Management Solutions Segment, Systems Integration Segment and Security Software Solutions Segment. Included in the Security Software Solutions Segment are the operations of Authentidate, Trac Med and AG. The Document Management Solutions Segment operates as Docstar, specifically in document imaging. The Systems Integration Segment operates as DJS. The Document Management Solutions Segment sells through a national network of dealers (approximately 100 dealers) and anticipates the addition of several new dealers each quarter to expand into markets not currently served. The Systems Integration Segment’s market is primarily in the Albany, New York region. The Security Software Solutions Segment sells their products and services on a global basis using a direct sales model and reseller arrangements. The Corporate Division's expenses are non-operating expenses which include all public company related activities, employee/director stock option expense and apply to all of the Company’s operating divisions and therefore are stated as a reconciling item in our segment data. The Corporate Division’s assets consist of primarily cash and cash equivalents, marketable securities and goodwill. The Company’s segment information follows:

The Company has classified certain investments known as auction rate securities as marketable securities on its balance sheet. The auction rate securities the Company purchases are generally triple A or double A rated. With regard to the auction rate securities the Company purchases, the interest yield generally resets every 35 days or sooner. The securities are purchased at par value and sold at par value with no adjustment to market value required. Many of the securities are insured by a third party insurance company and the issuer is sometimes a municipality or municipality run corporation.

On the Company’s Form 10Q for the three months ended September 30, 2004, the Company had certain auction rate securities classified as cash and cash equivalents on its Balance Sheet and Statement of Cash Flow. As reported on the Company’s Form 10K/A for the year ended June 30, 2004, the Company reclassified these securities from cash and cash equivalents to marketable securities. As a result of this change, the Statement of Cash Flow for the three months ended September 30, 2004 has been amended in this Form 10Q. The Company has included a line item entitled “Net sales of marketable securities” which totaled $1,375,000. As a result, the total “Net cash used/(provided) by investing activities” has been amended from $719,980 of cash used to $655,020 of cash provided. Total “Net increase(decrease) in cash and cash equivalents” has been amended from $2,452,503 of cash used to $1,077,503 of cash used. Furthermore, “Cash and cash equivalents, end of period” has been amended from $71,537,320 to $23,987,320 as $47,550,000 of auction rate securities were reclassified from cash and cash equivalents to marketable securities as of September 30, 2004.

The Company retains a third party valuation firm to perform an annual valuation of goodwill as of June 30. An adverse development or change in our business would require an interim assessment. There were no adverse developments or changes in our business that required an interim assessment for the three months ended September 30, 2005.

There were no changes in the carrying amount of goodwill for the three months ended September 30, 2005. The values at September 30, 2005 were as follows:

Intangible asset amortization expense for the three months ended September 30, 2005 and September 30, 2004 was $42,937 and $42,960. Below is a chart of intangible assets:

The Company amortizes intangible assets under the straight line method. Intangible amortization expense is expected to be as follows for the next five fiscal years:

During the three months ended September 30, 2005, no common stock options or common stock warrants were exercised.

As of October 1, 2004, the Company has the right to repurchase the outstanding 28,000 shares of Series B preferred stock at a redemption price equal to $25.00 per share, plus accrued and unpaid dividends. The holder, however, has the right to convert these shares of preferred stock into an aggregate of 500,000 shares of our common stock at a conversion rate of $1.40 per share. In the event the Company elects to redeem these securities, the holder will be able to exercise its conversion right subsequent to the date that we issue a notice of redemption but prior to the deemed redemption date as would be set forth in such notice. The Series B preferred stock was originally issued in a private financing which was completed in October 1999. The conversion and redemption features of this security were amended in October 2002 to provide for the rights and obligations described above in this note.     

As described in our report on Form 10-K for the fiscal year ended June 30, 2005, we are involved in the following pending and threatened legal proceedings. We are the defendant in a third party complaint filed by Shore Venture Group, LLC (Shore Venture) in Federal District Court in Pennsylvania. The third party complaint was filed against us on May 7, 2001. Shore Venture is the defendant to an action commenced by Berwyn Capital. The third party complaint alleges a claim for breach of contract and seeks indemnification. A trial was held in October, 2002 and we are currently awaiting the verdict of the judge. Management believes that the claim will not have a material adverse impact on our financial condition, results of operations or cash flows.

We are also the defendant in a claim filed by Shore Venture Group in the federal District Court for the District of New Jersey, under the caption Shore Venture Group, LLC, et al v. Authentidate Holding Corp., Authentidate, Inc. and John T. Botti. This complaint was filed on March 2, 2005 and an amended complaint was filed on or about April 26, 2005. On October 12, 2005, the parties entered into an agreement to arbitrate the claims asserted against us by Plaintiffs. On October 19, 2005, the Court approved and entered a Consent Order referring the case to arbitration by the American Arbitration Association and staying the lawsuit pending resolution of the arbitration. The plaintiffs seek additional shares of the common stock of our subsidiary, Authentidate, Inc., rights under one of our patent applications, and damage in connection with an alleged copyright infringement. We had conducted extensive settlement negotiations with Shore Venture in an effort to resolve all claims between the parties. However, negotiations were unable to result in a mutually agreeable settlement. Plaintiffs have not yet filed their arbitration brief. We intend to defend the action vigorously. Management believes that the resolution of all of our claims with Shore Venture will not have a materially adverse effect on our financial condition. However, there can be no assurance that such belief will ultimately prove to be accurate or that other facts adverse to our position currently not known to management will not be uncovered, in which case the ultimate resolution of this claim could potentially have a material adverse effect on our financial position.

In June, July and August 2005, six purported shareholder class actions were filed in the United States District Court for the Southern District of New York against our company and certain of our current and former officers and directors. Plaintiffs in these actions allege that defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Sections 11, 12(a), and 15 of the Securities Act of 1933. The alleged class period is August 6, 2002 through May 27, 2005. The securities law claims are based on the allegation that we failed to disclose that the USPS could cancel its August 2002 contract with us if we did not meet certain performance metrics, and when we disclosed on September 8, 2004 that we failed to comply with those metrics and on May 27, 2005 that we had received a second notice from the USPS that we had failed to obtain the minimum revenue required under the agreement, the market price of our stock declined. The class action complaints seek unspecified monetary damages. On October 5, 2005 the Court granted the motion of one plaintiff, the Illinois State Board of Investment, to be appointed as lead plaintiff under the Private Securities Litigation Reform Act. The caption of the case is in re Authentidate Holding Corp. Securities Litigation., C.A. No. 05 Cir. 5323 (LTS). Plaintiff is scheduled to file an amended consolidated complaint on January 3, 2006; defendants’ motion to dismiss the complaint is scheduled to be filed on March 4, 2006. Oral argument on the motion to dismiss is scheduled for June 30, 2006.

In addition to the class action complaints, four purported shareholder derivative actions were filed against certain former and current directors and officers of the Company in June and July 2005 in the United States District Court for the Southern District of New York. The derivative actions are based on substantially the same events and factual allegations as the class actions and assert claims that Authentidate was injured by an alleged breach of fiduciary duty, waste, mismanagement, violations of Sarbanes-Oxley, and misappropriation of inside information. The derivative complaints seek, among other things, damages, equitable relief, restitution, and payment of costs and expenses incurred in the litigation (including legal fees). Plaintiffs in the derivative actions have entered into a Court-approved stipulation providing for the consolidation of their actions and the selection of Maxine Philips as the lead plaintiff. Plaintiff is scheduled to file a consolidated complaint on November 14, 2005. Defendants’ response is due on January 13, 2006.

In addition, in August 2005, we were notified of the filing of a complaint in which the plaintiff alleges that our products and systems incorporating secure time stamping technology, including but not limited to our Electronic Postmark system, infringes certain of the plaintiff’s patent rights. The complaint was filed in the United States District Court for the Middle District of Florida and is entitled TimeCertain LLC vs. Authentidate Holding Corporation, Authentidate, Inc. and NCipher Inc. As relief, the complaint seeks, among other things, injunctive relief and damages. The complaint was served on September 21, 2005, and our Answer, which we plan to timely file, is due on November 10, 2005. We are continuing to assess the situation and the patents being asserted. We intend to defend the action vigorously. Based on the facts of which we are currently aware, management believes that the resolution of all of our claims with TimeCertain will not have a materially adverse effect on our financial condition. However, no assurances can be given that such belief will ultimately prove to be accurate or that other facts adverse to our position currently not known to management will not be uncovered, in which case the ultimate resolution of this claim could potentially have a material adverse effect on our financial condition.

We are engaged in no other litigation which would be anticipated to have a material adverse effect on our financial condition, results of operations or cash flows.

On July 31, 2002, we entered into a strategic alliance agreement with the United States Postal Service to serve as the preferred provider of the USPS Electronic Postmark® (EPM) service. Under the terms of the agreement, our subsidiary, Authentidate, Inc., provides the management, technology and support for the United States Postal Service’s EPM system. The USPS is the vendor of the EPM to the end user. The USPS Electronic Postmark® provides evidence that the content of a document or file existed at a specific date and time and is intended to protect the integrity of the document or file by ensuring that it cannot be altered without detection. The EPM uses our patent pending technology offering highly sophisticated encryption methodology ensuring document authenticity and is intended to be able to be added to any application regardless of the computing platform or operating system.

To date, we have not achieved the revenue metrics required under our agreement with the United States Postal Service. We received a third letter from the USPS in October 2005, which letter stated the Company continues to fail to attain the performance metrics required by the Strategic Alliance Agreement. However, the USPS also stated it has elected not to terminate the agreement at this time and will continue to fulfill its obligations under the agreement as long as it remains in effect. The Company and the United States Postal Service have continued to discuss various amendments to the original agreement and we believe these discussions will lead to changes to the contract that we and the United States Postal Service will both agree to and which will enable us to continue our relationship with the United States Postal Service. If we are unsuccessful in completing these negotiations and should we fail to satisfy one or more of the performance metrics under this agreement, the United States Postal Service could, subject to our right to cure any such failure, terminate our agreement.

We have entered into various agreements by which we may be obligated to indemnify the other party with respect to certain matters. Generally, these indemnification provisions are included in contracts arising in the normal course of business under which we customarily agree to hold the indemnified party harmless against losses arising from a breach of representations related to such matters as intellectual property rights. Payments by us under such indemnification clauses are generally conditioned on the other party making a claim. Such claims are generally subject to challenge by us and to dispute resolution procedures specified in the particular contract. Further, our obligations under these arrangements may be limited in terms of time and/or amount and, in some instances, we may have recourse against third parties for certain payments made by us. It is not possible to predict the maximum potential amount of future payments under these indemnification agreements due to the conditional nature of our obligations and the unique facts of each particular agreement. Historically, the Company has not made any payments under these agreements that have been material individually or in the aggregate. As of September 30, 2005, we were not aware of any obligations under such indemnification agreements that would require material payments.

Certain statements in this Form 10-Q, including information set forth under Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”). We desire to avail ourselves of certain “safe harbor” provisions of the Act and are therefore including this special note to enable us to do so. Forward-looking statements in this Form 10-Q or hereafter included in other publicly available documents filed with the Securities and Exchange Commission, reports to our stockholders and other publicly available statements issued or released by us involving known and unknown risks, uncertainties and other factors which could cause our actual results, performance (financial or operating) or achievements to differ from the future results, performance (financial or operating) or achievements expressed or implied by such forward-looking statements. Such future results are based upon our management’s best estimates based upon current conditions and the most recent results of operations. These risks include, but are not limited to risks associated with the market acceptance of the Docstar, Authentidate and related product lines, competition, pricing, technological changes, technological implementation of the Authentidate business plan, related decisions by the USPS, and other risks as discussed in our filings with the Securities and Exchange Commission, in particular our Annual Report on Form 10-K for the year ended June 30, 2005 and registration statements we have filed and which have been declared effective by the Securities and Exchange Commission pursuant to the Securities Act of 1933, as amended, all of which risk factors could adversely affect our business and the accuracy of the forward-looking statements contained herein.

Authentidate Holding Corp. is a holding company which operates its software, hardware and services business in three segments:

During the three months ended September 30, 2005, we derived approximately $1.5 million in revenue from our Document Management Solutions Segment, $1.7 million from our Systems Integration Segment, and $1.1 million from our Security Software Solutions Segment, respectively.

The Document Management Solutions Segment develops and sells document imaging software nationwide and depending on the customer, may bundle the software with computer hardware to offer customers a turn-key solution or may sell the software alone with no computer systems.

The Systems Integration Segment is an authorized sales and support provider for software products such as Microsoft Solutions and Lotus Notes. This Segment also sells computer hardware and provides software and integration services to businesses to meet their data management needs, primarily in the Albany, NY region.

The Security Software Solutions Segment is engaged in the business of providing end users with security software technology and services designed to accept and store a digital code which enables users to prove the authenticity of the date, time and the content of any electronic document. The product was released for sale in May, 2001. We believe that product integration development work will be necessary for some applications or customers. In April 2005, we launched a new service to authenticate and verify documents received by fax and in October 2005 we announced the introduction of CareFax^TM, a web-based, HIPAA-compliant fax solution that is intended to meet the compliance requirements associated with document processing in the healthcare sector.

On July 31, 2002, we entered into a strategic alliance agreement with the United States Postal Service to serve as the preferred provider of the USPS Electronic Postmark® (EPM) service. Under the terms of the agreement, our Authentidate, Inc. subsidiary provides the management, technology and support for the United States Postal Service’s EPM system. The USPS is the vendor of the EPM to the end user. The USPS Electronic Postmark® provides evidence that the content of a document or file existed at a specific date and time and is intended to protect the integrity of the document or file by ensuring that it cannot be altered without detection. The EPM uses our patent pending technology offering highly sophisticated encryption methodology ensuring document authenticity and is intended to be able to be added to any application regardless of the computing platform or operating system. During the 2005 fiscal year, we implemented a solutions-based approach to accelerate development of the market for the USPS EPM and in May 2005, we announced that the United States Postal Service approved an updated version of the USPS EPM service.

To date, we have not achieved the revenue metrics required under our agreement with the United States Postal Service. As previously reported, we received a letter from the USPS in September 2004, which letter stated that we had six months to cure our nonperformance of the metric standard described in such letter. We began negotiating with the Postal Service to complete a modification of this metric and in December 2004 believed that we cured the default. Despite those actions, in May 2005 the United States Postal Service notified us that we had failed to attain the performance metrics required by the Strategic Alliance Agreement during the period February 2005 through April 2005. In its notice, the Postal Service has advised us that although it intends to exercise its right to terminate the Strategic Alliance Agreement if we are unable to cure this default, it is willing to discuss further plans that we may have to attain the performance metrics in the Strategic Alliance Agreement. In October 2005, the United States Postal Service again notified us of our continuing failure to satisfy the performance metrics required by the Strategic Alliance Agreement. However, the USPS also stated that it has elected not to terminate the agreement at this time and will continue to fulfill its obligations under the agreement as long as it remains in effect. We have continued our efforts to cure the default claimed by the USPS and to discuss modifications to the Alliance Agreement. No assurances, however, can be given that we will be successful in completing these negotiations or that we will comply with the current performance metric in a timely manner. If we are unsuccessful in either of these tasks, the Postal Service may terminate the agreement.

Authentidate International sells the Authentidate product in the European marketplace and is currently focusing on the German market. As an accredited provider Authentidate International is able to generate legally valid time stamps in accordance with the German Digital Signature Act and European guidelines. Authentidate International develops and provides software solutions for electronic invoicing, secure e-mail, archiving, scanning, time stamping and workflow solutions.

Trac Medical Solutions developed a business model to apply the Authentidate technology to the medical supply business relating to the automation and processing of Certificates of Medical Necessity (CMN). Trac Medical Solutions developed its CareCert™ service and has entered into over thirty revenue-generating agreements to date. In February 2004, Trac Medical Solutions entered into an agreement with Homecare Association, LLC pursuant to which Trac Medical Solutions markets its CareCert service directly to the membership community of the American Association for Homecare. In connection with that agreement, Trac Medical Solutions engaged bConnected Software, Inc. to provide development services for an enterprise version of its CareCert service and to provide marketing and reselling services. Trac Medical announced the commercial release of CareCert^® ES during the quarter ended December 31, 2004. Trac Medical Solutions generates revenues through license fees, maintenance fees, support fees and the sale of transactions.

We are continuing to address the challenges of the markets in which the Security Software Solutions Segment operates, while continuing to grow the established businesses, the Document Management Solutions Segment and the Systems Integration Segment.

The financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America.

The financial statements include the accounts of Authentidate Holding Corp. and its subsidiaries. Intercompany transactions and balances have been eliminated. Equity investments where we do not exercise significant influence over the investee are accounted for under the cost method.

We consider all highly liquid debt instruments with maturities not exceeding three months when purchased to be cash equivalents. At September 30, 2005 and June 30, 2005, cash equivalents were composed primarily of investments in high quality short term investments such as commercial paper and overnight interest bearing deposits.

Our marketable securities are generally comprised of auction rate securities. These investments are generally rated AAA or AA by one or more national rating agencies. The auction rate securities have contractual maturities of up to 30 years. The auction rate securities that we invest in generally have interest re-set dates that occur every 7, 28 or 35 days and despite the long-term nature of their stated contractual maturity, we have the ability to quickly liquidate these securities at ongoing auctions every 35 days or less. We classify our investments in auction rate securities as “available for sale.” These investments are recorded at cost which approximates fair market value due to their variable interest rates, which typically reset every 7, 28 or 35 days. As a result, we had no cumulative gross unrealized holding gains (losses) or gross realized gains (losses) from our current investments. All income generated from these current investments was recorded as interest income. Because we do not hold any one auction rate security longer than one year, they have been classified as a current asset.

Accounts receivable represents receivables net of allowances for doubtful accounts. The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience and other currently available evidence.

Inventories are stated at the lower of cost or market and are valued at average cost.

Long-lived assets including property and equipment, software development costs, patent costs, trademarks and licenses are reviewed for impairment whenever events such as significant changes in the business climate, changes in product offerings, or other circumstances indicate that the carrying amount may not be recoverable.

Property and equipment (including assets held under capital leases) are stated at cost net of accumulated depreciation. Depreciation and amortization are determined using the straight-line method. Estimated useful lives of the assets range from three to forty years.

Repairs and maintenance are charged to expense as incurred. Renewals and betterments are capitalized. When assets are sold, retired or otherwise disposed of, the applicable costs and accumulated depreciation or amortization are removed from the accounts and the resulting gain or loss, if any, is recognized.

Software development and modification costs incurred subsequent to establishing technological feasibility are capitalized and amortized based on anticipated revenue for the related product with an annual minimum equal to the straight-line amortization over the remaining economic life of the related products (generally three years). These expenses are included in cost of sales.

Goodwill is reviewed for impairment annually or whenever events such as significant changes in the business climate, changes in product offerings, or other circumstances indicate that the carrying amount may not be recoverable. We perform our annual goodwill impairment test in the fourth quarter of each fiscal year.

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Revenue from the sale of products is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed and collectibility is reasonably assured. Service revenue is recognized as services are provided. We enter into transactions that represent multiple-element arrangements. These arrangements may include combinations of software licensing, post-contract customer support, software upgrades, transactions, set-up fees, hosting fees and credentialing fees. Multiple-element arrangements are assessed to determine whether they can be separated into more than one unit of accounting. A multiple-element arrangement is separated into more than one unit of accounting if all of the following criteria are met: the delivered item has value to the customer on a stand alone basis; there is objective and reliable evidence of the fair value of the undelivered items in the arrangement; and if the arrangement includes a general right of return relative to the delivered items, delivery or performance of the undelivered item is considered probable and substantially in our control. If these criteria are not met, then revenue is deferred until such criteria are met or until the period over which the last undelivered element is delivered, which is typically the life of the contract agreement. If these criteria are met, we allocate total revenue among the elements based on the sales price of each element when sold separately or based on fair value of each element if they are not sold separately which is referred to as vendor specific objective evidence or VSOE.

Our Document Management Solutions Segment has significant revenue from multiple element arrangements. Docstar sales include computer systems with loaded software (including the perpetual software license) as one deliverable and Docstar Softcare ™ as an additional deliverable. Each of these deliverables is separately sold products and therefore has vendor specific objective evidence of fair value. In some cases the deliverable is just the software and license with no computer. Docstar Softcare is a one year post-contract customer support and upgrade product. We recognize revenue on the system and perpetual software license when the product is shipped and title to the system passes to the customer. The Softcare deliverable is considered a when-and-if-available element. Softcare revenue is recognized ratably over the one year contract. Revenue is allocated to each element based on the prices of these two elements when sold separately.

The System Integration Segment revenue is mainly derived from the sale of computer hardware and does not generally involve multiple elements. Revenue is recognized when the hardware is shipped and title passes to the customer. This segment also has professional services revenue and this revenue is recognized when the services are completed and accepted by the customer. In some cases this segment may have a multiple element transaction when professional services and hardware are both sold to the customer. The hardware revenue is recognized when it is shipped to the customer and the professional services portion is recognized when the services are completed and accepted by the customer. Revenue for each element is allocated based on the sales price we charge for these elements when sold separately (VSOE).

The Security Software Solutions Segment may have multiple element sales and the separate elements may include licensing, maintenance, set-up, support, transaction fees and hosting services. Our Trac Medical subsidiary generally enters into sales contracts of one year. These contracts, which require customer set-up, may contain elements including software hosting, licensing, credentialing, transaction and post-contract customer support elements. Additionally, these contracts contain a prepaid transaction element and any unused transactions may be carried over, provided the customer renews their contract for another year. As this service/product is new, there is no evidence of value for any element, VSOE has not been established. Additionally, under these arrangements, all elements of the contract are being provided and/or accessed by the customer over our hosting site on a monthly basis over the estimated term of the contract. Therefore, revenue is deferred until set-up is complete and then recognized over the estimated term of the contract.

With regard to our Authentidate Inc. product, the Electronic Post Mark (EPM), revenue is recognized on the sale of EPMs to the USPS as EPMs are used by the end-user customer. With regard to our Authentidate AG subsidiary some revenue contracts may involve multiple element arrangements and because the elements cannot be separated into more than one unit of accounting the revenue is deferred and recognized ratably over the life of the contract which is generally one year. The multiple elements may include license fees, support fees, professional services, time stamp fees and maintenance fees. Authentidate AG may also receive revenue from professional services (without other elements) and such revenue is recognized as the professional services are completed and accepted by the customer.

We provide a one-year warranty on hardware products we assemble in our Document Management Solutions Segment. On products distributed for other manufacturers, the original manufacturer warranties the product. Warranty expense was not significant to any of the years presented.

We recognize advertising expenses as incurred.

These costs represent research and development expense and include salary and benefits, professional and consultant fees, amortization of licenses and supplies.

Assets and liabilities of non-U.S. operations are translated at the exchange rate on the balance sheet date generally and the income statements are translated at the average rates of exchange for the year. Gains or losses resulting from translating non-U.S. currency financial statements are recorded in “Comprehensive Income (Loss)” and accumulated in shareholders’ equity in the caption “Accumulated Comprehensive Income (Loss)”.

Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Examples include estimates of loss contingencies and product life cycles and assumptions such as elements comprising a software arrangement, including the distinction between upgrades/enhancements and new products; when technological feasibility is achieved for our products; the potential outcome of future tax consequences; and determining when investment impairments are other-than-temporary. Actual results and outcomes may differ from management's estimates and assumptions. We have based our estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances and we evaluate our estimates on a regular basis and make changes accordingly. Historically, our estimates relative to our critical accounting estimates have not differed materially from actual results; however, actual results may differ from these estimates under different conditions. If actual results differ from these estimates and other considerations used in estimating amounts reflected in our consolidated financial statements, the resulting changes could have a material adverse effect on our consolidated statement of income, and in certain situations, could have a material adverse effect on liquidity and our financial condition.

With regard to revenue recognition, revenue from the sale of products is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed and collectibility is reasonably assured. Service revenue is recognized as such services are provided. We enter into transactions that represent multiple-element arrangements. Those arrangements include combinations of licensing, transactions, set-up, maintenance, support and hosting services. Multiple-element transactions are assessed to determine whether they can be separated into more than one unit of accounting. A multiple-element arrangement is separated into more than one unit of accounting if all of the following criteria are met (a) the delivered item has value to the customer on a stand alone basis; (b) there is objective and reliable evidence of the fair value of the undelivered item; and (c) if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the delivered item is considered probable and substantially within our control. If these criteria are not met, then revenue is deferred until such criteria are met or until the period over which the last undelivered element is delivered, which is typically the life of the contract agreement.

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We write down inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of the inventory and the estimated market value based on assumptions about future demand and market conditions. We make estimates on the future recoverability of capitalized goodwill in the Security Software Solutions Segment which is highly dependent on the future success of the marketing and sales of this segment. We record a valuation allowance against deferred tax assets when we believe it is more likely than not that such deferred tax assets will not be realized.

We apply FAS No. 123R to account for employee and director stock option plans. The stock-based employee compensation expense was determined using the Black Scholes option-pricing model which values options based on the stock price at the grant date, the expected life of the option, the estimated volatility, expected dividend payments and the risk-free interest rate over the expected life of the options.

Financial instruments which subject us to concentrations of credit risk consist of cash and cash equivalents, marketable securities and trade accounts receivable. To reduce credit risk, we place our investments with several high credit quality financial institutions and typically invest in AA or better rated investments. Our credit customers are not concentrated in any specific industry or business. We establish an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information.

The following analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and notes contained elsewhere in this Form 10-Q.

We realized a consolidated net loss of $3,748,987 ($.11 per share) for the three months ended September 30, 2005 compared to a consolidated net loss of $2,906,089 ($.09 per share) for the three months ended September 30, 2004.

As reported in Footnote 5 (Segment Information) to the Consolidated Financial Statements appearing in this Form 10-Q, the net loss is the result of losses incurred primarily by our Security Software Solutions Segment and Corporate expenses. Our Security Software Solutions Segment has incurred significant sales, marketing, development, and general and administrative expenses this year and last to generate sales, to develop a market for its products including personnel, marketing programs and advertising, and to develop additional products including new software products for the content authentication market and for the healthcare market.

The consolidated net loss for the three months ended September 30, 2005 is approximately $843,000 more than it was for the same period last year. Most of the increased loss was due to $653,000 of stock option expenses recorded due to new rules requiring the expensing of options under FAS No. 123R. The remainder of the increased loss is due to an increase in selling, general and administrative expenses in the Corporate Division, which is more fully explained below. There was a decrease in the segment loss in the Security Software Solutions Segment of approximately $687,000 comparing current quarter to prior year quarter. The decrease was primarily due to increased sales of $528,000, as well as, a decrease in personnel costs of approximately $106,000 and consultant costs of approximately $73,000 in the quarter, offset against insignificant increases in various other categories. The Document Management Solutions segment profit decreased approximately $14,000, while the Systems Integration segment profit decreased approximately $29,000 for the three months ended September 30, 2005, compared to the three months ended September 30, 2004.

Consolidated sales were $4,303,536 and $3,662,398 for the three months ended September 30, 2005 and 2004, respectively. The increase versus the prior year period is primarily a result of an increase in the Security Software Solutions Segment of $528,000, mainly due to new customer sales. Sales for the Systems Integration Segment increased approximately $25,000 comparing the current period to corresponding period for the prior year. Sales for the Document Management Solutions Segment increased approximately $89,000 for the three months ended September 30, 2005 compared to the corresponding period for the prior year.

Consolidated gross profit for the three months ended September 30, 2005 and 2004 was $2,132,086 and $1,702,613, respectively. The consolidated gross profit margin was 49.5% and 46.5% for the three months ended September 30, 2005 and 2004, respectively. Gross profit margin is defined as gross profit as a percentage of sales. The increase comparing current year to prior year results from increased gross profit in the Security Software Solutions Segment and an increase to the Document Management Solutions Segment.

Selling, general and administrative expenses (S,G&A) consist of all other Company expenses except product development costs and interest. S,G&A expenses amounted to $5,038,057 and $4,209,357 for the three months ended September 30, 2005 and 2004, respectively. The largest increase was in Corporate Division which incurred increased personnel costs ($0.4 million), increased legal and accounting expenses ($0.3 million), consulting fees ($0.1 million), rent expense ($0.1 million), and increased director and officer liability insurance and director costs ($0.2 million) for the three months ended September 30, 2005.

These increases in our Corporate division related to the addition of staff, expenses incurred in connection with defending litigation, compliance with requirement of Sarbanes-Oxley Act of 2002, including costs related to our internal control over financial reporting, and renewing liability insurance coverage.

As a percentage of net sales, S,G&A costs were 117.1% for the three months ended September 30, 2005 and 114.9% for the three months ended September 30, 2004. This percentage increase is primarily due to the increase in SG&A expenses for the Corporate Division as discussed above.

Product development expenses, excluding capitalized costs, primarily relate to software development for the Security Software Solutions Segment. For the three month period September 30, 2005, these costs increased to $718,436, as compared to $701,274 the same period last year. We have a policy of capitalizing qualified software development costs after technical feasibility has been established and amortizing those costs over three years as cost of goods sold once the products are available to customers. The amortization expense of software development costs amounted to $109,016 for the three months ended September 30, 2005. Amortization expense of software development costs amounted to $82,147 for the three months ended September 30, 2004.

Our primary sources of funds to date have been the issuance of equity and the incurrence of third party debt. The principal balance of long-term debt at September 30, 2005 totaled $18,000, which relates to a note payable to the Empire State Development Corporation for the repayment of a grant.

In February 2004, we sold a total of 5,360,370 common shares in private placements pursuant to Section 4(2) of the Securities Act and Rule 506, promulgated there. We realized gross proceeds of approximately $73,700,000 from these transactions and received net proceeds of approximately $69,100,000 after payment of offering expenses and broker commissions.

Our DJS subsidiary has a $2.5 million revolving line of credit with a financial institution collateralized by all assets of DJS and guaranteed by Authentidate Holding Corp. The agreement restricts DJS from making cash advances to AHC, without obtaining a waiver from the financial institution. The interest rate is prime plus 1.75% with a minimum prime rate of 7%. DJS may borrow on this line based on a formula of qualified accounts receivable and inventory. The outstanding balance on this line of credit is $488,730 at September 30, 2005.

Property, plant and equipment expenditures totaled $172,765 and capitalized software development expenditures totaled $608,262 for the three months ended September 30, 2005, respectively. There are no significant purchase commitments outstanding.

Our unrestricted cash and cash equivalents balance at September 30, 2005 was $7,669,826 and total assets were $76,032,198 compared to unrestricted cash and cash equivalents of $6,429,210 and total assets of $79,708,605 at June 30, 2005. Our unrestricted cash balance at September 30, 2004 was $23,987,320 and our total assets as of such date were $91,995,649. We have invested our excess cash in marketable securities, which totaled $56,075,000 at June 30, 2005 and $49,600,000 at September 30, 2005. The decrease in our total assets from the three months ended September 30, 2004 to the three months ended September 30, 2005 is due primarily to cash used in operating activities. Unrestricted cash and cash equivalents decreased $16.3 million from September 30, 2004 to September 30, 2005 primarily due to cash outflows for operating activities of $13.1 million, purchases of marketable securities of $2.0 million and $1.2 million of other activity. We used $3,967,717 of cash in operating activities during the three months ended September 30, 2005. This compares to cash used in operating activities of $1,503,788 for the same period last year. Total cash flow provided by all activities was $1,240,616 for the three months ended September 30, 2005, compared to net cash used of $1,077,503 for the three months ended September 30, 2004. This increase in cash and cash equivalents during the three months ended September 30, 2005 is mainly due to our investing activities which involved the sale of marketable securities ($6,475,000), offset by software development costs ($608,262) and cash used in operating activities ($3,967,717). The decrease in cash during the three months ended September 30, 2004 was mainly due to operating activities, primarily the net loss ($2,906,089), offset by the sale of marketable securities ($1,375,000).

To date we have been largely dependent on our ability to sell additional shares of our common stock or other securities to obtain financing to fund our operating deficits. Under our current operating plan to introduce the Authentidate technology, our ability to improve operating cash flow has been highly dependent on the market acceptance of our products. We believe we have enough cash, cash equivalents and marketable securities to support our operations for at least the next twelve months.

Our future capital requirements may vary materially from those now planned. The amount of capital that we will need in the future will depend on many factors, including:

Financing Activities

We did not engage in any external financing activities to date in fiscal 2006 and during our 2005 fiscal year.

The events and contingencies described below have or may have impacted our liquidity and capital resources.

Presently, 28,000 shares of our Series B preferred stock, originally issued in a private financing in October 1999, remain outstanding. As of October 1, 2004, our right to redeem the outstanding 28,000 shares of Series B preferred stock is vested. Accordingly, we have the right to repurchase such shares at a redemption price equal to $25.00 per share, plus accrued and unpaid dividends. The holder, however, has the right to convert these shares of preferred stock into an aggregate of 500,000 shares of our common stock at a conversion rate of $1.40. In the event we elect to redeem these securities, the holder will be able to exercise its conversion right subsequent to the date that we issue a notice of redemption but prior to the deemed redemption date as would be set forth in such notice. As of June 30, 2005, no shares of the Series B preferred stock have been redeemed.

We are the defendant in a third party complaint filed by Shore Venture Group, LLC in the United States District Court for the Eastern District of Pennsylvania. The caption of this matter is Berwyn Capital Investments, Inc. v. Shore Venture Group, LLC et al. (defendants and Shore Venture Group, LLC as third party plaintiff) v. Authentidate Holding Corp. and Authentidate, Inc. (third party defendants). The third party complaint was filed against us on May 7, 2001. Shore Venture is the defendant to an action commenced by Berwyn Capital. The third party complaint alleges a claim for breach of contract and seeks indemnification. A trial was held in October, 2002 and we are currently awaiting the verdict of the judge. Management believes that the claim will not have a material adverse impact on our financial condition, results of operations or cash flows. However, no assurances can be given that such belief will ultimately prove to be accurate or that other facts adverse to our position currently not known to management will not be uncovered, in which case the ultimate resolution of this claim could potentially have a material adverse effect on our financial condition.

We are also the defendant in a case filed by Shore Venture Group, LLC in the United States District Court for the District of New Jersey, under the caption Shore Venture Group, LLC, et al v. Authentidate Holding Corp., Authentidate, Inc. and John T. Botti. This complaint was filed on March 2, 2005, and an amended complaint was filed on or about April 26, 2005. On October 12, 2005, the parties entered into an agreement to arbitrate the claims asserted against us by the Plaintiffs. On October 19, 2005, the Court approved and entered a Consent Order referring the case to arbitration by the American Arbitration Association and staying the lawsuit pending resolution of the arbitration. The Plaintiffs in this case seek additional shares of the common stock of our subsidiary, Authentidate, Inc., the right to exchange its stock in Authentidate, Inc., for publicly traded stock and securities in us, rights under one or more of our patent applications and damages in connection with an alleged copyright infringement. The lawsuit requested damages, injunctive relief, costs and attorneys’ fees. The Plaintiffs have not yet filed their arbitration brief. We intend to defend the action vigorously. Based on the facts of which we are currently aware, management believes that the resolution of all of our claims with Shore Venture will not have a materially adverse effect on our financial condition. However, no assurances can be given that such belief will ultimately prove to be accurate or that other facts adverse to our position currently not known to management will not be uncovered, in which case the ultimate resolution of this claim could potentially have a material adverse effect on our financial condition.

Between June and August 2005, several purported shareholder class and derivative actions were filed against our company and certain current and former officers and directors. The complaints and current status of these actions are described in detail under the caption “Legal Proceedings,” appearing in Item 1 of Part II of this Quarterly Report on Form 10-Q. Management is unable to determine at this time whether these complaints will have a material adverse impact on its financial condition, results of operations or cash flow.

In addition, in August 2005, we were notified of the filing of a complaint in which the plaintiff alleges that our products and systems incorporating secure time stamping technology, including but not limited to our Electronic Postmark system, infringes certain of the plaintiff’s patent rights. The complaint was filed in the United States District Court for the Middle District of Florida and is entitled TimeCertain LLC vs. Authentidate Holding Corporation, Authentidate, Inc. and NCipher Inc. As relief, the complaint seeks, among other things, injunctive relief and damages. The complaint was served on September 21, 2005, and our Answer, which we plan to timely file, is due on November 10, 2005. We are continuing to assess the situation and the patents being asserted. We intend to defend the action vigorously. Based on the facts of which we are currently aware, management believes that the resolution of all of our claims with TimeCertain will not have a materially adverse effect on our financial condition. However, no assurances can be given that such belief will ultimately prove to be accurate or that other facts adverse to our position currently not known to management will not be uncovered, in which case the ultimate resolution of this claim could potentiallyhave a material adverse effect on our financial condition.

On July 11, 2005, we entered into a lease agreement for general office space consisting of 19,695 total rentable square feet located in Berkeley Heights, New Jersey. The lease is for a term of ten years and four months, with a commencement date of October 1, 2005. Starting on October 1, 2005, we began occupying the premises on a rent-free basis for four months. For an additional two months we are entitled to occupy a portion of the premises on a rent-free basis. The annual rent in the first year will be $323,544 and increasing to $512,070 in year 2 and increasing at regular intervals until year 10 when the annual rent will be $561,308. The lease also provides us with a right of first offer on available space on the fifth floor of the corporate center as well as a one-time option to renew the lease for a term of five years at the then-current market rate for comparable buildings. We also have an option to terminate the lease five years and four month after the commencement date upon 12 months prior notice to the landlord. If we exercise this option, we would be required to pay an early termination fee of $568,202. As part of the lease agreement, we posted a letter of credit securing its lease payments of approximately $512,000.

As we previously announced, effective November 15, 2004, John T. Botti no longer serves as our President and Chief Executive Officer. In addition, Mr. Botti subsequently retired from his position as Chairman of the Board and on February 7, 2005, we entered into an Agreement and Release with Mr. Botti. Under that agreement, we agreed to pay to Mr. Botti the severance payments as set forth in his July 1, 2003 employment agreement and agreed to retain him to provide consulting services to us for a period of one year. Our severance obligations to Mr. Botti are described in greater detail below under the caption “Employment, Severance and Change of Control Agreements.” Under the consulting agreement, we agreed to pay Mr. Botti a monthly retainer of $10,000 in consideration of his provision of such services as may be requested by our Chief Executive Officer. The severance benefits have been accrued and are expected to be paid over the next 16 months.

In addition, as we previously announced effective December 31, 2004, Mr. Peter Smith no longer serves as our Executive Vice President – Chief Operating Officer. On February 8, 2005, we entered into an Agreement and Release with Mr. Smith and agreed to pay him a severance payment equal to his base salary for a period of up to twelve months. Our severance obligations to Mr. Smith are described in greater detail below under the caption “Employment, Severance and Change of Control Agreements.” The benefits have been accrued for in the second quarter of fiscal 2005 and are expected to be paid over the next three months.

On November 23, 2004, we invested $750,000 in an unaffiliated third party, Health Fusion, Inc. in connection with a strategic relationship we established with this company. We will invest an additional $750,000 in Health Fusion, contingent on Health Fusion achieving certain financial and other performance objectives.

On December 6, 2004, we assumed certain assets and liabilities of Cryptcom Securities, Inc., a privately-held technology consulting company, for a purchase price of $125,000. We will be obligated to pay an additional $425,000 to former shareholders of Cryptcom Securities, Inc. in the event our operation of the acquired assets generates certain financial measures by December 31, 2006. Additionally, we will be required to pay an “earn out” equal to a percentage of net income based on the performance of this division, commencing on the earlier of December 6, 2007 or the fiscal year immediately following the fiscal year during which the additional purchase price, $425,000, has been earned, and following for a term of five years from either date.

Following is a summary of the contractual commitments associated with our debt and lease obligations, as of September 30, 2005:

We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating parts of our business that are not consolidated into our financial statements. We do not have any arrangements or relationships with entities that are not consolidated into our financial statements that are reasonably likely to materially affect our liquidity or the availability of our capital resources. We have entered into various agreements by which we may be obligated to indemnify the other party with respect to certain matters. Generally, these indemnification provisions are included in contracts arising in the normal course of business under which we customarily agree to hold the indemnified party harmless against losses arising from a breach of representations related to such matters as intellectual property rights. Payments by us under such indemnification clauses are generally conditioned on the other party making a claim. Such claims are generally subject to challenge by us and to dispute resolution procedures specified in the particular contract. Further, our obligations under these arrangements may be limited in terms of time and/or amount and, in some instances, we may have recourse against third parties for certain payments made by us. It is not possible to predict the maximum potential amount of future payments under these indemnification agreements due to the conditional nature of our obligations and the unique facts of each particular agreement. Historically, we have not made any payments under these agreements that have been material individually or in the aggregate. As of September 30, 2005, we were not aware of any obligations under such indemnification agreements that would require material payments.

The impact of general inflation on our operations has not been significant to date and we believe inflation will continue to have an insignificant impact on us. However, price deflation in the major categories of components we purchase for the Docstar has been substantial and is anticipated to continue through fiscal 2006. Typically, new components such as new generations of microprocessors and new optical disk drive technologies etc. are introduced at premium prices, by its vendors. During this period, we earn lower margins on our products. As the life cycle progresses, competitive pressures could force vendor prices down and thus improve our profit margins. Competitive pressures from an evolving document imaging industry have required us to adjust our marketing model for selling Docstar to accommodate a lower entry point. Because much of DJS's business is service-related, price deflation has less of an impact on DJS's profits. We do not believe that the impact of inflation will have a significant impact on our Security Software Solutions Segment business lines.

There has been no new applicable accounting pronouncements issued that the Company has not yet adopted.

We have approximately $50 million invested in high quality, short term investments as of September 30, 2005. We do not believe that any of our financial instruments have significant risk associated with market sensitivity. We are not exposed to significant financial market risks from changes in foreign currency exchange rates and are only minimally impacted by changes in interest rates. However, in the future, we may enter into transactions denominated in non-U.S. currencies or increase the level of our borrowings, which could increase our exposure to these market risks. We have not used, and currently do not contemplate using, any derivative financial instruments.

At any time, fluctuations in interest rates could affect interest earnings on our cash and marketable securities. We believe that the effect, if any, of reasonably possible near term changes in interest rates on our financial position, results of operations, and cash flows would not be material. Currently, we do not hedge these interest rate exposures. The primary objective of our investment activities is to preserve capital. We have not used derivative financial instruments in our investment portfolio.

At September 30, 2005, our unrestricted cash and marketable securities totaled $57,269,826, most of which was invested in asset backed short term investments, commercial paper, and money market accounts. The remainder of our cash was in non-interest bearing checking accounts used to pay operating expenses.

Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Exchange Act) as of the end of the period covered by this report, have concluded that, based on the evaluation of these controls and procedures, our disclosure controls and procedures were effective.

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. Our management, however, believes our disclosure controls and procedures are in fact effective to provide reasonable assurance that the objectives of the control system are met.

No changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended September 30, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
                                                  

We are the defendant in a third party complaint filed by Shore Venture Group, LLC in the United States District Court for the Eastern District of Pennsylvania. The caption of this matter is Berwyn Capital Investments, Inc. v. Shore Venture Group, LLC et al. (defendants and Shore Venture Group, LLC as third party plaintiff) v. Authentidate Holding Corp. and Authentidate, Inc. (third party defendants). The third party complaint was filed against us on May 7, 2001. Shore Venture is the defendant to an action commenced by Berwyn Capital. The third party complaint alleges a claim for breach of contract and seeks indemnification. A trial was held in October, 2002 and we are currently awaiting the verdict of the judge. Management believes that the claim, if decided adverse to us, will not have a material adverse impact on our financial condition, results of operations or cash flows. However, no assurances can be given that such belief will ultimately prove to be accurate or that other facts adverse to our position currently not known to management will not be uncovered, in which case the ultimate resolution of this claim could potentially have a material adverse effect on our financial condition.

We are also the defendant in a case filed by Shore Venture Group, LLC in the United States District Court for the District of New Jersey, under the caption Shore Venture Group, LLC, et al v. Authentidate Holding Corp., Authentidate, Inc. and John T. Botti. This complaint was filed on March 2, 2005, and an amended complaint was filed on or about April 26, 2005. On October 12, 2005, the parties entered into an agreement to arbitrate the claims asserted against us by the Plaintiffs. On October 19, 2005, the Court approved and entered a Consent Order referring the case to arbitration by the American Arbitration Association and staying the lawsuit pending resolution of the arbitration. The Plaintiffs in this case seek additional shares of the common stock of our subsidiary, Authentidate, Inc., the right to exchange its stock in Authentidate, Inc., for publicly traded stock and securities in us, rights under one or more of our patent applications and damages in connection with an alleged copyright infringement. Prior to the commencement of this case, we had conducted extensive settlement negotiations with Shore Venture in an effort to resolve all claims between the parties. However, negotiations did not result in a mutually agreeable settlement. The lawsuit requested damages, injunctive relief, costs and attorneys’ fees. The Plaintiffs have not yet filed their arbitration brief. We intend to defend the action vigorously. Based on the facts of which we are currently aware, management believes that the resolution of all of our claims with Shore Venture, in the event decided adversely to us, will not have a materially adverse effect on our financial condition. However, no assurances can be given that such belief will ultimately prove to be accurate or that other facts adverse to our position currently not known to management will not be uncovered, in which case the ultimate resolution of this claim could potentially have a material adverse effect on our financial condition.

In June, July and August 2005, six purported shareholder class actions were filed in the United States District Court for the Southern District of New York against our company and certain of our current and former officers and directors. Plaintiffs in these actions allege that defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Sections 11, 12(a), and 15 of the Securities Act of 1933. The alleged class period is August 6, 2002 through May 27, 2005. The securities law claims are based on the allegation that we failed to disclose that the USPS could cancel its August 2002 contract with us if we did not meet certain performance metrics, and when we disclosed on September 8, 2004 that we failed to comply with those metrics and on May 27, 2005 that we had received a second notice from the USPS that we had failed to obtain the minimum revenue required under the agreement, the market price of our stock declined. The class action complaints seek unspecified monetary damages. On October 5, 2005 the Court granted the motion of one plaintiff, the Illinois State Board of Investment, to be appointed as lead plaintiff under the Private Securities Litigation Reform Act. The caption of the case is in re Authentidate Holding Corp. Securities Litigation., C.A. No. 05 Cir. 5323 (LTS). Plaintiff is scheduled to file an amended consolidated complaint on January 3, 2006; defendants’ motion to dismiss the complaint is scheduled to be filed on March 4, 2006. Oral argument on the motion to dismiss is scheduled for June 30, 2006.

In addition to the class action complaints, four purported shareholder derivative actions were filed against certain former and current directors and officers of the company in June and July 2005 in the United States District Court for the Southern District of New York. The derivative actions are based on substantially the same events and factual allegations as the class actions and assert claims that Authentidate was injured by an alleged breach of fiduciary duty, waste, mismanagement, violations of Sarbanes-Oxley, and misappropriation of inside information. The derivative complaints seek, among other things, damages, equitable relief, restitution, and payment of costs and expenses incurred in the litigation (including legal fees). Plaintiffs in the derivative actions have entered into a Court-approved stipulation providing for the consolidation of their actions and the selection of Maxine Philips as the lead plaintiff. Plaintiff is scheduled to file a consolidated complaint on November 14, 2005. Defendants’ response is due on January 13, 2006.

On July 13, 2005, a purported shareholder of our company wrote a letter to the Board of Directors demanding that the directors cause the company to commence an action against those directors and officers who the shareholder asserts are allegedly responsible for causing the company to make supposedly false and misleading statements about revenue the company expected to derive from the USPS contract and supposedly concealed certain internal control problems. The letter states that if such an action is not commenced, the shareholder will commence a derivative action. The Board of Directors has notified the derivative shareholder that it will determine and communicate its response to his demand in the near future.

In addition, in August 2005, we were notified of the filing of a complaint in which the plaintiff alleges that our products and systems incorporating secure time stamping technology, including but not limited to our Electronic Postmark system, infringes certain of the plaintiff’s patent rights. The complaint was filed in the United States District Court for the Middle District of Florida and is entitled TimeCertain LLC vs. Authentidate Holding Corporation, Authentidate, Inc. and NCipher Inc. As relief, the complaint seeks, among other things, injunctive relief and damages. The complaint was served on September 21, 2005, and our Answer, which we plan to timely file, is due on November 10, 2005. We are continuing to assessthe situation and the patents being asserted. We intend to defend the action vigorously. Based on the facts of which we are currently aware, management believes that the resolution of all of our claims with TimeCertain will not have a materially adverse effect on our financial condition. However, no assurances can be given that such belief will ultimately prove to be accurate or that other facts adverse to our position currently not known to management will not be uncovered, in which case the ultimate resolution of this claim could potentiallyhave a material adverse effecton our financial condition.

In addition, we are subject to other claims and litigation arising in the ordinary course of business. Our management considers that any liability from any reasonably foreseeable disposition of such other claims and litigation, individually or in the aggregate, would not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

On July 11, 2005, we entered into a lease agreement with The Connell Company for general office space consisting of 19,695 total rentable square feet located in Berkeley Heights, New Jersey. The lease is dated as of July 5, 2005 and we will use the premises as general office space for our operations. Our current office lease in New York, New York expires in March 2006. The lease is for a term of ten years and four months, with a commencement date of October 1, 2005. Starting on the commencement date, we will be entitled to occupy the premises on a rent-free basis for four months and for an additional two months thereafter we’re entitled to occupy a portion of the premises on a rent-free basis. In addition, prior to actual commencement date, we are entitled to occupy approximately 5,000 square feet of the premises on a rent-free basis for the period between the date the premises are first occupied and the actual commencement date. Commencing on the fifth month of the lease term, the rental rate will be $26.00 per square foot for a total of 15,579 rentable square fee or $33,754 per month. Thereafter, from month 7 through month 40, the rent for the entirety of the demised premises (19,695 rentable square feet) shall be $42,672; from month 41 through month 76, the rental rate shall be $45,134 per month and from month 77 to the end of the term, the monthly rent shall be $46,775. The lease also provides us with a right of first offer on available space on the fifth floor of the corporate center at the then-current prevailing fair market rate as well as a one-time option to renew the lease for a term of five years at the then-current market rate for comparable buildings. We also have the option to terminate the lease five years and four months after the commencement date upon 12 months prior notice to the landlord. If we exercise this option, we would be required to pay an early termination fee of $568,202. We have posted a letter of credit in the amount of $512,070 as a security deposit for the lease, which amount will be reduced by fifty-percent in the event we elect not to exercise our early termination right and remain in similar financial condition as it was on March 31, 2005.

As previously disclosed, on October 5, 2005, we received a third notice from the United States Postal Service confirming that we continue to fail to attain the performance metrics required by the Strategic Alliance Agreement. However, the USPS also stated that it has elected not to terminate the agreement at this time and will continue to fulfill its obligations under the agreement as long as it remains in effect. As previously reported, in May, 2005, Authentidate was notified by the United States Postal Service that it has failed to attain the revenue metrics required by the Strategic Alliance Agreement for the period of February 2005 through April 2005. At the time, the Postal Service also advised that it intends to exercise its right to terminate the Strategic Alliance Agreement if Authentidate is unable to cure this default. Authentidate continues its efforts to attain compliance with the applicable performance metrics and to discuss modifications to the Strategic Alliance Agreement with the Postal Service. No assurances, however, can be given that Authentidate will reach a mutually acceptable agreement with the Postal Service or that the Postal Service will not terminate the agreement at any time.

On October 18, 2005, we announced the introduction of CareFax™, a web-based, HIPAA-compliant fax solution that is intended to address compliance needs associated with document processing in the healthcare sector. CareFax is designed to enable healthcare organizations, such as medical equipment or service providers and insurance payors, to securely automate the work flow associated with the creation, sending, receiving and handling of faxed documents. The solution incorporates automatic authentication of faxed content to improve the auditability and verification of the document flow.

Pursuant to Section 10A (i) (2) of the Securities Exchange Act of 1934, we are responsible for listing the non-audit services approved by our Audit Committee to be performed by our independent registered public accounting firm. During the first quarter of 2006, the Audit Committee did not authorize our independent registered public accounting firm to provide any non-audit services.

The exhibits designated with an asterisk (*) are filed herewith. All other exhibits have been previously filed with the Commission and, pursuant 17 C.F.R. § 230.411, are incorporated by reference to the document referenced in brackets following the description of such exhibits.