Aeon Global Health Corp. - Quarter Report: 2007 March (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

COMMISSION FILE NUMBER: 0-20190

Authentidate Holding Corp.

(Exact name of registrant as specified in its charter)

(908) 787-1700

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

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  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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Authentidate Holding Corp.

Form 10-Q

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Authentidate Holding Corp. and Subsidiaries

Condensed Consolidated Balance Sheets

The accompanying notes are an integral part of the condensed consolidated financial statements

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Authentidate Holding Corp. and Subsidiaries

Condensed Consolidated Statements of Operations (Unaudited)

The accompanying notes are an integral part of the condensed consolidated financial statements

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Authentidate Holding Corp. and Subsidiaries

Condensed Consolidated Statements of Cash Flows (Unaudited)

The accompanying notes are an integral part of the condensed consolidated financial statements

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission and, in the opinion of management, reflect all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented. The condensed consolidated financial statements include the accounts of Authentidate Holding Corp. (AHC) and its subsidiaries Authentidate, Inc., Authentidate International AG, and Trac Medical Solutions, Inc. (collectively “Security Software Solutions”), and its Docstar division, (“Document Management Solutions”), and DJS Marketing Group, Inc. (“Systems Integration”), (collectively, the “Company”). All significant intercompany transactions and balances have been eliminated in consolidation. As discussed more fully below, the Document Management Solutions and Systems Integration businesses and related assets and liabilities are in the process of being sold and, accordingly, are presented as discontinued operations and assets held for sale. Amounts for continuing operations have been reclassified/regrouped for all periods presented to conform to a more traditional software and software services company presentation. The results of operations for the three and nine months ended March 31, 2007 are not necessarily indicative of the results to be expected for the full year. Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These condensed 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, 2006 and the attached Management’s Discussion and Analysis of Financial Conditions and Results of Operations.

On January 10, 2007, the Company announced that it had entered into a non-binding letter of intent for the sale of the Document Management Solutions and Systems Integration businesses to a group headed by two members of the businesses’ current senior management team. According to the letter of intent, the Company will receive approximately $8.5 million for the businesses and related assets, which include cash of $750,000 and the land and building located in Schenectady, New York. Approximately $7 million of the selling price will be received in cash and the Company will finance the balance through a long-term note. We are in the process of negotiating a definitive acquisition agreement with the purchasing group. Although no assurances can be given that we will be successful in completing this transaction on these terms, or at all, we anticipate that a transaction may be completed by the end of our fiscal year, June 30, 2007.

2. Loss Per Share

The following table sets forth the calculation of basic and diluted loss per share for the periods presented (in thousands, except per share data):

All common stock equivalents were excluded from the calculation of net loss per share for the periods presented because their impact is antidilutive, or for discontinued operations, not material. At March 31, 2007, employee and non-executive director options (4,700,000), warrants (712,000), performance based consultant options (375,000) and convertible preferred stock (500,000) were outstanding. At March 31, 2006, employee and non-executive director options (4,920,000), warrants (1,262,000), performance based consultant options (375,000) and convertible preferred stock (500,000) were outstanding.

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

3. Share-Based Compensation

The impact of share-based compensation expense on the results of operations is as follows (in thousands, except per share data):

The Company computed the estimated fair values of all share-based compensation using the Black-Scholes option pricing model and the assumptions set forth in the following table. The Company based its estimate of the life of these options on historical averages over the past five years. The Company retained a third party valuation firm to calculate expected volatility which was based on the Company’s historical stock volatility, historical stock volatility of comparable companies in the industry and implied volatilities based on the spot market for traded options in the Company and comparable companies in the industry. The assumptions used in the Company’s Black-Scholes calculations for fiscal 2007 and 2006 are as follows:

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

The Black-Scholes option-pricing model requires the input of highly subjective assumptions. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models may not provide a reliable single measure of the fair value of share-based compensation for employee stock options. Management will continue to assess the assumptions and methodologies used to calculate estimated fair value of share-based compensation as circumstances change and additional data becomes available over time, which may result in changes to these assumptions and methodologies. Such changes could materially impact the Company’s fair value determination.

Stock option activity under the Employees and Non-Executive Directors Stock Option Plans (the “Plans”) for the period ended March 31, 2007 is as follows (in thousands, except per share and average life data):

Non-executive director options are granted at market price and vest on the grant date.

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Unvested options as of March 31, 2007, and changes in such options during the nine month period then ended are summarized below (in thousands, except per share and average life data):

As of March 31, 2007, there was $946,000 of total unrecognized compensation expense related to unvested share-based compensation arrangements granted under the Plans. This expense is expected to be recognized over a weighted-average period of 21 months.

There were no options exercised during the nine months ended March 31, 2007 and 6,700 options exercised during the nine months ended March 31 2006. The total intrinsic value of those options was $14,000. The weighted average grant date fair value of options granted during the nine month periods ended March 31, 2007 and 2006 was approximately $0.75 and $0.79, respectively. These values were calculated using the Black-Scholes option-pricing model.

The total fair value of options vested was $1,184,600 and $625,000 for the nine month periods ended March 31, 2007 and 2006, respectively.

During fiscal 2006 the Company issued 375,000 stock options to an independent consultant, exercisable at $3.25 per share. These options do not vest until the consultant realizes at least $1.0 million in sales of the Company’s Security Software Solutions products; therefore no expense has been recorded as no sales have been realized to date. These options are not included in the disclosures above. These options expire at the later of seven years from the grant date or five years from the vesting date.

Effective January 17, 2007, the Board of Directors amended the terms of existing stock options previously granted to the Company’s current employees whereby such options expire ten years from the original grant date. The incremental share-based compensation expense related to this change is being amortized as the related options vest.

On January 17, 2007, the shareholders approved several amendments to the 2001 Non-Executive Director Stock Option Plan whereby non-executive director stock options expire ten years from the original date of grant, non-executive directors will have up to two years to exercise their options after leaving the board and may elect to receive up to 50% of their cash director compensation in restricted common stock of the Company issued at fair value in accordance with the terms of the Plan. For the period ending March 31, 2007, the Company issued 17,075 shares of restricted common stock (valued at approximately $25,000) to certain non-executive directors in connection with this program.

4. Comprehensive Loss:

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

5. Segment Information

FAS 131, Disclosures about Segments of an Enterprise and Related Information, requires certain financial and supplementary information to be disclosed about operating segments of an enterprise. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision maker is our Chief Executive Officer.

The Company operates in one reportable segment. The Company’s Security Software Solutions business operates in the United States and Germany and is engaged in the development and sale of software and software services that enable enterprises and individuals to exchange information securely and conduct trusted business transactions. In the United States these services generally incorporate its proprietary content authentication technology in the form of the United States Postal Service Electronic Postmark^® (EPM). In Germany these applications provide electronic signature and time stamping solutions for use with a variety of corporate processes including electronic billing and archiving business processes in the European market. The software applications offered in Europe are compliant with the German Signature Act and European guidelines. Our software applications and services are sold through a direct sales effort and reseller arrangements.

Revenues from external customers for our Security Software Solutions business include revenues from our German operations of approximately $1,324,000 and $2,406,000 for the three and nine month periods ended March 31, 2007 and $884,000 and $1,988,000 for the three and nine month periods ended March 31, 2006. This operation had assets of approximately $2,103,000 and $1,201,000 at March 31, 2007 and 2006, respectively.

Revenues and operating income (loss) from discontinued operations are as follows (in thousands):

6. Marketable Securities

The Company classifies investments known as auction rate securities as marketable securities on its balance sheet. The auction rate securities are generally triple A or double A rated. The interest yield generally resets every 35 days or sooner and 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 a corporation run by a municipality.

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

7. Goodwill and Other Intangible Assets

The Company performs an annual valuation of goodwill at the end of the fiscal year. Any adverse development or change in our business during the year would require an interim assessment. For the nine months ended March 31, 2007 there were no adverse developments or changes that required such an assessment and the carrying amount of goodwill has not changed. Approximately $7,291,000 for goodwill relates to our business in Germany.

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

The Company amortizes other intangible assets under the straight line method. Amortization expense was approximately $179,000 for the nine months ended March 31, 2007. Amortization expense for the next five fiscal years is expected to be as follows (in thousands):

8. Shareholders’ Equity

The changes in Shareholders’ Equity for the nine months ended March 31, 2007 are summarized as follows (in thousands):

During the nine months ended March 31, 2007, no stock options or common stock warrants were exercised.

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

9. Preferred Stock

As of October 1, 2004, the Company has the right to repurchase the outstanding Series B preferred stock at a redemption price equal to $25.00 per share, plus accrued and unpaid dividends. The holder of such shares has the right to convert 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 in October 1999 and the conversion and redemption features were amended in October 2002 to provide for the rights and obligations described in this note.

10. Commitments and Contingencies

We were 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 was 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 and Shore Venture was the defendant to an action commenced by Berwyn Capital. The third party complaint alleged a claim for breach of contract and indemnification. On November 13, 2006 we entered into a settlement agreement with Berwyn Capital and on January 19, 2007 we entered into a settlement agreement with Shore Venture Group and Berwyn Capital, pursuant to which each of the parties agreed to a release of judgment, withdraw their appeals and a termination of all proceedings relating to this matter, without any admissions of wrongdoing or fault on our part. On January 23, 2007 Berwyn Capital, Shore Venture Group and we filed a joint stipulation of dismissal of appeals with the United States Court of Appeals for the 3^rd Circuit and on January 24, 2007 the United States Court of Appeals for the 3^rd Circuit issued an order dismissing the appeals. On January 30, 2007 each of Berwyn Capital and Shore Venture Group filed a satisfaction of judgment with the United States District Court for the Eastern District of Pennsylvania. All amounts paid by us under these settlement agreements were recorded as an expense during the year ended June 30, 2006.

We are 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. The complaint in this case 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 or more of our patent applications, and damages 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. The lawsuit requested damages, injunctive relief, costs and attorneys’ fees. On October 18, 2006, Shore Venture filed a demand for arbitration with the American Arbitration Association. On December 4, 2006 we filed a response to the demand and are defending the action vigorously. The parties are currently in the discovery phase of the arbitration. Based on the facts of which we are currently aware, management believes that the resolution of this claim, in the event decided adversely to us, will not have a material 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, 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 those actions alleged that defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Sections 11 and 15 of the Securities Act of 1933. The securities law claims were based on the allegations that we failed to disclose that our August 2002 agreement with the USPS contained certain performance metrics, and that the USPS could cancel the agreement if we did not meet these metrics; that we did not disclose complete and accurate information as to our performance under, and efforts to renegotiate, the USPS agreement; and that when we did disclose that the USPS might cancel the agreement, the market price of our stock declined. On October 5, 2005 the Court consolidated the class actions under the caption In re Authentidate Holding Corp. Securities Litigation., C.A. No. 05 Civ. 5323 (LTS), and appointed the Illinois State Board of Investment as lead plaintiff under the Private Securities Litigation Reform Act. The plaintiff filed an amended consolidated complaint on January 3, 2006, which asserted the same claims as the prior complaints and also alleged that Authentidate violated the federal securities laws by misrepresenting that it possessed certain patentable technology. On July 14, 2006, the Court dismissed the amended complaint in its entirety; certain claims were dismissed

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

with prejudice and plaintiff was given leave to replead those claims which were not dismissed with prejudice. In August 2006, plaintiff filed a second amended complaint, which does not assert any claims relating to the Company’s patents or under the Securities Act of 1933, but which otherwise is substantially similar to the prior complaint. The second amended complaint seeks unspecified monetary damages. The Company moved to dismiss the second amended complaint on November 13, 2006, the motion is pending before the court.

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. These federal court derivative actions were based on substantially the same events and factual allegations as the original class action complaints and asserted 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 sought, 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 entered into a Court-approved stipulation providing for the consolidation of their actions and the selection of Maxine Philips as the lead plaintiff. Plaintiffs filed a consolidated complaint on November 14, 2005, which defendants moved to dismiss on January 13, 2006 on the ground that plaintiffs had not made a proper demand on the Board of Directors. On March 20, 2006, before the motion to dismiss was decided, plaintiffs in the federal court derivative action voluntarily dismissed their complaint without prejudice. On April 6, 2006, the court held a hearing to confirm, among other things, that plaintiffs had not received any payment or other consideration for the dismissal of their claims. At the hearing plaintiffs agreed to file a motion seeking court approval for the dismissal. Plaintiffs filed this motion on April 18, 2006 and the court entered an order dismissing the consolidated complaint on May 5, 2006. Subsequently, on May 25, 2006, the plaintiffs sent a letter to the Board of Directors demanding that it file a derivative suit on behalf of the Company which asserts the same claims as the complaint which plaintiffs voluntarily dismissed only weeks earlier.

On December 13, 2005, a purported shareholder derivative action was filed in the Supreme Court of New York, Schenectady County, entitled Elkin v. Goldman et al., No. 2005-2240. Plaintiff in that action demanded that our Board of Directors file a derivative action on behalf of the Company against nine of its current and former directors and officers. The complaint asserts the same claims that are alleged in the first federal court derivative actions. The Board of Directors, following a recommendation from a committee of the Board composed of outside, non-employee directors who were advised by independent outside counsel, concluded that commencing litigation, as demanded by Elkin, is not in our best interest.

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 the USPS 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 was titled TimeCertain LLC vs. Authentidate Holding Corporation, Authentidate, Inc. and NCipher Inc. As a result of a Markman hearing to determine the meaning of the claims of the patents at issue, on December 22, 2006 the Court issued a final Order construing the claims of the patents at issue. The claim construction Order was very favorable for us and adopted the meanings that we propounded for the claim terms. On February 16, 2007, the parties entered into a settlement agreement favorable to the Company pursuant to which TimeCertain agreed to dismiss all of its claims in the lawsuit with prejudice. On February 26, 2007, the Court issued a final Order dismissing all of TimeCertain’s claims with prejudice, thereby ending this lawsuit.

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.

In July 2002, we entered into an agreement with the USPS to provide the management, technology and support for the USPS EPM System. The USPS is the vendor of the EPM to the end user or application solution provider and we serve as a preferred provider of the EPM service. The USPS EPM incorporates our proprietary content authentication technology. From September 2004 through October 2005, we received several letters from the USPS regarding our failure to satisfy the performance metrics under our agreement. In its last letter dated October 2005, the USPS notified us of our continuing failure to satisfy the performance metrics under the agreement, but also stated that it had 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 been in negotiations with the USPS to amend the agreement and develop a new arrangement. No assurances, however, can be given that we will be successful in completing these negotiations or that the USPS will not terminate the agreement at any time. Further, the initial term of our alliance agreement with the USPS will expire in July 2007 unless the parties agree to extend the agreement. No assurances can be given that the parties will agree to extend the agreement.

Further, in October 2006, the USPS released a Request for Information (RFI) for Time and Date Stamp Technology and Management to identify additional companies that may be interested in, and potentially capable of, providing the USPS EPM service. This exercise would enable the USPS to explore alternative business models for the EPM service, with a view to promoting wider adoption of the service across multiple business segments. We have submitted our response to the RFI and continue to operate under our strategic alliance agreement with the USPS. We are currently the only provider designated by the USPS to offer the EPM service.

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Authentidate Holding Corp. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

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 March 31, 2007, we were not aware of any obligations under such indemnification agreements that would require material payments.

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Forward-Looking Statements and Factors That May Affect Future Results

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 our products and services, 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, 2006 and subsequently filed Quarterly Reports on Form 10-Q, all of which risk factors could adversely affect our business and the accuracy of the forward-looking statements contained herein.

Overview

Authentidate Holding Corp. (AHC), is a world wide provider of software and software services that enable enterprises and individuals to exchange information securely and conduct trusted business transactions. Through its subsidiaries, AHC provides software applications and software services that address a variety of business needs for our customers, including reducing costs, improving productivity and enhancing compliance with regulatory requirements. Our scalable software offerings focus on workflow management, content authentication and electronic signature and time stamping services.

For a number of years, we have experienced net losses and negative cash flow from operating activities. Our principal activities during this period have focused on developing new products, hiring management, refining our business strategies and repositioning our businesses for growth. Although we believe we are well positioned for such growth, we expect to continue to generate net losses and negative cash flow for the foreseeable future as we expand our operations. See “Liquidity and Capital Resources”.

On January 10, 2007, the Company announced that it had entered into a non-binding letter of intent for the sale of the Document Management Solutions and Systems Integration businesses to a group headed by two members of the businesses’ current senior management team. According to the letter of intent, the Company will receive approximately $8.5 million for the businesses and related assets, which include cash of $750,000 and the land and building located in Schenectady, New York. Approximately $7 million of the selling price will be received in cash and the Company will finance the balance through a long term note. We are in the process of negotiating a definitive acquisition agreement with the purchasing group. Although no assurances can be given that we will be successful in completing this transaction on these terms, or at all, we anticipate that a transaction may be completed by the end of our fiscal year ending June 30, 2007.

The Document Management Solutions and Systems Integration businesses and the related assets and liabilities have been presented as discontinued operations and assets held for sale in the condensed consolidated financial statements for all periods presented. The results of operations for discontinued operations were not significant for these periods.

The Company operates its Security Software Solutions business in the United States and Germany. In the United States the business is engaged in the development and sale of software services that incorporate our proprietary content authentication technology in the form of the USPS Electronic Postmark ^® (EPM). Our content authentication technology (EPM) enables the user to have a digital record of a transaction created and stored with the USPS that can be used to verify the content, date, time and parties related to the transaction. In Germany the business is engaged in the development and sale of software applications that provide electronic signature and time stamping capabilities for a variety of corporate processes including electronic billing and archiving solutions. Our software applications offered in Europe are compliant with the German Digital Signature Act and European guidelines. We sell our software applications and software services through a direct sales effort and reseller arrangements.

During 2005 we shifted to our current solutions-based market approach in the United States to facilitate the adoption of our content authentication technology (EPM) and have continued our focus on the healthcare sector. Through August 2006, we developed several applications to complement our CareCert ™ service which was developed in 2004 including CareFax™ and an Electronic Claims Attachment (ECA) application. Building on our experience with customers in our target markets, in October 2006, we

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announced the launch of Inscrybe™ Healthcare, a new web-based information exchange platform for the healthcare industry. Inscrybe Healthcare accommodates interchangeable modes of communication including the web and faxes, and is designed to enable healthcare industry participants, such as physicians, hospitals, home health agencies, equipment providers, pharmacies, payors, regulators and others to securely exchange a variety of documents, such as medical records and forms for approving and supporting claims, without requiring major changes in their day-to-day operations. Since October 2006, we have migrated our CMN (Certificate of Medical Necessity) and Electronic Claims Attachment (ECA) service offerings to Inscrybe Healthcare and added a digital Plan of Care module for the Inscrybe Healthcare platform, which is designed to enable home health agencies to exchange and authenticate Medicare-required documentation with physicians, incorporating digital signature and trusted third-party verification capabilities. In April 2007 we announced our eOrder module for Inscrybe Healthcare which offers a robust array of benefits to homecare providers, including the ability to better serve referring physicians. The eOrder module enables physicians’ offices and other healthcare professionals to place orders with homecare providers and complete the associated paperwork simply and securely using a web-based catalog. We plan to develop additional modules to provide customers with an integrated suite of applications to serve their business needs.

In November 2006, we began a beta test of TrueBlue™, our new web-based electronic document authentication and exchange service targeted primarily at office professionals in a variety of document intensive market sectors. TrueBlue brings together the power of online communications with a number of essential features such as e-signature capabilities and content authentication using the EPM that can be flexibly combined and applied to a wide variety of uses. A commercial launch of TrueBlue is expected to occur by the end of our 2007 fiscal year.

We intend to continue our efforts to market our software applications and software services in the United States and European markets. We also intend to focus on identifying additional applications and markets where our technology can address customer needs.

Our Security Software Solutions revenues consist principally of transaction fees for hosted applications, software license fees, hosting fees and maintenance charges. Growth in our Security Software Solutions business is affected by a number of factors, including general economic and business conditions, and is characterized by long sales cycles. The timing of customer contracts, implementations and ramp-up to full utilization can have a significant impact on results and we believe our results over a longer period of time provide better visibility into our performance.

In July 2002, we entered into an agreement with the USPS to provide the management, technology and support for the USPS EPM System. The USPS is the vendor of the EPM to the end user or application solution provider and we serve as a preferred provider of the EPM service. The USPS EPM incorporates our proprietary content authentication technology. From September 2004 through October 2005, we received several letters from the USPS regarding our failure to satisfy the performance metrics under our agreement. In its last letter dated October 2005, the USPS notified us of our continuing failure to satisfy the performance metrics under the agreement, but also stated that it had 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 been in negotiations with the USPS to amend the agreement and develop a new arrangement. No assurances, however, can be given that we will be successful in completing these negotiations or that the USPS will not terminate the agreement at any time. Further, the initial term of our alliance agreement with the USPS will expire in July 2007 unless the parties agree to extend the agreement. No assurances can be given that the parties will agree to extend the agreement.

In October 2006, the USPS released a Request for Information (RFI) for Time and Date Stamp Technology and Management to identify additional companies that may be interested in, and potentially capable of, providing the USPS EPM service. This exercise would enable the USPS to explore alternative business models for the EPM service, with a view to promoting wider adoption of the service across multiple business segments. We have submitted our response to the RFI and continue to operate under our strategic alliance agreement with the USPS. We are currently the only provider designated by the USPS to offer the EPM service.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States and the rules of the Securities and Exchange Commission. The preparation of our condensed consolidated financial statements and related notes in accordance with generally accepted accounting principles requires us to make estimates, which include judgments and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses, and related disclosure of contingent assets and liabilities. We have based our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances. We evaluate our estimates on a regular basis and make changes accordingly. Actual results may differ from these estimates under different assumptions or conditions. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected.

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A critical accounting estimate is based on judgments and assumptions about matters that are uncertain at the time the estimate is made. Different estimates that reasonably could have been used or changes in accounting estimates could materially impact our financial statements. We believe that the policies described below represent our critical accounting policies, as they have the greatest potential impact on our financial statements. However, you should also review our Summary of Significant Accounting Policies beginning on page F-8 of the notes to our consolidated financial statements contained in our Annual Report on Form 10-K for the fiscal year ended June 30, 2006.

Long-Lived Assets

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

Software Development Costs

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 charge equal to the straight-line amortization over the remaining economic life of the related products (generally three years). Amortization expense is included in cost of sales.

Goodwill

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 at the end of each fiscal year using a discounted cash flow approach.

Revenue Recognition

Revenue is derived from hosted application transaction fees, software licenses, maintenance arrangements, hosting services, Electronic Postmark (EPM) sales and post contract customer support services. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed and collectibility is reasonably assured. 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, if the arrangement includes a general right of return relative to the delivered items, and 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 which is referred to as vendor specific objective evidence or VSOE.

Security Software Solutions revenue from hosted application transaction fees, EPM sales and post contract customer support services is recognized when the related service is provided and, when required, accepted by the customer. Software license revenue is recognized when the criteria discussed above is met. Maintenance and hosting services revenue is recognized over the period in which the service is performed. Revenue from multiple element arrangements that cannot be allocated to identifiable items is recognized ratably over the contract term which is generally one year.

Management Estimates

Preparing financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Examples include estimates of loss contingencies and product life cycles, 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 or other impairments exist. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We make estimates on the future recoverability of capitalized goodwill which is highly dependent on the future success of marketing and sales, 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 and we make assumptions in connection with the calculations of stock compensation expense. Actual results and outcomes may differ from management’s estimates, judgments and assumptions. We have based our estimates on historical experience and on various assumptions that are

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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 operations, and in certain situations, could have a material adverse effect on liquidity and our financial condition.

Stock-Based Compensation

We apply Statement of Financial Accounting Standard No. 123R, “Share Based Payment” (FAS 123R) to account for employee and director stock option plans. Share-based employee compensation expense is 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.

The Company computed the estimated fair values of all share-based compensation using the Black-Scholes option pricing model and the assumptions set forth in the following table. The Company based its estimate of the life of these options on historical averages over the past five years. The Company retained a third party valuation firm to calculate expected volatility which was based on the Company’s historical stock volatility, historical stock volatility of comparable companies in the industry and implied volatilities based on the spot market for traded options in the Company and comparable companies in the industry. The assumptions used in the Company’s Black-Scholes calculations for fiscal 2007 and 2006 are as follows:

The Black-Scholes option-pricing model requires the input of highly subjective assumptions. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models may not provide a reliable single measure of the fair value of share-based compensation for employee stock options. Management will continue to assess the assumptions and methodologies used to calculate estimated fair value of share-based compensation as circumstances change and additional data becomes available over time, which may result in changes to these assumptions and methodologies. Such changes could materially impact the Company’s fair value determination.

Concentrations of Credit Risk

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 condensed consolidated financial statements and notes thereto contained elsewhere in this Form 10-Q.

Results of Operations (continuing operations, except where noted)

Three and nine months ended March 31, 2007 compared to three and nine months ended March 31, 2006.

Revenues increased approximately 42% to $1,793,000 for the quarter ended March 31, 2007, compared to $1,265,000 for the prior year period. These results reflect increases in transaction volumes and new customers in both our US and German operations. Revenues for the nine months ended March 31, 2007 reflect the same trends as the quarter and increased slightly to $3,678,000 from $3,645,000 for the prior year which included approximately $623,000 related to the amortization of deferred revenue and other one-time revenues. Excluding these one-time revenues from the prior year results, revenues increased approximately 22%.

Cost of revenues increased to $800,000 for the quarter ended March 31, 2007, compared to $362,000 for the prior year period. This increase reflects the increase in revenues discussed above and an increase in amortization expense for capitalized software development costs. Cost of revenues for the nine months ended March 31, 2007 increased to $1,860,000 compared to $1,033,000 for the same period in the prior year due primarily to the increase in amortization discussed above.

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Selling, general and administrative (SG&A) expenses decreased to $4,026,000 for the quarter ended March 31, 2007, compared to $4,985,000 for the same period in 2006. This decrease reflects cost management activities for the quarter which were offset in-part by legal expenses for on-going actions of approximately $500,000. SG&A expenses for the nine months ended March 31, 2007 decreased to $12,584,000 compared to $13,574,000 for the comparable period in 2006. This decrease reflects cost management and lower share based compensation expense offset primarily by legal expenses for on-going actions of approximately $1,800,000. The prior year amounts are also higher because they include accrued severance of approximately $670,000 for the quarter and year-to-date periods.

Product development expenses decreased to $710,000 for the quarter ended March 31, 2007, compared to $857,000 for the comparable period in 2006. Product development spending relates primarily to our investment in our US business and fluctuates period to period based on the amounts capitalized. Total spending for the quarter, including capitalized amounts, was $1,105,000 compared to $1,403,000 for the prior year. Product development expenses for the nine months ended March 31, 2007 increased to $2,443,000 compared to $2,282,000 for the comparable period in 2006. Total spending for the period was $3,613,000 compared to $3,827,000 for the prior year.

Interest and other income decreased $22,000 to $490,000 for the quarter ended March 31, 2007 and was essentially flat for the nine month periods ended March 31, 2007 and 2006. These trends reflect higher interest rates during the current year periods, net of the effect of lower cash and investment balances as we continue to invest in our business.

Net loss from continuing and discontinued operations for the quarter ended March 31, 2007 was $3,381,000, or $0.10 per share, compared to $4,601,000, or $0.13 per share, for the quarter ended March 31, 2006. Net loss from continuing and discontinued operations for the nine months ended March 31, 2007 was $11,488,000, or $0.33 per share, compared to $11,902,000, or $0.35 per share, for the comparable period in 2006. Amounts for discontinued operations were not significant for the periods presented. The decrease in net loss reflects the increase in revenues and the cost management activities discussed above. These improvements were offset to some extent by the higher legal expenses during fiscal 2007.

Liquidity and Capital Resources

Overview

Our operations and product development activities have required substantial capital investment to date. Our primary sources of funds have been the issuance of equity and the incurrence of third party debt. In February 2004, we sold 5,360,370 common shares in private placements pursuant to Section 4(2) of the Securities Act of 1933 and Rule 506, promulgated thereunder. 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. We have been using the cash raised in this financing to fund our operations and product development activities since that time.

Property, plant and equipment expenditures totaled approximately $308,000, software license expenditures totaled approximately $287,000 and capitalized software development expenditures totaled approximately $1,170,000 for the nine months ended March 31, 2007. We have developed and intend to continue to develop new applications to grow our business and address new markets.

Cash Flows

At March 31, 2007, cash, cash equivalents and marketable securities amounted to approximately $32,414,000 and total assets at that date were $53,325,000. These amounts have decreased since June 30, 2006 by $13,491,000 and $11,209,000, respectively, as we utilized cash principally to fund operating losses, product development activities, changes in working capital and capital expenditures for corporate infrastructure during the nine months ended March 31, 2007. Cash used for the period also includes expenditures of approximately $2,400,000 for on-going legal actions and settlements and $430,000 for payment of accrued severance obligations. We expect to continue to use cash to fund operating losses, product development activities and capital expenditures for the foreseeable future.

Net cash used by operating activities for the nine months ended March 31, 2007 was $11,907,000 compared to $10,173,000 for the comparable period in 2006. This increase is due primarily to the legal expenditures discussed above and changes in working capital.

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Net cash used by investing activities, excluding purchases and sales of marketable securities, was $1,765,000 for the nine months ended March 31, 2007, compared to $2,990,000 for the comparable period in 2006. This decrease relates primarily to the amount of product development spending capitalized in 2007.

Cash flows from financing activities for the nine months ended March 31, 2007 and 2006 were not significant.

Cash flows for discontinued operations were not significant for the nine months ended March 31, 2007.

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, product development activities and capital expenditures. Under our current operating plan to grow our Security Software Solutions business, 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 have not engaged in any external financing activities in fiscal 2007 and 2006.

Other Matters

The events and contingencies described below have impacted or may impact 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 these 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 March 31, 2007, no shares of the Series B preferred stock have been redeemed.

We are the defendant or respondent in a proceeding arising out of our contractual relationships with Shore Venture Group, LLC alleging that we have infringed certain patent rights. The complaint,, the relief sought and the current status of the action is described in detail under the caption “Legal Proceedings,” appearing in Item 1 of Part II of this Quarterly Report on Form 10-Q.

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.

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Commitments

Office Lease Commitments

We entered into the lease agreement for our executive offices on July 11, 2005. The lease is for a term of ten years and four months, with a commencement date of October 1, 2005 and covers approximately 19,700 total rentable square feet. The annual rent in the first year was $324,000 increasing to $512,000 in year 2 and increasing at regular intervals until year 10 when the annual rent will be approximately $561,000. The lease also provides us with a right of first offer on available space adjacent to our space, as well as, a one-time option to renew the lease for a term of five years at the then-current market rate. We also have an 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 approximately $568,000. As part of the lease agreement, we posted a letter of credit securing our lease payments of approximately $512,000.

The offices of our subsidiary Authentidate International, AG are located at Grobenbaumer Weg 6, 404072 Dusseldorf. We lease approximately 669 square meters at an annual rent of approximately $130,000 pursuant to a lease agreement which expires May 31, 2007. We have an option to extend the lease for additional one-year terms.

Severance Other and Commitments

Effective November 15, 2004, John T. Botti departed as our President and Chief Executive Officer. Subsequently, Mr. Botti 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 severance payments as set forth in his employment agreement equal to his base salary for twenty-four months through January 2007. We also agreed to retain him to provide consulting services to us for a one year term. 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 were accrued in fiscal 2005.

On January 9, 2006, we entered into a Termination Agreement and a separate consulting agreement with John J. Waters, our Executive Vice President–Chief Administrative Officer and a member of our board of directors. Pursuant to the Termination Agreement, Mr. Waters relinquished his employment position in favor of a consulting relationship, effective as of January 1, 2006. We agreed to pay and/or provide to Mr. Waters (a) an amount of approximately $350,000, in accordance with the terms and conditions of the consulting agreement; (b) an amount of $5,000 for attorneys’ fees; and (c) the accelerated vesting of all options granted to him, along with the continuation of the exercise period for the duration of their original term. Mr. Waters continues to serve on our board of directors. The full cost of this arrangement was accrued during the year ended June 30, 2006 and paid in full by September 30, 2006.

On January 26, 2006, Dennis H. Bunt, our Chief Financial Officer, entered into a Termination Agreement and resigned his position effective April 30, 2006. Pursuant to the Termination Agreement, we agreed to pay and/or provide Mr. Bunt (a) a severance payment of approximately $315,000, payable in equal installments over a period of twenty-four months; (b) an additional payment of $33,000 as additional severance and reimbursement of certain expenses; and (c) the accelerated vesting of all options granted to him and the continuation of the exercise period in which he may exercise such options. The full cost of this arrangement was accrued during the year ended June 30, 2006.

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 may 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. Additionally, we will be required to pay an “earn out” equal to a percentage of net income based on the performance of this division for the period December 6, 2007 through December 5, 2012.

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Contractual Commitments

A summary of the contractual commitments associated with our lease obligations as of March 31, 2007 is as follows (in thousands):

Total operating leases do not reflect contingencies associated with our contract with Health Fusion, Inc. or our acquisition of certain assets and liabilities of Cryptcom Securities, Inc., both of which are described above.

Off-Balance Sheet Arrangements

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 March 31, 2007, we were not aware of any obligations under such indemnification agreements that would require material payments.

Effects of Inflation and Changing Prices

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.

Present Accounting Standards Not Yet Adopted

In June 2006, the FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 provides guidance on the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact of this standard on our Consolidated Financial Statements.

In September 2006, the FASB issued Financial Accounting Standard (FAS) No. 157, “Fair Value Measurements”. FAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value. FAS No. 157 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of this standard on our Consolidated Financial Statements.

In February 2007, the FASB issued Financial Accounting Standard (FAS) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. FAS No. 159 provides an option to report selected financial assets and financial liabilities using fair value. The standard establishes required presentation and disclosures to facilitate comparisons with companies that use different measurements for similar assets and liabilities. FAS No. 159 is effective for fiscal years beginning after November 15, 2007, with early adoption allowed only if FAS No. 157 is also adopted. We are currently evaluating the impact of this standard on our Consolidated Financial Statements.

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We have approximately $24,063,000 invested in high quality, short term investments as of March 31, 2007. 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.

Interest Rate Risk

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 March 31, 2007, our unrestricted cash and marketable securities totaled $32,414,000, 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.

Evaluation of Disclosure Controls and Procedures

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 at the reasonable assurance level.

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 errors 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.

Changes in Internal Control over Financial Reporting

There was no change in our system of internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during our fiscal quarter ended March 31, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II Other Information

We were 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 and Shore Venture was the defendant to an action commenced by Berwyn Capital. The third party complaint alleged a claim for breach of contract and indemnification. On November 13, 2006 we entered into a settlement agreement with Berwyn Capital and on January 19, 2007 we entered into a settlement agreement with Shore Venture Group and Berwyn Capital, pursuant to which each of the parties agreed to a release of judgment, withdraw their appeals and a termination of all proceedings relating to this matter, without any admissions of wrongdoing or fault on our part. On January 23, 2007 Berwyn Capital, Shore Venture Group and we filed a joint stipulation of dismissal of appeals with the United States Court of Appeals for the 3^rd Circuit and on January 24, 2007 the United States Court of Appeals for the 3^rd Circuit issued an order dismissing the appeals. On January 30, 2007 each of Berwyn Capital and Shore Venture Group filed a satisfaction of judgment with the United States District Court for the Eastern District of Pennsylvania. All amounts paid by us under these settlement agreements were recorded as an expense during the year ended June 30, 2006.

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We are 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. The complaint in this case 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 or more 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. The lawsuit requested damages, injunctive relief, costs and attorneys’ fees. On October 18, 2006, Shore Venture filed a demand for arbitration with the American Arbitration Association. On December 4, 2006 we filed a response to the demand and are defending the action vigorously. The parties are currently in the discovery phase of the arbitration. Based on the facts of which we are currently aware, management believes that the resolution of this claim, in the event decided adversely to us, will not have a material 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.

As previously reported, we are defendants in a purported shareholder class action alleging violations of the Securities Exchange Act of 1934 and the Securities Act of 1933 and shareholder derivative lawsuits based on substantially the same allegations as in the class action complaints. No material developments in these proceedings occurred during the quarter ended March 31, 2007. The current status of these proceedings are described in detail in Note 10 to our condensed consolidated financial statements.

In addition, in August 2005, we were notified of the filing of a complaint in which the plaintiff alleged that our products and systems incorporating secure time stamping technology, including but not limited to the USPS 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 was titled TimeCertain LLC vs. Authentidate Holding Corporation, Authentidate, Inc. and NCipher Inc. As a result of a Markman hearing to determine the meaning of the claims of the patents at issue, on December 22, 2006 the Court issued a final Order construing the claims of the patents at issue. The claim construction Order was very favorable for us and adopted the meanings that we propounded for the claim terms. On February 16, 2007, the parties entered into a settlement agreement favorable to the Company pursuant to which TimeCertain agreed to dismiss all of its claims in the lawsuit with prejudice. On February 26, 2007, the Court issued a final Order dismissing all of TimeCertain’s claims with prejudice, thereby ending this lawsuit.

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.

As provided for under the Private Securities Litigation Reform Act of 1995, we wish to caution shareholders and investors that the following important factors, among others discussed throughout this Report on Form 10-Q , including certain revisions to the risk factors included in our annual report on Form 10-K for the fiscal year ended June 30, 2006 and subsequent filings with the SEC, have affected, and in some cases could affect, our actual results of operation and cause our results to differ materially from those anticipated in forward looking statements made herein. Our business, results of operations and financial condition may be materially and adversely affected due to any of the following risks. The risks described below are not the only ones we face. Additional risks we are not presently aware of or that we currently believe are immaterial may also impair our business operations. The trading price of our common stock could decline due to any of these risks. In assessing these risks, you should also refer to the other information contained or incorporated by reference in this quarterly report on Form 10-Q, including our financial statements and related notes.

Risks Related to Our Business

Failure to increase our revenue and keep our expenses consistent with revenues could prevent us from achieving and maintaining profitability.

We incurred net losses of approximately $17,823,000, $19,184,000, and $15,669,000 for the fiscal years ended June 30, 2006, 2005 and 2004, respectively and a net loss of approximately $11,488,000 for the nine months ended March 31, 2007. We have expended, and will continue to be required to expend, substantial funds to pursue product development projects and enhance marketing and sales efforts for our Security Software Solutions products and to otherwise operate our business. Therefore, we will need to generate higher revenues from our Security Software Solutions business to achieve and maintain profitability and cannot

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assure you that we will be profitable in any future period. Our prospects should be considered in light of the difficulties frequently encountered in connection with the establishment of a new business line, which characterizes our Security Software Solutions business, such as the difficulty in creating a viable market, the significant related development and marketing costs and the overall competitive environment in which we operate. Accordingly, there can be no assurance that we will be able to achieve profitable operations in future operating periods.

Our capital requirements are significant and we have historically financed our operations through private placements of securities.

Our capital requirements have been and will continue to be significant. We have been substantially dependent upon private placements of our securities and on short-term and long-term loans from lending institutions to fund such requirements. We are expending significant amounts of capital to develop, promote and market the products and services in our Security Software Solutions business, such as our Inscrybe Healthcare platform and related modules and our TrueBlue offering. Due to these expenditures, we have incurred significant losses to date. We used approximately $13,743,000 and $10,795,000 in cash for continuing operating activities for the fiscal years ended June 30, 2006 and 2005, respectively, and used approximately $11,907,000 in cash for continuing operating activities in the nine months ended March 31, 2007. We expect the proceeds received from our February 2004 private financing, in which we raised approximately $69,100,000 in net proceeds, to satisfy our cash needs for the foreseeable future. No assurances can be given that we will be able to attain sales levels and support our costs through revenues derived from operations. If we are unable to attain projected sales levels for our Security Software Solutions business, it may be necessary to raise additional capital to fund operations and to meet our obligations in the future.

If the United States Postal Service cancels our agreement, we will need to incur additional costs in our efforts to successfully commercialize this technology.

We entered into the strategic alliance agreement with the United States Postal Service (USPS) to incorporate our content authentication service into their Electronic Postmark ^® Service (EPM). The USPS has the right to cancel the contract in the event we are unable to perform our obligations, including recognizing sufficient revenues, as required by the agreement. Further, the USPS has the right to terminate the agreement at its convenience. When we initially entered into our agreement with the USPS in July 2002, we agreed on certain performance metrics. The original revenue metric had not been attained and in September 2004 the USPS notified us of a failure to comply with the revenue metric, which commenced a six month period to achieve compliance with the metrics. We continue to hold discussions with the USPS to agree upon a modification of our arrangement with the USPS.

On May 27, 2005, the USPS delivered a second notice stating 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 USPS advised us that although it intended to exercise its right to terminate the strategic alliance agreement if we’re unable to cure this default, it was willing to discuss further plans that we had to attain the performance metrics. On October 5, 2005, we received a third notice from the USPS 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.

Our strategic alliance agreement with the USPS may also be adversely affected by recently enacted legislation regarding the USPS. On December 20, 2006, the President signed into law PL 109-435. This statute defines as “postal services” essentially the carriage of paper and printed matter, but grandfathers other services that were being offered by the USPS as of January 1, 2006, which we believe would include the EPM. Therefore, the statute permits USPS to continue providing the EPM service. However, the legislation further directs the Postal Regulatory Commission (PRC) to review non-postal services within two years to determine whether they should continue taking into account “the public need for the service” and “the ability of the private sector to meet the public need for the service.” Based upon this language, the PRC may review the EPM and other services to determine whether there is an ongoing need for such services and whether the USPS should continue to offer the services to meet any such public need. Accordingly, there can be no assurance the USPS will elect to continue its current level of support of the EPM in the future. We have been in negotiations with the USPS to amend the agreement and develop a new arrangement. No assurances, however, can be given that we will be successful in completing these negotiations or that the USPS will not terminate the agreement at any time, in which case we will not generate any revenue from the sales of EPMs. Further, the initial term of our alliance agreement with the USPS will expire in July 2007 unless the parties agree to extend the agreement. No assurances can be given that the parties will agree to extend the agreement.

Further, in October 2006, the USPS released a Request for Information (RFI) for Time and Date Stamp Technology and Management to identify additional companies that may be interested in, and potentially capable of, providing the USPS EPM service. This exercise would enable the USPS to explore alternative business models for the EPM service, with a view to promoting wider adoption of the service across multiple business segments. We have submitted our response to the RFI and continue to operate under our strategic alliance agreement with the USPS. We are currently the only provider designated by the USPS to offer the EPM service.

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We rely to a certain extent on our products’ compatibility with Microsoft Corporation’s products for the development of a market for the USPS EPM.

On October 21, 2003 we launched an interface with Microsoft Office to provide for an interface with the USPS EPM. We cannot provide assurance that we will achieve significant sales from this relationship. Microsoft is under no obligation for any purchase commitments or guarantees and the agreement does not obligate Microsoft to purchase USPS EPM transactions. Further, Microsoft may terminate this initiative at its convenience. In the event Microsoft elects to terminate this relationship, it could impair our ability to develop a market for our content authentication business and retard the adoption of the USPS EPM.

We have been named as a party to several class action and derivative action lawsuits, and we may be named in additional litigation, all of which could require significant management time and attention and result in significant legal expenses. An unfavorable outcome in one or more of these lawsuits could have a material adverse effect on our business, financial condition, results of operations and cash flows.

As described in detail at Item 1. “Legal Proceedings” of Part II of this Report on Form 10-Q, several purported class action complaints were filed in federal court alleging that we and certain of our current and former officers and directors violated the federal securities laws. Subsequently, four purported shareholder derivative actions were filed against certain current and former officers and directors based on allegations substantially similar to those set forth in the purported class actions. The expense of defending such litigation may be substantial and the time required to defend the actions could divert management’s attention from the day-to-day operations of our business, which could adversely affect our business, results of operations and cash flows. In addition, an unfavorable outcome in such litigation could have a material adverse effect on our business, results of operations and cash flows.

Our success is dependent on the performance of our management and the cooperation, performance and retention of our executive officers and key employees.

Our business and operations are substantially dependent on the performance of our senior management team and executive officers. These persons have worked together for only a short period of time. If our management team is unable to perform it may adversely impact our results of operations and financial condition. We do not maintain “key person” life insurance on any of our executive officers. The loss of one or several key employees could seriously harm our business. Any reorganization or reduction in the size of our employee base could harm our ability to attract and retain other valuable employees critical to the success of our business.

If we lose key personnel or fail to integrate replacement personnel successfully, our ability to manage our business could be impaired.

Our future success depends upon the continued service of our key management, technical, sales, finance, and other critical personnel. Other than our CEO and CFO, our key personnel do not have employment agreements and we cannot assure you that we will be able to retain them. Key personnel have left our company in the past and there likely will be additional departures of key personnel from time to time in the future. The loss of any key employee could result in significant disruptions to our operations, including adversely affecting the timeliness of product releases, the successful implementation and completion of company initiatives, the effectiveness of our disclosure controls and procedures and our internal control over financial reporting, and the results of our operations. In addition, hiring, training, and successfully integrating replacement sales and other personnel could be time consuming, may cause additional disruptions to our operations, and may be unsuccessful, which could negatively impact future revenues.

Our reported financial results could be adversely affected by changes in financial accounting standards or by the application of existing or future accounting standards to our business as it evolves. For example, accounting for employee stock options under FAS 123R has had a material impact on our consolidated results of operations and earnings per share.

As a result of the enactment of the Sarbanes-Oxley Act and the review of accounting policies by the SEC and national and international accounting standards bodies, the frequency of accounting policy changes may accelerate. For example, the adoption of FAS123(R) required us to adopt a different method of determining and accounting for the compensation expense of our employee stock options. As a result of the adoption of FAS 123(R), our losses during fiscal 2006 and 2007 were higher than they would have been had we not been required to adopt FAS 123(R). This will continue to be the case for future periods. We cannot predict the effect that this adverse impact on our reported operating results will have on the trading price of our common stock. This and other possible changes to accounting standards, could adversely affect our reported results of operations. Further, accounting policies affecting software revenue recognition have been the subject of frequent interpretations, which could significantly affect the way we account for revenue related to our products. As we enhance, expand and diversify our business and product offerings, the application of existing or future financial accounting standards, particularly those relating to the way we account for revenue, could have a significant adverse effect on our reported results although not necessarily on our cash flows.

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If the carrying value of our long-lived assets is not recoverable, an impairment loss must be recognized which would adversely affect our financial results.

We will evaluate our long-lived assets, including property and equipment, goodwill, acquired product rights, and other intangible assets, whenever events or circumstances occur which indicate that these assets might be impaired. Goodwill is evaluated annually for impairment at the end of each fiscal year, regardless of events and circumstances. In fiscal 2005 we recorded an impairment charge of approximately $4,800,000 for goodwill and other long-term intangible assets. As of March 31, 2007, we had approximately $7,300,000 of goodwill principally from our acquisition of Authentidate International, AG. We will continue to evaluate the recoverability of the carrying amount of our long-lived assets, and we may incur substantial impairment charges, which could adversely affect our financial results.

We have incurred significant additional costs concerning our international operations and may incur additional costs in the future.

We have incurred substantial costs in supporting the operation of our German subsidiary, Authentidate International, AG. In March 2005, we entered into a new two-year employment agreement with Mr. Jan Wendenburg, the Chief Executive Officer of Authentidate International, pursuant to which he received a base salary of approximately, $257,000 through March 2007, assuming current exchange rates. We have extended this agreement through May 2007 pending our negotiations with him of a new employment agreement. Further, for the fiscal years ended June 30, 2005 and 2006, and the nine months ended March 31, 2007, we advanced or made capital investments of approximately $2,600,000 to this subsidiary. We cannot provide any assurance that we will recoup any of these amounts from this subsidiary. We expect to incur additional costs in the future in connection with the operations of this subsidiary.

Developing and implementing new or updated products and services may take longer and cost more than expected.

We rely on a combination of internal development, strategic relationships, licensing and acquisitions to develop our products and services. The cost of developing new services and technology solutions, such as Inscrybe Healthcare and related modules and TrueBlue, is inherently difficult to estimate. Our development and implementation of proposed products and services may take longer than originally expected, require more testing than originally anticipated and require the acquisition of additional personnel and other resources. If we are unable to develop new or updated products and services on a timely basis and implement them without significant disruptions to the existing systems and processes of our customers, we may lose potential sales and harm our relationships with current or potential customers.

New or updated products and services will not become profitable unless they achieve sufficient levels of market acceptance, which may require significant efforts and costs.

There can be no assurance that customers and potential customers will accept from us new or updated products and services. The future results of our Software Security Solutions business will depend, in significant part, on the success of new products and services. Current and potential customers may choose to use similar products and services offered by our competitors or may not purchase new or updated products or services, especially when they are initially offered and if they require changes in equipment or workflow. For services we are developing or may develop in the future, there can be no assurance that we will attract sufficient customers or that such services will generate sufficient revenues to cover the costs of developing, marketing and providing those services. Furthermore, there can be no assurance that any pricing strategy that we implement for any new products and services will be economically viable or acceptable to the target markets. Failure to achieve broad penetration in target markets with respect to new or updated products and services could have a material adverse effect on our business prospects. Further, achieving market acceptance for new or updated products and services is likely to require substantial marketing efforts and expenditure of significant funds to create awareness and demand by potential customers.

We do not have patents on all the technology we use, which could harm our competitive position.

On May 2, 2006, we were issued our first U.S. patent and we also have seven issued foreign patents. In addition, we have nine U.S. and nine foreign patent applications pending relating to the technology and business processes underlying our Security Software Solutions applications. However, some of the technology embodied in some of our current products cannot be patented. We have registered the trademarks “Authentidate,” “CareCert,” “DocStar” and the DocStar logo in the US and the trademark “Authentidate” in Germany and in the European Community. We have also sought to register a number of additional trademarks in the US and certain foreign markets, including “Authentimark,” “Authentifax,” “Inscrybe,” “TrueBlue,” “Electronic Trust Mark,” “ETM” and “CareFax”.

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We continue to take steps to protect our intellectual property rights including filing additional trademark and patent applications where appropriate. We rely on confidentiality agreements with our key employees to the extent we deem it to be necessary. We further intend to file patent applications for any new products we may develop, to the extent that we believe that any technology included in such products is patentable. There can be no assurance that any patents in fact, will be issued or that any such patents that do issue will be effective to protect our products and services from duplication by other manufacturers or developers or to prevent our competitors from offering similar products and services

Other companies operating within our business segments may independently develop substantially equivalent proprietary information or otherwise obtain access to our know-how, much of which is maintained as trade secrets. In addition, there can be no assurance that we will be able to afford the expense of any litigation which may be necessary to enforce our rights under any patent. Although we believe that the products we sell do not and will not infringe upon the patents or violate the proprietary rights of others, it is possible that such infringement or violation has occurred or may occur. On August 25, 2005, we became aware of an action filed against us entitled TimeCertain LLC vs. Authentidate Holding Corporation, Authentidate, Inc. and NCipher Inc. The plaintiff in this matter had claimed that our products and systems incorporating secure time-stamping technology, including but not limited to the USPS Electronic Postmark system, infringes certain of its patent rights. This matter has resulted in a favorable settlement for the Company in which all of the plaintiff’s claims were dismissed with prejudice and the case terminated (for additional information, see Part II, Item 1, “Legal Proceedings”). We have investigated patents held by third parties of which we are aware and believe that our products and services do not infringe on the claims of these patents. Although we have not received notice of any other claims that our products or services are infringing, we can not provide any assurances that our products and services do not infringe upon any third party patents, including the patents we have investigated. As described under the caption “Legal Proceedings,” we are currently defending a claim by Shore Venture Group, in which it alleges, among other things, 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. The case which was brought in federal court has been stayed in favor of arbitration. On October 18, 2006, Shore Venture filed a demand for arbitration with the American Arbitration Association. On December 4, 2006 we filed a response to the demand and are defending this action vigorously. In the event that products we sell or services we provide are deemed to infringe upon the patents or proprietary rights of others, we could be required to modify our products and/or services or obtain a license for the manufacture, use and/or sale of such products and services. There can be no assurance that, in such an event, we would be able to do so in a timely manner, upon acceptable terms and conditions, or at all, and the failure to do any of the foregoing could have a material adverse effect upon our business. Moreover, there can be no assurance that we will have the financial or other resources necessary to defend against a patent infringement or proprietary rights violation action. In addition, if our products, services or proposed products or services are deemed to infringe upon the patents or proprietary rights of others, we could, under certain circumstances, become liable for damages or subject to an injunction, which could also have a material adverse effect on our business.

Because we derive a majority of our license revenues from sales of a few products and solutions, any decline in demand for these products could severely harm our ability to generate revenues.

We derive a majority of our revenues from a limited number of software products and services. In addition, our focus on building our Security Software Solutions business software products is concentrated within the market for products and services designed to provide content integrity and workflow automation. As a result, we are particularly vulnerable to fluctuations in demand for these products, whether as a result of competition, product obsolescence, technological change, customer spending, or other factors. If our revenues derived from these software products were to decline significantly, our business and operating results would be adversely affected.

Some of our products and solutions have long and unpredictable sales cycles, which may impact our quarterly operating results.

Transactions for some of our products, including our Security Software Solutions business, require customers to undertake customized installations to integrate the solutions into their legacy systems and require them to modify existing business practices. The period from our initial contact with a potential customer until the execution of an agreement is difficult to predict and can be in excess of six months. The sales cycles for these transactions can be long and unpredictable due to a number of uncertainties such as:

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We are unable to control or influence many of these factors. Further, we have experienced delays in the pace of adoption and use by our customers of our transaction-based offerings, such as CareCert™ and CareFax ™, which has adversely affected our earnings. We may experience similar delays with Inscrybe Healthcare ™ and TrueBlue™ as well. During the sales cycle and the implementation period, we may expend substantial time, effort and money preparing contract proposals, negotiating contracts and implementing solutions without receiving any related revenue. In addition, many of our expenses are relatively fixed in the short term, including personnel costs and technology and infrastructure costs. Accordingly, our inability to generate sufficient revenues from these offerings has a direct impact on our results of operations.

The failure to properly manage our growth could cause our business to lose money.

We are expanding our marketing and distribution efforts for our Security Software Solutions business in order to develop and pursue existing and potential market opportunities. This growth is expected to place a significant demand on management and operational resources. In order to manage growth effectively, we must implement and improve our operational systems and controls on a timely basis. If we fail to implement these systems and controls, our business, financial condition, results of operations and cash flows will be materially and adversely affected.

Our software products and web site may be subject to intentional disruption.

Although we believe we have sufficient controls in place to prevent intentional disruptions, such as software viruses specifically designed to impede the performance of our products, we may be affected by such efforts in the future. Further, despite the implementation of security measures, this infrastructure or other systems that we interface with, including the Internet and related systems, may be vulnerable to physical break-ins, hackers, improper employee or contractor access, programming errors, attacks by third parties or similar disruptive problems, resulting in the potential misappropriation of our proprietary information or interruptions of our services. Any compromise of our security, whether as a result of our own systems or systems that they interface with, could substantially disrupt our operations, harm our reputation and reduce demand for our services.

Performance problems with our systems or system failures could cause us to lose business or incur liabilities.

Our customer satisfaction and our business could be harmed if we experience transmission delays or failures or loss of data in the systems we use to provide services to our customers, including transaction-related services. These systems are complex and, despite testing and quality control, we cannot be certain that problems will not occur or that they will be detected and corrected promptly if they do occur. In providing these services, we rely on internal systems as well as communications and hosting services provided by third parties, such as the Internet. To operate without interruption, both we and the service providers we use must guard against:

We have experienced periodic system interruptions in the past, and we cannot guarantee that they will not occur again. In the event of a catastrophic event at one of our data centers or any third party facility we use, we may experience an extended period of system unavailability, which could negatively impact our business. Further, if such an event caused the loss of stored data, it could have a material adverse impact on our business or cause us to incur material liabilities. Although we maintain insurance for our business, we cannot guarantee that our insurance will be adequate to compensate us for all losses that may occur or that this coverage will continue to be available on acceptable terms or in sufficient amounts.

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In addition, some of our web-based services may, at times, be required to accommodate higher than expected volumes of traffic. At those times, we may experience slower response times or system failures. Any sustained or repeated interruptions or disruptions in these systems or increase in their response times could damage our relationships with customers. Further, the Internet has experienced, and is likely to continue to experience, significant growth in the number of users and the amount of traffic. If the Internet continues to experience increased usage, the Internet infrastructure may be unable to support the demands placed on it which could harm its reliability and performance. Any significant interruptions in our services or increases in response time could result in a loss of potential or existing users of services and, if sustained or repeated, could reduce the attractiveness of our services.

Our security software products and services may not be accepted by the market, which would seriously harm our business.

Demand and market acceptance for our software security offerings remain subject to a high level of uncertainty. Achieving widespread acceptance of these products will continue to require substantial marketing efforts and the expenditure of significant funds to create and maintain brand recognition and customer demand for such products. Demand for our products depends on, among other things:

There can be no assurance that adequate marketing arrangements will be made and continued for such products and there can be no assurance that any of these products will ever achieve or maintain widespread market acceptance or that the sale of such products will be profitable.

If we cannot continuously enhance our products in response to rapid changes in the market, our business will be harmed.

The software-based services industry and computer industry are characterized by extensive research and development efforts which result in the frequent introduction of new products which render existing products obsolete. Our ability to compete successfully in the future will depend in large part on our ability to maintain a technically competent research and development staff and our ability to adapt to technological changes in the industry and enhance and improve existing products and successfully develop and market new products that meet the changing needs of our customers. Although we are dedicated to continued research and development of our products with a view towards offering products with the most advanced capabilities, there can be no assurance that we will be able to continue to develop new products on a regular basis which will be competitive with products offered by other manufacturers. At the present time, we do not have a targeted level of expenditures for research and development. We will evaluate all opportunities but believe the majority of our research and development will be devoted to enhancements of our existing products.

Technological improvements in new products that we and our competitors offer, as well as the general decline in the economy and other factors, have resulted in recent declines in retail prices for computer products. As competitive pressures have increased, many companies have ceased operation and liquidated inventories, further increasing downward pricing pressure. Such declines have, in the past, and may in the future, reduce our profit margins.

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If our products are not competitive, our business will suffer.

We are engaged in the highly competitive businesses of developing software-based workflow and authentication products. These markets are also continually evolving and, in some cases, subject to rapid technological change. Many of our competitors have greater financial, technical, product development, marketing and other resources than we do. These organizations may be better known than we are and have more customers than we do. We cannot provide assurance that we will be able to compete successfully against these organizations. We believe that the principal competitive factors affecting our markets include fault-tolerance, reliability, performance, ease of use, scalability, manageability, price and customer service and support. There can be no assurance that we will be able to successfully incorporate these factors into our products and to compete against current or future competitors or that competitive pressure we face will not harm our business. If we are unable to develop and market products to compete with the products of competitors, our business will be materially and adversely affected.

Our Security Software Solutions segment, including Inscrybe Healthcare, TrueBlue, the USPS EPM and our electronic signing solutions are relatively new business lines and although the level of competition across the product line is unknown at this point in time, the field of software-based security solutions is highly competitive. There can be no assurances, however, that any of these products will achieve market acceptance.

We also expect that competition will increase as a result of industry consolidations and the formation of new companies with new, innovative product offerings. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of our prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Increased competition is likely to result in price reductions, reduced operating margins and loss of market share, any of which could harm our business.

Our software products are complex and are operated in a wide variety of computer configurations, which could result in errors or product failures.

Our software products are complex and may contain undetected errors, failures or bugs that may arise when they are first introduced or when new versions are released. These products may be installed and used in large-scale computing environments with different operating systems, system management software and equipment and networking configurations, which may cause errors or failures in our products or may expose undetected errors, failures or bugs in our products. Our customers’ computer environments are often characterized by a wide variety of configurations that make pre-release testing for programming or compatibility errors difficult and time-consuming. Despite testing by us and by others, errors, failures or bugs may not be found in new products or releases after commencement of commercial shipments. Errors, failures or bugs in our products could result in negative publicity, product returns, loss of or delay in market acceptance of our products or claims by customers or others. Alleviating these problems could require significant expenditures of our capital and resources and could cause interruptions, delays or cessation of our product licensing, which could cause us to lose existing or potential customers and would adversely affect our financial conditions, results of operations and cash flows. Most of our license agreements with customers contain provisions designed to limit our exposure to potential product liability claims. It is possible, however, that these provisions may not prove effective in limiting our liability.

We have a significant amount of net operating loss carryforwards which we may not be able to utilize in certain circumstances.

At June 30, 2006, the date of our most recent fiscal year end, we had net operating loss carryforwards (“NOLS”) for federal income tax purposes of approximately $83,000,000 available to offset future taxable income. Under Section 382 of the Internal Revenue Code of 1986, as amended, utilization of prior NOLS is limited after an ownership change, as defined in Section 382, to an annual amount equal to the value of the corporation’s outstanding stock immediately before the date of the ownership change multiplied by the federal long-term exempt tax rate. Use of our NOLS could also be limited as a result of grants of stock options under stock option plans and other events. In the event we achieve profitable operations, any significant limitation on the utilization of NOLS would have the effect of increasing our current tax liability.

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Risks Related to Our Common Stock

Our stock price is volatile and could decline.

The price of our common stock has been, and is likely to continue to be, volatile. For example, our stock price during the fiscal year ended June 30, 2006 traded as low as $1.86 per share and as high as $4.30 per share. During the nine months ended March 31, 2007, our stock price has traded in the range of $1.20 to $2.73 per share. We cannot assure you that your initial investment in our common stock will not fluctuate significantly. The market price of our common stock may fluctuate significantly in response to a number of factors, some of which are beyond our control, including: