NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1 -         ORGANIZATION AND BASIS OF PRESENTATION

SmartMetric, Inc. (the “Company” or “SmartMetric”) was incorporated in the State of Nevada on December 18, 2002. SmartMetric’s main product is a fingerprint sensor activated card with a finger sensor onboard the card and a built-in rechargeable battery for portable biometric identification. This card may be referred to as a biometric card or the SmartMetric Biometric Datacard.   SmartMetric has completed development of its card along with pre mass manufacturing cards but has not yet begun to mass manufacture the biometric fingerprint activated cards.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management of the Company, the accompanying unaudited financial statements contain all the adjustments (which are of a normal recurring nature) necessary for a fair presentation. Operating results for the three months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending June 30, 2015. For further information, refer to the financial statements and the footnotes thereto contained in the Company’s Annual Report on Form 10-K for the year ended June 30, 2014, as filed with the Securities and Exchange Commission.

Going Concern

As shown in the accompanying condensed consolidated financial statements the Company has sustained recurring losses of $552,002 and $1,019,463 for the three months ended September 30, 2014 and 2013 respectively, and has an accumulated deficit of $19,865,943at September 30, 2014.   The Company has spent a substantial portion of its time and capital resources in the development of its technology.

There is no guarantee that the Company will be able to raise enough capital or generate revenues to sustain its operations.  These conditions raise substantial doubt about the Company’s ability to continue as a going concern.

Management believes that the Company’s capital requirements will depend on many factors.  These factors include the final phase of development and mass production being successful as well as product implementation and distribution.

The condensed consolidated financial statements do not include any adjustments relating to the carrying amounts of recorded assets or the carrying amounts and classification of recorded liabilities that may be required should the Company be unable to continue as a going concern.

NOTE 2 -         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, SmartMetric Australia Pty. Ltd.  All significant intercompany accounts and transactions have been eliminated in consolidation.

SMARTMETRIC INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 2 -         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  On an ongoing basis, the Company evaluates its estimates, including, but not limited to, those related to income taxes and contingencies.  The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.  Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid debt instruments and other short-term investments with an initial maturity of three months or less to be cash equivalents.  Any amounts of cash in financial institutions over FDIC insured limits exposes the Company to cash concentration risk. The Company has no cash equivalents.

Fair Value of Financial Instruments

The carrying amounts reported in the condensed consolidated balance sheet for cash, accounts payable, and accrued expenses approximate fair value because of the immediate or short-term maturity of these financial instruments.

ASC 820 defines fair value, provides a consistent framework for measuring fair value under generally accepted accounting principles and expands fair value financial statement disclosure requirements. ASC 820’s valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect our market assumptions. ASC 820 classifies these inputs into the following hierarchy:

Level 1 inputs: Quoted prices for identical instruments in active markets.

Level 2 inputs: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3 inputs: Instruments with primarily unobservable value drivers.

Research and Development

The Company annually incurs costs on activities that relate to research and development of new technology and products.  Research and development costs are expensed as incurred.

Revenue Recognition

The Company has not recognized revenues to date.  The Company anticipates recognizing revenue in accordance with the contracts it enters into for the sale and distribution of its products.

SMARTMETRIC INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 2 -         SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Accounts Receivable

The Company will extend credit based on its evaluation of the customers’ financial condition, generally without requiring collateral.  Exposure to losses on receivables is expected to vary by customer due to the financial condition of each customer.  The Company will monitor exposure to credit losses and maintains allowances for anticipated losses considered necessary under the circumstances.  The Company has not recorded any receivables, and therefore no allowance for doubtful accounts.

Uncertainty in Income Taxes

GAAP requires the recognition and measurement of uncertain income tax positions using a “more-likely-than-not” approach.   Management evaluates Company tax positions on an annual basis and has determined that as of September 30, 2014 no accrual for uncertain income tax positions is necessary.

The Company files income tax returns in the United States ("U.S.") federal jurisdiction.  Generally, the Company is no longer subject to U.S. federal examinations by tax authorities for fiscal years prior to 2010.  The Company does not file in any other jurisdiction and remains open for audit for all tax years as the statute of limitations does not begin until the returns are filed.

Advertising Costs

The Company will expense the cost associated with advertising as incurred.

Equipment

Equipment is stated at cost.  Depreciation is computed using the straight-line method over the estimated economic useful lives of the assets ranging from 3 - 5 years.

Impairment of Long-Lived Assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable.  The Company does not perform a periodic assessment of assets for impairment in the absence of such information or indicators.  Conditions that would necessitate an impairment assessment include a significant decline in the observable market value of an asset, a significant change in the extent or manner in which an asset is used, or a significant adverse change that would indicate that the carrying amount of an asset or group of assets is not recoverable.  For long-lived assets to be held and used, the Company recognizes an impairment loss only if its carrying amount is not recoverable through its undiscounted cash flows and measures the impairment loss based on the difference between the carrying amount and estimated fair value.

Loss Per Share of Common Stock

Basic net loss per common share is computed using the weighted average number of common shares outstanding.  The calculation of diluted earnings per share ("EPS") includes consideration of dilution arising from common stock equivalents, such as stock issuable pursuant to the exercise of stock options and warrants.  Common stock equivalents were not included in the computation of diluted earnings per share on the consolidated statement of operations due to the fact that the Company reported a net loss and to do so would be anti-dilutive for the periods presented.

Stock-Based Compensation

The Company measures expense for issuances of stock-based compensation to employees and others at fair value of the stock and warrants issued, as this is more reliable than the fair value of the services received complete. The fair value of the equity instrument is charged directly to compensation expense and additional paid-in capital.

SMARTMETRIC INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Reclassifications

Certain amounts in the prior period condensed consolidated financial statements have been reclassified for comparative purposes to conform to the presentation in the current period condensed consolidated financial statements. These reclassifications had no effect on previously reported results.

NOTE 3 -         PREPAID EXPENSES

Prepaid expenses represent the unexpired terms of various consulting agreements and expire through January 2016, as well as advance rental payments.  The Company issued common stock and warrants as consideration for the consulting services, and were valued based on the stock price or computed warrant value at the time of the respective agreements.

Amortization expense was $375 for the three months ended September 30, 2014 and 2013, respectively.

NOTE 5 -         COMMITMENTS

Patent License Agreement

Effective August 1, 2004, the Company executed a license agreement with Applied Cryptography, Inc. (“ACI”), a corporation controlled by the Company’s president and the owner of certain technology. Pursuant to the license agreement, the Company has the right to make use of this technology for the purpose of developing software and systems to be used by the Company to provide any or all of the following: 1) secure transactions over the Internet from home and office computers; 2) an automatic method for connecting to remote computers; 3) a method of developing targeted advertising to home and/or office computers; and 4) identity verification and access control as provided for in the patent. Pursuant to this license agreement, ACI is to receive 2% of all revenues generated by the Company on products which utilize this patented technology. The license fee is to be paid within 45 days of the end of each quarter. In the event no revenues are generated through the use of any of the licensed patents during a given quarter, no money shall be owed ACI for such quarter. ACI has the right to rescind the license agreement and reclaim all rights and interest in the patents if certain events, such as the Company’s filing for bankruptcy protection or reorganization, occur. The license agreement remains in effect for the lives of the patents. The Company may utilize the technological applications anywhere in the world without limitation.  Upon execution of the Assignment and Assumption Agreement on December 11, 2009 (see Note 6), the Patent License Agreement was terminated.

During November 2012, the Company acquired license rights to ACI's Medical Keyring Device technology in consideration of the Company's issuance to ACI of 200,000 shares of its Series B Convertible Preferred Stock.

During September 2013, the Company acquired license rights to ACI's BioCentric Cloud Device technology in consideration of the Company's issuance to ACI of 200,000 shares of its Series B Convertible Preferred Stock. Effective November 5, 2014, the Company increased the number of preferred shares designated as Series B, and accordingly, the shares were issued to ACI on November 10, 2014.

SMARTMETRIC INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Lease Agreement

In February 2012, the company entered into a facilities lease in Buenos Aires, Argentina for its manufacturing activities. The lease term is from March 1, 2012 through January 31, 2015. The Company terminated this lease and vacated its Argentina facility in February, 2014. The Company also utilizes offices in Australia, Israel and Las Vegas, Nevada. The Company’s main office is located in Las Vegas, Nevada. Rent expense under all leases for the three months ended September 30, 2014 and 2013 was $7,222 and $31,631, respectively.

Related Party Transactions

The Company’s Chief Executive Officer has made cash advances to the Company with an aggregate amount due of $9,522 and $0 at September 30, 2014 and June 30, 2014, respectively. The Company has made cash advances to its Chief Executive Officer with an aggregate amount due of $0 and $22,478 at September 30, 2014 and June 30, 2014, respectively. These advances bear interest at the rate of five percent (5%) per annum.

The Company has accrued the amounts of $172,515 and $125,015 at September 30, 2014 and June 30, 2014, respectively, as deferred Officer’s salary, for the difference between the Chief Executive Officer’s annual salary and the amounts paid.

SMARTMETRIC INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 6 -         STOCKHOLDERS’ EQUITY (DEFICIT)

Preferred Stock

As of September 30, 2014, the Company has 5,000,000 shares of preferred stock, par value $0.001, authorized and 210,000 shares issued and outstanding.

On December 11, 2009, the Company filed a Certificate of Designation with the State of Nevada, to designate 500,000 shares of the preferred stock to be designated as Series B Convertible Preferred Stock (“Series B Convertible Preferred Stock”). Effective November 5, 2014, the number of shares designated as Series B Convertible Preferred Stock was increased to 1,000,000 shares.

Each share of Series B Convertible Preferred Stock has a par value of $0.001, and a stated value equal to $5.00 (“Stated Value”). Holders of the Series B Convertible Preferred Stock are entitled to receive dividends or other distributions with the holders of the common stock of the Company on an as converted basis when, as, and if declared by the directors of the Company. Holders of the Series B Convertible Preferred Stock are entitled to convert all or any one (1) share of the Series B Convertible Preferred Stock into fifty (50) shares of common stock.

Upon any liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary (“liquidation”), holders of the Series B Convertible Preferred Stock are entitled to receive out of the assets, whether capital or surplus, of the Company an amount equal to the Stated Value, pro rata with the holders of the common stock.

On December 11, 2009, the Company entered into an Assignment and Assumption Agreement with ACI (the “assignment and Assumption Agreement”). In accordance with the Assignment and Assumption Agreement, ACI conveyed, assigned and transferred to the Company all of ACI’s rights, title and interest in and to the Patent (see Note 5) and delegated to the Company all of its duties and obligations to be performed under the Patent; and the Company hereby accepts the assignment of all of ACI’s rights, title and interest to the Patent and the rights and delegation of duties and obligations and agrees to be bound by and to assume such duties and obligations.

In consideration for the assignment of the Patent, the Company issued 200,000 shares of Series B Convertible Preferred Stock. ACI may only convert these shares into common shares (in accordance with the conversion terms noted herein) upon delivering to the Company, a third party valuation of the assigned Patent conducted by a nationally qualified accounting firm or IP law firm mutually agreed upon between the Company and ACI, indicating that such Patent is valued at a minimum of $1,000,000.

On November 12, 2012, the Company issued 200,000 shares of its Series B Convertible Preferred Stock to ACI in consideration for ACI’s patent relating to the Medical Keyring Device.

In July 2013, ACI elected to convert 190,000 shares of Series B Convertible Preferred Stock, issued in 2012, into 9,500,000 shares of the Company’s common stock.

During September 2013, the Company acquired license rights to ACI's BioCentric Cloud Device technology in consideration of the Company's issuance to ACI of 200,000 shares of its Series B Convertible Preferred Stock. Effective November 5, 2014, the Company increased the number of preferred shares designated as Series B, and accordingly, the shares were issued to ACI on November 10, 2014.

SMARTMETRIC INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

In accordance with Staff Accounting Bulletin (“SAB”) topic 5G “Transfers of Non-monetary Assets by Promoters and Shareholders” the Company recorded these transactions at ACI’s carrying basis of the Patents, which was $0.

Class A Common Stock

As of September 30, 2014, the Company has 50,000,000 shares of Class A common stock, par value $0.001, authorized and no shares issued and outstanding. In October 2003, the Company issued 50,000,000 shares of Class A common stock at par value ($50,000). These shares were converted into 50,000,000 shares of common stock in 2006.

Common Stock

The Company was incorporated on December 18, 2002, with 45,000,000 shares of Common Stock, par value $0.001. The articles of incorporation were amended in 2006 to increase the number of authorized shares to 100,000,000 shares, and again in 2009 to increase the number of authorized shares to 200,000,000.

As of September 30, 2014, the Company has 169,189,382 shares of common stock issued and outstanding.

During the three months ended September 30, 2013, the Company sold for cash 515,367 shares and twenty-four month warrants to purchase an additional 515,367 shares at $0.70 per share for net proceeds of $123,474.

During the three months ended September 30, 2013, the Company issued 130,875 shares for consulting services valued at $70,898, based on the stock price at the time of the respective agreements underlying the services provided.

During the three months ended December 31, 2013, the Company issued 2,134,166 shares for consulting services valued at $339,900, based on the stock price at the time of the respective agreements underlying the services provided.

During the three months ended December 31, 2013, the Company sold for cash 660,000 shares and twenty-four month warrants to purchase an additional 660,000 shares at $0.60 per share for net proceeds of $118,700.

During the three months ended March 31, 2014, the Company sold for cash 2,120,000 shares and twenty-four month warrants to purchase: (i) 4,240,000 shares at $0.70 per share, and (ii) 2,136,960 shares at $1.00 per share, for net proceeds of $338,687.

During the three months ended March 31, 2014, the Company issued 2,798,776 shares for consulting and legal services valued at $375,149, based on the stock price at the time of the respective agreements underlying the services provided.

During the three months ended June 30, 2014, the Company sold for cash 1,812,500 shares and twenty-four month warrants to purchase: (i) 3,625,000 shares at $0.70 per share, and (ii) 1,827,000 shares at $1.00 per share, for net proceeds of $289,405.

During the three months ended June 30, 2014, the Company issued 1,490,170 shares for consulting and legal services valued at $205,192, based on the stock price at the time of the respective agreements underlying the services provided.

SMARTMETRIC INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

During the three months ended September 30, 2014, the Company sold for cash 4,893,731 shares and twenty-four month warrants to purchase: (i) 1,375,000 shares at $0.70 per share, and (ii) 724,500 shares at $1.00 per share, for net proceeds of $307,662.

During the three months ended June 30, 2014, the Company issued 200,000 shares for consulting and legal services valued at $32,000, based on the stock price at the time of the respective agreements underlying the services provided.

Warrants

From time to time the Company granted warrants in connection with private placements of securities, as described herein.

In October 2009, the Company executed a warrant agreement with an investor relations company for 5,000,000 warrants to be issued in two tranches. The first tranche of 2,500,000 warrants (the “October warrants”) has been issued in October 2009, and the second tranche of 2,500,000 warrants has been issued on March 31, 2010 (the “March warrants”). The October warrants, which were set to expire October 25, 2014(as extended) but have been further extended by the Company to expire on October 25, 2015, have strike prices as follows: 1,000,000 at $0.10 per share; 1,000,000 at $0.15 per share; and 500,000 at $0.20 per share. The March warrants, which were set to expire March 29, 2015 (as extended) but have been further extended by the Company to expire on March 29, 2016, have strike prices as follows: 500,000 at $0.20 per share; 1,000,000 at $0.25 per share; and 1,000,000 at $0.30 per share.

In June 2011, the Company issued warrants to purchase 1,000,000 shares of its common stock at an exercise price of $0.50 per share as partial consideration for a consulting agreement.  These warrants were set to expire on June 3, 2014 (as extended) but have been further extended by the Company to expire on June 3, 2015.

In connection with the extension of the above referenced warrants during the year ended June 30, 2014, which were partial consideration in connection with a new consulting agreement, the Company assigned a value of $209,300 using the Black-Scholes option pricing model. The Company recorded the charge to consulting expenses over the term of the new consulting agreement, which expired in July 2014.

In May 2012, the Company issued warrants to purchase 250,000 shares of its common stock at an exercise price of $0.50 per share, as partial consideration for a consulting agreement for public relations services.  The warrants expired in May 2014.

As of September 30, 2014 and June 30, 2014, the following is a breakdown of the Company’s warrant activity:

SMARTMETRIC INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 6 -        STOCKHOLDERS’ EQUITY (DEFICIT) (CONTINUED)

At September 30, 2014, all of the 21,103,500 warrants are vested and 15,103,500 warrants expire at various times through January 15, 2016, 1 million warrants expire on June 20, 2015, 2.5 million warrants expire on October 25, 2015, and 2.5 million warrants expire on March 29, 2016.

NOTE 7 -        INCOME TAXES

The Company provides for income taxes at the end of each interim period based on the estimated effective tax rate for the full fiscal year.  Cumulative adjustments to the Company’s estimate are recorded in the interim period in which a change in the estimated annual effective rate is determined.

The Company has estimated its effective tax rate to be 0%, based primarily on losses incurred and the uncertainty of realization of the tax benefit of such losses.

NOTE 8 -        LITIGATION

On July 27, 2010, the Company filed a second amended complaint (the “Visa and MasterCard Complaint”) in the United States District Court, Central District of California (the “Court”), Case No. 2:10-cv-01864, against MasterCard, Inc. and Visa, Inc. alleging patent infringement on the Company’s patent, U.S. Patent 6,792,464 (the “ ‘ 464 Patent”) (the “Visa and MasterCard Case”).

On August 29, 2011, the Company filed a complaint in the United States District Court, Central District of California, against Master Card, Inc. (“MasterCard”) and Visa, Inc. (“Visa”) alleging patent infringement on the ‘464 Patent (the “August 2012 Case”). In a prior Visa and MasterCard Case and AMEX case, the Court excluded “contactless” credit card/pay system from the scope of the ‘464 patent claims..  In the August 2012 Case, the Company charged that VISA and MasterCard’s EMV debit/credit card systems infringe the ‘464 Patent.  These systems do allow for physical insertion of an EMV/credit card into a recess of a data card reader.

The Company has presented a claim for damages and a paid up royalty in the amount of $13.4 billion in connection with its patent infringement litigation against MasterCard and Visa, Inc. In October 2013, the Court held that the Defendants did not infringe on the ‘464 Patent. The Company believes this ruling is in error and has appealed the ruling.

VISA and MasterCard have, subsequent to our lodging an appeal, asked the District Court to award them attorneys' fees and costs approximating $3 million. SmartMetric is opposing this request, which SmartMetric believes is without merit because SmartMetric filed its suit in good faith, and has litigated the case in an objectively reasonable manner. SmartMetric expects the issue to be argued on December 9, 2013, and decided then, or soon thereafter. VISA and MasterCard have, subsequent to our lodging our motion in the Federal Circuit Court, filed a motion in the District Court to award attorneys' fees and costs. SmartMetric has opposed this motion, which SmartMetric believes is without merit because SmartMetric filed its suit in good faith, and has litigated the case in an objectively reasonable manner.

SmartMetric has filed motions asking the Federal Circuit Court to find that both Visa Inc. and MasterCard do in fact infringe the SmartMetric Patent and further asking the Court to agree that the defendants should pay 25% of the savings that accrue as a result of using the technology in dispute.

On September 12, 2014, the Company filed an appeal before the full bench of the Federal Circuit Court in Washington D.C. in respect of an appeal of a prior ruling of non infringement on the part of the defendants Visa Inc. and MasterCard International Inc. by the Federal District Court for the Central District of California in the last quarter of the calendar year ending December 31, 2013.

From time to time we may be a defendant or plaintiff in various legal proceedings arising in the normal course of our business.   Except as described herein, we know of no material, active, pending or threatened proceeding against us or our subsidiaries, nor are we, or any subsidiary, involved as a plaintiff or defendant in any material proceeding or pending litigation.