10-Q 1 d10q.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-Q (Mark one) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 FOR THE QUARTER ENDED MARCH 31, 2002 OR [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 COMMISSION FILE NUMBER 000-24733 ---------- ENTRUST, INC. (Exact name of registrant as specified in its charter) MARYLAND 62-1670648 (State or other jurisdiction of (IRS employer identification no.) incorporation or organization) ONE HANOVER PARK, SUITE 800 16633 DALLAS PARKWAY ADDISON, TX 75001 (Address of principal executive offices & zip code) Registrant's telephone number, including area code: (972) 713-5800 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 such filing requirements for the past 90 days. Yes [X] No [ ] There were 65,081,936 shares of the registrant's $.01 par value Common stock outstanding as of May 3, 2002. ================================================================================ ENTRUST, INC. TABLE OF CONTENTS

Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets............................ 3 Condensed Consolidated Statements of Operations.................. 4 Condensed Consolidated Statements of Cash Flows.................. 5 Notes to Condensed Consolidated Financial Statements............. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................ 11 Item 3. Quantitative and Qualitative Disclosures about Market Risk....... 26 PART II. OTHER INFORMATION Item 1. Legal Proceedings................................................ 28 Item 6. Exhibits and Reports on Form 8-K................................. 28 SIGNATURES.................................................................... 29

Entrust, Entrust Logo (Elmer), Entrust-Ready, and getAccess are registered trademarks of Entrust, Inc. or a subsidiary of Entrust, Inc. in certain countries. Entrust Authority, Entrust TruePass, Entrust GetAccess, Entrust Entelligence, Entrust Cygnacom, are trademarks or service marks of Entrust, Inc. or a subsidiary of Entrust, Inc. in certain countries. All other trademarks and service marks used in this quarterly report are the property of their respective owners. 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ENTRUST, INC. CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited) DECEMBER 31, MARCH 31, 2001 2002 ------------ ----------- (In thousands, except share data) ASSETS Current assets: Cash and cash equivalents .................................................. $ 45,267 $ 41,295 Short-term marketable investments .......................................... 108,288 101,368 Accounts receivable (net of allowance for doubtful accounts of $3,909 at December 31, 2001 and $3,270 at March 31, 2002) ................................................ 23,732 25,123 Prepaid expenses and other ................................................. 5,202 6,581 --------- --------- Total current assets .................................................. 182,489 174,367 Long-term marketable investments ............................................. 9,038 7,910 Property and equipment, net .................................................. 17,390 16,141 Purchased product rights, net ................................................ 2,838 2,554 Goodwill, net ................................................................ 6,436 6,436 Other purchased intangibles, net ............................................. 4,750 4,750 Long-term strategic investments .............................................. 5,076 5,076 Other long-term assets, net .................................................. 1,421 1,371 --------- --------- Total assets .......................................................... $ 229,438 $ 218,605 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable ......................................................... $ 13,815 $ 13,368 Accrued liabilities ...................................................... 15,121 13,816 Accrued restructuring charges ............................................ 46,988 40,664 Deferred revenue ......................................................... 17,553 15,487 --------- --------- Total current liabilities ............................................. 93,477 83,335 Long-term liabilities ........................................................ 116 737 --------- --------- Total liabilities ..................................................... 93,593 84,072 --------- --------- Shareholders' equity: Common stock, par value $0.01 per share; 64,432,052 and 65,092,279 issued and outstanding shares at December 31, 2001 and March 31, 2002, respectively ........................................................... 645 652 Additional paid-in capital ............................................... 781,879 783,621 Unearned compensation .................................................... (100) (45) Accumulated deficit ...................................................... (645,190) (648,534) Accumulated other comprehensive loss ..................................... (1,389) (1,161) --------- --------- Total shareholders' equity ............................................ 135,845 134,533 --------- --------- Total liabilities and shareholders' equity ............................ $ 229,438 $ 218,605 ========= =========

See notes to condensed consolidated financial statements 3 ENTRUST, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited) THREE MONTHS ENDED MARCH 31, ------------------- 2001 2002 -------- ------- (In thousands, except per share data) Revenues: License.................................................................. $ 10,559 $12,089 Services and maintenance................................................. 20,946 15,434 -------- ------- Total revenues....................................................... 31,505 27,523 -------- ------- Cost of revenues: License.................................................................. 901 942 Services and maintenance................................................. 13,346 8,494 -------- ------- Total cost of revenues................................................ 14,247 9,436 -------- ------- Gross profit................................................................ 17,258 18,087 -------- ------- Operating expenses: Sales and marketing...................................................... 26,580 12,145 Research and development................................................. 9,487 6,033 General and administrative............................................... 4,687 3,506 Amortization of purchased product rights................................. 1,377 284 Amortization of goodwill and other purchased intangibles................. 28,900 -- -------- ------- Total operating expenses.............................................. 71,031 21,968 -------- ------- Loss from operations........................................................ (53,773) (3,881) Interest income............................................................. 3,244 932 -------- ------- Loss before provision for income taxes...................................... (50,529) (2,949) Provision for income taxes.................................................. 350 395 -------- ------- Net loss ................................................................. $(50,879) $(3,344) ======== ======= Net loss per share: Basic ................................................................ $ (0.81) $ (0.05) Diluted .............................................................. $ (0.81) $ (0.05) Weighted average common shares used in per share computations: Basic ................................................................ 62,911 64,762 Diluted .............................................................. 62,911 64,762

See notes to condensed consolidated financial statements 4 ENTRUST, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited) THREE MONTHS ENDED MARCH 31, -------------------- 2001 2002 -------- -------- (In thousands) OPERATING ACTIVITIES: Net loss .................................................. $(50,879) $ (3,344) Non-cash items in net loss: Depreciation and amortization .......................... 32,503 2,219 Unearned compensation amortized ........................ 56 55 Revenue from non-monetary transaction .................. (353) -- Changes in operating assets and liabilities: (Increase) decrease in accounts receivable ............. 4,295 (1,322) Increase in prepaid expenses and other ................. (764) (1,379) Increase (decrease) in accounts payable ................ 260 (444) Decrease in accrued liabilities ........................ (12,873) (1,038) Decrease in accrued restructuring charges .............. -- (6,324) Increase (decrease) in deferred revenue ................ 950 (2,027) -------- -------- Net cash used in operating activities ............... (26,805) (13,604) -------- -------- INVESTING ACTIVITIES: Purchases of marketable investments .................... (47,623) (41,400) Dispositions of marketable investments ................. 72,778 49,448 Purchases of property and equipment .................... (5,073) (530) Increase in long-term investments ...................... (1,496) -- Increase in other long-term assets ..................... (1,016) (54) -------- -------- Net cash provided by investing activities............ 17,570 7,464 -------- -------- FINANCING ACTIVITIES: Repayment of long-term liabilities ..................... (72) (58) Increase in long-term deposits ......................... -- 474 Proceeds from exercise of stock options and employee stock purchase plan ................................. 1,924 1,734 -------- -------- Net cash provided by financing activities ........... 1,852 2,150 -------- -------- EFFECT OF EXCHANGE RATE CHANGES ON CASH ...................... 342 18 -------- -------- NET DECREASE IN CASH AND CASH EQUIVALENTS .................... (7,041) (3,972) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ............. 24,241 45,267 -------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD ................... $ 17,200 $ 41,295 ======== ========

See notes to condensed consolidated financial statements 5 ENTRUST, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (in thousands, except share and per share data, unless indicated otherwise) NOTE 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared on the same basis as the audited annual consolidated financial statements and, in the opinion of management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations and cash flows. The results of operations for the three months ended March 31, 2002 are not necessarily indicative of the results to be expected for the full year. Certain information and footnote disclosures normally contained in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the Notes to Consolidated Financial Statements for the year ended December 31, 2001 contained in the Company's Annual Report on Form 10-K. NOTE 2. EQUITY INVESTMENT IN ENTRUST JAPAN CO., LTD. ("Entrust Japan") On April 12, 2002, the Company increased its investment in the voting capital of Entrust Japan from an ownership share of less than 10% to approximately 37% by exchanging cash of approximately $1.5 million, Entrust software product and distribution rights for certain Entrust products for the Japanese market, for additional shares in Entrust Japan. The Company's increased investment follows additional investments in Entrust Japan made by Toyota and SECOM in the fourth quarter of 2001. The Company has concluded that because, as of the second quarter of 2002, it has the ability to exercise significant influence over the operations of Entrust Japan, that beginning in the same period of 2002, it will account for its investment in Entrust Japan under the equity method, in accordance with the provisions of APB No. 18, "The Equity Method of Accounting for Investments in Common Stock" and ARB No. 51, "Consolidated Financial Statements". Accordingly, the Company will include its share of post-acquisition losses of Entrust Japan on the step-by-step acquisition method in its consolidated losses for the current fiscal year. In addition, the Company will record an adjustment to consolidated accumulated deficit to pick up the post-acquisition losses of Entrust Japan of prior years, attributable to the less than 10% ownership block previously acquired. As a result, the Company's previous investment in Entrust Japan of $0.4 million, at March 31, 2002, will be written down to zero in the second quarter of 2002 and the Company will begin including its share of current year losses in its operating results in that same quarter. NOTE 3. AMORTIZATION OF GOODWILL AND OTHER PURCHASED INTANGIBLE ASSETS Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"), which revises the accounting for purchased goodwill and intangible assets, became effective for the Company beginning January 1, 2002. Under SFAS No. 142, goodwill and intangible assets, with balances of $6.4 million and $4.8 million, respectively, at March 31, 2002, with indefinite lives will no longer be amortized, but will be tested for impairment annually and also in the event of an impairment indicator. The Company assessed the carrying value of its goodwill and intangible assets in the first quarter of 2002 to determine the complete impact of the adoption of SFAS No. 142. No further impairment was required at March 31, 2002. The Company's net loss, on a pro forma basis, assuming the cessation of goodwill amortization as required under SFAS No. 142 had been in effect from January 1, 2001, is as follows: 6 (Unaudited) Three Months Ended March 31, ------------------ 2001 2002 -------- ------- Reported net loss ...................................... $(50,879) $(3,344) SFAS No. 142 adjustment ................................ 28,900 -- -------- ------- Pro forma net loss ..................................... $(21,979) $(3,344) ======== ======= Pro forma net loss per share ........................... $ (0.35) $(0.05) ======== ======= NOTE 4. RESTRUCTURING AND OTHER SPECIAL NON-RECURRING CHARGES On June 4, 2001, the Company announced a Board-approved restructuring program to refocus on the Company's most significant market opportunities and to reduce operating costs due to the macroeconomic factors that were negatively affecting technology investment in the market. The restructuring program included a workforce reduction, consolidation of excess facilities, and discontinuance of non-core products and programs. The workforce portion of the restructuring was largely completed by the end of the fourth quarter of 2001 and primarily related to severance costs, fringe benefits due to severed employees and outplacement services. The consolidation of excess facilities included the closure of eight offices throughout the world, but the majority of the costs related to the Company's facility in Santa Clara, CA. These costs are payable contractually over a period up to 10 years, which is the lease term of the Santa Clara facility, reduced by estimated sublease recoveries. The Company continues to evaluate ongoing possibilities to settle this obligation in the most economic manner and, therefore, it has been classified as current in nature. The discontinuance of non-core products and programs was primarily related to the discontinuance of certain of the Company's services business initiatives and certain desktop applications that had not achieved their growth and profitability objectives. In addition, the Company withdrew from certain committed marketing events and programs. The cash outflow related to the majority of these discontinued products and programs is expected to be substantially completed by the end of the second quarter of 2002, while estimated minimum royalty obligations related to certain discontinued products of $4.2 million are payable contractually over the next three years. No adjustments were made during the first quarter of 2002. Summary of accrued restructuring charges The following table is a summary of the accrued restructuring charges as at March 31, 2002 (table in millions):

Accrued Accrued Restructuring Restructuring Charges at Charges at December 31, Cash March 31, 2001 Payments 2002 ------------- -------- ------------- Workforce reduction and other personnel costs... $ 2.3 $1.0 $ 1.3 Consolidation of excess facilities.............. 34.6 1.8 32.8 Discontinuance of non-core products and programs..................................... 10.1 3.5 6.6 ----- ---- ----- Total........................................... $47.0 $6.3 $40.7 ===== ==== =====

NOTE 5. NET INCOME (LOSS) PER SHARE AND SHARES OUTSTANDING 7 Basic net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of shares of Common stock of all classes outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of shares of Common stock and potential Common stock outstanding, and when dilutive, options to purchase Common stock using the treasury stock method. The dilutive effect of the options to purchase Common stock are excluded from the computation of diluted net income (loss) per share if their effect is antidilutive. For the three months ended March 31, 2002, the antidilutive effect excluded from the diluted net loss per share computation due to the options to purchase Common stock was 1,789,392 shares. In the three months ended March 31, 2002, the Company issued 642,924 shares of Common stock related to the exercise of employee stock options and the sale of shares under the employee stock purchase plan. NOTE 6. STOCK OPTION EXCHANGE PROGRAM On June 19, 2001, the Company announced a voluntary stock option exchange program for its eligible employees. Under the program, the Company's employees were offered the opportunity to cancel, as of July 30, 2001, certain outstanding stock options to purchase shares of Common stock previously granted to them. In exchange, these employees received new options granted under the 1999 Non-Officer Employee Stock Incentive Plan. New options issued have terms and conditions that are substantially the same as those of the cancelled options. The Company believes that this voluntary exchange program complied with FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation" and related FASB EITF guidance and, accordingly, is not expected to result in any variable accounting compensation charges. Members of the Company's Board of Directors and executive officers were not eligible to participate in this program. Pursuant to the terms and conditions of the Offer to Exchange, a total of 592 eligible optionees participated in the option exchange program. The Company accepted for cancellation options to purchase 5,480,261 shares of its Common stock. Subject to the terms and conditions of the Offer to Exchange, the Company granted new options to purchase 5,033,822 shares of its Common stock on January 31, 2002, at an exercise price of $6.75 per share, which was the current market value, in exchange for the options surrendered and accepted under the program. Additionally, certain 16B Officers who were not eligible to participate in the option exchange program were offered the opportunity to receive a nominal cash or stock award to cancel a portion of their out of the money options. Three officers elected to participate in this program and, in total, 334,000 options were canceled with strike prices of between $19.25 and $50.00 for 15,220 shares of stock and $4,338.95 of cash. The expense for the fair value of the shares and the cash was recorded in operating expense in the first quarter of 2002. The Company has provided no promise to compensate the employees for any increases in the price of the stock after the cancellation date. Further, the Company does not intend to issue additional options to these employees within 6 months and one day of the date of cancellation. NOTE 7. MARKETABLE AND OTHER INVESTMENTS The Company maintains marketable investments mainly in a strategic cash management account. This account is invested primarily in highly rated corporate securities, in securities guaranteed by the U.S. government or its agencies and highly rated municipal bonds, primarily with a remaining maturity of not more than 12 months. The Company has the intent and ability to hold all of these investments until maturity. Therefore, all such investments are classified as held to maturity investments and are stated at amortized cost. At March 31, 2002, the amortized cost of the Company's held to maturity investments approximated fair value. Based on contractual maturities, these marketable investments were classified in either current assets or long-term assets. In addition, the Company had invested in an equity instrument of a publicly traded technology company. This investment had been classified as available for sale, in current assets, and was carried at fair value based on quoted market prices. This instrument was considered to be short-term in nature as it was management's intention to dispose of this investment within the year. Realized gains and losses on disposition of available for sale marketable investments are included in investment income in the results of operations. Unrealized gains and losses are included in other comprehensive income, except that the portion designated as being hedged in a fair value hedge is recognized in other income during the period of the hedge. The Company disposed of this investment during its first quarter of 2002, at approximately its carrying value. The Company has a policy that allows for the use of hedges on equity investments in publicly traded companies. However, the Company presently is not engaged in any such hedges. 8 The Company holds equity securities stated at cost, which represent long-term investments in private companies made for business and strategic alliance purposes, including Entrust Japan (Note 2). The Company's ownership share in these companies ranges from 1% to 10% of voting share capital at March 31, 2002. Consistent with the Company's policies for other long-lived assets, the carrying value of these long-term strategic investments is periodically reviewed for impairment based upon such quantitative measures as expected undiscounted cash flows as well as qualitative factors. In addition, the Strategic Investment Committee of the Board of Directors monitors and assesses the ongoing operating performance of the underlying companies for evidence of impairment. To date, the Company has recorded impairments totaling $10.8 million with respect to these investments. No loss from impairment was recorded in the quarter ended March 31, 2002. The Company recorded revenues representing 2% of total revenue for the three months ended March 31, 2002, with respect to arm's-length transactions with companies in which it has made strategic equity investments recorded at cost. NOTE 8. SEGMENT AND GEOGRAPHIC INFORMATION Segment information The Company conducts business in one operating segment: the design, production and sale of software products and related services for Internet security. The nature of the Company's products and services is similar and, in general, the type of customers for those products and services is not distinguishable. The Company does, however, prepare information for internal use by the Chief Operating Decision Maker ("CODM"), the President and Chief Executive Officer, on a geographic basis. Accordingly, the Company has included a summary of the segment financial information reported to the CODM as follows in the next section regarding geographic information. Geographic information Revenues are attributed to specific geographical areas based on where the sales order originated. Company assets are identified with operations in the respective geographic areas. The Company operates in three main geographic areas as follows: (Unaudited) Three Months Ended March 31, ------------------- 2001 2002 -------- -------- Revenues: United States .................................... $ 14,212 $10,863 Canada ........................................... 5,895 8,953 Europe, Asia and Other ........................... 11,398 7,707 -------- ------- Total revenues ................................ $ 31,505 $27,523 ======== ======= Income (loss) before income taxes: United States .................................... $(41,903) $ (153) Canada ........................................... (10,020) (3,195) Europe, Asia and Other ........................... 1,394 399 -------- ------- Total income (loss) before income taxes ....... $(50,529) $(2,949) ======== ======= 9 (Unaudited) December 31, March 31, 2001 2002 ------------ ----------- Total assets: United States ............................ $191,886 $182,027 Canada ................................... 32,916 32,419 Europe, Asia and Other ................... 4,636 4,159 -------- -------- Total ................................. $229,438 $218,605 ======== ======== NOTE 9. COMPREHENSIVE INCOME (LOSS) The components of comprehensive income (loss) are as follows:

(Unaudited) Three Months Ended March 31, ------------------ 2001 2002 -------- ------- Net loss...................................................... $(50,879) $(3,344) Reversal of unrealized loss on investments upon disposition... -- 220 Translation adjustments....................................... (1,643) 8 -------- ------- Comprehensive loss............................................ $(52,522) $(3,116) ======== =======

NOTE 10. LEGAL PROCEEDINGS On July 7, 2000, an action entitled Frankel v. Entrust Technologies Inc., et al., No. 2-00-CV-119, was filed in the U.S. District Court for the Eastern District of Texas. Subsequently, several similar actions were filed in the same court. All of these actions have been consolidated. On January 22, 2001, a consolidated amended complaint was filed. The consolidated amended complaint purports to be a class action lawsuit brought on behalf of persons who purchased or otherwise acquired the Company's Common stock during the period from October 19, 1999 through July 3, 2000. The complaint alleges that the defendants misrepresented and failed to disclose certain information about its business and prospects. The complaint asserts claims under the Securities Exchange Act of 1934. The complaint does not specify the amount of damages sought. The Company moved to dismiss the consolidated complaint. On July 31, 2001, the Court granted the motion to dismiss. The Court granted plaintiffs 30 days leave to file an amended complaint. On August 30, 2001, plaintiffs filed an amended complaint. On September 21, 2001, the Company moved to dismiss the amended complaint. The Court has not yet ruled on the Company's motion to dismiss. There has been no discovery to date, and no trial date has been established. The Company believes this class action is without merit and intends to deny all material allegations and to defend itself vigorously. An adverse judgment or settlement in this lawsuit could have a significant adverse impact on the Company's future financial condition or results of operations. 10 The Company is subject from time to time to various other legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, management does not believe that the outcome of any of these other legal matters will have a material adverse effect on the Company's consolidated results of operations or consolidated financial position. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This report contains forward-looking statements that involve risks and uncertainties. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including without limitation statements regarding our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this report are based on information available to us, up to and including, the date of this document, and we assume no obligation to update any such forward-looking statements. Our actual results could differ significantly from those anticipated in these forward-looking statements as a result of certain factors, including those set forth below, under "Overview", "Certain Factors that May Affect Our Business" and elsewhere in this report. OVERVIEW Background We are a leading global provider of Internet security solutions and services that make it safe to do business, communicate and complete transactions over the Internet. We have a broad set of identification, entitlements, verification, privacy and security management capabilities. Major businesses, service providers, financial institutions and government agencies in more than 40 countries rely on the privacy, security and trust provided through our portfolio of award-winning technologies. We were incorporated in December 1996 with nominal share capital, all of which was contributed by Nortel Networks Corporation and its subsidiary Nortel Networks Inc. At the close of business on December 31, 1996, Nortel Networks transferred to us certain of their assets and liabilities, intellectual property, rights, licenses and contracts. In exchange, Nortel Networks received Series A common stock, Special Voting stock, and cash consideration. At the close of business on December 31, 1996, we issued Series B common stock in a private placement. After the completion of the private placement, Nortel Networks owned approximately 73% of the outstanding shares of our voting stock assuming conversion of the Series B common stock and Series B Non-Voting common stock. On August 21, 1998, we closed our initial public offering, issuing 5,400,000 shares of our Common stock at an initial public offering price of $16 per share. The net proceeds from the offering, after deducting underwriting discounts and commissions and offering expenses incurred, were approximately $79.1 million. On February 29, 2000 and March 2, 2000, we closed our follow-on offering, which included an over-allotment option closing, issuing an aggregate of 2,074,260 shares of our Common stock at an offering price $82 per share. The net proceeds from the offering, after deducting underwriting discounts and commissions and offering expenses incurred, were approximately $161.5 million. On June 4, 2001, we changed our name to Entrust, Inc. At March 31, 2002, Nortel Networks owned approximately 19.5% of our Common stock. Business Overview 11 During the first quarter of 2002, Entrust continued its strategy of focusing on core vertical and geographic markets. We were also successful in expanding the sales of our Secure Web Portal product solution. Revenues from the Secure Web Portal solution, which is the combination of our TruePass and getAccess products, increased 36% from the fourth quarter of 2001 and over 100% from the first quarter a year ago. Other highlights from the quarter included: . Key customer wins in core vertical markets. The five largest sales of the quarter were to: the Government of Canada Secure Project; a new customer that is a large pharmaceutical provider based in Europe; a large chip manufacturer; a large governmental health care agency; and the China Financial Certificate Authority, CFCA. . Major financial services customers in the first quarter included: SWIFT, CFCA and two new customers that are utilizing Entrust's Secure Web Portal solution for their online banking portal. . Entrust announced key deployment successes with Egg, an online financial services provider, which now has deployed over 2 million users of Entrust GetAccess (TM) products, and the California Highway Patrol, whose internal affairs division is using Entrust Entelligence (TM) products to provide e-mail and file encryption department-wide; and . Entrust was also selected to provide the Southampton City Council with a Secure Web Portal solution using Entrust GetAccess(TM) software for the first phase of its 'SmartPath' project in the UK. The Entrust Secure Web Portal solution was selected to allow up to 6,000 users to make secure transactions with the council. The project could potentially grow to 250,000 users. From a technology perspective, key accomplishments for the quarter included: . The release of Entrust TruePass software v.6.0. This is the latest version of Entrust's zero-footprint enhanced identification solution. The new release offers enhanced capabilities including support for devices like smart cards, mobile phones and PDA's; . Penetration of Entrust's Secure Web Portal solution continued this quarter as evidenced by the strong demand for Entrust TruePass and Entrust GetAccess software. The two products combined to represent over one-third of the Company's software revenue in the quarter; and . Entrust launched a marketing program around its Secure E-Forms solution. This solution helps governments and enterprises move paper-based processes to the Internet with the added functionality of an auditable transaction record with digital signatures, access control for the form content and easy integration with top e-forms providers including Adobe, Accelio and Shana. We remain focused on our core markets, both vertical and geographic, and our core technology strengths in enhanced Internet security. Our success continues to be dependant on our ability to design, develop, market and sell our Internet security solutions to our global customers. Critical Accounting Policies The nature of our business is not highly complex, as we operate in one primary business. We develop, market and sell Internet security software solutions. We also perform professional services to install, support and integrate our Internet security software solutions with other applications. We operate globally in a functional organization. We do not have any off-balance sheet financing, other than operating leases entered into in the normal course of business, and we do not actively engage in hedging transactions. In the first quarter of 2002, our most complex accounting judgments were made in the areas of software revenue recognition, goodwill impairment, restructuring and other special non-recurring charges, impairment of long-term strategic investments and allowance for doubtful accounts. The goodwill impairment, and restructuring and other special non-recurring charges are not anticipated to be recurring in nature. However, the restructuring and 12 other special non-recurring charges will continue to require judgment until such time as the corresponding accruals are fully paid out and/or no longer required. Software revenue recognition, impairment of long-term strategic investments, and allowance for doubtful accounts are expected to continue to be an on-going element of our accounting processes and judgments. Software Revenue Recognition With respect to software revenue recognition, we recognize revenues in accordance with the provisions of the American Institute of Certified Public Accountants' Statement of Position No. 97-2, "Software Revenue Recognition" and SOP No. 98-9, "Modifications of SOP No. 97-2, Software Revenue Recognition, with Respect to Certain Transactions". Revenues from perpetual software license agreements are recognized upon receipt of an executed license agreement, or an unconditional order under an existing license agreement, and shipment of the software, if there are no significant remaining vendor obligations, collection of the receivable is probable and payment is due within twelve months. Revenues from license agreements requiring the delivery of significant unspecified software products in the future are accounted for as subscriptions and, accordingly, are recognized ratably over the term of the agreement from the first instance of product delivery. Due to the complexity of some software license agreements, we routinely apply judgment to the application of software revenue recognition accounting principles to specific agreements and transactions. Different judgments and/or different contract structures could have led to different accounting conclusions, which could have had a material effect on our reported quarterly earnings. Goodwill Impairment We assess the impairment of identifiable intangibles, long-lived assets and related goodwill and enterprise-level goodwill on a periodic basis or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In 2001, we performed our valuation of these assets based on Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of", APB Opinion No. 17, "Intangible Assets", and the relevant provisions of the SEC's SAB No. 100, "Restructuring and Impairment Charges". During the second quarter of 2001, we recorded an impairment of goodwill of $327.0 million. $325.4 million of this amount was the result of the acquisition of enCommerce, Inc., "enCommerce", in 2000 and $1.6 million from the acquisition of r3 Security Engineering AG, "r3", in 1998. In performing this impairment assessment, management made judgments regarding the anticipated future cash flows from these acquisitions. Different assumptions in this assessment could have led to a different impairment amount, which could have had a material effect on our reported earnings. As of March 31, 2002, goodwill, other intangible assets and purchased product rights, net of accumulated amortization, amounted to $13.7 million. SFAS No. 142, "Goodwill and Other Intangible Assets" became effective for us on January 1, 2002 and, as a result, we ceased to amortize approximately $11.2 million of goodwill and other purchased intangibles. We will continue to amortize $2.5 million of purchased product rights. We had recorded approximately $62.1 million of amortization on these amounts during 2001, including $28.9 million in the first quarter of 2001, and would have recorded approximately $8.7 million of amortization during 2002. In lieu of amortization, we are required to perform an initial impairment review of our goodwill in 2002 and an annual impairment review thereafter. We completed our initial review during the first quarter of 2002 and concluded that no further impairment was required at March 31, 2002. We currently do not expect to record further impairment charges upon completion of the annual impairment review. However, there can be no assurance that, at the time of future reviews, a material impairment charge will not be required. Restructuring and Other Special Non-recurring Charges 13 On June 4, 2001, we announced that our board of directors had approved a restructuring program to refocus on the most significant market opportunities and to reduce operating costs due to the macroeconomic factors that were negatively affecting technology investment in the market. The restructuring program included a workforce reduction, consolidation of excess facilities, and discontinuance of non-core products and programs. As a result of the restructuring and other related special non-recurring charges and the impact of the macroeconomic conditions on us and our global base of customers, we recorded restructuring and special non-recurring charges, excluding goodwill impairment, of $106.6 million in the second fiscal quarter of 2001, with subsequent adjustments in the third and fourth quarters totaling $1.4 million. We conducted our assessment of the accounting effects of the restructuring program in accordance with EITF No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity", SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of", APB Opinion No. 9, "Reporting the Results of Operations" and the relevant provisions of the SEC's SAB No. 100, "Restructuring and Impairment Charges". Our assessment required assumptions in estimating the original accrued restructuring charges of $65.5 million on June 30, 2001, including estimating future recoveries of sublet income from excess facilities, liabilities from employee severances, and costs to exit business activities. Changes in these assessments with respect to the accrued restructuring charges of $40.7 million at March 31, 2002, could have a material effect on our reported results. To date, no material adjustments have been required. In addition, actual results could vary from these assumptions, resulting in an adjustment that could have a material effect on our future financial results. Impairment of Long-term Strategic Investments We assess the recoverability of the carrying value of strategic investments on a regular basis. Factors that we consider important and that we believe could trigger impairment include, but are not limited to, the likelihood that the company in which we invested would have insufficient cash flows to operate for the next twelve months, significant changes in the company's operating performance or business model and changes in overall market conditions. These investments are in private companies of which we typically own less than 10% of the outstanding stock. Because there is not a liquid market for these securities, we often must make estimates of the value of our investments. We recorded charges related to other than temporary declines in the value of certain strategic investments of $10.8 million in 2001. We also recorded a gain on the disposition of a long-term strategic investment of $1.6 million in 2001. It was determined that no further adjustment to the carrying value of the investments was necessary during the first quarter of 2002. As of March 31, 2002, long-term strategic investments, net of valuation allowances, amounted to $5.1 million. Allowance for Doubtful Accounts We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. At the time of a transaction, we assess whether the fee associated with the revenue transaction is fixed and determinable and whether collection is reasonably assured. We assess whether the fee is fixed and determinable based on the payment terms associated with the transaction and the creditworthiness of the customer. If any portion of a fee is due after 365 days from the invoice date, we account for the fee as not being fixed and determinable. In these cases, we recognize revenue as the fees become due. We assess collection based on a number of factors, including previous transactions with the customer and the creditworthiness of the customer. We do not request collateral from our customers. If we determine that collection of a fee is not reasonably assured, we defer the fee and recognize revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash. We base our ongoing estimate of allowance for doubtful accounts primarily on the aging of the balances in the accounts receivable, our historical collection patterns and changes in the credit-worthiness of our customers. 14 While credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Our accounts receivable include material balances from a limited number of customers, with five customers accounting for 59% of accounts receivable at March 31, 2002, as discussed in "Certain Factors That May Affect Our Business". Therefore, changes in the assumptions underlying this assessment or changes in the financial condition of our customers could result in a different required allowance, which could have a material impact on our reported quarterly earnings. As of March 31, 2002, accounts receivable totaled $25.1 million, net of an allowance for doubtful accounts of $3.3 million. RESULTS OF OPERATIONS The following table sets forth certain condensed consolidated statement of operations data expressed as a percentage of total revenues for the periods indicated:

(Unaudited) THREE MONTHS ENDED MARCH 31, ------------------ 2001 2002 ------ ----- Revenues: License .................................................... 33.5% 43.9% Services and maintenance ................................... 66.5 56.1 ------ ----- Total revenues ......................................... 100.0 100.0 ------ ----- Cost of revenues: License .................................................... 2.8 3.4 Services and maintenance ................................... 42.4 30.9 ------ ----- Total cost of revenues ................................. 45.2 34.3 ------ ----- Gross profit ................................................. 54.8 65.7 ------ ----- Operating expenses: Sales and marketing ........................................ 84.4 44.1 Research and development ................................... 30.1 21.9 General and administrative ................................. 14.9 12.8 Amortization of purchased product rights ................... 4.4 1.0 Amortization of goodwill and other purchased intangibles.... 91.7 -- ------ ----- Total operating expenses ............................... 225.5 79.8 ------ ----- Loss from operations ......................................... (170.7) (14.1) Interest income .............................................. 10.3 3.4 ------ ----- Loss before provision for income taxes .............................................. (160.4) (10.7) Provision for income taxes ................................... 1.1 1.4 ------ ----- Net loss ..................................................... (161.5)% (12.1)% ====== =====

15 REVENUES We generate revenues from licensing the rights to our software products to end-users and, to a lesser extent, from sublicense fees from resellers. We also generate revenues from consulting, training and post-contract support, or maintenance, performed for customers who license our products. We recognize revenues in accordance with the provisions of the SOP No. 97-2, "Software Revenue Recognition" and SOP No. 98-9, "Modifications of SOP No. 97-2, Software Revenue Recognition, with Respect to Certain Transactions". Revenues from perpetual software license agreements are recognized upon receipt of an executed license agreement, or an unconditional order under an existing license agreement, and shipment of the software, if there are no significant remaining vendor obligations, collection of the receivable is probable and payment is due within twelve months. Revenues from license agreements requiring the delivery of significant unspecified software products in the future are accounted for as subscriptions and, accordingly, are recognized ratably over the term of the agreement from the first instance of product delivery. Revenues from maintenance services are recognized ratably over the term of the maintenance period, which is typically one year. If maintenance services are included free of charge or discounted in a license agreement, such amounts are unbundled from the license fee at their fair market value based upon the value established by independent sales of such maintenance services to other customers. Revenues from the sale of Web server certificates are also recognized ratably over the term of the certificate, which is typically one to two years. Consulting and training revenues are generally recognized as the services are performed. Consulting services are typically performed under separate service agreements and are usually performed on a time and materials basis. Such services primarily consist of implementation services related to the installation and deployment of our products and do not include significant customization or development of the underlying software code. We use the percentage-of-completion method to account for fixed-price custom development contracts. Under this method, we recognize revenues and profit as the work on the contract progresses. Revenues are recognized by applying the percentage of the total cost incurred to date divided by the total estimated contract cost to the total contract value, and any projected loss is recognized immediately. The project cost estimates are reviewed on a regular basis. Total Revenues Total revenues decreased 13% from $31.5 million for the three months ended March 31, 2001 to $27.5 million for the three months ended March 31, 2002. Total revenues derived from North America decreased 1% from $20.1 million for the three months ended March 31, 2001 to $19.8 million for the three months ended March 31, 2002, while total revenues derived from outside of North America decreased 32% from $11.4 million for the three months ended March 31, 2001 to $7.7 million for the three months ended March 31, 2002. The majority of the overall decline in total revenues in the first three months of 2002 was experienced in Europe, Asia and other international locales, which is mainly due to the continued softening of the economic climate internationally and to our restructuring program from the second quarter of 2001, which resulted in fewer sales resources being applied in all regions, particularly in Asia Pacific and Latin America. The level of non-North American revenues has fluctuated from period to period and this trend is expected to continue for the foreseeable future. The relatively unchanged levels of North American revenues reflected the prolonged economic downturn experienced in this region and throughout the industry. The full effect of the economic downturn appears to have been felt first, and for the longest time period, in the North American market. In the three months ended March 31, 2002, one customer accounted for approximately 16% of total revenues, while no other single customer accounted for 10% or more of total revenues. 16 License Revenues License revenues increased 14% from $10.6 million for the three months ended March 31, 2001 to $12.1 million for the three months ended March 31, 2002, representing 34% and 44% of total revenues in the respective periods. The increase in license revenues in absolute dollars was primarily driven by the demand from both governments and enterprises for the Entrust Secure Web Portal Solutions, as well as the continued focus of our sales and marketing organization on core industries, such as government and financial. License revenues as a percentage of total revenues increased for the three months ended March 31, 2002 compared to the same period in 2001 due to decreasing demand for services and maintenance from our customers. The decline in demand reflected the timing of support renewals and professional services contracts and the delayed effect on demand for these services of the reduced license revenues base experienced in recent periods. Services and Maintenance Revenues Services and maintenance revenues decreased 26% from $20.9 million for the three months ended March 31, 2001 to $15.4 million for the three months ended March 31, 2002, representing 66% and 56% of total revenues in the respective periods. The decrease in services and maintenance revenues in absolute dollars was primarily the result of a decrease in demand for consulting services and customer support, resulting from the slowed growth of the license revenue base of customers experienced over the last year and the timing of support contract renewals on this license revenue base. Also, because our customer base has not been growing as rapidly as in the past, the demand for consulting services has declined as fewer customers have deployment and integration requirements, particularly in Europe where several large integration contracts ended in 2001. The decrease in services and maintenance revenues as a percentage of total revenues was primarily the result of a shift in mix of revenues from services and maintenance to license revenues during the first quarter of 2002. This shift was largely due to an increase in demand for the Entrust Secure Web Portal Solutions, and a decrease in customer demand for our services and maintenance business. COST OF REVENUES Cost of License Revenues Cost of license revenues consists primarily of costs associated with product media, documentation, packaging and royalties to third-party software vendors. Amortization of purchased product rights, acquired as part of the acquisition of enCommerce, has been excluded from cost of license revenues and instead has been included in operating expenses. Cost of license revenues increased slightly from $901,000 for the three months ended March 31, 2001 to $942,000 for the three months ended March 31, 2002, representing 3% of total revenues in each of the respective periods. The increase in cost of license revenues in absolute dollars was primarily a result of higher royalty fees paid to third-party software vendors, which reflects the increase in license revenues in general for the first three months of 2002, compared to the same period of 2001. The mix of third-party products may vary from period to period and consequently, our gross margins and our results of operations could be adversely affected. Cost of Services and Maintenance Revenues Cost of services and maintenance revenues consists primarily of personnel costs associated with customer support, training and consulting services, as well as amounts paid to third-party consulting firms for those services. Cost of services and maintenance revenues decreased from $13.3 million for the three months ended March 31, 2001 to $8.5 million for the three months ended March 31, 2002, representing 42% and 31% of total revenues for the respective periods. The decrease in absolute dollars during the three months ended March 31, 2002 reflected the decreased costs associated with lower levels of services and maintenance revenues experienced during the period. The decrease in the cost of services and maintenance revenues as a percentage of total revenues, especially in Europe, in the three months ended March 31, 2002 reflected higher productivity and utilization of available services resources compared to the same period of the previous year due to utilization targets being met on the additional investment made in new professional service personnel in prior periods. Further, the decrease as a percentage of 17 total revenues was indicative of the fact that services and maintenance revenues declined while license revenues increased in the first quarter of 2002, compared to the same quarter of 2001. Services and maintenance gross profit as a percentage of services and maintenance revenues was 36% and 45% for the three months ended March 31, 2001 and 2002, respectively. This increase in the services and maintenance gross profit as a percentage of services and maintenance revenues for the three months ended March 31, 2002, compared to the same period in 2001, reflected lower costs associated in professional services, as well as a shift in the services revenue mix from lower margin professional services revenues to higher margin support and maintenance revenues. We also eliminated several unprofitable service lines as part of our restructuring plan in the second quarter of 2001. OPERATING EXPENSES Sales and Marketing Sales and marketing expenses decreased from $26.6 million for the three months ended March 31, 2001 to $12.1 million for the comparable period in 2002. Sales and marketing expenses represented 84% of total revenues for the three months ended March 31, 2001, compared to 44% for the comparable period in 2002. The decrease in absolute dollars was due mainly to the cost reduction strategies implemented through our restructuring program which took effect in June 2001. In addition, until the implementation of our restructuring plan, we continued to make significant investments in marketing to support the launch of new products, services and marketing programs and we had continued our strategy of (a) investing in hiring and training our direct sales organization in anticipation of future market growth, and (b) investing in marketing efforts in support of new product launches. The decrease in sales and marketing expenses as a percentage of total revenues for the three months ended March 31, 2002, compared to the same period in 2001, reflected the cost savings from the restructuring plan, and the lower than expected revenues in the first three months of 2001. We will continue to focus on improving the productivity of our sales and marketing organizations and on gaining efficiencies in the related processes in light of current economic conditions. Failure of these investments in sales and marketing, as adjusted through our restructuring plan, to generate future revenues will have a significant adverse effect on our operations. Due to the changes in the economic environment and the impact of the restructuring program, particularly the curtailment of certain products and presence in certain geographies, we had recorded bad debt write-offs and additional provisions to the allowance for doubtful accounts totaling $7.7 million in the year ended December 31, 2001, which was recorded primarily in sales and marketing expenses. During the first quarter of 2002, the allowance for doubtful accounts decreased by $0.6 million as a result of better cash collections during the quarter, and as such, an additional bad debt expense was not required. Research and Development Research and development expenses decreased from $9.5 million for the three months ended March 31, 2001 to $6.0 million for the comparable period in 2002. Research and development expenses represented 30% of total revenues for the three months ended March 31, 2001, compared to 22% for the comparable period in 2002. The decreased investment in research and development expenses in absolute dollars was due mainly to the cost reduction strategies implemented through our restructuring program which took effect in June 2001. In addition, employees were added during the first three months of 2001, primarily in connection with the continuing expansion and enhancement of our product offerings and our commitment to quality assurance and testing, globalization of these product offerings, and due to the integration of enCommerce. However, we believe that we must continue to maintain our investment in research and development in order to maintain our technological leadership position and, thus, expect research and development expenses to increase in absolute dollars in the future as additional experienced security experts and software engineers are required. General and Administrative 18 General and administrative expenses decreased from $4.7 million for the three months ended March 31, 2001 to $3.5 million for the comparable period in 2002. General and administrative expenses represented 15% of total revenues for the three months ended March 31, 2001, compared to 13% for the comparable period in 2002. The decrease in general and administrative expenses in absolute dollars and in percentage was mainly due to the cost reduction strategies implemented through our restructuring program which took effect in June 2001. We continue to look for ways to gain efficiencies throughout our administrative processes through the enhancements and improvements to our infrastructure. Amortization of Goodwill, Purchased Product Rights and Other Purchased Intangibles Amortization expense in connection with acquisition-related intangibles decreased from the prior period, due to the impairment of goodwill, purchased product rights and other purchased intangibles recorded in June 2001, as well as the adoption of SFAS No. 142 as of the first quarter of 2002. In June 2001, the Financial Accounting Standards Board (FASB) approved for issuance Statement of Financial Accounting Standards No. 142 (SFAS No. 142), "Goodwill and Intangible Assets", which revises the accounting for purchased goodwill and intangible assets. Under SFAS No. 142, goodwill and intangible assets with indefinite lives will no longer be amortized, but will be tested for impairment annually and also in the event of an impairment indicator. We have adopted SFAS No. 142 as of January 1, 2002. This adoption has affected the amortization of intangibles, resulting from the following past acquisitions: On March 14, 2000, we completed the acquisition of CygnaCom, a company based in McLean, Virginia that delivers information technology products and services, with expertise in public key infrastructure, cryptographic technologies, security engineering and systems integration and development. Pursuant to the stock purchase agreement dated March 14, 2000, entered into between us, CygnaCom and the shareholders of CygnaCom, we agreed to acquire all of the outstanding shares of CygnaCom for an aggregate purchase price of $16.6 million, which included cash consideration of $16.0 million. The acquisition was recorded under the purchase method of accounting and, therefore, the results of operations of CygnaCom are included in our financial statements from the acquisition date. Upon consummation of the acquisition, CygnaCom became a wholly owned subsidiary. In connection with this acquisition, we recorded goodwill of $16.6 million, and goodwill amortization of $1.4 million was expensed for the three months ended March 31, 2001. No goodwill amortization was recorded for the three months ended March 31, 2002, due to the adoption of SFAS No. 142. On June 26, 2000, we completed the acquisition of enCommerce, a company based in Santa Clara, California, that provides software and services for managing global e-business relationships. The acquisition of enCommerce's outstanding capital stock, options and warrants for a total consideration of $505.5 million was accounted for under the purchase method of accounting, which resulted in an allocation of $449.6 million to purchased product rights, goodwill and other purchased intangibles. Also, in connection with this acquisition, an appraisal was done of the intangible assets, resulting in $29.6 million of the purchase price being allocated to in-process research and development that had not yet reached technological feasibility and had no alternative future use. This in-process research and development was expensed in 2000. Amortization of goodwill and other purchased intangibles of $27.3 million was expensed for the three months ended March 31, 2001. No amortization of these assets was recorded for the same period in 2002, due to the adoption of SFAS No. 142. Amortization of purchased product rights of $1.4 million and $284,000 was expensed for the three months ended March 31, 2001 and 2002, respectively. In addition, we recorded goodwill amortization of $235,000 for the three months ended March 2001 with respect to goodwill recorded as a result of the acquisition of r3 in 1998. No amortization of this asset was recorded for the same period in 2002, due to the adoption of SFAS No. 142. Interest Income Interest income decreased from $3.2 million for the three months ended March 31, 2001 to $932,000 for the comparable period in 2002. Interest income represented 10% of total revenues for the three months ended March 31, 19 2001, compared to 3% for the comparable period in 2002. The decrease in interest income reflected the reduced balance of funds invested, as these amounts have been drawn down to fund cash flow from operations and to acquire long-lived assets and long-term strategic investments. In addition, the decrease was due to the lower interest rates that were available during the first three months of 2002, as compared to the same period in 2001. Provision for Income Taxes We recorded an income tax provision of $350,000 for the three months ended March 31, 2001, compared with an income tax provision of $395,000 for the same period of 2002. We account for income taxes in accordance with SFAS No. 109. The effective income tax rates differed from statutory rates primarily due to the non-deductibility of the amortization of goodwill and other purchased intangible assets, as well as an adjustment of the valuation allowance that has offset substantially the tax benefits from the significant net operating loss and tax credit carry-forwards available. LIQUIDITY AND CAPITAL RESOURCES We used cash of $13.6 million in operating activities during the three months ended March 31, 2002. This cash outflow was primarily a result of a net loss before non-cash charges of $1.1 million, a decrease in accrued liabilities and accounts payable of $1.5 million, a decrease in accrued restructuring charges of $6.3 million, a decrease in deferred revenue of $2.0 million, and an increase in accounts receivable and prepaid expenses of $2.7 million during the period. Our average days sales outstanding at March 31, 2002 was 82 days, which represents an increase over the 75 days that we reported at December 31, 2001. The overall increase in days sales outstanding from December 31, 2001 reflects an increase in the accrued unbilled receivable for the Government of Canada "Secure Channel" project that will not be billed and collected until the second quarter of 2002, and a decrease in the allowance for doubtful accounts. For purposes of calculating average days sales outstanding, we divide accounts receivable at period end by the current quarter's revenues and multiply this amount by 90 days. The level of accounts receivable at each quarter end will be affected by the concentration of revenues in the final weeks of each quarter and may be negatively affected by increased international revenues in relation to total revenues as licenses to international customers often have longer payment terms. During the three months ended March 31, 2002, we provided $7.5 million of cash in investing activities, primarily due to cash provided by reductions in marketable investments in the amount of $8.0 million (net of $41.4 million of marketable investment purchases). We also invested $530,000 in property and equipment, primarily for computer hardware, furniture and leasehold improvements required to complete the fit-up of our new Addison, Texas facility. Cash provided by financing activities for the three months ended March 31, 2002 was $2.1 million, primarily from the exercise of employee stock options and the sale of shares under our employee stock purchase plan. For disclosure regarding our contractual obligations and commercial commitments, please see notes 9 and 14 to our consolidated financial statements for the year ended December 31, 2001 contained in our Annual Report on Form 10-K. We incurred no new significant contractual obligations or commitments during the first quarter of 2002. As of March 31, 2002, our cash, cash equivalents and marketable investments in the amount of $150.6 million provided our principal sources of liquidity. Overall, we used $12.0 million from our cash, cash equivalents and marketable investments in the three months ended March 31, 2002. Although we expect improved profitability for the remainder of 2002 as we work towards breakeven operating earnings, we estimate that we will continue to use cash throughout 2002 to fund operating losses and to satisfy the obligations accrued for under our restructuring program. While there can be no assurance as to the extent of usage-of-liquid resources in the current fiscal year, we believe that our cash flows from operations and existing cash, cash equivalents and marketable investments will be sufficient to meet our needs for at least the next twelve months. 20 Certain Factors That May Affect Our Business Our quarterly revenues and operating results are subject to significant fluctuations and such fluctuations may lead to a reduced market price for our stock. Our quarterly revenues and operating results have varied in the past and may continue to fluctuate in the future. We believe that period-to-period comparisons of our operating results are not necessarily meaningful, but securities analysts and investors often rely upon these comparisons as indicators of future performance. If our operating results in any future period fall below the expectations of securities analysts and investors, the market price of our securities would likely decline. Factors that have caused our results to fluctuate in the past and which are likely to affect us in the future include the following: . length of sales cycles associated with our product offerings; . the timing, size and nature of our licensing transactions; . market acceptance of new products or product enhancements by us or our competitors; . the relative proportions of revenues derived from licenses and services and maintenance; . the timing of new personnel hires and the rate at which new personnel become productive; . changes in pricing policies by our competitors; . changes in our operating expenses; and . fluctuations in foreign currency exchange rates. In addition, in June 2001 we signed a $17.6 million contract with Bell Nexxia for the Government of Canada project known as "Secure Channel". This contract is being accounted for on a subscription basis over four fiscal quarters, with software revenue recognition beginning in the second quarter of 2001 and ending during the first quarter of 2002. As a result of the completion of the subscription period, we will have to increase new software license revenues by a larger amount than achieved in the past four quarters in order to maintain operating results at current levels. While we are focused on marketing programs and revenue generating opportunities to increase software revenues, there can be no assurances that these initiatives will be successful. Estimating future revenues is difficult, and our failure to do so accurately may lead to a reduced market price for our stock and reduced profitability. Estimating future revenues is difficult because we ship our products soon after an order is received and, as such, we do not have a significant backlog. Thus, quarterly license revenues depend heavily upon orders received and shipped within the same quarter. Moreover, we historically have recorded 50% to 80% of our total quarterly revenues in the third month of the quarter, with a concentration of revenues in the second half of that month. We expect that this concentration of revenues, which is attributable in part to the tendency of some customers to make significant capital expenditures at the end of a fiscal quarter and to sales patterns within the software industry, will continue for the foreseeable future. Our expense levels are based, in significant part, upon our expectations as to future revenues and are largely fixed in the short term. We may be unable to adjust spending in a timely manner to compensate for any unexpected shortfall in revenues. Any significant shortfall in revenues in relation to our expectations could have an immediate and significant effect on our profitability for that quarter and may lead to a reduced market price for our stock. Our restructuring of operations may not achieve the results we intend and may harm our business. In June 2001, we announced a restructuring of our business, which included a reduction in work force and the closure of three international locations, as well as other steps we took to reduce expenses. The planning and implementation of our restructuring has placed, and may continue to place, a significant strain on our managerial, operational, financial and other resources. Additionally, the restructuring may negatively affect our employee 21 turnover, recruiting and retention of important employees. If we are unable to implement our restructuring effectively or if we experience difficulties in effecting the restructuring, our expenses could increase more quickly than we are expecting. If we find that our restructuring announced in June 2001 did not sufficiently decrease the growth of our expenses, we may find it necessary to implement further streamlining of our expenses, to perform another reduction in our headcount or to undertake a further restructuring of our business. Because of the lengthy and unpredictable sales cycle associated with our large software transactions, we may not succeed in closing transactions on a timely basis or at all, which would adversely affect our revenues and operating results. Transactions for our solutions often involve large expenditures, and the sales cycles for these transactions are often lengthy and unpredictable. Factors affecting the sales cycle include: . customers' budgetary constraints; . the timing of customers' budget cycles; and . customers' internal approval processes. We may not succeed in closing such large transactions on a timely basis or at all, which could cause significant variability in our revenues and results of operations for any particular period. If our results of operations and cash flows fall below the expectations of securities analysts, our stock price may decline. A limited number of customers has accounted for a significant percentage of our revenues, which may decline if we cannot keep or replace these customer relationships. Historically, a limited number of customers has accounted for a significant percentage of our revenues. In 1999, our three largest customers accounted for 31% of revenues, with the largest customer accounting for 24% of revenues. In 2000, our three largest customers accounted for 12% of revenues. In 2001, our three largest customers accounted for 18% of revenues. Our three largest customers accounted for 28% of revenues for the three months ended March 31, 2002. We anticipate that our results of operations in any given period will continue to depend to a significant extent upon revenues from a small number of customers. In addition, we anticipate that such customers will continue to vary over time, so that the achievement of our long-term goals will require us to obtain additional significant customers on an ongoing basis. Our failure to enter into a sufficient number of large licensing agreements during a particular period could have a significant adverse effect on our revenues. If the Internet security market does not continue to grow, demand for our products and services will be adversely affected. The market for Internet security solutions is at an early stage of development. Continued growth of the Internet security market will depend, in large part, on the following: . the continued expansion of Internet usage and the number of organizations adopting or expanding intranets and extranets; . the ability of network infrastructures to support an increasing number of users and services; . the public recognition of the potential threat posed by computer hackers and other unauthorized users; and . the continued development of new and improved services for implementation across the Internet, intranets and extranets. A decline in the growth of this market could reduce demand for our products, adversely affecting our revenues and results of operations. A breach of security at one of our customers, whether or not due to our products, could harm our reputation and reduce the demand for our products. The processes used by computer hackers to access or sabotage networks and intranets are rapidly evolving. A 22 well-publicized actual or perceived breach of network or computer security at one of our customers, regardless of whether such breach is attributable to our products, third-party technology used within our products or any significant advance in techniques for decoding or "cracking" encrypted information, could adversely affect the market's perception of us and our products, and could have an adverse effect on our reputation and the demand for our products. As our products contain errors or bugs, sales of our products would likely decline if some of these bugs or the number of bugs were significant. Like virtually all software systems, our products contain errors, failures or bugs that our existing testing procedures have not detected. The errors may become evident at any time during the life of our products. The discovery of any errors, failures or bugs in any products, including third-party technology incorporated into our products, may result in: . adverse publicity; . product returns; . the loss or delay of market acceptance of our products; and . third-party claims against us. Accordingly, the discovery of any errors, failures or bugs would have a significant adverse effect on the sales of our products. Our revenues may decline if we cannot compete successfully in an intensely competitive market. We target our products at the rapidly evolving market for Internet security solutions. Many of our current and potential competitors have longer operating histories, greater name recognition, larger installed bases and significantly greater financial, technical, marketing and sales resources than we do. As a result, they may be able to react more quickly to emerging technologies and changes in customer requirements, or to devote greater resources to the promotion and sale of their products. In addition, certain of our current competitors in particular segments of the security marketplace may in the future broaden or enhance their offerings to provide a more comprehensive solution competing more fully with our functionality. Increased competition, as well as consolidation of competitors, could result in lower prices, reduced margins or the failure of our products and services to achieve or maintain market acceptance, any of which could have a serious adverse effect on our business, financial condition and results of operations. Our business will not be successful if we do not keep up with the rapid changes in our industry. The emerging market for Internet security products and related services is characterized by rapid technological developments, frequent new product introductions and evolving industry standards. To be competitive, we have to continually improve the performance, features and reliability of our products and services, particularly in response to competitive offerings, and be first to market with new products and services or enhancements to existing products and services. Our failure to develop and introduce new products and services successfully on a timely basis and to achieve market acceptance for such products and services could have a significant adverse effect on our business, financial condition and results of operations. We may have difficulty managing our expanding operations, which could adversely affect our ability to successfully grow our business. The growth in the size and complexity of our business over the past few years has placed a significant strain on our managerial, operational and financial resources. Our ability to manage future growth, if any, will depend upon our ability to: . continue to implement and improve operational, financial and management information systems on a timely basis; and 23 . expand, train, motivate and manage our work force. Our personnel, systems, procedures and controls may not be adequate to support our operations. The geographic dispersal of our operations, including the separation of our headquarters in Addison, Texas, from our research and development facilities in Ottawa, Canada, and Santa Clara, California and from our European headquarters in Reading, United Kingdom, may make it more difficult to manage our growth. If we fail to continue to attract and retain qualified personnel, our business may be harmed. Our future success depends upon our ability to continue to attract and retain highly qualified scientific, technical, sales and managerial personnel. Competition for such personnel is intense, particularly in the field of cryptography, and there can be no assurance that we can retain our key scientific, technical, sales and managerial employees or that we can attract, motivate or retain other highly qualified personnel in the future. If we cannot retain or are unable to hire such key personnel, our business, financial condition and results of operations could be significantly adversely affected. Future acquisitions or investments could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our results of operations. It is possible, as part of our future growth strategy, that we will from time-to-time acquire or make investments in companies, technologies, product solutions or professional services offerings. With respect to these acquisitions, we would face the difficulties of assimilating personnel and operations from the acquired businesses and the problems of retaining and motivating key personnel from such businesses. In addition, these acquisitions may disrupt our ongoing operations, divert management from day-to-day business, increase our expenses and adversely impact our results of operations. Any future acquisitions would involve certain other risks, including the assumption of additional liabilities, potentially dilutive issuances of equity securities and incurrence of debt. In addition, these types of transactions often result in charges to earnings for such items as amortization of goodwill or in-process research and development expenses. We face risks associated with our international operations, which, if not managed properly, could have a significant adverse effect on our business, financial condition or results of operations. In the future, we may establish additional foreign operations, hire additional personnel and establish relationships with additional partners internationally. This expansion would require significant management attention and financial resources and could have an adverse effect on our business, financial condition and results of operations. Although our international sales currently are primarily denominated in U.S. dollars, we may increasingly denominate sales in foreign currencies in the future. In addition, our international business may be subject to the following risks: . difficulties in collecting international accounts receivable; . difficulties in obtaining U.S. export licenses, especially for products containing encryption technology; . potentially longer payment cycles for customer payments; . increased costs associated with maintaining international marketing efforts; . introduction of non-tariff barriers and higher duty rates; . difficulties in enforcement of contractual obligations and intellectual property rights; . difficulties managing personnel and operations in remote locations; and . increased complexity in global corporate tax structure. Any one of these could significantly and adversely affect our business, financial condition or results of operations. If the laws regarding exports of our products further limit or otherwise restrict our business, we could be 24 prohibited from shipping our products to restricted countries, which would result in a loss of revenues. Some of our products are subject to export controls under laws of the U.S., Canada and other countries. The list of products and countries for which exports are restricted, and the relevant regulatory policies, are likely to be revised from time to time. If we cannot obtain required government approvals under these regulations, we may not be able to sell products abroad or make products available for sale internationally via computer networks such as the Internet. Furthermore, U.S. governmental controls on the exportation of encryption products and technology may in the future restrict our ability to freely export some of our products with the most powerful information security encryption technology. We may not be able to protect our intellectual property rights, which could make us less competitive and cause us to lose market share. Our future success will depend, in part, upon our intellectual property rights and our ability to protect these rights. We rely on a combination of patent, copyright, trademark and trade secret laws, nondisclosure agreements, shrink-wrap licenses and other contractual provisions to establish, maintain and protect our proprietary rights. Despite our efforts to protect our proprietary rights, unauthorized third parties may: . copy aspects of our products; . obtain and use information that we regard as proprietary; or . infringe upon our patents. Policing piracy and other unauthorized use of our products is difficult, particularly in international markets and as a result of the growing use of the Internet. In addition, third parties might successfully design around our patents or obtain patents that we would need to license or design around. Finally, the protections we have obtained may not be sufficient because: . some courts have held that shrink-wrap licenses, because they are not signed by the licensee, are not enforceable; . our trade secrets, confidentiality agreements and patents may not provide meaningful protection of our proprietary information; and . we may not seek additional patents on our technology or products and such patents, even if obtained, may not be broad enough to protect our technology or products. Our inability or failure to protect our proprietary rights could have a significant adverse effect on our business, financial condition or results of operations. We have been subject to, and may in the future become subject to, intellectual property infringement claims that could be costly and could result in a diversion of management's attention. As the number of security products in the industry and the functionality of these products further overlaps, software developers and publishers may increasingly become subject to claims of infringement or misappropriation of the intellectual property or proprietary rights of others. We received notice from one of our customers stating that we may be responsible for indemnifying that customer under a product license agreement for infringement of patents assigned to a third party. To date, the customer has not made a formal claim for indemnification from us. In addition, third parties may assert infringement or misappropriation claims against us in the future. Defending or enforcing our intellectual property could be costly and could result in a diversion of management's attention, which could have a significant adverse effect on our business, financial condition or results of operations. A successful claim against us could also have a significant adverse effect on our results of operations for the period in which damages are paid. We may lose access to technology that we license from outside vendors, which loss could adversely affect our ability to sell our products. We rely on outside licensors for patent and/or software license rights in technology that is incorporated into and is necessary for the operation of our products. For example, our ability to provide Web server certificates in the 25 future is dependent upon a licensing agreement we have with Baltimore Technologies, one of our primary competitors. Our success will depend in part on our continued ability to have access to such technologies that are or may become important to the functionality of our products. Any inability to continue to procure or use such technology could have a significant adverse effect on our ability to sell some of our products. Our stock price is volatile and may continue to be volatile in the future. The trading price of our common stock has been, and is expected to continue to be, highly volatile and may be significantly and adversely affected by factors such as: . actual or anticipated fluctuations in our operating results; . announcements of technological innovations; . new products or new contracts by us or our competitors; . developments with respect to patents, copyrights or propriety rights; . conditions and trends in the security industry; . changes in financial estimates by securities analysts; and . general market conditions and other factors. Nortel Networks is able to exercise significant influence over all matters requiring stockholder and board approval and could make decisions about our business that conflict with the interests of other stockholders. As of April 30, 2002, Nortel Networks Limited, through its subsidiary, Nortel Networks Inc., beneficially owned approximately 19.5% of our outstanding voting stock, and one of our ten directors was a representative of Nortel Networks. Accordingly, Nortel Networks has the ability to exert significant influence over our affairs, including the election of directors and decisions relating to our strategic and operating activities. This concentration of ownership may have the effect of delaying or preventing a change in control that other stockholders may find favorable. Provisions of our charter and bylaws may delay or prevent transactions that are in your best interests. Our charter and bylaws contain provisions, including a staggered board of directors that may make it more difficult for a third party to acquire us, or may discourage bids to do so. These provisions could limit the price that investors might be willing to pay for shares of our common stock and could make it more difficult for a third party to acquire, or could discourage a third party from acquiring, a majority of our outstanding voting stock. Our board of directors also has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock could make it more difficult for a third party to acquire, or may discourage a third party from acquiring, a majority of our outstanding voting stock. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Risk Associated with Interest Rates Our investment policy states that we will invest our cash reserves, including cash, cash equivalents and marketable investments, in investments that are designed to preserve principal, maintain liquidity and maximize return. We actively manage our investments in accordance with these objectives. Some of these investments are subject to interest rate risk, whereby a change in market interest rates will cause the principal amount of the underlying investment to fluctuate. Therefore, a depreciation in principal value of an investment is possible in situations where the investment is made at a fixed interest rate and the market interest rate then subsequently 26 increases. We try to manage this risk by maintaining our cash, cash equivalents and marketable investments with high quality financial institutions and investment managers. We also restrict the investments to primarily securities with short-term maturities, such that, at March 31, 2002, the majority of our marketable investments had maturities of less than six months from that date. As a result, we believe that our exposure to market risk related to interest rates is minimal. The following table presents the cash, cash equivalents and marketable investments that we held at March 31, 2002, that would have been subject to interest rate risk, and the related ranges of maturities as of that date:

MATURITY (in thousands) Within 3 Months 3-6 Months > 6 Months > 12 Months --------------- ---------- ---------- ----------- Investments classified as cash and cash equivalents... $36,238 $ -- $ -- $ -- Investments classified as held to maturity marketable investments ........... 51,223 20,917 29,228 7,910 ------- ------- ------- ------ Total amortized cost ........................... $87,461 $20,917 $29,228 $7,910 ======= ======= ======= ====== Fair value ........................................... $87,842 $20,972 $29,216 $7,891 ======= ======= ======= ======

Risk Associated with Exchange Rates We are subject to foreign exchange risk as a result of exposures to changes in currency exchange rates, specifically between the United States and Canada, the United Kingdom, Germany, France, Japan and Switzerland. However, this exposure is considered to be minimal due to the fact that the United Kingdom, German, French, Japanese and Swiss operations are not significant, and the Canadian operations are naturally hedged against exchange rate fluctuations since both revenues and expenses are denominated in Canadian dollars. Therefore, an unfavorable change in the exchange rate for the Canadian subsidiary would result in lower revenues when translated into U.S. dollars, but the expenses would be lowered in a corresponding fashion. As a result, we do not engage in formal hedging activities, but we do periodically review the potential impact of this risk to ensure that the risk of significant potential losses remains minimal. Risk Associated with Equity Investments We have invested in several privately held companies, most of which are technology companies in the start-up or development stage, or are companies with technologies and products that are targeted at geographically distant markets. If the demand for the technologies and products offered by these privately held companies materializes slowly, to a minimum extent, or not at all in the relevant markets, we could lose all or substantially all of our investments in these companies. To date, we have recorded losses of $10.8 million from impairments and a realized gain of $1.6 million from dispositions in connection with these investments. No additional impairments were recorded in the quarter ended March 31,2002. On April 12, 2002, we increased our investment in the voting capital of Entrust Japan from an ownership share of less than 10% to approximately 37% by exchanging cash of approximately $1.5 million, Entrust software product and distribution rights for certain Entrust products for the Japanese market, for additional shares in Entrust Japan. Our increased investment follows additional investments in Entrust Japan made by Toyota and SECOM in the fourth quarter of 2001. We have concluded that because, as of the second quarter of 2002, we have the ability to exercise significant influence over the operations of Entrust Japan, that beginning in the same period of 2002, we will account for this investment in Entrust Japan under the equity method, in accordance with the provisions of APB No. 18, "The Equity Method of Accounting for Investments in Common Stock" and ARB No. 51, "Consolidated Financial Statements". Accordingly, we will include our share of post-acquisition losses of Entrust Japan on the step-by-step acquisition method in our consolidated losses for the current fiscal year. In addition, we will record an adjustment to consolidated accumulated deficit to pick up the post-acquisition losses of Entrust Japan of prior years, attributable to 27 the less than 10% ownership block previously acquired. As a result, our previous investment in Entrust Japan of $0.4 million, at March 31, 2002, will be written down to zero in the second quarter of 2002 and we will begin including our share of current year losses in our operating results in that same quarter. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On July 7, 2000, an action entitled Frankel v. Entrust Technologies, Inc., et al., No. 2-00-CV-119, was filed in the U.S. District Court for the Eastern District of Texas. Subsequently, several similar actions were filed in the same court. All of these actions have been consolidated. On January 22, 2001, a consolidated amended complaint was filed. The consolidated amended complaint purports to be a class action lawsuit brought on behalf of persons who purchased or otherwise acquired our Common stock during the period from October 19, 1999 through July 3, 2000. The complaint alleges that the defendants misrepresented and failed to disclose certain information about our business and prospects. The complaint asserts claims under the Securities Exchange Act of 1934. The complaint does not specify the amount of damages sought. We moved to dismiss the consolidated complaint. On July 31, 2001, the Court granted the motion to dismiss. The Court granted plaintiffs 30 days leave to file an amended complaint. On August 30, 2001, plaintiffs filed an amended complaint. On September 21, 2001, we moved to dismiss the amended complaint. The Court has not yet ruled on our motion to dismiss. There has been no discovery to date, and no trial date has been established. We believe this class action is without merit we intend to deny all material allegations and to defend ourselves vigorously. An adverse judgment or settlement in this lawsuit could have a significant adverse impact on our future financial condition or results of operations. We are subject to various other legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, management does not currently believe that the outcome of any of these legal matters will have a significant adverse effect on our consolidated results of operations or consolidated financial position. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K List of Exhibits The exhibits listed on the Index to Exhibits immediately preceding such exhibits are filed as part of this report. Reports on Form 8-K: No reports on Form 8-K were filed in the quarter ended March 31, 2002. 28 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ENTRUST, INC. ------------- (Registrant) Dated: May 10, 2002 /s/ David L. Thompson -------------------------------------------- David L. Thompson Chief Financial Officer and Senior Vice President of Finance (Principal Financial and Accounting Officer) 29 ENTRUST, INC. INDEX TO EXHIBITS EXHIBIT DESCRIPTION ------- ----------- 10.1 Stock Exchange Agreement dated February 21, 2002 between Entrust, Inc. and F. William Conner 10.2 Restricted Stock Agreement Granted Under Amended and Restated 1996 Stock Incentive Plan, as amended, dated February 21, 2002 between Entrust, Inc. and David L. Thompson 10.3 Restricted Stock Agreement Granted Under Amended and Restated 1996 Stock Incentive Plan, as amended, dated February 21, 2002 between Entrust, Inc. and William McGee 30