<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 17, 1998
REGISTRATION NO. 333-57275
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- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
AMENDMENT NO. 4
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
ENTRUST TECHNOLOGIES INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
---------------
MARYLAND 7371 62-1670648
(STATE OR OTHER (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
JURISDICTION OF CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
INCORPORATION OR
ORGANIZATION)
---------------
2323 NORTH CENTRAL EXPRESSWAY
RICHARDSON, TEXAS 75080
(972) 994-8000
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
---------------
JOHN A. RYAN
PRESIDENT AND CHIEF EXECUTIVE OFFICER
ENTRUST TECHNOLOGIES INC.
2323 NORTH CENTRAL EXPRESSWAY
RICHARDSON, TEXAS 75080
(972) 994-8000
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
---------------
COPIES TO:
JOHN A. BURGESS, ESQ. KEITH F. HIGGINS, ESQ.
HALE AND DORR LLP ROPES & GRAY
60 STATE STREET ONE INTERNATIONAL PLACE
BOSTON, MASSACHUSETTS 02109 BOSTON, MASSACHUSETTS 02110
TELEPHONE: (617) 526-6000 TELEPHONE: (617) 951-7000
TELECOPY: (617) 526-5000 TELECOPY: (617) 951-7050
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date hereof.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
check the following box. [_]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [_]
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CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AGGREGATE AMOUNT OF
SCURITIES TO BE REGISTERED E OFFERING PRICE (1) REGISTRATION FEE (2)
-------------------------------------------------------------------------------
<S> <C> <C>
Common Stock, $.01 par value per
share................................. $156,032,006 $46,030
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</TABLE>
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(1) Estimated solely for the purpose of calculating the amount of the
registration fee pursuant to Rule 457(o) under the Securities Act of 1933,
as amended.
(2) $38,358 of such fee has been previously paid by the Registrant.
---------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
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<PAGE>
EXPLANATORY NOTE
This Registration Statement contains two forms of prospectus: one to be used
in connection with a United States offering of shares (the "U.S. Prospectus")
and one to be used in connection with a concurrent international offering of
shares (the "International Prospectus"). The U.S. Prospectus and the
International Prospectus are identical except that they contain different
front and back cover pages and different descriptions of the plan of
distribution (contained under the caption "Underwriting" in each of the U.S.
and International Prospectuses). The form of U.S. Prospectus is included
herein and is followed by those pages to be used in the International
Prospectus which differ from, or are in addition to, those in the U.S.
Prospectus. Each of the pages for the International Prospectus included herein
is labeled "Alternate Page for International Prospectus".
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED AUGUST 17, 1998
7,066,667 SHARES
[ENTRUST TECHNOLOGIES LOGO APPEARS HERE]
COMMON STOCK
(PAR VALUE $.01 PER SHARE)
-----------
Of the 7,066,667 shares of Common Stock offered, 5,653,334 shares are being
offered hereby in the United States and 1,413,333 shares are being offered in a
concurrent international offering outside the United States. The initial public
offering price and the aggregate underwriting discount per share will be
identical for both offerings. See "Underwriting".
Of the 7,066,667 shares of Common Stock offered, 5,400,000 shares are being
sold by the Company and 1,666,667 shares are being sold by the Selling
Stockholders. See "Principal and Selling Stockholders". The Company will not
receive any of the proceeds from the sale of the shares being sold by the
Selling Stockholders.
Prior to this offering, there has been no public market for the Common Stock
of the Company. It is currently estimated that the initial public offering
price per share will be between $14.00 and $16.00. For factors to be considered
in determining the initial public offering price, see "Underwriting".
SEE "RISK FACTORS" BEGINNING ON PAGE 6 FOR CERTAIN CONSIDERATIONS RELEVANT TO
AN INVESTMENT IN THE COMMON STOCK.
The Common Stock has been approved for quotation on the Nasdaq National
Market under the symbol "ENTU".
-----------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
-----------
<TABLE>
<CAPTION>
INITIAL PUBLIC UNDERWRITING PROCEEDS TO PROCEEDS TO SELLING
OFFERING PRICE DISCOUNT(1) COMPANY(2) STOCKHOLDERS
-------------- ------------ ----------- -------------------
<S> <C> <C> <C> <C>
Per Share.......... $ $ $ $
Total(3)........... $ $ $ $
</TABLE>
- -----
(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933.
(2) Before deducting estimated expenses of $900,000 payable by the Company.
(3) The Selling Stockholders have granted the U.S. Underwriters an option for
30 days to purchase up to an additional 848,000 shares at the initial
public offering price per share, less the underwriting discount, solely to
cover over-allotments. Additionally, the Selling Stockholders have granted
the International Underwriters a similar option with respect to an
additional 212,000 shares as part of the concurrent international offering.
If such options are exercised in full, the total initial public offering
price, underwriting discount and proceeds to Selling Stockholders will be
$ , $ and $ , respectively. See "Underwriting".
-----------
The shares offered hereby are offered severally by the U.S. Underwriters, as
specified herein, subject to receipt and acceptance by them and subject to
their right to reject any order in whole or in part. It is expected that
certificates for the shares will be ready for delivery in New York, New York on
or about , 1998, against payment therefor in immediately available funds.
GOLDMAN, SACHS & CO.
DONALDSON, LUFKIN & JENRETTE
NATIONSBANC MONTGOMERY SECURITIES LLC
WARBURG DILLON READ LLC
-----------
The date of this Prospectus is , 1998.
<PAGE>
[Inside front cover]
On the left half of the page is a circular photo montage showing a globe and
various computer-related images. On the right-hand side of the page is the
caption "Enterprise Security with Real-World PKI Solutions". In the middle of
the page on the left side is the Company's name.
[Inside front cover fold-out, left page]
In the top half of the page is a photograph of the boxed versions of the
Company's Entrust PKI and Entrust Enterprise Desktop Suite Products. The lower
half of the page contains the following text:
Entrust Products
<TABLE>
<S> <C>
ENTRUST/DIRECT (TM)
ENTRUST/AUTHORITY(TM) Provides Entrust automated key
Provides comprehensive and certificate management
Certification Authority and features to secure Web sessions
key recovery capabilities
ENTRUST/EXPRESS(TM)
ENTRUST/ADMIN(TM) Provides security for popular
Performs PKI e-mail applications
administrative tasks
ENTRUST-READY(TM)
ENTRUST/DIRECTORY(TM) NETSCAPE(R) SOLUTION
Scalable directory system for Enables Entrust product
storage of key information features to be used with
Netscape Communicator
ENTRUST/TOOLKIT(TM)
A family of standards-based ENTRUST/ICE(TM) RELEASE 2.0
security APIs Provides security for files
and folders
ENTRUST/COMMERCECA(TM)
Comprehensive security for ENTRUST ENTERPRISE
credit card transactions DESKTOP SUITE(TM)
Provides for a comprehensive
solution for desktop security in
a single software package
</TABLE>
[Inside front cover fold-out, right-hand page]
The following text is in the top half of the page: "The Entrust Public-Key
Infrastructure. The Entrust PKI is an integrated, open and scalable software
framework that operates across multiple platforms, network devices and
applications." In the lower half of the page, a cartoon figure of a computer
with keys next to it is identified by the caption "Entrust PKI". This cartoon
is connected by arrows to four additional cartoon diagrams surrounding it and
labeled as follows: "SET Certs--Credit Card Transactions; Enterprise Certs--E-
mail, Desktop, Remote access, E-forms; Web Certs--E-commerce, Internet banking
and brokerage; VPN certs (expected to become available in late 1998)--Router,
Gateways, Firewalls, Access devices".
CERTAIN PERSONS PARTICIPATING IN THE OFFERINGS MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS IN SUCH
SECURITIES, AND THE IMPOSITION OF A PENALTY BID, IN CONNECTION WITH THE
OFFERINGS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING".
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and the Company's Consolidated Financial Statements, including the
Notes thereto, appearing elsewhere in this Prospectus. Except as otherwise
noted herein, all information in this Prospectus: (i) reflects the filing upon
the closing of the Offerings of the Company's Amended and Restated Articles of
Incorporation, which redesignates the Company's Series A Common Stock as Common
Stock (the "Common Stock"); (ii) gives effect to the conversion upon the
closing of the Offerings of all outstanding shares of the Company's Series B
Common Stock and Series B Non-Voting Common Stock into an aggregate of
13,063,836 shares of Common Stock; (iii) assumes the issuance of 7,700,000
shares of Common Stock to Northern Telecom Limited upon the surrender of shares
of the Company's Special Voting Stock and the concurrent exchange of
Exchangeable Shares of Entrust Technologies Limited, a majority-owned
subsidiary of the Company (the "Canadian Subsidiary"); (iv) gives effect to a
four-for-one stock split in the form of a stock dividend effected in July 1998;
and (v) assumes no exercise of the Underwriters' over-allotment option. See
"Underwriting". Unless otherwise specified herein, references to the "Company"
or "Entrust" mean Entrust Technologies Inc. and its subsidiaries.
THE COMPANY
Entrust Technologies Inc. ("Entrust" or the "Company") develops, markets and
sells products and services that allow enterprises to manage trusted, secure
electronic communications and transactions over today's advanced networks,
including the Internet, extranets and intranets. The Entrust solution automates
the management of digital certificates, which are similar to electronic
passports, through public key infrastructure ("PKI") technology designed to
assure the privacy and authenticity of internal and external electronic
communications. The Entrust PKI is an integrated, open and scalable software
framework that operates across multiple platforms, network devices and
applications, including e-mail, browsers, electronic commerce, electronic
forms, remote access and other product offerings from leading vendors. The
Company's product suite was first released in 1994, and has since been licensed
for use in global enterprises and government entities such as the Canadian
government, Citibank, the FDIC, J.P. Morgan, NASA, the Republic of Singapore
and the United Kingdom Post. In addition, over three million Entrust
certificates have been issued to date for use by the Company's customers.
The widespread adoption in recent years of public and private networks has
revolutionized the manner in which organizations communicate and conduct
business. These advanced networks provide an attractive medium for
communications and commerce because of their global reach, accessibility, use
of open standards and ability to permit interactions on a real-time basis. At
the same time, they have afforded businesses a user-friendly, low-cost way to
conduct a wide variety of commercial functions electronically. Today,
organizations are increasingly utilizing these networks to access new markets,
improve customer service and streamline business processes through applications
such as e-mail, messaging, remote access, intranet-based applications, on-line
customer support and supply chain applications.
The very openness and accessibility that has stimulated the use of public and
private networks has also driven the need for solutions that address the five
critical network security needs: access control, confidentiality, integrity,
authentication and non-repudiation. To address these needs, enterprises have
increasingly adopted the public key authentication and verification technology
offered by digital certificates. However, the mere issuance of digital
certificates does not ensure that a user's access is properly monitored, that
privileges associated with access are accurately and currently defined, or that
the certificates in question have not been withdrawn or replaced. The
proliferation of users and certificates greatly complicates management of these
issues, which are
3
<PAGE>
critical to maintaining an effective security environment across and between
enterprises. Moreover, unless digital certificates can be easily utilized on a
consistent and reliable basis across multiple applications, organizations face
the challenge and cost of maintaining a separate security infrastructure for
each application, requiring separate keys and certificates, multiple passwords
and inconsistent or incomplete security implementations.
The Company's PKI solution provides highly functional and flexible management
of network security features across an enterprise and between organizations.
The Entrust PKI solution offers enterprises all of the functionality necessary
for full life cycle management of public keys and digital certificates,
including enterprise certificates for use across multiple applications, Web
certificates for secure Web transactions and electronic commerce certificates
for secure credit card transactions. Entrust products can support multiple
applications and large numbers of simultaneous users, while seamlessly
effecting complex certification and key recovery functions, enabling
enterprises to significantly reduce their overall costs for addressing security
requirements.
The Company's objective is to maintain and enhance its position as the
leading provider of comprehensive PKI solutions, building on its four years of
product deployment experience and its 140-person research and development team
that includes researchers with international reputations in their fields. The
Company's marketing strategy is to target Global 2000 organizations and large
government entities that have significant requirements for comprehensive PKI
solutions and the resources to deploy them broadly. The Company also has an
Entrust Partner Program to achieve widespread adoption of its PKI solution.
This program includes VAR and OEM partners that create bundled solutions which
allow customers to purchase total desktop applications incorporating Entrust
functionality. These VAR and OEM partners include Digital Equipment
Corporation, EDS, Hewlett-Packard, IBM and Tandem, which resell the Company's
products with their hardware and networking solutions, as well as Check Point
Software, Symantec and TimeStep, which plan to bundle the Company's PKI
solutions with their own software products. The program also includes
consultant and systems integration partners that recommend and implement
Entrust-Ready security solutions as part of their overall service offerings to
customers. These partners, which include Coopers & Lybrand, Deloitte & Touche
and KPMG Peat Marwick, differentiate their offerings through the inclusion of
PKI functionality to broaden the Company's sales channels. In order to promote
the interoperability of the Company's PKI solution with a wide range of third
party product offerings, the Company has developed relationships with leading
technology providers such as Cisco, Lotus Development, Netscape and Shiva.
The Company was originally established in January 1994 as the Secure Networks
group of Northern Telecom Limited and its subsidiary, Northern Telecom Inc., to
pursue the development and sale of PKI products and services, and was
incorporated as a Maryland corporation in December 1996. The Company's
principal executive offices are located at 2323 North Central Expressway,
Richardson, Texas 75080, and its telephone number at that location is (972)
994-8000.
----------------
Entrust is a registered trademark, and Entrust-Ready, the Entrust design
(Elmer), Entrust/Authority, Entrust/Admin, Entrust/Directory,
Entrust/Entelligence, Entrust/Web Connector, Entrust/CommerceCA, Entrust/Lite,
Entrust/Solo, Entrust/ICE, Entrust/Express, Entrust/Direct, Entrust/True
Delete, Entrust/Toolkit, Entrust PKI, Entrust InSource, Entrust Partner and
Entrust SecureSummit are trademarks or service marks, of Entrust Technologies
Limited, a majority-owned subsidiary of Entrust Technologies Inc. Other
trademarks and service marks used in this Prospectus are the property of their
respective owners.
4
<PAGE>
THE OFFERINGS
The offering of 5,653,334 shares of Common Stock initially being offered in
the United States (the "U.S. Offering") and the concurrent offering of
1,413,333 shares of Common Stock initially being offered outside the United
States (the "International Offering") are collectively referred to herein as
the "Offerings". The closing of the International Offering is conditioned upon
the closing of the U.S. Offering and vice versa. See "Underwriting".
Common Stock offered:
<TABLE>
<S> <C>
By the Company:
U.S. Offering.......................... 4,320,000 shares
International Offering................. 1,080,000 shares
5,400,000
By the Selling Stockholders:
U.S. Offering ......................... 1,333,334 shares
International Offering ................ 333,333 shares
1,666,667
Total ............................... 7,066,667
</TABLE>
------
<TABLE>
----------
<S> <C>
Common Stock to be outstanding after the
Offerings............................... 47,643,164 shares(1)
Nasdaq National Market symbol.............. ENTU
Use of proceeds by the Company............. For working capital and other general
corporate purposes, including product
development and potential acquisitions
of complementary businesses, products or
technologies. See "Use of Proceeds".
</TABLE>
- -------
(1) Includes 6,549,480 shares of Special Voting Stock and excludes (i) an
aggregate of 9,587,960 shares of Common Stock reserved for issuance under
the Company's Amended and Restated 1996 Stock Incentive Plan, of which
7,385,764 shares were subject to outstanding options as of June 30, 1998 at
a weighted average exercise price of $2.96 per share, and (ii) an aggregate
of 400,000 shares of Common Stock reserved for issuance under the Company's
1998 Employee Stock Purchase Plan.
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
------------------------------- ----------------
1994 1995 1996 1997 1997 1998
------ ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DA-
TA:
Total revenues.............. $3,881 $ 3,973 $12,802 $25,006 $ 9,891 $20,938
Gross profit................ 2,696 2,989 9,252 20,090 7,551 17,028
Income (loss) from opera-
tions...................... 27 (2,424) 56 (490) (4) (21,816)
Net income (loss)........... 138 (2,123) 387 514 396 (21,439)
Net income (loss) per basic
share(1) .................. $ 0.02 $ 0.01 $ (0.69)
Net income (loss) per di-
luted share(1)............. $ 0.01 $ 0.01 $ (0.69)
Shares used to compute net
income (loss)
per basic share(1)......... 30,700 30,700 30,849
Shares used to compute net
income (loss)
per diluted share(1)....... 41,743 41,064 46,686
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1998
-----------------------
ACTUAL AS ADJUSTED(2)
------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments...... $ 4,369 $78,799
Working capital........................................ 3,138 77,568
Total assets........................................... 24,152 98,582
Shareholders' equity (deficit)......................... (6,733) 84,710
</TABLE>
- -------
(1) See Note 2 of Notes to the Company's Consolidated Financial Statements for
the calculation of basic and diluted net income (loss) per share.
(2) Gives effect to the sale of the 5,400,000 shares of Common Stock offered by
the Company pursuant to the Offerings at an assumed initial public offering
price of $15.00 per share, after deducting the estimated underwriting
discount and offering expenses. See "Use of Proceeds".
5
<PAGE>
RISK FACTORS
In addition to the other information in this Prospectus, the following risk
factors should be considered carefully in evaluating the Company and its
business before purchasing the shares of Common Stock offered by this
Prospectus. This Prospectus contains forward-looking statements that involve
risks and uncertainties. The cautionary statements contained in this
Prospectus should be read as being applicable to all related forward-looking
statements wherever they appear in this Prospectus. The Company's actual
results could differ materially from those discussed here. Important factors
that could cause or contribute to such differences include those discussed
below, as well as those discussed elsewhere in this Prospectus.
POTENTIAL FLUCTUATION AND UNCERTAINTY OF QUARTERLY OPERATING RESULTS
The Company's quarterly revenues and operating results have varied
substantially and may continue to fluctuate due to a number of factors,
including the timing, size and nature of the Company's licensing transactions;
the market acceptance of new products or product enhancements by the Company
or its competitors; product and price competition; the relative proportions of
revenues derived from licenses and services and maintenance; changes in the
Company's operating expenses; personnel changes; foreign currency exchange
rates; and fluctuations in economic and financial market conditions. The
timing, size and nature of individual licensing transactions are important
factors in the Company's quarterly results of operations. Transactions for the
Company's PKI solution often involve large expenditures, and the sales cycles
for these transactions are often lengthy and unpredictable. In addition, the
sales cycle associated with these transactions is subject to a number of
uncertainties, including customers' budgetary constraints, the timing of
customers' budget cycles and customers' internal approval processes. There can
be no assurance that the Company will be successful in closing such large
transactions on a timely basis or at all.
Estimating future revenues is difficult because the Company ships its
products soon after an order is received and as such does not have a
significant backlog. Thus, quarterly license revenues are heavily dependent
upon orders received and shipped within the same quarter. Moreover, the
Company has generally recorded 70% to 80% of its total quarterly revenues in
the third month of the quarter, with a concentration of revenues in the second
half of that month. The Company expects that this concentration of revenues
which is, in part, attributable to the tendency of certain 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.
The Company's expense levels are based, in significant part, on its
expectations as to future revenues and are largely fixed in the short term. As
a result, the Company may be unable to adjust spending in a timely manner to
compensate for any unexpected shortfall in revenues. Accordingly, any
significant shortfall of revenues in relation to the Company's expectations
would have an immediate and material adverse effect on the Company's financial
condition and results of operations for that quarter. In addition, the Company
plans to increase operating expenses to expand its research and development,
managerial, finance, sales and marketing and service and support
organizations. The timing of such expansion and the rate at which new
personnel become productive could cause material fluctuations in quarterly and
annual results of operations.
Due to all of the foregoing factors, the Company believes that period-to-
period comparisons of its results of operations are not necessarily meaningful
and that results in any particular quarter are not necessarily indicative of
future performance. Future revenues and results of operations may vary
substantially from quarter to quarter. In future quarters the Company's
results of operations may be below the expectations of public market analysts
and investors. In either case, the price of the Company's Common Stock could
be materially adversely affected. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
6
<PAGE>
LENGTHY SALES CYCLE; DELAYS IN DEPLOYMENT
Implementing the Company's PKI solution is complex and often requires
customers to make significant commitments of time and capital. During a
potential customer's evaluation of available network security products, the
Company spends substantial time, effort and resources educating the customer
about the value of the Company's PKI solution. Sales of the Company's products
require an extensive education and marketing effort throughout a customer's
organization because decisions to acquire such products generally involve a
significant number of customer personnel in various functional and geographic
areas, each having specific and often conflicting requirements. A variety of
factors, including factors over which the Company has little or no control,
may cause potential customers to favor a competing vendor or to delay or
forego a purchase. As a result, the sales cycle for the Company's products is
long, often ranging between six and nine months, and subject to significant
risks, including customers' budgetary constraints and internal acceptance
procedures, over which the Company has little or no control. Due to the
lengthy sales cycle for its products, the Company's ability to forecast the
timing and amount of specific sales is limited, and the delay or failure to
complete one or more large licensing transactions could have a material
adverse effect on the Company's business, financial condition or results of
operations.
Achievement of the Company's financial and other strategic goals is also
dependent upon the broad deployment of its PKI solution within enterprises
once an initial sale has been made. Because the Company's products are
deployed throughout the enterprise, the Company's customers have, from time to
time, and may in the future, delay deployment of the Entrust PKI solution for
a range of reasons, including delays in definition of applicable security
policies and procedures, integration of the solution with other IT components
or initiatives, coordination of the Entrust solution with business
reengineering or other organizational changes and training of systems
administrators and users. Delays in deployment, in turn, may limit the number
of additional customer purchases and discourage the widespread adoption of the
Company's products by other organizations.
RAPID TECHNOLOGICAL CHANGE; NEW PRODUCT AND SERVICE INTRODUCTIONS
The emerging market for network security products and related services is
characterized by rapid technological developments, frequent new product
introductions and evolving industry standards. The emerging nature of this
market and its rapid evolution will require the Company to improve the
performance, features and reliability of its products and services,
particularly in response to competitive offerings, and to be first to market
with new products and services or enhancements to existing products and
services. The success of new product introductions is dependent on several
factors, including proper new product definition and differentiation, timely
completion and introduction of new products, and market acceptance of the
Company's new products and services. The Company may not be successful in
developing and marketing new products and services that respond to competitive
and technological developments and changing customer needs. The failure of the
Company 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 material adverse effect on the Company's business, financial
condition and results of operations. In addition, the introduction of new
technologies or advances in techniques for gaining unauthorized network access
could render the Company's existing products obsolete or unmarketable. For
example, any slowdown in the adoption of digital certificates, or the
introduction of any alternative security infrastructures, because of the
introduction of new technologies or otherwise, could have a material adverse
effect on the Company's business, financial condition and long-term prospects.
Advances in techniques by individuals and entities seeking to gain
unauthorized access to networks could expose the Company's existing products
to new and unexpected attacks and require accelerated development of new
products or require the Company to invest resources in products that may not
become profitable. The adoption of new formal standards, or the evolution of
new de facto standards, could require the reconfiguration of the Company's
products, reduce their technical competitiveness or
7
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impede their adoption and deployment. Failure to counter challenges to current
products or introduce product offerings that keep pace with the technological
changes introduced by competitors or persons seeking to breach information
security could have a material adverse effect on the Company's business,
financial condition or results of operations. See "Business--Products and
Product Development".
COMPETITION
The Company's products are targeted at the new and rapidly evolving market
for PKI solutions. Although the competitive environment in this market has yet
to develop fully, the Company anticipates that it will be intensely
competitive, subject to rapid change and significantly affected by new product
and service introductions and other market activities of industry
participants.
Because of the broad functionality of its PKI solution, the Company competes
with vendors offering a wide range of security products and services. The
Company competes with companies offering commercial certification authority
products and services, such as VeriSign, GTE Cybertrust Solutions, XCert and
IBM in the market for issuing and maintaining digital certificates for use on
public and private networks. Certain of these companies are primarily service
providers rather than software solution vendors. The Company also competes
with companies such as Baltimore Technologies of Ireland, which offer PKI
product solutions for enterprises. In addition, the Company expects to compete
with established companies, such as Security Dynamics and Network Associates,
which have each announced their intention to introduce PKI products that would
be integrated with their other security offerings, as well as Microsoft
Corporation, which has announced its intention to offer a certificate server
product building on its existing security framework in the near future. In
addition, other major networking vendors could, in the future, bundle digital
certificates with their product offerings. The Company also competes with most
major networking device companies and firewall vendors in the emerging market
for providing security across virtual private networks ("VPNs"). The Company
expects that competition from established and emerging companies in the
financial and telecommunications industries will also increase in the near
term, and that certain of the Company's primary long-term competitors may not
yet have entered the market. Increased competition could result in pricing
pressures, reduced margins or the failure of the Company's products and
services to achieve or maintain market acceptance, any of which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Many of the Company's current and potential competitors have longer
operating histories, greater name recognition, larger installed customer bases
and significantly greater financial, technical and marketing resources than
the Company. As a result, they may be able to adapt more quickly to new or
emerging technologies and changes in customer requirements, or to devote
greater resources to the promotion and sale of their products than the
Company. In addition, current and potential competitors have established or
may in the future establish collaborative relationships among themselves or
with third parties, including third parties with whom the Company has
strategic relationships, to increase the ability of their products to address
the security needs of the Company's prospective customers. Accordingly, it is
possible that new competitors or alliances may emerge and rapidly acquire
significant market share. If this were to occur, the Company's business,
financial condition or results of operation could be materially adversely
affected. The Company may also compete for sales of its Entrust products
against its original equipment manufacturer ("OEM") licensees, who resell
Entrust products under their own brand names. The Company contemplates
offering other OEMs licenses to sell Entrust products provided under the
licensee's own brand name and therefore may face further competition for sales
revenues. See "Business--Sales, Marketing and Business Development". The
Company's current and potential competitors may also develop network security
products that are more effective than the Company's current or future products
and the Company's technologies and products may be rendered obsolete by such
developments. See "Business--Competition".
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DEPENDENCE ON LARGE CUSTOMERS
Historically, a limited number of customers has accounted for a significant
percentage of the Company's revenues. In 1995, two customers accounted for 53%
and 18% of revenues, respectively. In 1996, three customers accounted for an
aggregate of 64% of revenues, and 29%, 20% and 15% of revenues, respectively.
In 1997, three customers accounted for 19%, 12% and 11% of revenues,
respectively. The Company anticipates that its 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, the Company anticipates that
such customers will continue to vary over time, so that the achievement of the
Company's long-term goals will require the Company to obtain additional
significant customers on an ongoing basis. The failure of the Company to enter
into a sufficient number of large licensing agreements during a particular
period could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Overview".
MANAGEMENT OF GROWTH
The Company is currently experiencing rapid growth that is placing a
significant strain on its management and other resources. The Company's
business has grown significantly in size and complexity over the past three
years. Total revenues increased from $4.0 million in 1995 to $25.0 million in
1997. In addition, the number of employees increased from 43 to 250 during the
same period. During 1997, the number of sales and marketing personnel
increased from 23 to 87, and the Company expects to hire additional sales and
marketing and other personnel during 1998. The growth in the size and
complexity of the Company's business as well as its customer base has placed
and is expected to continue to place a significant strain on the Company's
management and operations. In addition, certain of the Company's senior
management have had limited experience in managing publicly traded companies.
The Company anticipates that continued growth, if any, will require it to
recruit and hire a substantial number of new development, managerial, finance,
sales and marketing and support personnel. The Company may not be successful
at hiring or retaining such personnel. The Company's ability to compete
effectively and to manage future growth, if any, will depend on its ability to
continue to implement and improve operational, financial and management
information systems on a timely basis and to expand, train, motivate and
manage its work force. The Company's personnel, systems, procedures and
controls may not be adequate to support its operations. The geographic
dispersal of the Company's operations, including the separation of its
headquarters in Richardson, Texas, from its research and development facility
in Ottawa, Canada, may make it more difficult to manage the Company's growth.
CHALLENGES OF R/3/ INTEGRATION
On June 8, 1998, the Company completed the acquisition of r/3/ Security
Engineering AG ("r/3/"), a company based in Zurich, Switzerland that provides
consulting, applied research and product development services related to
commercial security and encryption solutions. The combination of the two
companies will require, among other things, integration and coordination of
the companies, their respective research and development efforts, and other
business operations. There can be no assurance that such integration will be
accomplished smoothly or successfully. The difficulties of such integration
may also be affected by linguistic and cultural differences, as well as the
necessity of coordinating geographically separated organizations within
differing regulatory environments. The integration of certain operations will
require the dedication of management resources which may temporarily distract
attention from the day-to-day business of the combined company. The inability
of management to successfully integrate the operations of the two companies
could have a material adverse effect on the Company's business, financial
condition and results of operations.
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INDUSTRY REGULATION
The Company's products are subject to export controls under laws of the
U.S., Canada and other countries, and the Company believes that it has
obtained all necessary export approvals. There can be no assurance, however,
that the countries for which exports are restricted, and the regulatory
policies with respect thereto, will not be revised from time to time. The
inability of the Company to obtain required government approvals under these
regulations could materially adversely affect the ability of the Company to
sell products abroad or make products available for sale via international
computer networks such as the Internet. Furthermore, U.S. governmental
controls on the exportation of encryption products and technology may in the
future restrict the ability of the Company to freely export some of its
products with the most powerful information security encryption technology.
The Company is currently authorized under exemptions contained in an interim
U.S. export procedure to export products with encryption technology that is
more powerful than would be permitted in the absence of such authorization or
interim procedure. There can be no assurance that the interim procedure, which
expires on December 31, 1998, will be extended or that, if extended, the
Company will continue to meet the qualifications for exemption thereunder.
Furthermore, there can be no assurance that export versions of the Company's
products will be sought by foreign customers. As a result, foreign competitors
subject to less stringent export controls on their products may be able to
compete more effectively than the Company in the global information security
market. There can be no assurance that these factors will not have a material
adverse effect on the Company's business, financial condition or results of
operations. See "Business--Regulatory Matters".
Due to the increasing popularity of the Internet and other computer
networks, it is possible that laws and regulations may be enacted covering
issues such as user privacy, pricing, content and quality of products and
services. For example, the Telecommunications Act of 1996 prohibits the
transmission over the Internet of certain types of information and content.
The increased attention focused upon these issues as a result of the adoption
of other laws or regulations may reduce the rate of growth of the Internet and
other computer networks, which in turn could result in decreased demand for
the Company's products or could otherwise have a material adverse effect on
the Company's business, financial condition and results of operations. In
addition, the imposition of governmental regulations requiring the escrow and
governmental recovery of private encryption keys, as has been proposed from
time to time by various law enforcement agencies within the United States
government, could have a substantial chilling effect on the acceptance and use
of encryption products and public networks for secure communications, which,
in turn, could result in decreased demand for the Company's products or could
otherwise have a material adverse effect on the Company's business, financial
condition and results of operations.
Under the current U.S. government policy, U.S. encryption export controls do
not apply to encryption products which meet all of the following criteria: (i)
are produced and exported from outside of the U.S.; (ii) do not contain U.S.-
origin encryption technologies, unless such technologies are "publicly
available"; (iii) do not contain U.S.-origin encryption source code, unless
such source code is obtained in printed (i.e., "hard copy") form; (iv) are
developed and produced without technical assistance from any U.S. person or
entity; and (v) contain no more than a de minimis amount of U.S.-origin non-
encryption software or technology. The Company believes, and has informed the
U.S. government, that certain of the Company's products are exempt from U.S.
encryption export restrictions under these criteria. The Company, however, has
not obtained any formal U.S. government ruling that any of its products
produced and shipped from outside the U.S. may be exempt from U.S. encryption
export controls, and there can be no assurance that the U.S. government will
refrain from asserting jurisdiction over one or more of the Company's
products. Such a decision by the U.S. government to assert jurisdiction could
result in penalties for past shipments and could restrict future sales of the
Company's products outside the U.S. and Canada, having a potentially material
adverse effect on the Company's business, financial condition and results of
operations.
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COMPETITIVE MARKET FOR TECHNICAL PERSONNEL
The Company's future performance depends, in significant part, upon the
continued service of its key scientific, technical, sales and management
personnel. The loss of the services of one or more of the Company's key
personnel could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company does not maintain
key person life insurance policies on any of its employees. The Company's
future success also depends on its continuing ability 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 the Company can retain its
key scientific, technical, sales and managerial employees or that it can
attract, motivate or retain other highly qualified scientific, technical,
sales and managerial personnel in the future. If the Company cannot retain or
is unable to hire such key personnel, the Company's business, financial
condition and results of operations could be materially adversely affected.
See "Business--Employees".
RISKS REGARDING SALES STRATEGY; RELIANCE ON EVOLVING DISTRIBUTION CHANNELS
To sell to its targeted markets, the Company has established, and intends to
expand, a direct sales force. Unless the Company's direct sales force is able
to generate significant additional revenues as it is expanded, the Company's
operating results may be adversely affected while the Company incurs
expenditures in hiring and training additional sales personnel. In addition,
because the Company's products and target market require relatively
experienced sales personnel, the Company may be unable to achieve its sales
goals if it cannot identify and hire sufficient numbers of sales personnel
with requisite industry experience, or train such personnel on a timely basis.
Although direct sales have to date accounted for a majority of the Company's
revenues, the Company has established, and intends to expand, a dedicated
partnership program including technology partners, VARs, OEMs, service
providers, development partners, distributors and other technology, marketing
and sales partners. The Company's relationships with many of these partners
have only been established recently. The Company therefore cannot yet evaluate
the degree to which its partnership programs will facilitate the broad
adoption of its PKI solution or provide alternate marketing and selling
channels for the Company's products. In addition, the Company may not be able
to manage potential conflicts among channel partners effectively, economic
conditions or industry demand may adversely affect these or other indirect
channels and one or more of its partners may devote greater resources to
marketing and supporting the products of other companies.
RISKS ASSOCIATED WITH THE INFORMATION SECURITY MARKET
The market for the Company's PKI solution is at an early stage of
development. A decline in demand for the Company's products, whether as a
result of competition, technology change, the public's perception of the need
for security products, developments in the hardware and software environments
in which these products operate, general economic conditions or other factors,
could have a material adverse effect on the Company's business, financial
condition or results of operations. Continued growth of this market will
depend, in large part, upon the continued expansion of Internet usage and in
the number of organizations adopting or expanding intranets and extranets, the
ability of their respective 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 private and public
networks. If the network systems or complementary products and services are
not developed in a timely manner and, consequently, the market for the
Company's products fails to grow or grows more slowly than the Company
currently anticipates, its business, operating results and financial condition
would be materially and adversely affected.
A well-publicized actual or perceived breach of network or computer security
at one of the Company's customers, regardless of whether such breach is
attributable to the Company's products,
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could adversely affect the market's perception of the Company and the
Company's products, and could have an adverse effect on the Company's
business, financial condition or results of operations. In addition, although
the effectiveness of the Company's products is not dependent upon the secrecy
of its proprietary technology or licensed technology, the public disclosure of
its proprietary technology could result in a perception of breached security
and reduced effectiveness of the Company's products, which could have a
material adverse effect on the Company's business, financial condition or
results of operations.
Any significant advance in techniques for decoding or "cracking" encrypted
information could render some or all of the Company's existing products
obsolete or unmarketable. The Company's PKI solution depends in part on the
application of certain mathematical principles. The security afforded by the
Company's encryption technology is predicated on the assumption that
"factoring" of the composite of large prime numbers is difficult. If an "easy
factoring" method is developed, the security afforded by the Company's
encryption technology would be reduced or eliminated. There can be no
assurance that such a development will not occur. Moreover, even if no
breakthrough in factoring is discovered, factoring problems can theoretically
be solved by computer systems having sufficient speed and power. If such
improved techniques for decrypting encrypted information are developed or
rendered possible by the increased availability of powerful computing
resources, a material adverse effect on the Company's business, financial
condition and results of operations could result.
RISKS OF ERROR OR FAILURES
Products as complex as those offered by the Company may contain undetected
errors, failures or bugs when first introduced or when new versions are
released; such errors and failures may be detected at any point during the
product life cycle. Many companies offering software products have in the past
discovered failures and bugs in certain of their product offerings and have
experienced delays or lost revenues during the period required to correct
these errors. The computer technology environment is characterized by a wide
variety of standard and non-standard configurations that make pre-release
testing for programming or compatibility errors very difficult and time-
consuming, especially with the many configurations and variations of equipment
and operating systems in computer networks. Furthermore, despite testing by
the Company and by others, products may contain errors, failures or bugs that
are discovered only after commencement of commercial shipments by the Company.
Errors, failure or bugs in the Company's products could result in adverse
publicity, product returns, loss of or delay in market acceptance of the
Company's products or claims by the customer or others against the Company.
Alleviating such problems could require the Company to make significant
expenditures of capital and resources and could cause interruptions, delays or
cessation of service to the Company's customers. The Company attempts to limit
its liability to customers, including liability arising from a failure of the
security features contained in the Company's products, through contractual
limitations of warranties and remedies. However, some courts have held similar
contractual limitations of liability, or the "shrink-wrap licenses" in which
they sometimes are embodied, to be unenforceable. Accordingly, there can be no
assurance that such limitations will be enforced. The Company does not
currently carry product liability insurance. The processes and methodologies
used by computer hackers to access or sabotage networks and intranets are
rapidly evolving and are generally not recognized until launched against one
or more systems. Therefore, the Company, in most cases, is unable to
anticipate the methodologies or tactics of hackers prior to their
implementation. Any compromise of the security offered by the Company's
products, in a single incident or a series of incidents, could have a material
adverse effect on its business, operating results and financial condition. The
publicity surrounding any security breaches could adversely affect the public
perception of the security offered by the Company's PKI solution, which in
turn could also have a material adverse effect on its business, financial
condition and results of operations.
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INTERNATIONAL SALES RISKS
Although the Company has had limited sales outside of the U.S. and Canada,
the Company expects to increase its sales in international markets. In order
to expand international sales, the Company must establish additional foreign
operations, hire additional personnel and establish relationships with
additional partners. This expansion will require significant management
attention and financial resources and could have a material adverse effect on
the Company's business, financial condition and results of operations. In
addition, there can be no assurance that the Company will be able to maintain
or increase international market demand for the Company's products and
services. Although the Company's international sales are primarily denominated
in U.S. dollars, the Company has significant payroll and other obligations
that are denominated in Canadian dollars, and expects to incur an increasing
percentage of obligations denominated in foreign currencies. A change in the
value of the U.S. dollar relative to foreign currencies could make the
Company's products more expensive and, therefore, potentially less competitive
in those markets and could otherwise adversely affect the Company's ability to
meet its foreign-currency-denominated obligations. Currently, the Company does
not employ currency hedging strategies to reduce this risk. In addition, the
Company's international business may be subject to a variety of risks,
including difficulties in collecting international accounts receivable or
obtaining U.S. export licenses, potentially longer payment cycles, increased
costs associated with maintaining international marketing efforts, the
introduction of non-tariff barriers and higher duty rates and difficulties in
enforcement of contractual obligations and intellectual property rights. There
can be no assurance that such factors will not have a material adverse effect
on the Company's future international sales and, consequently, on the
Company's business, financial condition or results of operations.
LIMITED PROTECTION OF PROPRIETARY RIGHTS AND DEPENDENCE ON LICENSED RIGHTS
The Company relies on a combination of patent, trade secret, copyright and
trademark laws, non-disclosure agreements and contractual provisions to
establish and protect its proprietary rights. The Company also uses a printed
"shrink-wrap" license for users of its products in order to protect certain of
its copyrights and trade secrets. The Company attempts to protect its trade
secrets and other proprietary information through agreements with suppliers,
non-disclosure and non-competition agreements with employees and consultants
and other security measures.
There can be no assurance that the Company will seek patents on aspects of
its technology relating to its information security products, that any such
patents will be issued or that any such additional patents will be
sufficiently broad to protect the Company's technology relating to its
information security products. The status of computer-related patents involves
complex legal and factual questions and the breadth of claims allowed is
uncertain. Accordingly, there can be no assurance that patent applications
filed by the Company will result in patents being issued or that its existing
patents, and any patents that may be issued to it in the future, will afford
protection against competitors with similar technology, nor can there be any
assurance that patents issued to the Company will not be infringed upon or
designed around by others or that others will not obtain patents that the
Company would need to license or design around. If existing or future patents
containing broad claims are upheld by the courts, the holders of such patents
might be in a position to require the Company to obtain licenses to continue
to use such technology. There can be no assurance that any such licenses that
might be required for the Company's products would be available on reasonable
terms, if at all.
The Company relies on outside licensors, including RSA Data Security, Inc.
("RSA"), for patent and/or software license rights in encryption technology
that is incorporated into and is necessary for the operation of the Company's
products. The Company's success will depend in part on its continued ability
to have access to such technologies that are or may become important to the
functionality of its products. See "Business--Intellectual Property" and
"Certain Transactions". Any
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inability to continue to procure or use such technology on terms similar to
existing licenses could have a material adverse effect on the Company's
business, financial condition and results of operations.
Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or
to obtain and use information that the Company regards as proprietary.
Policing unauthorized use of the Company's products is difficult, and while
the Company is unable to determine the extent to which piracy of its software
products exists, such piracy can be expected to be a persistent problem,
particularly in international markets and as a result of the growing use of
the Internet. Some courts have held that shrink-wrap licenses, because they
are not signed by the licensee, are not enforceable. The Company's trade
secrets or confidentiality agreements may not provide meaningful protection of
the Company's proprietary information. Furthermore, there can be no assurance
that others will not independently develop similar technologies or duplicate
any technology developed by the Company or that the Company's technology will
not infringe upon patents of other rights owned by others. The Company's
inability to protect its proprietary rights could have a material adverse
effect on the Company's business, financial condition or results of
operations. Further, the Company may be subject to additional risk as it
enters into transactions in countries where intellectual property laws are not
well developed or are poorly enforced. Legal protections of the Company's
rights may be ineffective in such countries, and technology developed in such
countries may not be protectable in jurisdictions where protection is
ordinarily available.
As the number of information security products in the industry increases 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.
There can be no assurance that third parties will not assert infringement or
misappropriation claims against the Company in the future with respect to
current or future products.
Any claims or litigation, with or without merit, to defend or enforce the
Company's intellectual property could be costly and could result in a
diversion of management's attention, which could have a material adverse
effect on the Company's business, financial condition or results of
operations. Adverse determinations in such claims or litigation could also
have a material adverse effect on the Company's business, financial condition
or results of operations.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As a result, many companies' software and computer systems
may need to be upgraded or replaced in order to comply with such "Year 2000"
requirements. Although the Company believes that its products and systems are
Year 2000 compliant, the Company utilizes third-party equipment and software
that may not be Year 2000 compliant. Failure of such third-party equipment or
software to be Year 2000 compliant could require the Company to incur
unanticipated expenses to remedy any problems, which could have a material
adverse effect on the Company's business, financial condition and results of
operations. Furthermore, the purchasing patterns of customers or potential
customers may be affected by Year 2000 issues as companies expend significant
resources to correct their current systems for Year 2000 compliance. These
expenditures may result in reduced funds being available to implement the
infrastructure needed to conduct trusted and secure communications and
commerce over public and private networks or to purchase products and services
such as those offered by the Company, which could have a material adverse
effect on the Company's business, financial condition and results of
operations.
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BENEFITS OF THE OFFERINGS TO CURRENT STOCKHOLDERS
After the Offerings, it is expected that a public market will exist for the
Common Stock. At an initial public offering price of $15.00 per share, there
will be a substantial increase in the market value of the Common Stock held by
the Company's current stockholders over their original purchase price.
Following the closing of the Offerings, such stockholders will hold an
aggregate of 40,576,497 shares of Common Stock (39,516,497 shares if the
Underwriters' over-allotment option is exercised in full). In addition, the
Selling Stockholders are selling an aggregate of 1,666,667 shares of Common
Stock in the Offerings (2,726,667 shares if the Underwriters' over-allotment
option is exercised in full), resulting in aggregate proceeds to the Selling
Stockholders of approximately $25.0 million (approximately $40.9 million if
the Underwriter's over-allotment option is exercised in full). See "Dilution",
"Management" and "Principal and Selling Stockholders".
CONCENTRATION OF OWNERSHIP; CONFLICTS OF INTEREST
Upon completion of the Offerings, Northern Telecom Limited ("NTL") and its
subsidiary, Northern Telecom Inc. ("NTI", and, together with NTL and its
affiliates, "Nortel") will beneficially own approximately 56.4% of the
Company's outstanding Common Stock, and three of the Company's five directors,
David D. Archibald, F. William Conner and Frank A. Dunn, will be
representatives of Nortel. Accordingly, Nortel will continue to have the
ability to exert significant control over the Company's affairs, including
without limitation control over the election of the Company's directors and
control over the Company's strategic and operating activities. This
concentration of ownership and Board representation may have the effect of
delaying or preventing a change in control of the Company. In addition, under
a strategic alliance agreement NTL and the Company entered in 1996 (the
"Strategic Alliance Agreement"), NTL may restrict the Company, for so long as
NTL maintains beneficial ownership of a majority of the voting power of the
Company, from any act which may reasonably be anticipated to contravene any
material instrument binding on NTL, any order of any governmental body which
has jurisdiction over NTL or any of its assets, or any applicable law or
regulation. See "Management", "Principal and Selling Stockholders" and
"Certain Transactions".
Conflicts of interest may arise between the Company and Nortel in a number
of areas relating to their past and ongoing relationships. Under the Strategic
Alliance Agreement, the Company has granted to NTL for three years, or for as
long as the Company is controlled by NTL, whichever is longer, the right to
distribute Entrust products on terms no less favorable to NTL than the terms
of the agreements then in effect with other resellers of the Company's
products. The Company also granted to NTL a royalty-bearing license to use and
modify the Company's source code in NTL products on terms no less favorable to
NTL than those offered to other source code licensees. Although NTL has
informed the Company that it does not currently intend to compete against the
Company, there are no contractual or other restrictions on NTL's ability to
engage in competitive activities.
The directors of the Company who are officers of Nortel may also have
conflicts of interest with respect to matters potentially or actually
affecting both companies, such as acquisitions, financings and other corporate
opportunities that may be suitable for either one. To the extent that these
opportunities arise, the directors must consider such factors as whether the
opportunity is presented to the directors in their capacities as directors of
the Company, whether the opportunity is within the Company's line of business
consistent with its strategic objectives and whether the Company would be able
to undertake or benefit from such opportunity. There can be no assurance that
conflicts will be resolved in favor of the Company.
BROAD DISCRETION AS TO USE OF PROCEEDS
The Company intends to use the net proceeds, as determined by management in
its sole discretion, for working capital and general corporate purposes,
including product development and
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the possible acquisition of additional businesses and technologies that are
complementary to the current or future business of the Company. The Company
has not determined the specific allocation of the net proceeds among the
various uses described above and, accordingly, investors in the Offerings will
rely upon the judgment of the Company's management with respect to the use of
proceeds. See "Use of Proceeds".
NO PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK PRICE
Prior to the Offerings, there has been no public market for the Common
Stock, and there can be no assurance that an active trading market will
develop or be sustained after the Offerings or that the market price of the
Common Stock will not decline below the initial public offering price. The
initial public offering price will be determined by negotiations among the
Company and the Representatives of the Underwriters. See "Underwriting" for a
discussion of the factors to be considered in determining the initial public
offering price. The trading price of the Common Stock is likely to be highly
volatile and may be significantly and adversely affected by factors such as
actual or anticipated fluctuations in the Company's operating results,
announcements of technological innovations, new products or new contracts by
the Company or its competitors, developments with respect to patents,
copyrights or propriety rights, conditions and trends in the software
industry, changes in financial estimates by securities analysts, general
market conditions and other factors. The public equity markets have from time
to time experienced significant price and volume fluctuations that have
particularly affected the market prices for the stock of technology companies
as a group but have been unrelated to the performance of particular companies.
These broad market fluctuations, as well as shortfalls in sales or earnings as
compared with securities analysts' expectations, changes in such analysts'
recommendations or projections and general economic and market conditions, may
materially and adversely affect the market price of the Common Stock. See
"Underwriting".
DIVIDENDS
No cash dividends have been paid on the Common Stock to date, and the
Company does not anticipate paying dividends in the foreseeable future. See
"Dividend Policy".
DILUTION
Purchasers of shares of Common Stock in the Offerings will suffer an
immediate and substantial dilution in the net tangible book value of the
Common Stock from the initial public offering price. In addition, if the
average closing price of the Company's Common Stock for the first 10 trading
days following the Company's initial public offering (the "Market Price") is
less than $12.08, then the Company will be required to pay the former r/3/
shareholders the difference between the Market Price and $12.08 on their
1,167,288 shares of Common Stock. The Company has the option to make this
payment in cash or shares of Common Stock, and, if the Market Price is
substantially less than $12.08, the payment would further dilute new investors
in the Offerings. See "Dilution" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS
Sales of substantial amounts of shares of Common Stock in the public market
following the Offerings could adversely affect the market price of the Common
Stock. All of the Company's directors, officers and stockholders, as well as
all holders of options to purchase Common Stock, have agreed, pursuant to
lock-up agreements with the Representatives of the Underwriters or, in the
case of the option holders, pursuant to stock option agreements with the
Company (collectively, the "Lock-Up Agreements"), not to offer, sell, contract
to sell or otherwise dispose of their shares of Common Stock for 180 days
after the date of the Prospectus. Goldman, Sachs & Co. may release all or any
part of the shares subject to the Lock-Up Agreements at any time in its sole
discretion and
16
<PAGE>
without notice. Upon expiration of such 180-day period, in addition to the
shares of Common Stock offered hereby (and assuming no exercise of outstanding
options), approximately 39,397,169 additional shares of Common Stock will be
available for sale in the public market in accordance with Rules 144 or 701
under the Securities Act of 1933, as amended (the "Securities Act"). Promptly
following the consummation of the Offerings, the Company intends to register
an aggregate of 9,987,960 shares of Common Stock issuable under its stock
plans. The Company is unable to predict the effect that sales made under Rule
144, or otherwise, may have on the then prevailing market price of the Common
Stock. Following the Offerings, the holders of approximately 39,397,169 shares
of Common Stock are entitled to certain piggyback and demand registration
rights with respect to such shares. By exercising their registration rights,
such holders could cause a large number of shares to be registered and sold in
the public market. Sales pursuant to Rule 144 or other exemptions from
registration, or pursuant to registration rights, may have an adverse effect
on the market price for the Common Stock and could impair the Company's
ability to raise capital through an offering of its equity securities. See
"Description of Capital Stock", "Shares Eligible for Future Sale" and
"Underwriting".
POTENTIAL ADVERSE EFFECT OF ANTI-TAKEOVER PROVISIONS; POSSIBLE ISSUANCE OF
PREFERRED STOCK
The Company's Articles of Incorporation and Bylaws contain provisions,
including a staggered board of directors, that may make it more difficult for
a third party to acquire, or may discourage acquisition bids for, the Company.
These provisions could limit the price that certain investors might be willing
to pay for shares of the 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 the outstanding voting stock of the Company. See "Description of
Capital Stock". The Company's Board of Directors also has the authority to
issue up to 5,000,000 shares of preferred stock, $.01 par value per share
("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. See
"Description of Capital Stock--Preferred Stock". 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 the outstanding voting
stock of the Company.
17
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the shares of Common Stock
offered by the Company pursuant to the Offerings are estimated to be
$74,430,000 after deducting the estimated underwriting discount and offering
expenses and assuming an initial public offering price of $15.00 per share.
The Company will not receive any proceeds from the sale of shares of Common
Stock by the Selling Stockholders hereunder. See "Principal and Selling
Stockholders".
The principal purposes of the Offerings are to establish a public market for
the Common Stock, to facilitate future access by the Company to public equity
markets and to obtain additional working capital.
The Company intends to use the net proceeds of the Offerings for working
capital and other general corporate purposes, including product development.
The Company may also use a portion of the net proceeds of the Offerings to
fund acquisitions of complementary businesses, products or technologies,
although there are currently no commitments or agreements with respect to any
such acquisitions. See "Risk Factors--Broad Discretion as to Use of Proceeds".
Pending such use, the Company intends to invest the net proceeds of the
Offerings in short-term, investment grade, interest-bearing securities.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its shares of
Common Stock. The Company currently intends to retain all of its earnings, if
any, to finance future growth and therefore does not anticipate paying cash
dividends in the foreseeable future. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Liquidity and Capital
Resources".
18
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of June
30, 1998 (i) on an actual basis, (ii) on a pro forma basis as described in
Note 2 below, and (iii) as further adjusted reflecting the issuance and sale
of the 5,400,000 shares of Common Stock offered hereby by the Company pursuant
to the Offerings, at an assumed initial public offering price of $15.00 per
share and after deducting the estimated underwriting discount and offering
expenses. See "Use of Proceeds". The capitalization information set forth in
the table below is qualified by reference to the Company's Consolidated
Financial Statements and Notes thereto appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
JUNE 30, 1998
-------------------------------------
PRO FORMA
ACTUAL(1) PRO FORMA(2) AS ADJUSTED(2)
--------- ------------ --------------
(IN THOUSANDS)
<S> <C> <C> <C>
Long-term debt (including current portion
of long-term debt)...................... $ 30 $ 30 $ 30
------- ------- -------
Redeemable Series A common stock(3)...... 17,013 -- --
------- ------- -------
Shareholders' equity:
Preferred stock, $.01 par value;
5,000,000 shares authorized, no shares
issued or outstanding (actual); no
shares issued or outstanding (pro forma
and pro forma as adjusted)............. -- -- --
Common stock, $.01 par value; no shares
authorized, issued or outstanding
(actual); 100,000,000 shares authorized
(pro forma and pro forma as adjusted);
35,693,684 shares issued and
outstanding (pro forma);
41,093,684 shares issued and
outstanding (pro forma as
adjusted)(4)........................... -- 357 411
Series A common stock, $.01 par value;
100,000,000 shares authorized;
20,312,040 shares issued and
outstanding (actual); no shares
authorized, issued or outstanding (pro
forma and pro forma as adjusted)....... 203 -- --
Series B common stock, $.01 par value;
260,000 shares authorized; 221,052
shares issued and outstanding (actual);
no shares authorized, issued or
outstanding (pro forma and pro forma as
adjusted).............................. 2 -- --
Series B non-voting common stock, $.01
par value; 260,000 shares authorized;
38,948 shares issued and outstanding
(actual); no shares authorized, issued
or outstanding (pro forma and pro forma
as adjusted)........................... -- -- --
Special voting stock, $.01 par value;
15,000,000 shares authorized; 7,700,000
shares issued and outstanding (actual);
6,549,480 shares issued and outstanding
(pro forma and pro forma as adjusted).. 77 65 65
Additional paid-in capital............... 16,554 33,427 107,803
Unearned deferred compensation........... (733) (733) (733)
Accumulated other comprehensive income
(loss).................................. (48) (48) (48)
Accumulated deficit...................... (22,788) (22,788) (22,788)
------- ------- -------
Total shareholders' equity (deficit)..... (6,733) 10,280 84,710
------- ------- -------
Total capitalization..................... $10,310 $10,310 $84,740
======= ======= =======
</TABLE>
- --------
(1) Assumes (i) the filing in July 1998 of Articles of Amendment to the
Company's Articles of Incorporation increasing the authorized number of
shares of Preferred Stock, Series A Common Stock and Special Voting Stock
and (ii) the Company's four-for-one stock split in the form of a stock
dividend, effective as of July 1998.
(2) Gives effect to (i) the conversion of all outstanding shares of the
Company's Series B Common Stock and Series B Non-Voting Common Stock into
an aggregate of 13,063,836 shares of Common Stock upon the closing of the
Offerings, (ii) the expiration of the repurchase rights of the Redeemable
Series A Common Stock upon the closing of the Offerings, (iii) the
issuance of an aggregate of 1,150,520 shares of Common Stock upon the
surrender of a like number of shares of the Company's Special Voting Stock
and the concurrent exchange of a like number of Exchangeable Shares of
Entrust Technologies Limited by NTL upon the closing of the Offerings, and
(iv) the filing upon the closing of the Offerings of the Company's Amended
and Restated Articles of Incorporation eliminating the Company's Series B
Common Stock and Series B Non-Voting Common Stock, redesignating the
Company's Series A Common Stock as Common Stock and authorizing
100,000,000 shares of Common Stock.
(3) The holders of the Redeemable Series A Common Stock are entitled to the
same rights and privileges as the Series A Common Stock, except for
additional special provisions as described in Note 12 of Notes to the
Company's Consolidated Financial Statements. At June 30, 1998, there were
1,167,288 shares of Redeemable Series A Common Stock issued and
outstanding.
(4) Excludes (i) an aggregate of 9,587,960 shares of Common Stock reserved for
issuance under the Company's Amended and Restated 1996 Stock Incentive
Plan, of which 7,385,764 shares were subject to outstanding options as of
June 30, 1998 at a weighted average exercise price of $2.96 per share, and
(ii) an aggregate of 400,000 shares of Common Stock reserved for issuance
under the Company's 1998 Employee Stock Purchase Plan, which Plan will not
become effective until the closing of the Offerings. See "Management--
Stock Plans" and Note 8 of Notes to the Company's Consolidated Financial
Statements.
19
<PAGE>
DILUTION
The pro forma net tangible book value of the Company as of June 30, 1998 was
$6.7 million, or $0.16 per share of Common Stock. Pro forma net tangible book
value per share is determined by dividing the Company's tangible net worth
(tangible assets less liabilities) by the number of shares of Common Stock
outstanding, after giving effect to the expiration of the repurchase rights of
the Redeemable Series A Common Stock, the conversion of the Company's Series B
Common Stock and Series B Non-Voting Common Stock into an aggregate of
13,063,836 shares of Common Stock upon the closing of the Offerings and
assuming the issuance of 7,700,000 shares of Common Stock to NTL upon the
surrender of shares of the Company's Special Voting Stock and the concurrent
exchange of Exchangeable Shares of the Canadian Subsidiary. After giving
effect to the sale of the shares of Common Stock offered by the Company
pursuant to the Offerings at an assumed initial public offering price of
$15.00 per share and after deducting the estimated underwriting discount and
offering expenses, the pro forma net tangible book value of the Company as of
June 30, 1998 would have been $81.1 million, or $1.70 per share. This
represents an immediate increase in such pro forma net tangible book value of
$1.54 per share to existing stockholders and an immediate dilution of $13.30
per share to new investors purchasing shares in the Offerings. If the initial
public offering price is higher or lower, the dilution to the new investors
will be greater or less, respectively. The following table illustrates the per
share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share................ $15.00
Pro forma net tangible book value per share prior to the
Offerings................................................... $0.16
Increase per share attributable to the Offerings............. 1.54
Pro forma net tangible book value per share after the Offer-
ings.......................................................... 1.70
------
Dilution per share to new investors............................ $13.30
======
</TABLE>
The following table summarizes, as of June 30, 1998, the total number of
shares of Common Stock purchased from the Company, the total consideration
paid and the average consideration paid per share by the existing stockholders
and by the new investors based (for new investors) upon an assumed initial
public offering price of $15.00 per share (before deducting the estimated
underwriting discount and offering expenses):
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------ -------------------
AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders (1)
........................ 42,243,164 88.7% $35,054,233 30.2% $ 2.44
New investors (1) ....... 5,400,000 11.3 81,000,000 69.8 $15.00
---------- ----- ----------- -----
Total.................. 47,643,164 100.0% $16,054,233 100.0%
========== ===== =========== =====
</TABLE>
- --------
(1) The net effect of sales by the Selling Stockholders in the Offerings will
be to reduce the number of shares held by existing stockholders to
40,576,497 shares, or 85.2% of the total number of shares of Common Stock
outstanding after the Offerings (or 39,516,497 shares and 82.9% if the
Underwriters' over-allotment option is exercised in full), and to increase
the number of shares held by new investors to 7,066,667 shares, or 14.8%
of the total number of shares of Common Stock outstanding after the
Offerings ( or 8,126,667 shares and 17.1% if the Underwriters' over-
allotment option is exercised in full).
As of June 30, 1998, there were also outstanding options to purchase an
additional 7,385,764 shares of Common Stock at a weighted average exercise
price of $2.96 per share. To the extent the foregoing options are exercised,
there will be further dilution to new investors in the pro forma net tangible
book value of their shares. See "Capitalization", "Management--Stock Plans--
Amended and Restated 1996 Stock Incentive Plan" and Note 8 of Notes to the
Company's Consolidated Financial Statements.
20
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below for the years ended
December 31, 1995, 1996 and 1997 and at December 31, 1996 and 1997 are derived
from the Company's Consolidated Financial Statements, which appear elsewhere
in this Prospectus, and which have been audited by Deloitte & Touche Chartered
Accountants. The selected consolidated financial data set forth below for the
year ended December 31, 1994 and as of December 31, 1994 and 1995 are derived
from the Company's audited financial statements, which are not included in
this Prospectus. The selected consolidated financial data for the six months
ended June 30, 1997 and 1998 and as of June 30, 1998 are derived from
unaudited financial statements of the Company which appear elsewhere in this
Prospectus. Consolidated financial data is unavailable for periods prior to
1994, because the Company had no revenues and did not exist as a separate
business unit. In the opinion of management, the unaudited financial
statements have been prepared on a basis consistent with the Company's
Consolidated Financial Statements and include all adjustments (consisting only
of normal recurring adjustments) necessary for a fair presentation of the
Company's results of operations for those periods. The operating results for
the six months ended June 30, 1998 are not necessarily indicative of the
results to be expected for the full year ending December 31, 1998. The data
set forth below should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the
Company's Consolidated Financial Statements and Notes thereto included
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
------------------------------ --------------
1994 1995 1996 1997 1997 1998
------ ------- ------ ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DA-
TA:
Revenues:
License................... $1,194 $ 1,845 $8,689 $16,486 $ 5,677 $ 15,845
Services and maintenance.. 2,687 2,128 4,113 8,520 4,214 5,093
------ ------- ------ ------- ------- --------
Total revenues.......... 3,881 3,973 12,802 25,006 9,891 20,938
------ ------- ------ ------- ------- --------
Cost of revenues:
License................... 6 34 393 502 229 812
Services and maintenance.. 1,179 950 3,157 4,414 2,111 3,098
------ ------- ------ ------- ------- --------
Total cost of revenues.. 1,185 984 3,550 4,916 2,340 3,910
------ ------- ------ ------- ------- --------
Gross profit............... 2,696 2,989 9,252 20,090 7,551 17,028
------ ------- ------ ------- ------- --------
Operating expenses:
Sales and marketing....... 1,083 1,914 3,858 11,193 3,999 11,008
Research and development.. 898 2,287 2,874 5,692 2,077 5,357
General and administra-
tive..................... 688 1,212 2,464 3,695 1,479 2,271
Acquired in-process re-
search and development... -- -- -- -- -- 20,208
------ ------- ------ ------- ------- --------
Total operating ex-
penses................. 2,669 5,413 9,196 20,580 7,555 38,844
------ ------- ------ ------- ------- --------
Income (loss) from opera-
tions..................... 27 (2,424) 56 (490) (4) (21,816)
Interest income............ -- -- -- 723 415 217
------ ------- ------ ------- ------- --------
Income (loss) before (pro-
vision) benefit for income
taxes..................... 27 (2,424) 56 233 411 (21,599)
(Provision) benefit for in-
come taxes................ 111 301 331 281 (15) 160
------ ------- ------ ------- ------- --------
Net income (loss).......... $ 138 $(2,123) $ 387 $ 514 $ 396 $(21,439)
====== ======= ====== ======= ======= ========
Net income (loss) per basic
share(1).................. $ 0.02 $ 0.01 $ (0.69)
Net income (loss) per di-
luted share(1)............ $ 0.01 $ 0.01 $ (0.69)
Shares used in basic per
share computation(1)...... 30,700 30,700 30,849
Shares used in diluted per
share computation(1)...... 41,743 41,064 46,686
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------ JUNE 30,
1994 1995 1996 1997 1998
------ ------ ------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments.......................... $ -- $ -- $ -- $12,638 $4,369
Working capital (deficit)............. 1,831 1,016 (1,186) 13,707 3,138
Total assets.......................... 2,231 2,190 3,687 24,757 24,152
Shareholders' equity (deficit)........ 2,095 1,672 (60) 14,662 (6,733)
</TABLE>
- -------
(1) See Note 2 of Notes to the Company's Consolidated Financial Statements for
the calculation of basic and diluted net income per share.
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company develops, markets and sells products and services that allow
enterprises to manage trusted, secure electronic communications and
transactions over today's advanced networks, including the Internet, extranets
and intranets. The Entrust solution automates the management of digital
certificates, which are similar to electronic passports, through PKI
technology designed to assure the privacy and authenticity of internal and
external electronic communications. The Entrust PKI is an integrated, open and
scalable software framework that operates across multiple platforms, network
devices and applications, including e-mail, browsers, electronic commerce,
electronic forms, remote access and other product offerings from leading
vendors.
The Company was originally established in January 1994 as the Secure
Networks group of NTL and its subsidiary, NTI, to pursue the development and
sale of PKI products. During December 1996, Nortel restructured its Secure
Networks group by incorporating Entrust Technologies Inc. in Maryland and
Entrust Technologies Limited in Ontario, Canada. The assets and business of
the Secure Networks group within NTI and NTL were then transferred to Entrust
Technologies Inc. and Entrust Technologies Limited, respectively. As a result
of the restructuring and concurrent private placement described below, Entrust
Technologies Inc. became a majority-owned subsidiary of NTI, and Entrust
Technologies Limited became a majority-owned subsidiary of Entrust
Technologies Inc., with NTL possessing a minority interest in such subsidiary.
The Company's revenues consist of license revenues and services and
maintenance revenues. License revenues consist of fees for the license of the
Company's products; services revenues consist of fees for consulting and
training and maintenance revenues are fees for post-contract support
("maintenance"). The Company's revenues have increased from $4.0 million in
1995 to $25.0 million in 1997, and from $9.9 million for the six months ended
June 30, 1997 to $20.9 million for the six months ended June 30, 1998. During
the six months ended June 30, 1998, the Company incurred a net loss of $21.4
million, which included $20.2 million of in-process research and development
expense. The Company expects to incur net losses through the remainder of
1998.
The Company generates revenues primarily from licensing the rights to its
software products to enterprise customers and from sublicense fees from
resellers. In October 1997, the American Institute of Certified Public
Accountants issued a Statement of Position ("SOP") No. 97-2, "Software Revenue
Recognition", which the Company adopted, effective January 1, 1998, which has
had no effect on the Company's method of recognizing revenues. Prior to 1997,
the Company's revenue recognition policy was in accordance with the provisions
of the previous authoritative guidance provided by SOP 91-1, "Software Revenue
Recognition".
Revenues from perpetual software license agreements are recognized as
revenues 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 and collection of the
receivable is probable.
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 material basis.
Such services primarily consist of implementation services related to the
installation and deployment of the Company's products and do not include
significant customization or development of the underlying software code.
Revenues from maintenance 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 to customers.
22
<PAGE>
In any period a significant portion of the Company's revenues may be derived
from large sales to a limited number of customers. In 1995, two customers
accounted for 53% and 18% of revenues, respectively. In 1996, three customers
accounted for an aggregate of 64% of revenues, and 29%, 20% and 15% of
revenues, respectively. In 1997, three customers accounted for 19%, 12% and
11% of revenues, respectively. The customer that accounted for 29% of 1996
revenues accounted for 19% of 1997 revenues. See "Risk Factors--Dependence on
Large Customers".
The Company has recorded deferred compensation of $784,000 in 1998 as a
result of stock option grants that were made with exercise prices less than
the fair value of the shares of Common Stock on the applicable dates of grant.
The deferred compensation will be amortized as the options vest over a four-
year period.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain
consolidated statement of operations data expressed as a percentage of
revenues:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------- ----------------
1995 1996 1997 1997 1998
------- ------- ------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DA-
TA:
Revenues:
License.................. 46.4% 67.9% 65.9% 57.4% 75.7%
Services and mainte-
nance................... 53.6 32.1 34.1 42.6 24.3
------- ------- ------- ------- --------
Total revenues......... 100.0 100.0 100.0 100.0 100.0
------- ------- ------- ------- --------
Cost of revenues:
License.................. 0.9 3.0 2.0 2.3 3.9
Services and mainte-
nance................... 23.9 24.7 17.7 21.3 14.8
------- ------- ------- ------- --------
Total cost of reve-
nues.................. 24.8 27.7 19.7 23.6 18.7
------- ------- ------- ------- --------
Gross profit............... 75.2 72.3 80.3 76.4 81.3
------- ------- ------- ------- --------
Operating expenses:
Sales and marketing...... 48.2 30.1 44.8 40.4 52.6
Research and develop-
ment.................... 57.6 22.4 22.7 21.0 25.6
General and administra-
tive.................... 30.5 19.3 14.7 15.0 10.8
Acquired in-process re-
search and
development............. -- -- -- -- 96.5
------- ------- ------- ------- --------
Total operating ex-
penses................ 136.3 71.8 82.2 76.4 185.5
------- ------- ------- ------- --------
Income (loss) from opera-
tions..................... (61.1) 0.5 (1.9) -- (104.2)
Interest income............ -- -- 2.9 4.2 1.0
------- ------- ------- ------- --------
Income (loss) before (pro-
vision) benefit for income
taxes..................... (61.1) 0.5 1.0 4.2 (103.2)
(Provision) benefit for in-
come taxes................ 7.6 2.5 1.1 (0.2) 0.8
------- ------- ------- ------- --------
Net income (loss).......... (53.5)% 3.0% 2.1% 4.0% (102.4)%
======= ======= ======= ======= ========
</TABLE>
SIX MONTHS ENDED JUNE 30, 1997 AND 1998
REVENUES
Total revenues increased 112% from $9.9 million for the six months ended
June 30, 1997 to $20.9 million for the six months ended June 30, 1998.
Revenues derived from sales outside North
23
<PAGE>
America, primarily Europe and Japan, accounted for 3% and 30% of total
revenues for the six months ended June 30, 1997 and 1998, respectively. The
Company plans to expand its international operations by hiring additional
personnel, recruiting international resellers and establishing additional
operations abroad, and, accordingly, the Company anticipates that
international revenues will increase in absolute dollars and as a percentage
of total revenues during 1998. Delays or difficulties in the integration of
the operations of Entrust and r/3/ could adversely affect the Company's
ability to generate such international revenues.
LICENSE REVENUES. License revenues increased 179% from $5.7 million for the
six months ended June 30, 1997 to $15.8 million for the six months ended June
30, 1998, representing 57% and 76% of total revenues in the respective
periods. The increase in license revenues in absolute dollars was primarily
attributable to increased market awareness and acceptance of the Company's
products, continued enhancement and development of the Company's product
offerings and increased sales and marketing activities. The increase in
license revenues as a percentage of total revenues reflected the Company's
continued focus on the product side of its business and the increased use of
third-party consulting firms and systems integrators to provide implementation
services to its customers.
SERVICES AND MAINTENANCE REVENUES. Services and maintenance revenues
increased 21% from $4.2 million for the six months ended June 30, 1997 to $5.1
million for the six months ended June 30, 1998, representing 43% and 24% of
total revenues in the respective periods. The increase in services and
maintenance revenues was primarily the result of an increase in demand for
consulting services and customer support and, to a lesser extent, training
services associated with increased sales of the Company's applications. The
higher percentage of services and maintenance revenues as a percentage of
total revenues for the six months ended June 30, 1997 was related to higher
levels of revenues associated with a significant custom development software
agreement with the Canadian government and two system integration arrangements
in which the Company provided turnkey solutions that included system hardware
components in addition to software installation and implementation services.
Services and maintenance revenues for the six months ended June 30, 1998 did
not include revenues from such turnkey arrangements and included a lesser
amount of revenues related to the custom development agreement with the
Canadian government than was recorded for the same period in 1997.
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. Cost of license revenues increased from $229,000
for the six months ended June 30, 1997 to $812,000 for the six months ended
June 30, 1998, representing 4% and 5% of license revenues for the respective
periods.
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 costs paid to third-
party consulting firms for those services. Cost of services and maintenance
revenues increased from $2.1 million for the six months ended June 30, 1997 to
$3.1 million for the six months ended June 30, 1998, representing 21% and 15%
of total revenues for the respective periods. The increase in absolute dollars
reflected the increased costs associated with the higher levels of services
and maintenance revenues during the six months ended June 30, 1998. The higher
percentage of cost of services and maintenance revenues as a percentage of
total revenues for the six months ended June 30, 1997 reflected the cost of
the system hardware components related to the system integration arrangements
described above. The Company does not anticipate any arrangements in the
future that would include such hardware components as part of the solution
provided to its customers.
24
<PAGE>
OPERATING EXPENSES
SALES AND MARKETING. Sales and marketing expenses consist primarily of
personnel costs associated with the selling and marketing of the Company's
products, including salaries, commissions and travel and entertainment. Such
expenses also include the cost of advertising, trade shows and marketing and
promotional materials. Sales and marketing expenses increased from $4.0
million for the six months ended June 30, 1997 to $11.0 million for the six
months ended June 30, 1998, representing 40% and 53% of total revenues in the
respective periods. The increase in sales and marketing expenses in absolute
dollars and as a percentage of revenues reflected the Company's continued
focus on increasing direct sales and marketing expenditures to address certain
international and vertical markets. In addition, the Company increased the
number of employees in sales, marketing and business development from 49 at
June 30, 1997 to 133 at June 30, 1998. The Company also launched a new seminar
series and participated in a major trade show during the six months ended June
30, 1998. The Company is in the process of significantly expanding its direct
sales force in North America and Europe and anticipates that sales and
marketing expenses will increase in absolute dollars. If the Company does not
achieve commensurate increases in revenues during future periods, sales and
marketing expenses would increase as a percentage of revenues, and the
Company's results from operations and liquidity could be adversely affected.
RESEARCH AND DEVELOPMENT. Research and development expenses include software
development costs and consist primarily of personnel costs associated with the
Company's engineers, cryptographers and contractors. Research and development
expenses increased from $2.1 million for the six months ended June 30, 1997 to
$5.4 million for the six months ended June 30, 1998, representing 21% and 26%
of total revenues for the respective periods. The increase in research and
development expenses in absolute dollars and as a percentage of total revenues
was primarily the result of increased staffing and the associated support cost
of software engineers, cryptographers and contractors in connection with the
expansion and enhancement of the Company's product line and for quality
assurance and testing. The Company believes that it must continue to invest in
research and development in order to maintain its technological leadership
position and, accordingly, expects research and development expenses to
continue to increase in absolute dollars as it hires additional experienced
security experts and software engineers. If the Company does not achieve
commensurate increases in revenues during future periods, research and
development expenses would increase as a percentage of revenues, and the
Company's results from operations and liquidity could be adversely affected.
In accordance with Statement of Financial Accounting Standards No. 86,
Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise
Marketed, the Company has evaluated the establishment of technological
feasibility of its various products during the development phase. The time
period during which costs could be capitalized from the point of reaching
technological feasibility, which has been defined as development of a beta
model, until the time of general product release is very short, and,
consequently, the amounts that could be capitalized are not material to the
Company's financial position or results of operations. Therefore, the Company
charges all product development expenses to operations in the period incurred.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of personnel costs related to management, accounting and human
resources, and the associated overhead costs. General and administrative
expenses increased from $1.5 million for the six months ended June 30, 1997 to
$2.3 million for the six months ended June 30, 1998, representing 15% and 11%
of total revenues in the respective periods. This increase in absolute dollars
was primarily due to increased staffing and related expenditures required to
enhance the infrastructure to support the Company's growth.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. On June 8, 1998, the Company
completed the acquisition of r/3/, a company based in Zurich, Switzerland that
provides consulting, applied
25
<PAGE>
research and product development services related to commercial security and
encryption solutions. Pursuant to the Share Purchase Agreements dated May 30,
1998, entered into between the Company and the shareholders of r/3/, the
Company agreed to acquire all the outstanding shares of r/3/ in exchange for
an aggregate of 1,167,288 shares of the Company's Common Stock and cash
consideration of approximately $4.4 million. In the event the Common Stock is
not listed on a national securities market or exchange within one year after
the closing of the acquisition, the r/3/ shareholders have the right to
require the Company to repurchase the Common Stock at $14.58 per share.
Additionally, if the average closing price of the Company's Common Stock for
the first 10 trading days following the Company's initial public offering (the
"Market Price") is less than $12.08, then the Company will be required to pay
the difference between the Market Price and $12.08 to the r/3/ shareholders in
cash or in additional stock. This acquisition was recorded under the purchase
method of accounting, and, therefore, the results of operations of r/3/ and
the fair value of the acquired assets and liabilities are included in the
Company's financial statements beginning on the acquisition date. Upon
consummation of the acquisition, r/3/ became a wholly owned subsidiary of the
Company.
In connection with the acquisition, the Company obtained an appraisal of the
intangible assets, which resulted in $20.2 million of the purchase price being
allocated to in-process research and development that has not yet reached
technological feasibility and has no alternative future use, which was
expensed in the six months ended June 30, 1998.
The value assigned to purchased in-process technology was determined by
identifying research and development projects in areas for which technological
feasibility has not yet been established. This relates primarily to the
completion of a suite of encryption and security applications (the "r3
Suite"). The value was determined by estimating the costs to develop the
purchased in-process technology into commercially viable products, estimating
the resulting net cash flows from such projects and discounting the net cash
flows back to their present value.
The nature of the efforts to develop the purchased in-process technology
into commercially viable products relate to the completion of all planning,
designing, prototyping, security testing and verification activities that are
necessary to ensure that the r3 Suite is produced to meet design
specifications, including functions, features and technical performance
requirements. The efforts to develop the purchased in-process technology also
include verifying the technology's compatibility and interoperability with
other applications. The estimated cost for completion of this activity is
approximately $2.3 million in 1998, $3.2 million in 1999, $3.7 million in 2000
and $2.9 million in 2001. However, these estimates are subject to change,
given the uncertainties of the development process, and no assurance can be
given that deviations from these estimates will not occur.
The revenue forecasts used to value the in-process research and development
are based on the Company's estimates of market size and growth, expected
trends in technology (such as new encryption and security algorithms) and the
nature and expected timing of new product introductions by the Company and its
competitors. Historically, r/3/ has generated revenues from consulting
engagements and future revenue growth is almost entirely dependent upon the
in-process projects. The estimated revenues for the in-process projects peak
in 2002 and then decline rapidly as other new products are expected to enter
the market. If these projects are not successfully developed, the sales and
profitability of the combined company may be adversely affected in future
periods.
The estimated cost of sales as a percentage of revenues used in the
valuation decrease over time primarily due to the strategic shift from
consulting revenues to product revenues and r/3/'s expected ability to achieve
efficiencies due to economies of scale. As a result of the shift in strategy,
the estimated cost of sales as a percentage of revenues is expected to
decrease from 80% in 1998 to 20% by 2002, once the Company has successfully
introduced the in-process products.
The estimated selling, general and administrative expenses are expected to
increase as r/3/'s business model shifts from consulting to product-based
revenues. Selling, general and administrative
26
<PAGE>
expenses are expected to significantly increase between 1998 and 2000 as the
Company must create the necessary sales infrastructure to successfully
accomplish its strategic shift.
r/3/'s margins for earnings before interest and taxes ("EBIT") are projected
to increase as the Company introduces its in-process products and as revenues
increase. EBIT margins will be negative in 1998, due primarily to significant
investment in the research and developmental projects. As revenues grow, the
Company is expected to achieve efficiencies due to economies of scale, and
EBIT margins are projected to increase.
The rates utilized to discount the net cash flows back to their present
value are based on several studies of venture capital rates of return. Because
of the nature of the forecast and the risks associated with the developmental
projects, a discount rate of 40% was appropriate for the business enterprise
and the in-process projects. This discount rate is commensurate with r/3/'s
stage of development; the uncertainties in the economic estimates described
above; the inherent uncertainty surrounding the successful development of the
purchased in-process technology; the useful life of such technology; the
profitability levels of such technology and the uncertainty of technological
advances that are unknown at this time.
The combined company is expected to benefit from the favorable reputations
of Entrust in the North American encryption and securities market and r/3/'s
favorable reputation in the European market. Additionally, the combined
company is expected to benefit from the utilization and integration of
Entrust's technology, marketing and financial resources.
The forecasts used by the Company in valuing in-process research and
development were based upon assumptions the Company believes to be reasonable
but which are inherently uncertain and unpredictable. The Company's
assumptions may be incomplete or inaccurate, and unanticipated events and
circumstances are likely to occur. For these reasons, actual results may vary
from the results forecasted.
INTEREST INCOME
Interest income of $415,000 and $217,000 for the six months ended June 30,
1997 and 1998, respectively, reflected investment income earned on the
proceeds from the Company's private placement of Series B Common Stock in
January 1997. The decrease in investment income for the six months ended June
30, 1998 as compared to the same period in 1997 reflected a reduction of
interest earned during the period as a result of lower amounts of cash, cash
equivalents and short-term investments in 1998 compared to 1997.
PROVISION FOR INCOME TAXES
The Company recorded a provision for income taxes of $15,000 for the six
months ended June 30, 1997 and a benefit of $160,000 for the six months ended
June 30, 1998. Income taxes are accounted for in accordance with Statement of
Financial Accounting Standards No. 109. The effective income tax rate differed
from the statutory income tax rate in both periods primarily due to the impact
of the Canadian research and development tax credits claimed.
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
REVENUES
Total revenues increased 222% from $4.0 million in 1995 to $12.8 million in
1996 and increased 95% from $12.8 million in 1996 to $25.0 million in 1997.
Revenues derived from sales outside North America, primarily Europe, accounted
for less than 1% of total revenues in 1995 and 4% and 5% of total revenues in
1996 and 1997, respectively.
27
<PAGE>
LICENSE REVENUES. License revenues increased from $1.8 million in 1995 to
$8.7 million in 1996 and $16.5 million in 1997, representing 46%, 68% and 66%
of total revenues in the respective periods. The increase in license revenues
in absolute dollars was primarily attributable to increased market awareness
and acceptance of the Company's products, continued enhancement and
development of the Company's product offerings and increased sales and
marketing activities.
SERVICES AND MAINTENANCE REVENUES. Services and maintenance revenues
increased from $2.1 million in 1995 to $4.1 million in 1996 and $8.5 million
in 1997, representing 54%, 32% and 34% of total revenues in the respective
periods. The increase in services and maintenance revenues in absolute dollars
was primarily the result of an increase in demand for consulting and systems
implementation services from customers purchasing the Company's products for
enterprise-wide implementations, and an increase in maintenance revenues from
a larger installed product base. Services and maintenance revenues in 1996 and
1997 included revenues from a significant custom development software
agreement with the Canadian government, which is being recognized on the
percentage-of-completion basis through 1999. The Company did not enter into
any significant custom development software arrangements during 1997 and does
not expect such arrangements to be significant to services and maintenance
revenues in the future. As the Company continues to implement its strategy of
encouraging third-party organizations such as systems integrators to become
proficient in implementing the Company's products, consulting revenues as a
percentage of services and maintenance revenues may decrease.
COST OF REVENUES
COST OF LICENSE REVENUES. Cost of license revenues increased from $34,000 in
1995 to $393,000 in 1996 and $502,000 in 1997, representing 2%, 5% and 3% of
license revenues in the respective periods.
COST OF SERVICE AND MAINTENANCE REVENUES. Cost of services and maintenance
revenues increased from $950,000 in 1995 to $3.2 million in 1996 and $4.4
million in 1997, representing 45%, 77% and 52% of services and maintenance
revenues in the respective periods. The increase in cost of services and
maintenance revenues as a percentage of services and maintenance revenues in
1996 resulted primarily from several system integration arrangements in which
the Company provided customers with turnkey solutions that included system
hardware components in addition to software installation and implementation
services. The Company does not anticipate any arrangements in the future that
would include such hardware components as part of the solution provided to its
customers.
OPERATING EXPENSES
SALES AND MARKETING. Sales and marketing expenses increased from $1.9
million in 1995 to $3.9 million in 1996 and $11.2 million in 1997,
representing 48%, 30% and 45% of total revenues in the respective periods. The
increase in absolute dollars was primarily related to the expansion of the
Company's sales and marketing resources, increased commission expenses as a
result of higher sales levels and increased marketing activities, including
trade show, direct mail and other promotional expenses.
RESEARCH AND DEVELOPMENT. Research and development expenses increased from
$2.3 million in 1995 to $2.9 million in 1996 and $5.7 million in 1997. As a
percentage of total revenues, research and development expenses were 58%, 22%
and 23%, in 1995, 1996 and 1997, respectively. The increase in research and
development expenses in absolute dollars was primarily the result of increased
staffing and associated support costs of software engineers, cryptographers
and contractors in connection with the expansion and enhancement of the
Company's product line and for quality assurance and testing.
28
<PAGE>
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
from $1.2 million in fiscal 1995 to $2.5 million in 1996 and $3.7 million in
1997, representing 31%, 19% and 15% of total revenues in the respective
periods. The increase in general and administrative expense in absolute
dollars was primarily due to increased staffing and related expenditures
required to enhance the infrastructure to support the Company's growth.
INTEREST INCOME
Interest income of $723,000 in 1997 reflected investment income earned on
the proceeds from the Company's private placement of Series B Common Stock in
January 1997.
PROVISION FOR INCOME TAXES
The Company recorded income tax benefits of $301,000 in 1995 and $331,000 in
1996 and recorded a provision for income taxes of $281,000 for 1997. Income
taxes are accounted for in accordance with Statement of Financial Accounting
Standards No. 109. The effective income tax rates differed from the statutory
income tax rates primarily due to the impact of the Canadian research and
development tax credits claimed.
SELECTED QUARTERLY OPERATING RESULTS
The Company's quarterly operating results have varied substantially in the
past and are likely to vary substantially from quarter to quarter in the
future due to a variety of factors. Estimating future revenues is difficult
because the Company ships its products soon after an order is received and as
such does not have a significant backlog. Thus, quarterly license revenues are
heavily dependent upon orders received and shipped within the same quarter.
Moreover, the Company has generally recorded 70% to 80% of its total quarterly
revenues in the third month of the quarter, with a concentration of revenues
in the second half of that month. This concentration of revenues is, in part,
attributable to the tendency of certain customers to make significant capital
expenditures at the end of a fiscal quarter and to sales patterns within the
software industry. The Company expects these revenue patterns to continue for
the foreseeable future. In addition, quarterly license revenues are dependent
on the timing of revenue recognition, which can be affected by many factors,
including the timing of customer installations and the fulfillment of
acceptance criteria. In this regard, the Company has from time to time
experienced delays in recognizing revenues with respect to certain orders.
Despite the uncertainties in its revenue patterns, the Company's operating
expenses are based upon anticipated revenue levels and such expenses are
incurred on an approximately ratable basis throughout the quarter. As a
result, if expected revenues are deferred or otherwise not realized in a
quarter for any reason, the Company's business, operating results and
financial condition would be materially adversely affected.
The following tables set forth the Company's statement of operations data
for each of the six quarters in the period ended June 30, 1998, as well as the
percentage of the Company's total revenues represented by each item. This
unaudited quarterly information has been prepared on the same basis as the
annual information presented elsewhere in this Prospectus and, in management's
opinion, reflects all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the information for the
quarters presented. This information should be read in conjunction with the
Company's Consolidated Financial Statements and Notes thereto appearing
elsewhere in this Prospectus. The operating results for any quarter are not
necessarily indicative of results for any future period.
29
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30,
1997 1997 1997 1997 1998 1998
-------- -------- --------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues:
License................ $2,632 $3,045 $4,949 $5,860 $7,681 $ 8,164
Services and mainte-
nance................. 1,471 2,743 2,137 2,169 2,243 2,850
------ ------ ------ ------ ------ --------
Total revenues....... 4,103 5,788 7,086 8,029 9,924 11,014
------ ------ ------ ------ ------ --------
Cost of revenues:
License................ 104 125 131 142 342 470
Services and mainte-
nance................. 628 1,483 1,174 1,129 1,478 1,620
------ ------ ------ ------ ------ --------
Total cost of reve-
nues................ 732 1,608 1,305 1,271 1,820 2,090
------ ------ ------ ------ ------ --------
Gross profit............ 3,371 4,180 5,781 6,758 8,104 8,924
------ ------ ------ ------ ------ --------
Operating expenses:
Sales and marketing.... 1,698 2,301 3,528 3,666 4,936 6,072
Research and develop-
ment.................. 952 1,125 1,700 1,915 2,285 3,072
General and administra-
tive.................. 686 793 1,026 1,190 1,064 1,207
Acquired in-process re-
search
and development....... -- -- -- -- -- 20,208
------ ------ ------ ------ ------ --------
Total operating ex-
penses.............. 3,336 4,219 6,254 6,771 8,285 30,559
------ ------ ------ ------ ------ --------
Income (loss) from oper-
ations................. 35 (39) (473) (13) (181) (21,635)
Interest income......... 209 206 164 144 146 71
------ ------ ------ ------ ------ --------
Income (loss) before
(provision) benefit for
income taxes........... 244 167 (309) 131 (35) (21,564)
(Provision) benefit for
income taxes........... (20) 5 226 70 160 --
------ ------ ------ ------ ------ --------
Net income (loss)....... $ 224 $ 172 $ (83) $ 201 $ 125 $(21,564)
====== ====== ====== ====== ====== ========
Net income (loss) per
share
Basic.................. $ 0.01 $ 0.01 $ -- $ 0.01 $ -- $ (0.70)
====== ====== ====== ====== ====== ========
Diluted................ $ 0.01 $ -- $ -- $ -- $ -- $ (0.70)
====== ====== ====== ====== ====== ========
Shares used in per share
computation
Basic.................. 30,700 30,700 30,700 30,700 30,700 30,997
====== ====== ====== ====== ====== ========
Diluted................ 41,064 41,064 41,869 41,908 45,231 46,919
====== ====== ====== ====== ====== ========
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30,
1997 1997 1997 1997 1998 1998
-------- -------- --------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues:
License................ 64.1% 52.6% 69.8% 73.0% 77.4% 74.1%
Services and mainte-
nance................. 35.9 47.4 30.2 27.0 22.6 25.9
------ ------ ------ ------ ------ --------
Total revenues....... 100.0 100.0 100.0 100.0 100.0 100.0
------ ------ ------ ------ ------ --------
Cost of revenues:
License................ 2.5 2.2 1.8 1.8 3.4 4.3
Services and mainte-
nance................. 15.3 25.6 16.6 14.0 14.9 14.7
------ ------ ------ ------ ------ --------
Total cost of reve-
nues................ 17.8 27.8 18.4 15.8 18.3 19.0
------ ------ ------ ------ ------ --------
Gross profit............ 82.2 72.2 81.6 84.2 81.7 81.0
------ ------ ------ ------ ------ --------
Operating expenses:
Sales and marketing.... 41.4 39.8 49.8 45.7 49.8 55.1
Research and develop-
ment.................. 23.2 19.4 24.0 23.9 23.0 27.9
General and administra-
tive.................. 16.7 13.7 14.5 14.8 10.7 11.0
Acquired in-process re-
search
and development....... -- -- -- -- -- 183.5
------ ------ ------ ------ ------ --------
Total operating ex-
penses.............. 81.3 72.9 88.3 84.4 83.5 277.5
------ ------ ------ ------ ------ --------
Income (loss) from oper-
ations................. 0.9 (0.7) (6.7) (0.2) (1.8) *
Interest income......... 5.1 3.6 2.3 1.8 1.5 0.6
------ ------ ------ ------ ------ --------
Income (loss) before
(provision) benefit for
income taxes........... 6.0 2.9 (4.4) 1.6 (0.3) *
(Provision) benefit for
income taxes........... (0.5) 0.1 3.2 0.9 1.6 *
------ ------ ------ ------ ------ --------
Net income (loss)....... 5.5% 3.0% (1.2)% 2.5% 1.3% *
====== ====== ====== ====== ====== ========
</TABLE>
- --------
*Not meaningful
30
<PAGE>
License revenues have increased in each of the six quarters in the period
ended June 30, 1998. As a result of the increased acceptance of the Company's
product offerings and expansion of the Company's sales and marketing efforts
during the past six quarters, license revenues as a percentage of total
revenues increased from 70% for the quarter ended September 30, 1997 to 73%
and 74% for the quarters ended December 31, 1997 and June 30, 1998,
respectively. Cost of license revenues varies from period to period primarily
due to the amount of royalties payable by the Company to third-party software
suppliers. Services and maintenance revenues have decreased as a percentage of
total revenues since the quarter ended March 31, 1997, except for the higher
percentage in the quarters ended June 30, 1997 and 1998. Services and
maintenance revenues for the quarter ended June 30, 1997 included revenues
from the hardware components of two system integration projects, which
contributed to the increase in services and maintenance revenues in absolute
dollars and as a percentage of total revenues compared to the other three-
month periods. Services and maintenance revenues for the six months ended June
30, 1998 increased as a percentage of total revenues from 23% in the first
three months of 1998 to 26% in the second three months of 1998. This increase
reflected an increase in maintenance renewals from the Company's increasing
customer base. Cost of services and maintenance revenues has been comparable
for all periods other than the quarter ended June 30, 1997, which included the
higher costs of the hardware components previously discussed. The increase in
operating expenses in absolute dollars from $7.6 million for the six months
ended June 30, 1997 to $38.8 million for the six months ended June 30, 1998
reflected the Company's expenses of $20.2 million for in-process research and
development and investment in growing the organization. The number of
employees has increased each quarter for the last six quarters and such
increases are expected to continue for the foreseeable future.
The Company intends to continue to increase its research and development
expenditures in order to pursue its strategy of maintaining technological
leadership in the PKI market. The Company also intends to increase sales and
marketing expenditures significantly as it expands its domestic and
international sales and marketing staff and develops indirect sales and
distribution channels. In addition, general and administrative expenses have
increased each quarter since the quarter ended March 31, 1997 as the Company
invested in the infrastructure needed to support its growing operations.
Accordingly, to the extent that continued increases in such expenses are not
accompanied by increased revenues, the Company's operating results and
financial condition may be materially adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
The Company operated as a division of Nortel from its inception in 1994
until December 1996, when it was separately incorporated as part of the
financing described below. See Note 1 of Notes to the Company's Consolidated
Financial Statements. As such, all of the Company's investing and financing
activities were handled through Nortel's centrally managed treasury function.
Therefore, the Company did not maintain separate cash balances until December
31, 1996. At the close of business on December 31, 1996, Nortel transferred to
the Company certain assets, liabilities, intellectual property rights,
licenses and contracts of the Secure Networks group of Nortel. In exchange,
Nortel received 20,300,000 shares of the Company's Common Stock and 7,700,000
shares of the Company's Special Voting Stock. See "Certain Transactions". In
January 1997, the Company issued an aggregate of 260,000 shares of its Series
B Common Stock and Series B Non-Voting Common Stock in a private placement for
an aggregate consideration of $24.0 million, net of the costs and expenses of
the private placement. The Company used approximately $8.0 million of the net
proceeds of the private placement to repay certain intercompany debt.
The Company used cash of $1.2 million and $2.1 million for operating
activities in 1995 and 1997 and generated cash of $2.8 million from operating
activities in 1996. The use of cash in 1995 was primarily a result of the net
loss for the period of $2.1 million, offset in part by a decrease in accounts
receivable and an increase in accounts payable. In 1997, the $2.1 million use
of cash for operating activities was due primarily to increases in accounts
receivable of $4.7 million and other receivables
31
<PAGE>
of $2.1 million, which were offset in part by the net income, and increases in
current liabilities for the same period. The increase in accounts receivable
resulted from the growth in revenues during the same period and the timing of
revenue recognition during the quarters within the period. The cash generated
from operating activities in 1996 resulted primarily from the generation of
net income for the year of $387,000 and increases in deferred revenues and
accrued liabilities. The Company generated cash of $2.1 million from operating
activities for the six months ended June 30, 1997 and used cash of $1.5
million for operating activities for the same period in 1998. The cash
generated for the six months ended June 30, 1997 resulted from increases in
amounts due to Nortel for expenses incurred by Nortel on behalf of the Company
and increases in accrued liabilities. The increase in cash used for operating
activities for the six months ended June 30, 1998 was related primarily to an
increase in accounts receivable of $2.8 million and in the net loss of $1.2
million, before the non-cash charge for acquired in-process research and
development, which were offset in part by an increase in accounts payable of
$1.7 million. The average days sales outstanding increased from 59 days at
December 31, 1996 to 80 and 87 days at December 31, 1997 and June 30, 1998,
respectively. For purpose of calculating average days sales outstanding, the
Company divides ending accounts receivable by the current quarter's revenues
and multiplies this amount by 90 days. The increase in days sales outstanding
was primarily attributable to an increase in the number of license
transactions closing at quarter end. 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 the expanded
international revenues in relation to total revenues as licenses to
international customers often have longer payment terms.
The Company's uses of cash for investing activities were for the purchase of
fixed assets and totaled $536,000, $693,000, $895,000 and $995,000 for the
years ended December 31, 1995, 1996 and 1997 and for the six months ended June
30, 1998, respectively. In 1997, the Company invested $8.6 million in short-
term investments, net of $3.7 million of dispositions of short-term
investments. Cash provided from investing activities for the six months ended
June 30, 1998 included $11.9 million from dispositions of short-term
investments, net of purchases of $5.1 million of short-term investments and
$4.4 million of cash related to the acquisition of r/3/.
During 1995, 1996 and 1997, the Company's financing activities were
primarily transfers of cash to and from Nortel, except for the net proceeds of
$16.0 million from the sale of Series B Common Stock in 1997.
As of June 30, 1998, the Company's principal sources of liquidity were its
cash and cash investments of $4.4 million. The Company believes that the net
proceeds from the sale of Common Stock offered by the Company together with
cash from operations and existing cash and cash equivalent balances will be
sufficient to meet its cash needs for at least the next 12 months.
32
<PAGE>
BUSINESS
Entrust develops, markets and sells products and services that allow
enterprises to manage trusted, secure electronic communications and
transactions over today's advanced networks, including the Internet, extranets
and intranets. The Entrust solution automates the management of digital
certificates, which are similar to electronic passports, through PKI
technology designed to assure the privacy and authenticity of internal and
external electronic communications. The Entrust PKI is an integrated, open and
scalable software framework that operates across multiple platforms, network
devices and applications, including e-mail, browsers, electronic commerce,
electronic forms, remote access and other product offerings from leading
vendors. The Company's product suite was first released in 1994, and has since
been licensed for use in global enterprises and government entities such as
the Canadian government, Citibank, the FDIC, J.P. Morgan, NASA, the Republic
of Singapore and the United Kingdom Post. In addition, over three million
Entrust certificates have been issued to date for use by the Company's
customers.
INDUSTRY BACKGROUND
The widespread adoption in recent years of public and private networks has
revolutionized the manner in which organizations communicate and conduct
business. These advanced networks provide an attractive medium for
communications and commerce because of their global reach, accessibility, use
of open standards and ability to permit interactions on a real-time basis.
Proliferation of these networks has facilitated the storage, analysis and
communication of critical information within and between organizations. At the
same time, they have afforded businesses a user-friendly, low-cost way to
conduct a wide variety of commercial functions electronically. Today,
organizations are increasingly utilizing these networks to access new markets,
improve customer service and streamline business processes through
applications such as e-mail, messaging, remote access, intranet-based
applications, on-line customer support and supply chain applications.
NEED FOR SECURE TRANSACTIONS
The very openness and accessibility that have stimulated the adoption and
growth of public and private networks create threats to the privacy and
integrity of information that is transmitted across or stored on them.
According to a survey taken at a 1997 industry conference, 70% of respondents
cited security concerns as the principal impediments to a broader use of the
Internet for commercial applications. Key consumer security concerns include
merchant impersonation, fraud and the risk that third parties may intercept
and use personal information such as credit card numbers, all of which may
inhibit the broader adoption of electronic commerce. Businesses relying on
public and private networks for internal communications risk the theft, loss,
alteration or dissemination of confidential data, loss of reputation and
economic loss through fraud. Threats to corporate data security arise both
from external sources such as competitors and computer hackers, as well as
internal sources, such as curious or disgruntled employees and contractors.
According to a recent FBI report, among U.S. enterprises reporting that they
had experienced computer security breaches, the average financial losses from
internal breaches were significantly higher than the losses sustained from
external breaches. These business risks have driven the demand for effective
and robust network and information security products.
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<PAGE>
The security risks associated with communications and commerce over public
and private networks have accentuated the need for information security
solutions that address the five critical network security needs:
. ACCESS CONTROL--Only authorized users should access, view or modify
certain data
. CONFIDENTIALITY--Data in transit over the network or in storage should
not be disclosed to unauthorized persons
. INTEGRITY--Data should not be altered or compromised by unauthorized
manipulation
. AUTHENTICATION--The identity of the data sender should be verified
. NON-REPUDIATION--The sender of a transmission should not be able to deny
or repudiate the transmission
A wide range of products and services has been introduced to address one or
more of these five critical network security needs. For example, access
control is provided by products such as firewalls and password tokens, which
limit network access only to users having recognized addresses or entering
recognized passwords, but are limited in their flexibility and do not address
such requirements as confidentiality, integrity, authentication and non-
repudiation. Encryption devices and programs provide confidentiality, but are
device-dependent and do not address issues of access control, integrity,
authentication and non-repudiation. The lack of flexibility and scalability
inherent in these solutions has led to the development of public key
encryption and digital certification systems combined in a public key
infrastructure, which can address all five critical network security needs.
PUBLIC KEY SECURITY
A public key infrastructure uses encryption algorithms in combination with
authentication and verification technology offered by digital certificates to
provide the user with a secure and reliable means of communicating and
effecting transactions over public and private networks.
PUBLIC KEY ENCRYPTION. Digital messages are encrypted and decrypted using a
cipher or key. Public key encryption systems assign each user a pair of linked
keys: a "public" key, which the user provides to others, and a "private" key,
which the user keeps secret. A user wishing to send a secure transmission
encrypts the transmission using the recipient's public key. To decode the
transmission, the recipient uses a private key that is uniquely able to decode
messages encoded with his or her corresponding public key. Thus, the
successful exchange of encrypted messages using a public key system requires
that message senders have the public keys for all recipients to whom they
desire to send messages, and that the recipients decode messages with their
own private keys. Public key encryption provides a high level of data
security, and thus addresses an enterprise's need for confidentiality of
electronic transmissions. However, because encryption alone does not give the
recipient of a message any information about the sender or ensure that a
message is not altered en route, the requirements for access control,
integrity, authentication and non-repudiation are not satisfied.
DIGITAL CERTIFICATION. The ability to ensure access control, authentication
and non-repudiation of digital transmissions can be achieved with digital
certification systems, which enable a recipient to verify that a message
originates from the expected sender. These systems use public and private keys
to create a special file called a digital signature. This signature is encoded
using the sender's private key. Upon receipt of the message, the recipient
obtains a copy of the sender's public key from a directory established by a
trusted administrator (a "Certification Authority" or "CA"), which verifies
that the message originated from the expected sender. Digital certificates
thus function as electronic passports that not only authenticate their owners'
identities and verify their owners' membership in certain organizations, but
also establish their owners' authority to engage in a given transaction.
Digital signature and certification technology can also be used to ensure the
integrity of a message by enclosing an encrypted summary or "hash" of the
message with the sender's digital
34
<PAGE>
signature. When the signature and hash are decrypted using the sender's public
key supplied by the CA, the system can automatically detect whether the
message was altered since it was signed.
MARKET ACCEPTANCE OF DIGITAL CERTIFICATION. Because of its security
benefits, digital certification has gained significant market acceptance,
particularly in sectors in which information security is critical, such as
government, finance, health care and telecommunications. Industry sources
believe that by 2000 digital certificates will be nearly as widely adopted by
the general public as e-mail is today. At least 40 U.S. states, as well as the
U.S. and Canadian governments and the European Union, have adopted or are
considering digital signature statutes that recognize the legal validity of
digitally signed documents. In addition, the banking industry's Secure
Electronic Transaction (SET) standard for Internet credit card purchases, as
well as the Internet secure packet transmission standard (IPsec) adopted by
most firewall, routing and access vendors, depend on digital certification.
NEED FOR A PUBLIC KEY INFRASTRUCTURE
The increasing acceptance of digital certificates has given rise to numerous
products and services that issue digital certificates or that are digital
certificate-ready. However, the mere issuance of digital certificates does not
ensure that a user's access is properly monitored, that privileges associated
with access are accurately and currently defined, or that the certificates in
question have not been withdrawn or replaced. Indeed, the proliferation of
users and certificates greatly complicates management of these issues, which
are critical to maintaining an effective security environment across and
between enterprises. To address these needs, enterprises must have a robust
public key infrastructure that supplements certificate issuance functions with
full life cycle management of public keys, including issuance, authentication,
storage, retrieval, backup, recovery, updating and revocation, in an easy-to-
use, cost-effective manner.
Moreover, unless digital certificates can be easily utilized on a consistent
and reliable basis across multiple applications (such as e-mail, browser,
electronic commerce, electronic forms and remote access), organizations will
face the challenge and cost of maintaining a separate security infrastructure
for each application, requiring separate keys and certificates, multiple
passwords and inconsistent or incomplete security implementations.
Furthermore, any PKI must be able to support an enterprise's security
requirements as the enterprise grows, business functions are altered and
underlying IT technologies evolve. To be effective, a public key
infrastructure must be able to accommodate a large number of users and
integrate diverse computing resources into a consolidated, reliable and secure
computing environment that meets the five critical network security needs of
access control, confidentiality, authentication, integrity and non-
repudiation. Achievement of these goals requires a highly functional and
flexible public key infrastructure for the management of network security
features across an enterprise and between organizations.
THE ENTRUST SOLUTION
Entrust develops, markets and distributes a comprehensive public key
infrastructure solution that enables enterprises to effect and manage secure
communications and transactions across a wide range of applications. The
Entrust PKI solution addresses the five critical network security needs of
enterprises and allows for consistent enterprise-wide security policy
management, enabling any enterprise to establish its own flexible, highly
reliable CA. It also offers users encryption functionality and full digital
signature and certification management in a single, easy-to-use, integrated
and automated solution. Among the benefits offered by Entrust's PKI solution
are:
. COMPREHENSIVE FUNCTIONALITY. The Company believes that it is the only
provider of a consolidated PKI solution offering the functionality
necessary for the full life cycle management of public keys and digital
certificates including: certificate issuance, certificate
authentication, key storage and backup, key retrieval and recovery,
certificate updating, certificate revocation and cross-certification of
CAs.
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<PAGE>
. MULTIPLE CERTIFICATE TYPES. The Entrust PKI supports multiple
certificate types and configurations, including enterprise certificates
that can be used across multiple applications, Web certificates for
secure Web transactions, electronic commerce certificates supporting
secure credit card transactions using the SET standard and certificates
for evolving communications technologies such as VPNs.
. VERSATILE, OPEN PLATFORM. The Entrust PKI enables secure transmissions
across a wide range of computing platforms (including Windows NT and
UNIX servers and Windows, UNIX, Macintosh and JAVA clients), enterprise
applications (including e-mail, browser, electronic commerce, electronic
forms and remote access), network infrastructure (including firewalls,
network operating systems and directories), and open industry standards
(such as the lightweight directory access protocol ("LDAP") and PKCS
11).
. HIGHLY SCALABLE ARCHITECTURE. Entrust products employ a distributed
computing architecture and directory management techniques that make
them highly scalable. The Company believes that its PKI solution, with
appropriate directory additions, can be configured to handle millions of
simultaneous users.
. EASE OF USE. Entrust products automatically effect complex certification
and key recovery functions without user interaction; most functions are
initiated using simple point and click graphical interfaces and are
accessed via a single user login.
. REDUCED COST OF OWNERSHIP. Because the Entrust PKI's comprehensive
functionality reduces duplication of personnel, its ease of use
simplifies training, and its ability to interact with a wide variety of
platforms and applications avoids the need to purchase multiple security
systems, the Entrust PKI enables enterprises to significantly reduce
overall costs for addressing security requirements.
STRATEGY
The Company's objective is to maintain and enhance its position as the
leading provider of comprehensive PKI solutions. Key elements of the Company's
strategy to achieve this objective include the following:
. MAINTAIN PRODUCT LEADERSHIP. The Company's PKI solution has been
deployed commercially through multiple versions for approximately four
years. The Company's technological leadership is attributable in large
part to its 140-person research and development team, which includes
researchers with international reputations in their fields. The Company
intends to maintain and enhance its technological leadership in the PKI
solutions market by continuing to invest in product research and
development, to extend the functionality and interoperability of its
products, and to participate actively in industry standards-setting
organizations.
. TARGET LARGE CUSTOMERS. The Company targets its sales and marketing
activities at Global 2000 organizations and large governmental entities
having significant requirements for comprehensive PKI solutions and the
resources to deploy them broadly. To address this market, the Company
maintains an experienced direct sales force and an active marketing
program targeted at large organizations. The Company is expanding its
sales force to address its target market more fully, and is
supplementing its sales force with a services capability to facilitate
implementation and deployment of products by large organizations.
. TARGET VERTICAL MARKETS OFFERING BROAD DEPLOYMENT OPPORTUNITIES. The
Company targets organizations in the government, finance, health care,
telecommunications and large manufacturing sectors, which have thousands
of customers, subscribers and service recipients who will, directly or
indirectly, benefit from the secure communications and transactions
enabled by the Company's PKI solution. The Company believes that the
successful implementation of its PKI solution within these selected
vertical markets will
36
<PAGE>
enable it to leverage the adoption of its products by such organizations
to include their customers, subscribers and service recipients.
. PROMOTE BRAND AWARENESS. The Company's goal is to equate its brand name
with trusted enterprise security. The Company undertakes a variety of
activities to promote the recognition of its brand identity and
products, including the promotion and sponsorship of industry groups and
conferences such as the Entrust SecureSummit in June 1998. The Company
also promotes its product standards and architecture by participating
actively in numerous industry standards-setting bodies.
. EXPAND STRATEGIC RELATIONSHIPS. In order to encourage widespread
acceptance of its PKI solution, the Company has established an Entrust
Partner Program which currently includes: (i) VAR and OEM partners, such
as Digital Equipment Corporation, EDS, Hewlett-Packard, IBM and Tandem,
which resell the Company's products with their hardware and networking
solutions, as well as Check Point Software, Symantec and TimeStep, which
plan to bundle the Company's PKI solution with their own software
products; (ii) consultant and system integration partners, such as
Coopers & Lybrand, Deloitte & Touche and KPMG Peat Marwick, which
recommend and implement Entrust-Ready security solutions as part of
their overall service offerings; (iii) development partners, which have
introduced more than 50 off-the-shelf Entrust-Ready applications and
(iv) interoperability partners such as Cisco, Lotus Development,
Netscape and Shiva, which offer products that utilize the security
features of the Entrust PKI solution. The Company intends to continue to
invest in and enhance the Entrust Partner Program both to offer complete
end-to-end security solutions to its customers and to broaden adoption
of its PKI solution across markets and geographic areas.
. EXPAND GLOBAL PRESENCE. The Company intends to expand its global
operations and currently has more than 55 employees based in Europe.
With its acquisition of r/3/ in June 1998, the Company obtained
substantial European research and development expertise for the
development of its PKI solution targeted at the European market. The
Company has supplemented its established direct sales and distribution
channels through the addition of distribution partners in central and
eastern Europe and Japan.
PRODUCTS AND PRODUCT DEVELOPMENT
The Entrust PKI solution provides an integrated, open and scalable security
framework that addresses an enterprise's data security needs across multiple
platforms and applications, including e-mail, browsers, electronic forms,
remote access and other product offerings from leading vendors. It also
includes robust features (such as support of dual key pairs) that make it well
suited for secure electronic commerce applications. The Entrust solution
includes: (i) a core PKI solution, which centrally manages and administers an
enterprise's security infrastructure, (ii) desktop applications that tightly
integrate features with Entrust's core PKI and common third-party desktop
applications, and (iii) application developer toolkits that provide open
application programmer interfaces (APIs) for the rapid development of Entrust-
Ready applications.
The Entrust core PKI solution comprises server software that manages and
administers life cycle digital certificates throughout an enterprise, an LDAP-
compliant directory for the storage and retrieval of keys, and
workstation/client software that enables users to utilize the functions
provided by the PKI. The core PKI solution is a powerful and flexible platform
for the generation and management of digital certificates, including
enterprise certificates supporting single or multiple applications within an
organization, Web certificates embedded on individual user browsers for
transaction authentication or electronic commerce certificates supporting
secure credit card transactions using the SET
37
<PAGE>
standard. The core solution is also configured to support the generation of
certificates for evolving communications technologies, such as VPNs, and
multiple hardware devices, such as smart cards, PC cards, biometric devices
and third-party key storage systems.
[ENTRUST PKI SOLUTION OVERVIEW FLOW CHART APPEARS HERE]
The graphic is entitled "Entrust PKI Solution Overview" and is structured as
follows:
There is a large rectangular box that contains the names of the products
constituting the Company's core PKI solution: (i) Entrust/Authority and
Entrust/Admin and (ii) Entrust Electronic Identities (Enterprise, Web, E-
Commerce and VPN (expected to become available in late 1998) Certificates).
Arrows emanate from the large box toward smaller boxes representing the
following: (a) applications (Entrust, Entrust-Ready (through the Entrust
Toolkit) and Third-Party (through Entrust Plug-Ins)), (b) the
Entrust/Directory, (c) network and firewalls and (d) hardware, smart cards and
other add-ons. The boxes representing Third-Party applications and the items
described in clauses (c) and (d) are shaded in gray.
/1/Expected to become available in late 1998.
ENTRUST CORE PKI SOLUTION
The Company's core PKI solution is designed with an open and flexible
software architecture that operates on a wide range of client/server
enterprise operating system platforms, including Windows NT, HP-UX, Solaris
and AIX servers, and Windows, HP-UX, Solaris, AIX, JAVA and Macintosh clients.
Its security kernel supports a wide variety of encryption algorithms,
including RSA, as well as symmetric and hashing algorithms, allowing customers
to select those algorithms best suited for their requirements. In addition to
its own directory system, the core system uses the industry LDAP standard to
interoperate with most other major certificate directory systems, allowing
customers to utilize existing directory systems and facilitating access to
other directories as required. The system architecture enables the Company to
add functionality as customer needs evolve and grow and allows the core system
to support the generation and maintenance of new certificate types easily,
responding to technology developments and market pressures. The system's
distributed computing architecture and directory management techniques also
enable the PKI to be scaled up as an enterprise's public key security needs
increase or as users are added to existing infrastructures. The Company
believes that, with appropriate directory additions, its core PKI solution
will be able to handle millions of simultaneous users.
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<PAGE>
The initial version of the Entrust PKI was released in 1994, with major
upgrades in 1996 and 1997; historically, the core solution has generated a
major portion of the Company's revenues. The last major release of the core
PKI, version 4.0, occurred in July 1998. The following table lists the
products that constitute Entrust's core PKI solution, as well as a brief
description and the introduction date of each product.
<TABLE>
<CAPTION>
PRODUCT NAME DESCRIPTION INTRODUCTION DATE
<S> <C> <C>
ENTRUST/AUTHORITY Provides comprehensive December 1994
certification authority and key
recovery capabilities, among
numerous other functions
- --------------------------------------------------------------------------------------
ENTRUST/ADMIN Performs PKI administrative tasks December 1994
- --------------------------------------------------------------------------------------
ENTRUST/DIRECTORY Scalable directory system for the June 1995
storage of key information
- --------------------------------------------------------------------------------------
ENTRUST ELECTRONIC Enterprise user "accounts" that December 1994
IDENTITIES authorize use of different types
of certificates, including:
------------------------------------------------------------
. Entrust/Entelligence Enables use of enterprise December 1994
certificates with multiple
enterprise applications
------------------------------------------------------------
. Entrust/Web Connector Enables use of digital March 1997
certificates with popular
browsers, such as those offered
by Microsoft and Netscape
------------------------------------------------------------
. Entrust/CommerceCA Enables use of digital March 1998
certificates with standards-based
SET wallets, merchant servers and
payment gateways
</TABLE>
The Company licenses its Entrust/Authority and Entrust/Admin products at a
combined list price of $15,000 per server. Entrust offers its
Entrust/Directory to enterprises for a list price of $3,000 for installations
of up to 5,000 users and $3,000 plus a per-user fee for installations of more
than 5,000 users. Enterprise Electronic Identities have a list price of $159
per licensed user, which allows the issuance of multiple certificates across
all Entrust-Ready applications in the enterprise. As a part of its core PKI
solution, the enterprise Electronic Identities are offered on a registered-
user basis. If an enterprise solution is not required, the Company also offers
customers with specialized security needs the ability to issue Web and
electronic commerce certificates at a charge of $2 per certificate. The actual
license fees paid by customers vary widely, based on the number of products
licensed, registered users, enabled platforms and volume discounts, if any.
ENTRUST/AUTHORITY. Entrust/Authority is the central component of the Entrust
PKI solution. Entrust/Manager provides the CA function for the Entrust core
PKI, and enables an enterprise to create, issue, manage, back-up, update and
revoke electronic identities. Entrust/Authority also
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<PAGE>
provides a secure enterprise key recovery system, issues certificate
revocation information, and establishes cross-certification relationships with
other trusted certification authorities. Because Entrust/Authority automates
these functions, users typically need to communicate with Entrust/Authority
only when they are initialized on the system; key update operations are
performed automatically and transparently, minimizing the need for on-going
user involvement. A sophisticated audit reporting system monitors all security
aspects of Entrust/Authority operations.
ENTRUST/ADMIN. Entrust/Admin provides administrative capabilities to three
types of personnel: security officers, Entrust administrators and directory
administrators. Through an easy-to-use graphical interface, security officers
can define the high-level security policies governing the operation of an
Entrust system, such as default lifetimes for encryption and signature key
pairs and the frequency with which certificate revocation lists (CRLs) are
automatically distributed. Entrust/Admin allows Entrust administrators to
perform the system's day-to-day administrative duties, including creating and
deleting user identities, changing users' names, helping users recover lost
keys and forgotten passwords, and revoking users' certificates when necessary.
Entrust/Admin also allows directory administrators to perform administrative
tasks associated with the directory on an automated, high-volume basis.
ENTRUST/DIRECTORY. As a convenience for its PKI customers, Entrust offers a
scalable LDAP-compliant directory for the storage of key information. The core
PKI solution will also operate with many other LDAP-compliant directories.
ENTRUST ELECTRONIC IDENTITIES. An Entrust Electronic Identity is an
individual user's "account" within the PKI. Entrust offers Electronic
Identities for full enterprise use, or for more limited Web or electronic
commerce use. An Entrust/Entelligence Electronic Identity can support numerous
key pairs and certificates over its lifetime, which may be utilized across
multiple Entrust-Ready and other third party applications. Updating of key
pairs and certificates is performed automatically and transparently and,
therefore, administrative overhead is reduced. These Electronic Identities are
implemented on client-side software that provides an easy-to-use interface
enabling users within an Entrust PKI to secure and unsecure files. This
software also allows users to specify options (such as file compression) and
select cryptographic algorithms while making the complexities of key and
certificate management transparent. An Entrust/Web Connector Electronic
Identity enables a user to use certificates with popular Web browsers and Web
servers, such as those offered by Netscape and Microsoft. These Web
certificates can have lifetimes that span multiple years and do not require
renewal on a yearly basis. Entrust/Commerce CA Electronic Identities enable
secure electronic commerce through the issuance and management of certificates
for SET wallets, merchant servers and payment gateways.
In addition to its enterprise core PKI solution, the Company also offers two
introductory PKI products: Entrust/Lite, which provides a PKI for workgroups
of up to 200 users, and Entrust/Solo, which provides individual users with
public key encryption and digital certificate capabilities. Entrust/Lite is
licensed for $50 per user and Entrust/Solo, which may be downloaded from the
Internet, is licensed for $49 for commercial use and for free for non-
commercial use.
ENTRUST APPLICATIONS
The Company's core PKI solution has been configured to support a wide
variety of applications from multiple vendors to enhance its flexibility and
usefulness. The Company has also developed a number of applications in order
to meet specific customer demands and facilitate the implementation of the
Entrust core PKI solution. These products either complement and interact with
the core PKI to offer the user enhanced functionality and increased
interoperability with third-party applications, or operate as independent
products, offering distinct functionality.
40
<PAGE>
The following table lists applications offered by the Company, including a
brief description, product pricing and the introduction date for the product.
<TABLE>
<CAPTION>
PRODUCT NAME DESCRIPTION PRICING INTRODUCTION
DATE
<C> <S> <C> <C>
ENTRUST/ICE 2.0 Provides security for files $39 per user March 1997
and folders
- ---------------------------------------------------------------------------------------
ENTRUST/EXPRESS 2.0 Provides security for $39 per user June 1997
popular e-mail
applications, such as
Microsoft's Exchange and
Outlook products
- ---------------------------------------------------------------------------------------
ENTRUST/DIRECT 3.0 Provides Entrust's $15 per user December 1997
automated key and
certificate management
features to secure Web
sessions
- ---------------------------------------------------------------------------------------
ENTRUST-READY Provides Entrust's $15 per user March 1998
NETSCAPE SOLUTION 1.0 automated key and
certificate management
features to Netscape's
Communicator 4.0 and
Enterprise Server
- ---------------------------------------------------------------------------------------
ENTRUST/TRUE DELETE 2.0 Securely deletes files Currently bundled April 1998
with other
Entrust products
- ---------------------------------------------------------------------------------------
ENTRUST/ENTERPRISE Provides a variety of $99 per user July 1998
DESKTOP SUITE 1.0 solutions including secure
e-mail, desktop encryption,
secure Web sessions,
secure file deletion and
customizable installation
in
a single software package
</TABLE>
APPLICATION DEVELOPER TOOLKIT
Because certificate management represents the most difficult aspect of
adding security to an application, the Company has provided the
Entrust/Toolkit to enable application developers to make third-party
applications Entrust-Ready while keeping the complexities of key and
certificate management transparent. The Entrust/Toolkit is a family of open,
easy-to-integrate security APIs that provide security services, including full
key life cycle management, to a broad range of applications.
NEW PRODUCT DEVELOPMENT
Entrust devotes significant resources to the development of new and enhanced
product functionality to maintain its technology and product leadership. The
Company employs a number of different methods for identifying product
extension opportunities and new product candidates,
41
<PAGE>
including user group meetings and direct feedback, an active program of
partnership and cooperation with companies developing complementary
technologies, and continued participation and leadership in industry
standards-setting bodies such as the Internet Engineering Task Force (IETF),
the North American Clearinghouse Association (NACHA), the American National
Standards Institute (ANSI) and others.
Some of the Company's current and planned product development efforts
include the use of certificate distribution with new devices (such as cellular
telephones, pagers and personal digital assistants), attribute certificates
for privilege management, electronic notary services, and monitoring and
assessment systems. The Company is also continuing to increase the number of
third-party applications and services that the Company's PKI solution can
manage, including VPN devices and routers and other popular user applications.
Entrust scientists are also actively engaged in the development and
improvement of the advanced cryptographic algorithms for use in Entrust
products, including exploration of the use of highly efficient algorithms such
as elliptical curve encryption.
PROFESSIONAL SERVICES AND SUPPORT
The Company believes that a high level of service and support is critical to
its success, and that a close and active service and support relationship is
important to facilitate rapid implementation of its solutions, assure customer
satisfaction and provide the Company with important information regarding
evolving customer requirements. Toward that end, the Company has made a
significant investment in expanding its professional services and support
organization, which, as of June 30, 1998, consisted of 68 employees. The
Company's professional services providers have a broad range of experience in
network security and include mathematicians, cryptographers and system
designers.
The Company's professional services organization provides consulting and
systems integration services to support customers in designing, implementing
and running their PKI solutions. Activities of the professional services
organization are supplemented with a professional services partner program
that includes Coopers & Lybrand, Deloitte & Touche and KPMG Peat Marwick. To
facilitate the integration of PKI management into the customer's business
operations, the Company also offers its Entrust InSource service, in which the
Company provides on-site PKI management for customers on a long-term basis, or
while the customer implements and trains personnel.
The Company's support offerings also include direct telephone consulting
support by experienced technical account representatives, toll-free telephone
customer support, 24-hour pager access, e-mail and fax support, Internet
access to the Company's knowledge repository, and discussion group access.
Payment of an annual maintenance fee also entitles customers to receive
software enhancements to their licensed versions of the Company's solution.
RESEARCH AND DEVELOPMENT
The Company's research and development efforts are focused on developing new
products, core technologies and enhancements to existing product lines to
maintain and extend its technology and product leadership position. The
Company spent approximately $2.3 million, $2.9 million and $5.7 million on
research and development in 1995, 1996 and 1997, respectively.
As of June 30, 1998, the Company's research and development staff consisted
of 140 employees, several of whom have international reputations in their
respective disciplines. With the addition of r/3/, the Company has added
significant research and development capabilities in Europe, including an
internationally recognized cryptographic team.
The Company's research and development staff is active in several prominent
standards-setting bodies, including IETF, ANSI, the Internet PKIX group and
ISO, and has contributed to a number of
42
<PAGE>
standards in the Internet and data security areas. The Company believes that it
is well-situated to respond to changes in relevant industry standards and to
continue to participate in the development of these standards as the
requirements of enterprises and users become increasingly complex.
CUSTOMERS
The Company's customers are generally domestic and foreign government
entities and Global 2000 companies, including financial, health care,
telecommunications and large manufacturing organizations. As of June 30, 1998,
the Company had licensed its software to more than 500 customers. The following
is a representative list of the Company's current customers that have accounted
for more than $200,000 of revenues each:
Banco Nazionale di Lavorno Interpay
Bell Emergis J.P. Morgan
Canadian Dept. of National Defense Nortel
Citibank Royal Canadian Mounted Police
S.W.I.F.T.
Columbia/HCA Healthcare Corporation Science Applications International
Digital Medical Systems United Kingdom Post
FDIC U.S. Coast Guard
Industry Canada
Historically, a limited number of customers has accounted for a significant
percentage of the Company's revenues. In 1995, two customers accounted for 53%
and 18% of revenues, respectively. In 1996, three customers accounted for an
aggregate of 64% of revenues, and 29%, 20% and 15% of revenues respectively. In
1997, three customers accounted for 19%, 12% and 11% of revenues, respectively.
Although the Company's largest customers have varied from period to period, the
Company anticipates that its results of operations in any given period will
continue to depend to a significant extent upon revenues from a small number of
customers. See "Risk Factors--Dependence on Large Customers".
SALES, MARKETING AND BUSINESS DEVELOPMENT
The Company offers its products and services through a multi-tiered approach
reflecting the characteristics and buying behavior of the markets it covers. As
of June 30, 1998, the Company had 133 employees in sales, marketing and
business development.
DIRECT SALES
To address its target market of Global 2000 organizations, the Company sells
its products and services in North America, the United Kingdom and Germany
primarily through a direct sales force. The Company believes that direct
coverage by the Company's sales force is necessary in light of the early stage
of PKI adoption and the sophisticated requirements of its targeted customer
base. The Company also believes that a direct sales force gives it a
competitive advantage in responding to customer needs as they evolve. The
Company's direct sales force is divided into five North American regions, the
United Kingdom and Germany. Within each region, teams are assigned specific
accounts as their exclusive responsibility. The Company has also focused its
sales efforts on key vertical markets that have a critical need for security
and understand the value it creates for their businesses. These markets include
government, finance, health care, telecommunications and large manufacturing.
The Company has established a General Markets Sales Group responsible for
pursuing identified customer opportunities outside the defined responsibilities
of the regional sales teams and accelerating the sales cycle. The direct sales
organization is also supplemented by targeted direct mail and telemarketing
campaigns developed by the Company's marketing organization.
43
<PAGE>
INDIRECT SALES
To supplement its direct sales force, the Company has established an Entrust
Partner Program involving a range of technology, marketing and sales
relationships including:
. VAR and OEM partners that focus on creating bundled solutions to permit
customers to purchase total desktop applications incorporating Entrust
functionality. These partners include Digital Equipment Corporation,
EDS, Hewlett-Packard, IBM and Tandem, which resell the Company's
products with their hardware and networking solutions, as well as Check
Point Software, Symantec and TimeStep, which plan to bundle the
Company's PKI solutions with their own software products.
. Interoperability partners such as Cisco, Lotus Development, Netscape and
Shiva, which offer products that utilize the security features of the
Entrust PKI solution.
. Consultant and systems integration partners that recommend and implement
Entrust-Ready security solutions as part of their overall service
offerings to customers, thereby differentiating their offerings through
the inclusion of PKI functionality. These partners include Coopers &
Lybrand, Deloitte & Touche and KPMG Peat Marwick.
. Referral partners that refer their consulting and integration customers
in designated markets to the Entrust PKI solution.
. Distributors and agents that promote and sell the Company's products in
defined geographic markets.
MARKETING
To support its sales force, the Company has a marketing group whose goals
are to create a consistent, focused communication strategy that increases
awareness of the Company's PKI solution and brand name, and to leverage that
awareness in the identification of new sales opportunities. The marketing
group conducts marketing programs that include direct mail, trade shows,
annual seminar series, executive breakfasts and ongoing customer communication
programs. The Company has organized a number of major trade shows, including
the Entrust SecureSummit '98 held in Chicago in June 1998. The Company also
provides frequent Web updates, search engine registration, online advertising
and product downloads. The Company's marketing personnel are dedicated to
maximizing brand success and periodically evaluating the Company's brand
recognition.
BUSINESS DEVELOPMENT
To identify and develop strategic relationships with targeted industry
partners more effectively, the Company has a business development organization
of 21 persons that pursues selected business development activities, including
the administration and promotion of the Company's Entrust Partner Program.
These activities permit the Company to strengthen relationships with existing
strategic partners and identify and encourage new providers of software,
network, computing and communications products to make their products Entrust-
Ready.
COMPETITION
The Company's products are targeted at the new and rapidly evolving market
for PKI solutions. Although the competitive environment in this market has yet
to develop fully, the Company anticipates that it will be intensely
competitive, subject to rapid change and significantly affected by new product
and service introductions and other market activities by industry
participants.
Because of the broad functionality of its PKI solution, the Company competes
with vendors offering a wide range of security products and services. The
Company competes with companies offering commercial certification authority
products and services such as VeriSign, GTE Cybertrust Solutions, XCert and
IBM in the market for issuing and maintaining digital certificates for use on
public
44
<PAGE>
and private networks. Certain of these companies, such as IBM and XCert,
provide a product-based solution, while others, such as VeriSign and GTE
Cybertrust Solutions, are primarily service providers. The Company also
competes with companies, such as Baltimore Technologies of Ireland, which
offer PKI product solutions for enterprises. In addition, the Company expects
to compete with established companies developing new PKI offerings, such as
Security Dynamics and Network Associates, which have each announced their
intention to introduce PKI products that would be integrated with their other
security product offerings, as well as Microsoft Corporation, which has
announced its intention to offer a certificate server product based on its
existing security framework in the near future. The Company expects that there
will be additional entrants to this marketplace. In addition, other major
networking vendors could, in the future, bundle digital certificates with
their product offerings. The Company typically competes with these vendors and
service providers on the basis of its ability to provide a centrally managed,
real-time, comprehensive infrastructure with the features and functionality to
support enterprise applications. In addition, the Company competes in the
emerging market for providing security across VPNs with most major networking
device companies, such as Ascend and Cisco, as well as firewall vendors such
as AXENT (Raptor) and Check Point Software.
The Company believes that the principal competitive factors affecting the
market for PKI technology include technical features, ease of use,
quality/reliability, level of security, scalability, customer service and
support and price. Although the Company believes that its products currently
compete favorably with respect to such factors, there can be no assurance that
the Company can maintain its competitive position against current and
potential competitors. See "Risk Factors--Competition". Many of the Company's
current and potential competitors have longer operating histories, greater
name recognition, larger installed bases and significantly greater financial,
technical, marketing and sales resources than the Company. 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 than the Company. In addition, certain of the Company's
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 the Company's functionality. The Company
may also compete in the future for sales of Entrust products against its OEM
licensees, who resell the Entrust solution under their own brand names.
REGULATORY MATTERS
The Company's products are subject to special export restrictions
administered by the governments of the United States, Canada and other
countries. The Company's products are also subject to import restrictions
and/or use restrictions imposed by countries such as France. Consequently, the
ability of the Company to export its products to destinations outside of the
U.S. and Canada is subject to a variety of government approvals or licensing
requirements. These export controls may also restrict the ability of the
Company to make some products available for sale via international computer
networks such as the Internet. Re-export of the products between countries
other than the U.S. and Canada may be subject to the export control laws of
those countries in addition to those provisions of the U.S. and/or Canadian
export control laws which apply to re-exports. In light of these restrictions,
the Company's products made available abroad may contain significantly weaker
encryption capabilities than those available to customers in the U.S. and
Canada, and there can be no assurance that the Company will continue to be
able to export its products to any destinations outside of the U.S. and
Canada. Such restrictions could potentially have an adverse effect on the
Company's business, financial condition or results of operations. See "Risk
Factors--Industry Regulation".
In October 1996, the U.S. government announced a new export control policy
for encryption products. Under the new policy, cryptography of any strength
may be authorized for export, after a one-time government review, as long as
the product provides for a key recovery method which will enable authorized
law enforcement agencies to access the keys required to decrypt lawfully
45
<PAGE>
intercepted encrypted data without the knowledge or consent of the user of the
encryption product. The U.S. government regulations provide flexibility with
respect to what specific key recovery mechanisms will be permitted; the
Company's products already provide some built-in key recovery features, and
the Company believes that its product architecture will satisfy the
government's criteria with few modifications.
Under an interim procedure in effect through December 31, 1998, vendors of
encryption products may be granted six-month authorizations to export from the
U.S. encryption products with key lengths between 40 and 56 bits, provided
that the vendor submits a written plan to develop a key recovery feature prior
to December 31, 1998, and shows satisfactory progress toward implementing that
plan. Each product is still subject to a one-time government review in order
to become eligible for this interim authorization. The Company has obtained
permission under this provision, which expires on December 31, 1998, to have
certain of its products exported without modification from the U.S. by U.S.
customers with operations abroad and by third-party distributors.
In the absence of a key recovery mechanism or an approved plan for such a
mechanism, current U.S. government policy is to prohibit exports (except to
Canada) of most encryption products with key lengths of greater than 56 bits,
except under individual licenses which may authorize exports of stronger
encryption products to financial institutions, subsidiaries of U.S. companies
and government agencies.
Under the current U.S. government policy, U.S. encryption export controls do
not apply to encryption products which meet all of the following criteria: (i)
are produced and exported from outside of the U.S.; (ii) do not contain U.S.-
origin encryption technologies, unless such technologies are "publicly
available"; (iii) do not contain U.S.-origin encryption source code, unless
such source code is obtained in printed (i.e., "hard copy") form; (iv) are
developed and produced without technical assistance from any U.S. person or
entity; and (v) contain no more than a de minimis amount of U.S.-origin non-
encryption software or technology. The Company believes, and has informed the
U.S. government, that certain of the Company's products are exempt from U.S.
encryption export restrictions under these criteria. The Company, however, has
not obtained any formal U.S. government ruling that any of its products
produced and shipped from outside the U.S. may be exempt from U.S. encryption
export controls, and there can be no assurance that the U.S. government will
refrain from asserting jurisdiction over one or more of the Company's
products. Such a decision by the U.S. government to assert jurisdiction could
result in penalties for past shipments and could restrict future sales of the
Company's products outside the U.S. and Canada, having a potentially material
adverse effect on the Company's business, financial condition and results of
operations.
INTELLECTUAL PROPERTY
The Company relies on a combination of patent, copyright, trademark and
trade secret laws, nondisclosure agreements and other contractual provisions
to establish, maintain and protect its proprietary rights. The Company owns
five issued U.S. patents (along with corresponding, pending foreign patent
applications) and 26 pending U.S. patent applications relating to the Entrust
products. These patents are and will continue to be subject to certain license
grants to others, including Nortel and its cross licensees, under patent cross
license agreements. See "Certain Transactions". The Company has copyright and
trade secret rights for its products, consisting mainly of source code and
product documentation. The Company uses a printed "shrink-wrap" license for
users of its products in order to protect certain of its copyrights and trade
secrets. The Company attempts to protect its trade secrets and other
proprietary information through agreements with suppliers, non-disclosure and
non-competition agreements with employees and consultants and other security
measures.
46
<PAGE>
There can be no assurance that the Company will seek patents on its
technology or products, that any such patents will be issued or that any such
additional patents will be sufficiently broad to protect the Company's
technology or products. The status of computer-related patents involves
complex legal and factual questions and the breadth of claims allowed is
uncertain. Accordingly, there can be no assurance that patent applications
filed by the Company will result in patents being issued or that its existing
patents, and any patents that may be issued to it in the future, will afford
protection against competitors with similar technology, nor can there by any
assurance that patents issued to the Company will not be infringed upon or
designed around by others or that others will not obtain patents that the
Company would need to license or design around. If existing or future patents
containing broad claims are upheld by the courts, the holders of such patents
might be in a position to require companies to obtain licenses. There can be
no assurance that licenses that might be required for the Company's products
would be available on reasonable terms, if at all.
The Company relies on outside licensors, including RSA, for patent and/or
software license rights in encryption technology that is incorporated into and
is necessary for the operation of the Company's products. The Company's
success will depend in part on its continued ability to have access to such
technologies that are or may become important to the functionality of its
products. Any inability to continue to procure or use such technology could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or
to obtain and use information that the Company regards as proprietary.
Policing unauthorized use of the Company's products is difficult, and while
the Company is unable to determine the extent to which piracy of its software
products exists, such piracy can be expected to be a persistent problem,
particularly in international markets and as a result of the growing use of
the Internet. Some courts have held that shrink-wrap licenses, because they
are not signed by the licensee, are not enforceable. There can also be no
assurance that the Company's trade secrets or confidentiality agreements will
provide meaningful protection of the Company's proprietary information.
Furthermore, there can be no assurance that others will not independently
develop similar technologies or duplicate any technology developed by the
Company or that the Company's technology will not infringe upon patents of
other rights owned by others. The Company's inability to protect its
proprietary rights could have a material adverse effect on the Company's
business, financial condition or results of operations.
As the number of information security products in the industry increases 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 right of others.
There can be no assurance that third parties will not assert infringement or
misappropriation claims against the Company in the future with respect to
current or future products. Further, the Company may be subject to additional
risk as it enters into transactions in countries where intellectual property
laws are not well developed or are poorly enforced. Legal protections of the
Company's rights may be ineffective in such countries, and technology
developed in such countries may not be protectable in jurisdictions where
protection is ordinarily available.
Any claims or litigation, with or without merit, to defend or enforce the
Company's intellectual property could be costly and could result in a
diversion of management's attention, which could have a material adverse
effect on the Company's business, financial condition or results of
operations. Adverse determinations in such claims or litigation could also
have a material adverse effect on the Company's business, financial condition
or results of operations. See "Risk Factors--Limited Protection of Proprietary
Rights and Dependence on Licensed Rights".
47
<PAGE>
EMPLOYEES
As of June 30, 1998, the Company had 397 full-time employees, 289 of whom
were employed by the Canadian Subsidiary. Of the Company's employees, 140 were
involved in research and development, 133 in sales, marketing and business
development, 68 in professional and customer support services and 56 in
administration and finance. No employees are covered by any collective
bargaining agreements, and the Company believes that its relationships with
its employees are good. The future success of the Company, however, will
depend upon its ability to attract and retain qualified personnel. Competition
for such personnel is often intense, and there can be no assurance that the
Company will be able to attract and retain adequate numbers of qualified
personnel in the future. See "Risk Factors--Competitive Market for Technical
Personnel".
FACILITIES
The Company's U.S. headquarters, including its executive offices and
administrative facilities, is located in Richardson, Texas, where it leases
approximately 3,219 square feet of office space. The Company also leases
approximately 69,000 square feet of office space at its Canadian headquarters
in Ottawa, Ontario, Canada. The Company currently intends to lease additional
office space in the Ottawa area to accommodate expected growth in
administrative, sales and marketing, research and development and operations
personnel. The Company also has offices located in London, England and Zurich,
Switzerland.
The Company also has sales offices in Chicago, Illinois, McLean, Virginia,
New York, New York and St. Louis, Missouri, a sales and business development
office in Menlo Park, California and a sales and professional services office
in Raleigh, North Carolina. The Company leases a sales and support office in
Bad Homburg, Germany.
LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company or any
of its property are subject.
48
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company, their ages and
positions as of June 30, 1998, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
John A. Ryan................... 42 President, Chief Executive Officer and
Director
Brian O'Higgins................ 42 Executive Vice President and Chief
Technology Officer
Bradley N. Ross................ 39 President of European Operations
Michele L. Axelson............. 48 Senior Vice President, Business Development
and Finance and Chief Financial Officer
Richard D. Spurr............... 44 Senior Vice President, Sales and Marketing
Hansen Downer.................. 46 Vice President, Professional Services
David D. Archibald(1).......... 56 Director
F. William Conner(1)........... 39 Director
Frank A. Dunn(2)............... 44 Director
Robert S. Morris(1)(2)......... 43 Director
</TABLE>
- --------
(1)Member of the Compensation Committee.
(2)Member of the Audit Committee.
JOHN A. RYAN has served as President and Chief Executive Officer and as a
director of the Company since its founding in December 1996. From October 1995
until December 1996 he served as the Vice President and General Manager for
the Multimedia and Internet Solutions business unit of Nortel. Prior to that
time, from August 1992 until October 1995, he served as Assistant Vice
President, Marketing for the Enterprise Network group of Nortel. Since joining
Nortel in 1981, he has also served in various senior positions in marketing,
customer service and finance. Mr. Ryan holds a Bachelor of Mathematics degree
from the University of Waterloo, Waterloo, Ontario, and is a Chartered
Accountant.
BRIAN O'HIGGINS has served as Executive Vice President and Chief Technology
Officer of the Company since its founding in December 1996. Mr. O'Higgins co-
founded the Nortel Secure Networks ("NSN") business unit in 1994, which became
Entrust Technologies Inc. in December 1996. Previously, he was employed by
Bell Northern Research Ltd. ("BNR"), the research and development subsidiary
of NTL, which he joined in 1979. Mr. O'Higgins holds a Bachelor of Science
degree in Electrical Engineering from Carleton University, Ottawa, Ontario.
BRADLEY N. ROSS has served as President of European Operations since March
1998. From December 1996 until March 1998, he served as the Company's
Executive Vice President Marketing and Product Line Management. Mr. Ross co-
founded NSN in 1994 with Mr. O'Higgins, which became Entrust Technologies Inc.
in December 1996. Previously, he was employed by BNR, which he joined in 1982
and held various positions in software design and program management for
Nortel's switching products. Mr. Ross holds Bachelor and Master of Science
degrees in Engineering from Queen's University, Kingston, Ontario, and a
Master of Business Administration degree in Management Science from the
Massachusetts Institute of Technology's Sloan School of Management, Cambridge,
Massachusetts.
49
<PAGE>
MICHELE L. AXELSON has served as Senior Vice President, Business Development
and Finance and Chief Financial Officer since joining the Company in May 1998.
From June 1996 until May 1998, she served as the Senior Vice President and
Chief Financial Officer for Scopus Technologies Inc., an enterprise customer
care software company. Prior to that time, from 1979 until June 1996, Ms.
Axelson held various positions at Arthur Andersen LLP, an international public
accounting firm, and was a partner of that firm from 1989 until June 1996. Ms.
Axelson is a Certified Public Accountant and holds a Bachelor of Science
degree in Business Administration from San Jose State University, San Jose,
California.
RICHARD D. SPURR has served as Senior Vice President, Sales and Marketing of
the Company since March 1998. Prior to that time, he served as Senior Vice
President of Global Sales of the Company since joining the Company in June
1997. Prior to joining the Company, from December 1990 to March 1997, he held
numerous executive positions for SEER Technologies, Inc., a developer of
component-based software applications, including Vice President of Strategic
Alliances from January 1994 to November 1996 and Vice President of Major
Accounts from December 1996 to March 1997. From June 1974 until December 1990,
Mr. Spurr served in various sales and sales management positions with IBM. Mr.
Spurr holds a Bachelor of Arts degree from the University of Notre Dame, South
Bend, Indiana.
HANSEN DOWNER has served as Vice President, Professional Services of the
Company since he joined the Company in December 1997. From February 1997 to
November 1997, Mr. Downer served as Vice President of Sales, Marketing and New
Product Development at Interpath Communications, Inc., an Internet service
provider. From March 1996 until August 1996, Mr. Downer served as Vice
President of Customer Service and Telecom Network Design for the Physician's
Desktop Company, a network development company and a subsidiary of Imonics
Corporation. From May 1995 until March 1996, Mr. Downer served as Vice
President of Business Development at Imonics Corporation, a client server
systems integration company focused on the health care industry. Prior to that
time, from 1979 to December 1994, he worked for Nortel in a number of roles.
Mr. Downer holds a Bachelor of Mathematics degree from the University of
Waterloo, Waterloo, Ontario.
DAVID D. ARCHIBALD has been a director of the Company since its founding in
December 1996. Mr. Archibald has served as Vice President and Deputy General
Counsel of NTL since March 1995, and has responsibility for legal affairs of
several of Nortel's operations and business units. Prior to that time, from
April 1979 to March 1995, Mr. Archibald served as Vice President and General
Counsel of Northern Telecom Canada Limited. Mr. Archibald holds a Bachelor of
Commerce degree and a Bachelor of Common Law from Dalhousie University,
Halifax, Nova Scotia.
F. WILLIAM CONNER has been a director of the Company since July 1997. He has
served as Senior Vice President and President of Nortel's Enterprise Data
Networks line of business since February 1998. From August 1995 until February
1998, Mr. Conner served as Executive Vice President, Sales and Marketing for
the Enterprise Networks line of business of Nortel. Prior to that time, from
1992 until July 1995, Mr. Conner held a variety of sales and marketing
executive positions in Nortel's voice and data enterprise lines of businesses.
Mr. Conner holds a Bachelor of Science degree in Mechanical Engineering from
Princeton University, Princeton, New Jersey and a Master of Business
Administration Degree from the University of Pennsylvania's Wharton School,
Philadelphia, Pennsylvania.
FRANK A. DUNN has been a director of the Company since July 1997. Mr. Dunn
has served as the Senior Vice President of Finance and Planning of Nortel
since March 1996. From January 1994 until March 1996, Mr. Dunn served as Vice
President of Finance for Nortel's North American lines of business, a
management division within NTL. Prior to that time, from March 1993 until
January 1994, Mr. Dunn served as NTL's Corporate Controller. Mr. Dunn holds a
Bachelor of Commerce degree from McGill University, Montreal, Quebec.
50
<PAGE>
ROBERT S. MORRIS has been a director of the Company since January 1997. Mr.
Morris founded Olympus Partners, a private investment firm, in 1989 and serves
as Managing Partner of Olympus Private Placement Fund, L.P., Olympus Growth
Fund II, L.P., Olympus Executive Fund, L.P. and Olympus Growth Fund III, L.P.
Mr. Morris serves on the boards of directors of TriNet Corporate Realty Trust,
Inc. and Candlewood Hotel Company, Inc. Mr. Morris holds a Bachelor of Arts
degree from Hamilton College, Clinton, New York and a Master of Business
Administration degree from the Amos Tuck School of Business at Dartmouth
College, Hanover, New Hampshire.
The Company anticipates adding at least one additional member to the Board
of Directors who is unaffiliated with the Company or Nortel.
The members of the Board of Directors were elected pursuant to the terms of
a Stockholders' Agreement, dated as of December 31, 1996, as amended, among
the Company and certain stockholders (the "Stockholders' Agreement"). The
Stockholders' Agreement terminates upon the closing of the Offerings.
Following the Offerings, the Board of Directors of the Company will be
divided into three classes, each of whose members will serve for a staggered
three-year term. The Board will consist of two Class I Directors (Messrs.
Archibald and Morris), two Class II Directors (Messrs. Conner and Ryan) and
one Class III Director (Mr. Dunn). At each annual meeting of stockholders, a
class of directors will be elected for a three-year term to succeed the
directors of the same class whose terms are then expiring. The Company's
Amended and Restated Bylaws (the "Bylaws") provide that such directors are
elected by a plurality of all votes cast at such meeting. The terms of the
Class I Directors, Class II Directors and Class III Director expire upon the
election and qualification of successor directors at the annual meeting of
stockholders held during the calendar years 1999, 2000 and 2001, respectively.
The Amended and Restated Articles of Incorporation of the Company provide for
a Board of Directors composed of five directors, unless otherwise increased or
decreased in the manner provided in the Bylaws. The Bylaws permit the
Company's Board of Directors, by a majority vote, to fix the number of
directors between three and ten.
Each executive officer serves at the discretion of the Board of Directors
and holds office until his or her successor is elected and qualified or until
his or her earlier resignation or removal. There are no family relationships
among any of the directors or executive officers of the Company.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has a Compensation Committee composed of Messrs.
Archibald, Conner and Morris, which establishes the compensation of, and
compensation policies applicable to, the Company's executive officers and
administers and grants stock options and other stock awards pursuant to the
Company's stock plans. The Board of Directors also has an Audit Committee
composed of Messrs. Dunn and Morris, which makes recommendations to the Board
of Directors concerning the appointment or replacement of the Company's
independent public accountants, confers with such accountants regarding such
accountants' audit of the Company and recommends and implements desired
changes to the scope of the Company's audit.
DIRECTOR COMPENSATION
Directors do not receive any cash fees for their services on the Board, but
are reimbursed for expenses incurred in connection with their attendance at
Board and committee meetings. In addition, non-employee directors of the
Company are eligible to receive stock options under the Company's Amended and
Restated 1996 Stock Incentive Plan. See "-- Stock Plans -- Amended and
Restated 1996 Stock Incentive Plan".
51
<PAGE>
EXECUTIVE COMPENSATION
The following table sets forth the total compensation paid or accrued for
the year ended December 31, 1997 for the Company's Chief Executive Officer and
its three other executive officers in the year ended December 31, 1997 whose
salary and bonus totaled at least $100,000 for the fiscal year (together, the
"Named Executive Officers"):
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
------------
AWARDS
------------
ANNUAL COMPENSATION SECURITIES
-------------------- UNDERLYING
NAME AND PRINCIPAL POSITION SALARY BONUS OPTIONS(1)
- ------------------------------------------ ---------- --------- ------------
<S> <C> <C> <C>
John A. Ryan ............................. $ 180,874 $ 79,800(2) 1,445,800
President and Chief Executive Officer
Brian O'Higgins........................... 94,319 46,123(2) 602,400
Executive Vice President and Chief Tech-
nology Officer
Bradley N. Ross........................... 94,175 45,298(2) 602,400
President of European Operations
Richard D. Spurr(3)....................... 68,217 43,820 440,000
Senior Vice President, Sales and Market-
ing
</TABLE>
- --------
(1) Represents the number of shares covered by options to purchase shares of
Common Stock granted during the year ended December 31, 1997. The Company
has never granted any stock appreciation rights.
(2)Represents bonuses paid for 1996 performance at Nortel.
(3)Represents compensation from June 1997 when Mr. Spurr joined the Company.
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth all individual grants of stock options to
each of the Named Executive Officers during the year ended December 31, 1997.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF STOCK
PRICE APPRECIATION FOR
INDIVIDUAL GRANTS OPTION TERM(2)
-------------------------------------------------------------- -----------------------
NUMBER OF PERCENT OF TOTAL
SECURITIES OPTIONS GRANTED
UNDERLYING TO EMPLOYEES EXERCISE OR BASE EXPIRATION
NAME OPTIONS GRANTED IN FISCAL YEAR PRICE PER SHARE(1) DATE 5% 10%
- ------------------------ --------------- ---------------- ------------------ ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
John A. Ryan............ 1,445,800(3) 21.4% $2.13 1/1/07 $ 1,932,169 $ 4,896,495
Brian O'Higgins......... 602,400(3) 8.9 2.13 1/1/07 850,048 2,040,150
Bradley N. Ross......... 602,400(3) 8.9 2.13 1/1/07 850,048 2,040,150
Richard D. Spurr........ 440,000(4) 6.5 2.13 1/1/07 588,016 1,490,149
</TABLE>
- --------
(1) The exercise prices represent the fair market value of the Common Stock on
the respective dates of grant, as determined by the Board of Directors.
(2) Amounts reported in these columns represent amounts that may be realized
upon exercise of the options immediately prior to the expiration of their
term assuming the specified compound rates of appreciation (5% and 10%) on
the market value of the Common Stock on the date of option grant over the
term of the options. These numbers are calculated based on rules
promulgated by the Securities and Exchange Commission and do not reflect
the Company's estimate of future stock price growth. Actual gains, if any,
on stock option exercises and Common Stock holdings are dependent on the
timing of such exercise and the future performance of the Common Stock.
There can be no assurance that the rates of appreciation assumed in this
table can be achieved or that the amounts reflected will be received by
the individuals.
(3) Each of the indicated options cumulatively vests as to one-fifth of the
underlying shares on January 1, 1997 and each of the first, second, third
and fourth anniversaries of January 1, 1997.
(4) The indicated option cumulatively vests as to one-fifth of the underlying
shares on July 23, 1997 and each of the first, second, third and fourth
anniversaries of July 23, 1997.
52
<PAGE>
FISCAL YEAR-END OPTION VALUES
The following table sets forth certain information concerning the number and
value of unexercised options held by each of the Named Executive Officers on
December 31, 1997. None of the Named Executive Officers exercised options
during the year ended December 31, 1997.
FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SHARES UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS AT
AT FISCAL YEAR END FISCAL YEAR-END(2)
---------------------------- -------------------------
NAME EXERCISABLE(1) UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------------- -------------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
John A. Ryan............. 578,320 867,480 $7,442,978 $11,164,468
Brian O'Higgins.......... 240,960 361,440 3,101,155 4,651,733
Bradley N. Ross.......... 240,960 361,440 3,101,155 4,651,733
Richard D. Spurr......... 88,000 352,000 1,132,560 4,530,240
</TABLE>
- --------
(1) Includes shares that became exercisable as of January 1, 1998.
(2) There was no public trading market for the Common Stock as of December 31,
1997. Accordingly, these values have been calculated on the basis of the
assumed initial public offering price of $15.00 per share, less the
applicable exercise price.
EMPLOYMENT AGREEMENTS
Pursuant to a letter agreement between John A. Ryan and the Company, dated
as of April 21, 1997, the Company agreed to employ Mr. Ryan as the Company's
President and Chief Executive Officer, with an annual salary of $185,000 and
an annual bonus of up to 35% of the base salary. The Company also agreed to
reimburse up to $35,000 of expenses related to executive perquisites in
Mr. Ryan's first year of employment as President and Chief Executive Officer,
and up to $12,000 for such expenses in each subsequent year of employment. Mr.
Ryan will receive a relocation assistance payment of up to $100,000 if he is
required to relocate his residence due to the relocation of the Company's
headquarters. If Mr. Ryan's employment is terminated by the Company within two
years of such a relocation, for any reason other than for cause, disability,
retirement, resignation or death, then Mr. Ryan is entitled to payment of his
base salary for up to 36 weeks. Mr. Ryan's employment is terminable at will.
Pursuant to a letter agreement between Brian O'Higgins and NTL, on behalf of
the Company, dated as of November 18, 1996, the Company agreed to employ Mr.
O'Higgins as the Company's Executive Vice President, Technology, with an
annual salary of CDN$130,000. Mr. O'Higgins was appointed as the Company's
Executive Vice President and Chief Technology Officer in December 1996, and in
September 1997 his annual salary was increased to CDN$160,000. Upon
termination of his employment without just cause, Mr. O'Higgins will be
entitled to payment of his base salary for 12 months, plus an allowance of
CDN$10,000 for benefits. Mr. O'Higgins has agreed not to compete against the
Company for 12 months following the termination of his employment with the
Company.
Pursuant to a letter agreement between Bradley N. Ross and NTL, on behalf of
the Company, dated as of November 18, 1996, the Company agreed to employ Mr.
Ross as the Company's Executive Vice President, Marketing and Product Line
Management, with an annual salary of CDN$130,000. Mr. Ross currently serves as
the Company's President of European Operations. In September 1997, Mr. Ross'
annual salary was increased to CDN$160,000. Upon termination of his employment
without just cause, Mr. Ross will be entitled to payment of his base salary
for 12 months, plus an allowance of CDN$10,000 for benefits. Mr. Ross has
agreed not to compete against the Company for 12 months following the
termination of his employment with the Company.
53
<PAGE>
Pursuant to a letter agreement between Richard D. Spurr and the Company,
dated as of June 4, 1997, the Company agreed to employ Mr. Spurr as the
Company's Vice President of Global Sales, with an annual salary of $125,000.
Mr. Spurr currently serves as the Company's Senior Vice President, Sales and
Marketing. Mr. Spurr is also eligible to receive up to $125,000 through the
Company's sales incentive program. Mr. Spurr's employment is terminable at
will.
Pursuant to a letter agreement between Michele L. Axelson and the Company,
dated as of July 2, 1998, the Company agreed to employ Ms. Axelson as the
Company's Senior Vice President, Finance and Business Development and Chief
Financial Officer, with an annual salary of $150,000 and a signing bonus of
$25,000, payable in two installments on the date of the letter and September
11, 1998. In addition, the Company loaned $375,000 to Ms. Axelson pursuant to
a demand note dated July 2, 1998 bearing interest at the rate of 6% per year.
Under the terms of the letter agreement, the principal and interest on the
loan will be repaid in four annual installments, and the Company may forgive
any such installment based on Ms. Axelson's successful performance of her
duties during the preceding year, as determined by the Chief Executive
Officer. The Company has also granted to Ms. Axelson an option to purchase up
to 300,000 shares of Common Stock of the Company. The vesting of 50% of any
unvested shares under the option will be accelerated if Ms. Axelson's
employment as Chief Financial Officer is terminated within one year following
an Acquisition Event (as defined in the Incentive Plan, described below). Ms.
Axelson's employment is terminable at will.
STOCK PLANS
AMENDED AND RESTATED 1996 STOCK INCENTIVE PLAN
The Company's Amended and Restated 1996 Stock Incentive Plan (the "Incentive
Plan") was adopted by the Board of Directors and approved by the stockholders
of the Company in December 1996. The Incentive Plan was amended and restated
by the Board in June 1998, and such amendment and restatement was approved by
the stockholders in July 1998. The Incentive Plan was further amended by the
Board of Directors in July 1998. Up to 9,600,000 shares of Common Stock
(subject to adjustment in the event of stock splits and other similar events)
may be issued pursuant to awards granted under the Incentive Plan.
The Incentive Plan provides for the grant of incentive stock options
intended to qualify under Section 422 of the Internal Revenue Code of 1986, as
amended (the "Code"), nonstatutory stock options, restricted stock awards and
other stock-based awards (collectively, "Awards").
Officers, employees, directors, consultants and advisors of the Company and
its subsidiaries (collectively, "Participants") are eligible to receive Awards
under the Incentive Plan, provided such consultants render bona fide services
not in connection with an offer or sale of securities in a capital raising
transaction. Under present law, however, incentive stock options may only be
granted to employees of the Company or its subsidiaries. The maximum number of
shares with respect to which an Award may be granted to any Participant under
the Incentive Plan may not exceed 5,000,000 shares per calendar year.
Participants who are granted options under the Incentive Plan receive the
right to purchase a specified number of shares of Common Stock at a specified
option price and subject to such other terms and conditions as are specified
in connection with the option grant. Options may be granted at an exercise
price which may be less than, equal to or greater than the fair market value
of the Common Stock on the date of grant. Under present law, incentive stock
options and options intended to qualify as performance-based compensation
under Section 162(m) of the Code may not be granted at an exercise price less
than the fair market value of the Common Stock on the date of grant (or less
than 110% of the fair market value in the case of incentive stock options
granted to optionees holding
54
<PAGE>
more than 10% of the voting power of the Company). The Incentive Plan permits
the Board of Directors to determine the manner of payment of the exercise
price of options, including payment by cash, check or in connection with a
"cashless exercise" through a broker, by surrender to the Company of shares of
Common Stock, by delivery to the Company of a promissory note or by any
combination of the permitted forms of payment.
The Incentive Plan is administered by the Board of Directors. The Board of
Directors has the authority to adopt, amend and repeal the administrative
rules, guidelines and practices relating to the Incentive Plan and to
interpret the provisions thereof. Pursuant to the terms of the Incentive Plan,
the Board of Directors may delegate authority under the Incentive Plan to one
or more committees of the Board of Directors and, subject to certain
limitations, to one or more executive officers of the Company. The Board of
Directors has authorized the Compensation Committee to administer the
Incentive Plan, including the granting of options to executive officers.
Subject to any applicable limitations contained in the Incentive Plan, the
Board of Directors, the Compensation Committee or any other committee or
executive officer to whom the Board of Directors delegates authority, as the
case may be, selects the recipients of Awards and determines (i) the number of
shares of Common Stock covered by options and the dates upon which such
options become exercisable, (ii) the exercise price of options, (iii) the term
of options and (iv) the number of shares of Common Stock subject to any
restricted stock or other stock-based Awards and the terms and conditions of
such Awards, including any conditions for repurchase, the issue price and
repurchase price.
In the event of a merger, liquidation or other Acquisition Event (as defined
in the Incentive Plan), the Incentive Plan authorizes the Board of Directors
to provide (i) that outstanding options be assumed or substituted by the
succeeding corporation, (ii) that unexercised options become exercisable in
full immediately prior to the consummation of the Acquisition Event, (iii) for
a cash payment to holders of outstanding options, followed by the termination
of such options, in certain circumstances, (iv) that all restricted stock
awards become free of all restrictions prior to the consummation of the
Acquisition Event or (v) that other stock-based Awards (x) become exercisable,
realizable or vested in full immediately prior to the consummation of the
Acquisition Event or (y) be assumed or substituted by the succeeding
corporation.
No Award may be granted under the Incentive Plan after December 2006, but
the vesting and effectiveness of Awards previously granted may extend beyond
that date. The Board of Directors may at any time amend, suspend or terminate
the Incentive Plan, except that no Award granted after an amendment of the
Incentive Plan and designated as subject to Section 162(m) of the Code by the
Board of Directors shall become exercisable, realizable or vested (to the
extent such amendment was required to grant such Award) unless and until such
amendment is approved by the Company's stockholders.
1998 EMPLOYEE STOCK PURCHASE PLAN
The Company's 1998 Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Board of Directors in July 1998 and approved by the
stockholders of the Company in August 1998. The Purchase Plan authorizes the
issuance of up to a total of 400,000 shares of Common Stock to participating
employees.
All employees of the Company, including directors of the Company who are
employees, and all employees of any participating subsidiaries whose customary
employment is more than 20 hours per week and more than five months in any
calendar year are eligible to participate in the Purchase Plan. Employees who
would immediately after the grant own 5% or more of the total combined voting
power or value of the stock of the Company or any subsidiary are not eligible
to participate. As of June 30, 1998, approximately 295 of the Company's
employees would have been eligible to participate in the Purchase Plan.
55
<PAGE>
On the first day of a designated payroll deduction period (the "Offering
Period"), the Company will grant to each eligible employee who has elected to
participate in the Purchase Plan an option to purchase shares of Common Stock
as follows: the employee may authorize a payroll deduction in any dollar
amount up to a maximum of 10% of such employee's base pay to be deducted by
the Company from such employee's base pay during the Offering Period. On the
last day of the Offering Period, the employee is deemed to have exercised the
option, at the option exercise price, to the extent of accumulated payroll
deductions. Under the terms of the Purchase Plan, the option exercise price
per share is an amount equal to 90%, or such other percentage as may be
determined by the Board of Directors consistent with the requirements of the
Code, of the fair market value of the Common Stock on either the first day or
the last day of the Offering Period, whichever is lower. Such fair market
value shall be determined by the Board of Directors in a manner consistent
with the requirements of the Code. In no event may an employee purchase in any
one Offering Period a number of shares which exceeds the number of shares
determined by dividing (i) the product of $2,083 and the number of whole
months in such Offering Period by (ii) the closing price on the commencement
date of the Offering Period or such other number as may be determined by the
Board of DIrectors prior to such commencement date. The Compensation Committee
may, in its discretion, choose an Offering Period of 12 months or less for
each offering and choose a different offering Period for each Offering.
If an employee is not a participant on the last day of the Offering Period,
such employee is not entitled to exercise any option, and the amount of such
employee's accumulated payroll deductions will be refunded. An employee's
rights under the Purchase Plan terminate upon voluntary withdrawal from the
Purchase Plan at any time, or when such employee ceases employment for any
reason, except that upon termination of employment because of death, the
balance in the employee's account shall be paid to the employee's beneficiary.
An employee may at any time prior to the close of business on the last day in
an Offering Period withdraw from the offering and draw out the entire balance
accumulated in the employee's account. Partial withdrawals are not permitted.
The employee may not begin participation again during the remainder of the
Offering Period, but may participate in any subsequent offering in accordance
with terms and conditions established by the Board or the Compensation
Committee. Rights under the Purchase Plan are not transferable by an employee
other than by will or the laws of descent and distribution.
The Purchase Plan terminates on July 21, 2000 or such earlier date as the
Board determines. Upon termination of the Purchase Plan all amounts in the
accounts of participating employees will be promptly refunded.
Because participation in the Purchase Plan is voluntary, the Company cannot
presently determine the number of shares of Common Stock to be purchased by
any particular current executive officer, by all current executive officers as
a group or by non-executive employees as a group.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Messrs. Archibald and Morris served during the year ended December 31, 1997
as members of the Compensation Committee of the Board of Directors. No
executive officer of the Company has served as director or member of the
compensation committee (or other committee serving an equivalent function) of
any other entity, any of whose executive officers serve as a director of or
member of the Compensation Committee of the Board of Directors. See "Certain
Transactions" for a description of transactions between the Company and
affiliates of Mr. Archibald.
56
<PAGE>
CERTAIN TRANSACTIONS
In connection with the incorporation and financing of the Company in
December 1996 and January 1997 (the "Financing"), the Company entered into an
asset transfer agreement with NTI (the "NTI Transfer Agreement"). In addition,
the Canadian Subsidiary entered into an asset transfer agreement with NTL (the
"NTL Transfer Agreement"). Messrs. Archibald, Conner and Dunn are officers of
Nortel, and, as Mr. Conner's compensation from Nortel is based in part upon
the Company's results of operations, Mr. Conner may be deemed to have an
indirect material interest in the transactions between the Company and Nortel.
Under the NTI Transfer Agreement, NTI received 20,300,000 shares of Common
Stock, an unsecured demand note in the amount of $8.0 million and the
assumption of certain liabilities by the Company in consideration for the
transfer to the Company of an exclusive license to exploit the intellectual
property rights transferred to the Canadian Subsidiary within the United
States, NTI's interest in executory contracts with distributors and customers
licensing Entrust products, equipment used by employees and contractors
dedicated to the Company's business and the records relating to the Company's
business. Prior to the execution of the NTI Transfer Agreement, the Company
was a division of Nortel and all of the officers of the Company were employees
of Nortel. Accordingly, the purchase price was not arrived at by an arm's-
length negotiation between Nortel and the Company. Rather, as part of the
Financing, Nortel determined that the consideration to be paid for its Entrust
business would be the net book value of the assets being transferred, which
the Company believes was the fair market value of the Entrust business at the
time of transfer.
Under the NTL Transfer Agreement, NTL received 7,700,000 Exchangeable
Special Shares of the Canadian Subsidiary (which stock is convertible into
shares of the Common Stock of the Company), one share of common stock of the
Canadian Subsidiary and the assumption of certain liabilities by the Company
in exchange for NTL's worldwide intellectual property rights underlying the
Entrust products (subject to the license of NTI and certain exceptions, see
"Business--Intellectual Property"), the inventory of the Company's business,
all executory contracts with suppliers, distributors and customers licensing
Entrust products (other than NTI's interest therein), and all personal
property and fixtures used by its employees and contractors dedicated to the
Company's business (other than NTI employees and contractors). Prior to the
execution of the NTL Transfer Agreement, the Company was a division of Nortel
and all of the officers of the Company were employees of Nortel. Accordingly,
the purchase price was not arrived at by an arm's-length negotiation between
Nortel and the Company. Rather, as part of the Financing, Nortel determined
that the consideration to be paid for its Entrust business would be the net
book value of the assets being transferred, which the Company believes was the
fair market value of the Entrust business at the time of transfer. The Company
also issued 7,700,000 shares of Special Voting Stock to NTL in connection with
this transaction. Pursuant to the terms of the Articles of Incorporation of
the Canadian Subsidiary, a holder of Exchangeable Special Shares may exchange
such shares for Common Stock at any time, on a one-for-one basis, by
delivering the certificates representing the Exchangeable Shares together with
certificates representing an equal number of shares of Special Voting Stock to
the Canadian Subsidiary. NTL received Exchangeable Special Shares from the
Canadian Subsidiary and shares of Special Voting Stock from the Company in
order to minimize Canadian taxes at the time of NTL's contribution of assets
under the NTL Transfer Agreement.
The Company entered into a strategic alliance agreement (the "Strategic
Alliance Agreement") pursuant to which it granted to NTL for three years, or
as long as the Company is controlled by NTL, whichever is longer, the right to
distribute Entrust products on terms no less favorable to NTL than the terms
of the agreements then in effect with other resellers of the Company. The
Company granted to NTL for three years, or as long as the Company is
controlled by NTL, whichever is longer, a royalty-bearing license to use and
modify the Company's source code in NTL products on terms no less
57
<PAGE>
favorable to NTL than those offered to other source code licensees. NTL
granted to the Company and the Company granted to NTL world-wide, royalty-free
licenses to use, sell or license any of the grantor's products or services,
excluding existing exclusive licenses, until the grant expires or NTL ceases
to control the Company, whichever comes first. In addition, NTL may restrict
the Company, for so long as NTL maintains beneficial ownership of a majority
of the voting power of the Company, from any act which may reasonably be
anticipated to contravene any material instrument binding on Nortel, any order
of any governmental body which has jurisdiction over Nortel or any of its
assets, or any applicable law or regulation. Upon the closing of the
Offerings, Nortel will beneficially own approximately 56.4% of the Company's
Common Stock. See "Risk Factors --Concentration of Ownership".
In connection with the Financing, the Company and NTL entered into an
intercompany services and operating agreement (the "Services Agreement") with
respect to services offered by NTL to the Company. The Services Agreement
provides that such services will be provided in exchange for fees (based upon
allocation of its current costs for such services not to exceed fair market
value), which management of the Company believes are substantially consistent
with the allocation of the costs of such services set forth in the historical
financial statements of the Company. The Company paid $2.9 million, $3.7
million and $273,000 in the years ended December 31, 1995, 1996 and 1997,
respectively, for research and development services provided by Bell Northern
Research Ltd., a subsidiary of Nortel. During the year ended December 31,
1997, the Company paid Nortel $299,000 for services rendered and reimbursed
Nortel $5.6 million for expenses paid by Nortel on behalf of the Company, net
of revenues collected by Nortel on the Company's behalf.
In connection with the Financing, in January 1997, the Company sold 257,500
shares of Series B Common Stock to a group of private investors for an
aggregate sale price of $25,750,000. In January 1997, the Company also sold
2,500 shares of Series B Non-Voting Common Stock to a private investor for an
aggregate sale price of $250,000 and issued an additional 36,448 shares of
Series B Non-Voting Common Stock to such investor in exchange for an
equivalent number of shares of Series B Common Stock.
The Company has adopted a policy providing that all material transactions
between the Company and its officers, directors and other affiliates must (i)
be approved by a majority of the members of the Company's Board of Directors
and by a majority of the disinterested members of the Company's Board of
Directors and (ii) be on terms no less favorable to the Company than could be
obtained from unaffiliated third parties.
For a description of certain employment and other arrangements between the
Company and its executive officers, see "Management--Employment Agreements".
58
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Common Stock of the Company as of June 30, 1998, by (i) each
person or entity known to the Company to own beneficially more than 5% of the
Common Stock, (ii) each of the directors of the Company, (iii) each of the
Named Executive Officers, (iv) each of the Selling Stockholders and (v) all
directors and executive officers as a group. Unless otherwise indicated, each
person or entity named in the table has sole voting power and investment power
(or shares such power with his or her spouse) with respect to all shares of
capital stock listed as owned by such person or entity.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY NUMBER OF SHARES TO BE
OWNED PRIOR SHARES OFFERED BENEFICIALLY OWNED
TO OFFERINGS(1) FOR SALE(2) AFTER OFFERINGS(1)(2)
--------------------- -------------- ---------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENTAGE NUMBER PERCENTAGE
- ------------------------ ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Northern Telecom
Limited(3)............. 28,000,000 66.3% 1,150,520 26,849,480 56.4%
8200 Dixie Road, Suite
100
Brampton, Ontario L6T
5P6
Olympus Partners(4)..... 5,034,553 11.9 206,459 4,828,094 10.1
Metro Center, 1 Station
Place
Stamford, CT 06902
Morgan Guaranty Trust
Company of
New York as Trustee,
and/or Investment
Manager and/or
Agent(5)............... 3,517,186 8.3 144,521 3,372,665 7.1
522 Fifth Avenue
New York, NY 10036
Societe Generale
Investment
Corporation(6)......... 2,512,276 5.9 103,229 2,409,047 5.1
1221 Avenue of the
Americas
New York, NY 10020
Orchid & Co., nominee
for T. Rowe Price
Threshold Fund III,
L.P.(7)................ 1,507,366 3.6 61,938 1,445,428 3.0
John A. Ryan(8)......... 578,320 1.4 -- 578,320 1.2
Brian O'Higgins(9)...... 240,960 * -- 240,960 *
Bradley N. Ross(10)..... 240,960 * -- 240,960 *
Richard D. Spurr(11).... 176,000 * -- 176,000 *
David D. Archibald...... -- * -- -- *
F. William Conner....... -- * -- -- *
Frank A. Dunn........... -- * -- -- *
Robert S. Morris(12).... 5,034,553 11.9 206,459 4,828,094 10.1
All executive officers
and directors as a
group (10
persons)(13)........... 6,370,793 14.6 206,459 6,164,334 12.6
</TABLE>
- --------
* Less than 1%
(1) The number of shares of Common Stock outstanding prior to the Offerings
includes (i) 42,243,164 shares of Common Stock outstanding as of June 30,
1998 and (ii) with respect to each person, the shares issuable by the
Company pursuant to options held by such persons which may be exercised
within 60 days following June 30, 1998 ("Presently Exercisable Options").
The number of shares beneficially owned by each stockholder is determined
under rules promulgated by the Securities and Exchange Commission, and
the information is not necessarily indicative of beneficial ownership for
any other purpose. Under such rules, beneficial ownership includes any
shares as to which the individual or entity has sole or shared voting
59
<PAGE>
power or investment power and any shares as to which the individual or
entity has the right to acquire beneficial ownership within 60 days after
June 30, 1998 through the exercise of any stock option, warrant or other
right. The inclusion herein of such shares, however, does not constitute
an admission that the named stockholder is a direct or indirect beneficial
owner of such shares.
(2) Assumes no exercise of the Underwriters' over-allotment option.
(3) The number of shares of Common Stock deemed outstanding prior to the
Offerings consists of (i) 20,300,000 shares held of record by NTI and
(ii) 7,700,000 shares of Common Stock issuable upon the exchange of
Exchangeable Shares of the Canadian Subsidiary. The number of shares of
Common Stock offered for sale consists of 1,150,520 shares of Common
Stock issuable upon the exchange of Exchangeable Shares of the Canadian
Subsidiary offered for sale by NTL. NTL beneficially owns, and has sole
voting and investment power with respect to, the shares of Common Stock
held of record by NTI. Exchangeable Shares may be exchanged at any time
for Common Stock. See "Certain Transactions". In addition to the number
of shares shown as offered for sale in the table, NTL has granted the
Underwriters the right to purchase up to an additional 799,916 shares
pursuant to the Underwriters' over-allotment option.
(4) The number of shares of Common Stock deemed outstanding prior to the
Offerings consists of (i) 50,245 shares held of record by Olympus
Executive Fund, L.P., a Delaware limited partnership ("Olympus
Executive"), (ii) 4,974,308 shares held of record by Olympus Growth Fund
II, L.P., a Delaware limited partnership ("Olympus Growth", and with
Olympus Executive, the "Olympus Funds"), and (iii) 10,000 shares subject
to Presently Exercisable Options granted to Robert S. Morris. The number
of shares of Common Stock offered for sale consists of (i) 2,065 shares
offered for sale by Olympus Executive and (ii) 204,394 shares offered for
sale by Olympus Growth. Olympus Partners may be deemed to have or share
voting and investment power with respect to all shares of Common Stock
held of record by the Olympus Funds. Shares subject to Presently
Exercisable Options held of record by Robert S. Morris, the managing
partner of Olympus Partners, are assignable to Olympus Growth. In
addition to the number of shares shown as offered for sale in the table,
Olympus Executive and Olympus Growth have granted the Underwriters the
right to purchase up to an additional 447 shares and 44,322 shares,
respectively, pursuant to the Underwriters' over-allotment option.
(5) The number of shares of Common Stock deemed outstanding prior to the
Offerings consists of (i) 2,743,406 shares held of record by Morgan
Guaranty Trust Company of New York, as Trustee of the Commingled Pension
Trust Fund (Multi-Market Special Investment Fund II) of Morgan Guaranty
Trust Company of New York ("Morgan Trust I"), (ii) 386,890 shares held of
record by Morgan Guaranty Trust Company of New York as Trustee of the
Multi-Market Special Investment Trust Fund of Morgan Guaranty Trust
Company of New York ("Morgan Trust II") and (iii) 386,890 shares held of
record by Morgan Guaranty Trust Company of New York, as Investment
Manager and Agent for a private client ("Morgan Trust III"). The number
of shares of Common Stock offered for sale consists of (i) 112,727 shares
offered for sale by Morgan Trust I, (ii) 15,897 shares offered for sale
by Morgan Trust II and (iii) 15,897 shares offered for sale by Morgan
Trust III. In addition to the number of shares shown as offered for sale
in the table, Morgan Trust I, Morgan Trust II and Morgan Trust III have
granted the Underwriters the right to purchase up to an additional 78,374
shares, 11,053 shares and 11,053 shares, respectively, pursuant to the
Underwriters' over-allotment option.
(6) In addition to the number of shares shown as offered for sale in the
table, Societe Generale Investment Corporation has granted the
Underwriters the right to purchase up to an additional 71,772 shares
pursuant to the Underwriters' over-allotment option.
(7) In addition to the number of shares shown as offered for sale in the
table, Orchid & Co. has granted the Underwriters the right to purchase up
to an additional 43,063 shares pursuant to the Underwriters' over-
allotment option.
60
<PAGE>
(8) Consists of 578,320 shares subject to Presently Exercisable Options.
(9) Consists of 240,960 shares subject to Presently Exercisable Options.
(10) Consists of 240,960 shares subject to Presently Exercisable Options.
(11) Consists of 176,000 shares subject to Presently Exercisable Options.
(12) The number of shares of Common Stock deemed outstanding prior to the
Offerings consists of (i) 5,024,553 shares held of record by the Olympus
Funds and (ii) 10,000 shares subject to Presently Exercisable Options.
The number of shares of Common Stock offered for sale consists of 206,459
shares offered for sale by the Olympus Funds. Mr. Morris, the managing
partner of Olympus Partners, may be deemed to have or share voting and
investment power with respect to all shares of Common Stock held of
record by the Olympus Funds. Mr. Morris disclaims beneficial ownership of
all shares held of record by the Olympus Funds. In addition to the number
of shares shown as offered for sale in the table, the Olympus Funds have
granted the Underwriters the right to purchase up to an additional 44,769
shares pursuant to the Underwriters' over-allotment option.
(13) The number of shares of Common Stock deemed outstanding prior to the
Offerings consists of (i) 5,024,553 shares held of record by the Olympus
Funds and (ii) 1,346,240 shares subject to Presently Exercisable Options.
The number of shares of Common Stock offered for sale consists of 206,459
shares offered for sale by the Olympus Funds. In addition to the number
of shares shown as offered for sale in the table, the Olympus Funds have
granted the Underwriters the right to purchase up to an additional 44,769
shares pursuant to the Underwriters' over-allotment option. See footnotes
(8)--(12) above.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 100,000,000 shares
of Common Stock, 15,000,000 shares of special voting stock, $.01 par value per
share ("Special Voting Stock"), and 5,000,000 shares of preferred stock, $.01
par value per share ("Preferred Stock"). As of June 30, 1998, there were
34,543,164 shares of Common Stock outstanding held by 22 stockholders and
7,700,000 shares of Special Voting Stock held by one stockholder. Upon the
closing of the Offerings there will be 41,093,684 shares of Common Stock,
6,549,480 shares of Special Voting Stock and no shares of Preferred Stock
outstanding.
The following summary of certain provisions of the Company's Common Stock,
Special Voting Stock, Preferred Stock, Articles of Incorporation and Bylaws is
materially complete but is qualified by reference to the provisions of
applicable law and to the Company's Amended and Restated Articles of
Incorporation (the "Articles of Incorporation"), Amended and Restated Bylaws
(the "Bylaws") and other agreements included as exhibits to the Registration
Statement of which this Prospectus is a part. See "Additional Information".
COMMON STOCK
Holders of Common Stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders and do not have cumulative voting
rights. Holders of Common Stock are entitled to receive ratably such
dividends, if any, as may be declared by the Board of Directors out of funds
legally available therefor, subject to any preferential dividend rights of
outstanding Preferred Stock. Upon the dissolution or liquidation of the
Company, subject to the prior rights of any outstanding Preferred Stock, the
holders of Common Stock are entitled to receive ratably the net assets of the
Company available after the payment of all debts and other liabilities.
Holders of Common Stock have no preemptive, subscription or redemption rights.
The outstanding shares of Common Stock are, and the shares of Common Stock
offered by the Company in the Offerings will be, when issued and paid for,
fully paid and nonassessable. The rights, preferences and privileges of
holders of Common Stock are subject to, and may be adversely affected by, the
rights of the holders of shares of any series of Preferred Stock which the
Company may designate and issue in the future. Certain holders of Common Stock
have the right to require the Company to effect the registration of their
shares of Common Stock in certain circumstances. See "--Registration Rights".
At present, there is no established trading market for the Common Stock.
Application has been made for the quotation of the Common Stock on the Nasdaq
National Market under the symbol "ENTU".
SPECIAL VOTING STOCK
The holders of Special Voting Stock are entitled to one vote for each share
held on all matters submitted to a vote of stockholders and do not have
cumulative voting rights. Except for such voting rights, the holders of
Special Voting Stock have no other rights in respect of such shares, including
without limitation rights to receive dividends or rights to receive assets of
the Company upon its dissolution, liquidation or winding up of its affairs.
In connection with the incorporation of the Canadian Subsidiary and the
Company, NTL was issued Exchangeable Shares of the Canadian Subsidiary. The
holder of Exchangeable Shares may exchange such shares for shares of the
Company's Common Stock at any time on or prior to December 31, 2006, on a one-
for-one basis. In addition, the Company generally has the right to demand such
exchange at any time on or prior to December 31, 2006. See "Certain
Transactions".
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PREFERRED STOCK
Under the terms of the Articles of Incorporation, the Board of Directors is
authorized, subject to any limitations prescribed by law, without stockholder
approval, to issue up to 5,000,000 shares of Preferred Stock in one or more
series. Each such series of Preferred Stock shall have such rights,
preferences, privileges and restrictions, including voting rights, dividend
rights, conversion rights, redemption privileges and liquidation preferences,
as shall be determined by the Board of Directors. The purpose of authorizing
the Board of Directors to issue Preferred Stock and determine its rights and
preferences is to eliminate delays associated with a stockholder vote on
specific issuances. The issuance of Preferred Stock, while providing desirable
flexibility in connection with possible acquisitions and other corporate
purposes, could have the effect of making it more difficult for a third party
to acquire, or of discouraging a third party from acquiring, a majority of the
outstanding voting stock of the Company. The Company has no present plans to
issue any shares of Preferred Stock.
MARYLAND LAW AND CERTAIN CHARTER AND BYLAW PROVISIONS
Under Section 3-601 et seq. of the General Corporation Law of Maryland (the
"Maryland Law") (the "Business Combination Statute"), to which the Company is
subject, certain "business combinations" (including mergers or similar
transactions subject to a statutory stockholder vote and additional
transactions involving transfers of assets or securities in specific amounts)
between a Maryland corporation subject to the Business Combination Statute and
(i) any person who beneficially owns, directly or indirectly, 10% or more of
the voting power of the corporation's outstanding voting shares after the date
on which the corporation had 100 or more beneficial owners of its stock or
(ii) any affiliate or associate of the corporation who, at any time within the
preceding two years and after the date on which the corporation had 100 or
more beneficial owners of its stock, was the beneficial owner, directly or
indirectly, of 10% or more of the voting power of the then-outstanding voting
stock of the corporation (an "Interested Stockholder"), or an affiliate
thereof, are prohibited for five years after the most recent date on which the
Interested Stockholder became an Interested Stockholder unless an exemption is
available. Thereafter, any such business combination must be recommended by
the board of directors of the corporation and approved by the affirmative vote
of at least: (i) 80% of the votes entitled to be cast by all holders of
outstanding voting shares of the corporation; and (ii) two-thirds of the votes
entitled to be cast by holders of outstanding voting shares of the corporation
other than shares held by the Interested Stockholder with whom the business
combination is to be effected, unless the corporation's stockholders receive a
minimum price (as described in the Business Combination Statute) for their
shares and the consideration is received in cash or in the same form as
previously paid by the Interested Stockholder for its shares. The Business
Combination Statute does not apply, however, to business combinations that are
(a) exempted in the corporation's charter prior to the time the corporation
became subject to the Business Combination Statute or (b) approved or exempted
by the board of directors prior to the time that the Interested Stockholder
becomes an Interested Stockholder. After a corporation becomes subject to the
Business Combination Statute, in order to amend the corporation's charter to
elect not to be subject to the foregoing requirements with respect to one or
more Interested Stockholders, the affirmative vote of at least 80% of the
votes entitled to be cast by all holders of outstanding shares of voting stock
and two-thirds of the votes entitled to be cast by holders of outstanding
shares of voting stock who are not Interested Stockholders is required. The
Company's Articles of Incorporation provide that business combinations between
the Company and any of NTL, NTI, affiliates of NTL or NTI, or the successors
or assigns of NTL, NTI or their affiliates are exempt from the provisions of
the Business Combination Statute.
Section 3-701 et seq. of the Maryland Law (the "Control Share Acquisition
Statute") provides that "control shares" of a Maryland corporation acquired in
a "control share acquisition" have no voting rights except to the extent
approved by a vote of two-thirds of the votes entitled to be cast on the
matter, excluding shares of stock owned by the acquiror or by officers or
directors who are
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employees of the corporation. The Company's Articles of Incorporation
generally exempt the applicability of the Control Share Acquisition Statute to
any control share acquisition of any shares of the capital stock of the
Company.
The Business Combination Statute and the Control Share Acquisition Statute
could have the effect of discouraging takeover proposals and delaying or
preventing a change of control of the Company not approved by its Board of
Directors.
The Articles of Incorporation provide for the division of the Board of
Directors into three classes as nearly equal in size as possible with
staggered three-year terms. See "Management--Executive Officers and
Directors". The Articles of Incorporation also provide that directors may be
removed only for cause by the affirmative vote of the holders of two-thirds of
the shares of capital stock of the Company entitled to vote. Under the
Articles of Incorporation, any vacancy on the Board of Directors, however
occurring, including a vacancy resulting from an enlargement of the Board of
Directors, may only be filled by vote of a majority of the directors then in
office. The limitations on the removal of directors and filling of vacancies
could have the effect of making it more difficult for a third party to
acquire, or of discouraging a third party from acquiring, control of the
Company.
Maryland Law provides generally that the affirmative vote of two-thirds or a
majority of the shares entitled to vote on any matter is required to amend a
corporation's articles of incorporation unless a corporation's articles of
incorporation requires a greater percentage. The Company's Articles of
Incorporation require the affirmative vote of the holders of at least 75% of
the shares of capital stock of the Company issued and outstanding and entitled
to vote to amend or repeal any of the provisions described in the previous
paragraph.
The Articles of Incorporation also provide that any action required or
permitted to be taken by the stockholders of the Company at an annual meeting
of stockholders may only be taken if it is properly brought before such
meeting. The Bylaws further provide that special meetings of the stockholders
may only be called by the President, the Board of Directors or the Secretary
upon the request of 50% of the shares of capital stock of the Company entitled
vote. Under the Bylaws, in order for any matter to be considered "properly
brought" before an annual meeting, a stockholder must comply with certain
requirements regarding advance notice to the Company. These provisions may
discourage another person or entity from making a tender offer for the Common
Stock, because such person or entity, unless it acquired at least 50% of the
outstanding voting securities of the Company, would be able to take action as
a stockholder (such as electing new directors or approving a merger) only at
the annual meeting of stockholders.
The Articles of Incorporation contain certain provisions permitted under the
Maryland Law relating to the liability of directors and officers. The
provisions eliminate a director's or officer's liability for monetary damages
to a corporation or its stockholders, except to the extent the director or
officer actually received an improper benefit or profit or the director's or
officer's action was the result of active and deliberate dishonesty. Further,
the Articles of Incorporation contain provisions to indemnify the Company's
directors and officers to the fullest extent permitted by the Maryland Law.
The Company believes that these provisions will assist the Company in
attracting and retaining qualified individuals to serve as directors.
REGISTRATION RIGHTS
Pursuant to an Amended and Restated Registration Rights Agreement (the
"Registration Rights Agreement") among the Company, NTI, NTL (NTL and NTI
collectively referred to as the "Nortel Stockholders") and certain of its
stockholders (the "Investors", and with the Nortel Stockholders, the
"Rightsholders"), such Rightsholders will be entitled to certain rights with
respect to the registration under the Securities Act of a total of
approximately 39,397,169 shares of Common Stock (the "Registrable Shares").
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The Nortel Stockholders as well as Investors holding in the aggregate at
least 35% of the Registrable Shares initially held by all Investors may each
require the Company to prepare and file a registration statement under the
Securities Act with respect to their Registrable Shares if such registration
would result in an offering with an aggregate offering price of at least $5.0
million. The Nortel Stockholders and the Investors are entitled to three and
two demand registration requests, respectively. The Company is not required to
file a demand registration statement for one year following the effective date
of the Offerings or within six months after the effective date of any other
registration statement, subject to certain restrictions.
If the Company proposes to register any of its securities under the
Securities Act, the Rightsholders will be entitled to include Registrable
Shares in such offering, subject to the right of the managing underwriter of
any underwritten offering to limit for marketing reasons the number of shares
of Registrable Shares included in the offering. See "Shares Eligible for
Future Sale".
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock will be American
Securities Transfer & Trust, Inc.
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SHARES ELIGIBLE FOR FUTURE SALE
Prior to the Offerings, there has been no public market for the securities
of the Company. Upon completion of the Offerings there will be 47,643,164
shares of Common Stock of the Company outstanding (assuming no exercise of the
outstanding options of the Company). Of these shares, the 7,066,667 shares
sold in the Offerings will be freely tradeable without restriction or further
registration under the Securities Act, except that any shares purchased by
"affiliates" of the Company, as that term is defined in Rule 144 ("Rule 144")
under the Securities Act ("Affiliates"), may generally only be sold in
compliance with the limitations of Rule 144 described below, and that shares
purchased by Zeron Capital, Odyssey and certain officers and directors of the
Company are subject to Lock-Up Agreements as described in "Underwriting".
The remaining 40,576,497 shares of Common Stock are deemed "restricted
securities" under Rule 144 and are all subject to the Lock-Up Agreements with
the Representatives of the Underwriters. Upon expiration of the Lock-Up
Agreements 180 days after the date of this Prospectus (and assuming no
exercise of outstanding options or exchange of Exchangeable Shares),
approximately 39,397,169 shares of restricted Common Stock will be available
for sale in the public market, subject to the provisions of Rule 144 under the
Securities Act.
The Company and all of its directors, officers, stockholders, who in the
aggregate will hold approximately 40,576,497 shares of Common Stock on the
date of this Prospectus, as well as holders of options to purchase Company
Common Stock, have agreed, pursuant to Lock-Up Agreements with the
Representatives of the Underwriters or, in the case of the option holders,
pursuant to stock option agreements with the Company, that, without the prior
written consent of Goldman, Sachs & Co., for a period of 180 days after the
date of this Prospectus, they will not offer, sell, contract to sell or
otherwise dispose of any shares of Common Stock, or any shares convertible
into or exchangeable for shares of Common Stock, owned directly by such
persons or with respect to which they have the power of disposition. Goldman,
Sachs & Co. may release all or part of the shares subject to the Lock-Up
Agreements at any time in its sole discretion.
In general, under Rule 144 as currently in effect, beginning 90 days after
the effective date of the Registration Statement of which this Prospectus is a
part, a stockholder, including an Affiliate, who has beneficially owned his or
her restricted securities (as that term is defined in Rule 144) for at least
one year from the later of the date such securities were acquired from the
Company or (if applicable) the date they were acquired from an Affiliate is
entitled to sell, within any three-month period, a number of such shares that
does not exceed the greater of 1% of the then outstanding shares of Common
Stock (approximately 476,432 shares immediately after the Offerings) or the
average weekly trading volume in the Common Stock during the four calendar
weeks preceding the date on which notice of such sale was filed under Rule
144, provided certain requirements concerning availability of public
information, manner of sale and notice of sale are satisfied. In addition,
under Rule 144(k), if a period of at least two years has elapsed between the
later of the date restricted securities were acquired from the Company or (if
applicable) the date they were acquired from an Affiliate of the Company, a
stockholder who is not an Affiliate of the Company at the time of sale and has
not been an Affiliate of the Company for at least three months prior to the
sale is entitled to sell the shares immediately without compliance with the
foregoing requirements under Rule 144.
Securities issued in reliance on Rule 701 (such as shares of Common Stock
acquired pursuant to the exercise of certain options granted under the
Company's stock plans) are also restricted securities and, subject to the
Lock-Up Agreements, beginning 90 days after the effective date of the
Registration Statement of which this Prospectus is a part, may be sold by
stockholders other than Affiliates of the Company so long as such sales comply
with the manner of sale provisions of Rule 144 and by Affiliates under Rule
144 without compliance with its one-year holding period requirement.
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The Company intends to file registration statements on Form S-8 under the
Securities Act to register all shares of Common Stock issuable under the
Incentive Plan and the Purchase Plan. Shares issued upon the exercise of stock
options after the effective date of the Form S-8 registration statements will
be eligible for resale in the public market without restriction, subject to
Rule 144 limitations applicable to Affiliates and the Lock-Up Agreements noted
above, if applicable.
Prior to the Offerings, there has been no public market for the Common
Stock, and no prediction can be made as to the effect, if any, that market
sales of shares of Common Stock or the availability of shares for sale will
have on the market price of the Common Stock prevailing from time to time.
Nevertheless, sales of significant numbers of shares of the Common Stock in
the public market could adversely affect the market price of the Common Stock
and could impair the Company's future ability to raise capital through an
offering of its equity securities.
Pursuant to the Registration Rights Agreement, certain holders of Common
Stock, holding an aggregate of 39,397,169 shares of Common Stock, will have
the ability to require the Company to register their shares of Common Stock,
subject to certain restrictions. See "Description of Capital Stock--
Registration Rights".
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CERTAIN U.S. TAX CONSIDERATIONS APPLICABLE TO
NON-U.S. HOLDERS OF THE COMMON STOCK
The following is a general discussion of certain U.S. federal income and
estate tax consequences of the ownership and disposition of Common Stock by a
person that, for U.S. federal income tax purposes, is a non-resident alien
individual, a foreign corporation, a foreign partnership or a foreign estate
or trust as defined in the U.S. Internal Revenue Code of 1986, as amended (the
"Code") (a "non-U.S. holder"). This discussion does not consider specific
facts and circumstances that may be relevant to a particular non-U.S. holder's
tax position and does not deal with all aspects of United States federal
income and estate taxation that may be relevant to non-U.S. holders (including
special rules applicable to certain United States expatriates), or with U.S.
state and local or non-U.S. tax consequences. Furthermore, the following
discussion is based on provisions of the Code, existing and proposed
regulations promulgated thereunder, and administrative and judicial
interpretations thereof as of the date hereof, all of which are subject to
change, possibly with retroactive effect. Each prospective non-U.S. holder is
urged to consult a tax adviser with respect to the U.S. federal tax
consequences of holding and disposing of Common Stock, as well as any tax
consequences that may arise under the laws of any U.S. state, municipality or
other taxing jurisdiction.
An individual may, among other ways, be deemed to be a resident alien (as
opposed to a non-resident alien) with respect to any calendar year by virtue
of being present in the United States on at least 31 days in such calendar
year and for an aggregate of at least 183 days during the current calendar
year and the two preceding calendar years (counting for such purposes all of
the days present in the current year, one-third of the days present in the
immediately preceding year and one-sixth of the days present in the second
preceding year). Resident aliens are subject to U.S. federal tax as if they
were U.S. citizens.
DIVIDENDS
As described above, the Company does not expect to pay dividends. In the
event the Company does pay dividends, dividends paid to a non-U.S. holder of
Common Stock will be subject to withholding of U.S. federal income tax at a
rate of 30% of the gross amount of the dividend or such lower rate as may be
specified by an applicable income tax treaty, unless the dividends are
effectively connected with the conduct of a trade or business by the non-U.S.
holder within the United States. Dividends that are effectively connected with
such holder's conduct of a trade or business in the United States are subject
to U.S. federal income tax on a net income basis at applicable graduated
individual or corporate rates, and are not generally subject to withholding,
if the holder complies with certain certification and disclosure requirements.
Any such effectively connected dividends received by a foreign corporation may
also, under certain circumstances, be subject to an additional "branch profits
tax" at a 30% rate or such lower rate as may be specified by an applicable
income tax treaty.
Under current law, dividends paid to an address outside the United States
are presumed to be paid to a resident of the country of address (unless the
payer has knowledge to the contrary) for purposes of the withholdings
discussed above and for purposes of determining the applicability of a tax
treaty rate. Under certain recently finalized Treasury Regulations (the "New
Withholding Regulations"), a non-U.S. holder of Common Stock will be required
to satisfy certain certification and other requirements in order to claim the
benefit of a reduced withholding tax rate with respect to dividends under an
applicable treaty. In addition, under the New Withholding Regulations, in the
case of Common Stock held by a foreign partnership, the certification
requirement would generally be applied to the partners and the partnership may
be required to provide certain information, including a United States taxpayer
identification number. The New Withholding Regulations also provide look-
through rules for tiered partnerships. The New Withholding Regulations are
generally effective for payments made after December 31, 1999, subject to
certain transition rules. Non-U.S. holders are
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encouraged to consult with their own tax advisors with respect to the
application of the New Withholding Regulations.
A non-U.S. holder of Common Stock that is eligible for a reduced rate of
U.S. withholding tax pursuant to an income tax treaty may obtain a refund of
any excess amounts withheld by filing an appropriate claim for refund with the
U.S. Internal Revenue Service.
GAIN ON DISPOSITION OF COMMON STOCK
A non-U.S. holder generally will not be subject to U.S. federal income tax
in respect of gain recognized on a disposition of Common Stock unless (i) the
gain is effectively connected with a trade or business of the non-U.S. holder
in the United States or, if a tax treaty applies, is attributable to a
permanent establishment maintained by the non-U.S. holder in the United
States, (ii) in the case of a non-U.S. holder who is an individual and holds
the Common Stock as a capital asset, such holder is present in the United
States for 183 or more days in the taxable year of the sale and certain other
conditions are met, or (iii) the Company is or has been a "U.S. real property
holding corporation" for federal income tax purposes at any time during the
five-year period ending on the date of the disposition and the non-U.S. holder
owned more than 5% of the Company's Common Stock at any time during such
period. The Company believes that it has not been and it is not a "U.S. real
property holding corporation" for U.S. federal income tax purposes and does
not currently anticipate becoming a "U.S. real property holding corporation".
Different tax consequences would apply to certain non-U.S. holders if the
Company were to become a "U.S. real property holding corporation." If an
individual non-U.S. holder falls under clause (i) above, he or she will be
taxed on his or her net gain derived from the sale at regular graduated U.S.
federal income tax rates. If an individual non-U.S. holder falls under clause
(ii) above, he or she will be subject to a flat 30% tax on the net gain
derived from the sale which gain may be offset by U.S. capital losses
recognized within the same taxable year of such sale. If a non-U.S. holder
that is a foreign corporation falls under clause (i) above, it will be taxed
on its gain at regular graduated U.S. federal income tax rates and, in
addition, may be subject to the branch profits tax equal to 30% of its
"effectively connected earnings and profits" within the meaning of the Code
for the taxable year, as adjusted for certain items, or at such lower rate as
may be specified by an applicable income tax treaty.
FEDERAL ESTATE TAXES
Common Stock owned or treated as owned by a non-U.S. holder at the time of
death, or Common Stock of which the non-U.S. holder made certain lifetime
transfers, will be included in such holder's gross estate for U.S. federal
estate tax purposes, unless an applicable estate tax treaty provides
otherwise.
U.S. INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING TAX
The Company must report annually to the U.S. Internal Revenue Service and to
each non-U.S. holder the amount of dividends paid to such holder (including
the name and address of such holder) and the tax withheld with respect to such
dividends, regardless of whether withholding was required. Copies of the
information returns reporting such dividends and withholding may also be made
available to the tax authorities in the country in which the non-U.S. holder
resides under the provisions of an applicable income tax treaty.
Under current law, backup withholding (which generally is a withholding tax
imposed at the rate of 31% on certain payments to persons that fail to furnish
certain information under the U.S. information reporting requirements) will
generally not apply to dividends paid to a non-U.S. holder at an address
outside the United States unless such non-U.S. holder is engaged in a trade or
business in the United States or unless the payer has knowledge that the payee
is a U.S. person. However,
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under the New Withholding Regulations (which are generally effective for
dividends paid after December 31, 1999), dividend payments may be subject to
backup withholding unless applicable certification requirements are satisfied.
See the discussion above with respect to rules applicable to foreign
partnerships under the New Withholding Regulations.
In general, backup withholding and information reporting will not apply to a
payment of the proceeds of a sale of Common Stock to or through a foreign
office of a broker. If, however, such broker is, for U.S. federal income tax
purposes, a U.S. person, a controlled foreign corporation, a foreign person
that derives 50% of more of its gross income for certain periods from the
conduct of a trade or business in the United States or, effective for payments
after December 31, 1999, a foreign partnership (i) more than 50% of the income
or capital interests of which are owned by U.S. persons or (ii) that is
engaged in a United States trade or business, such payments will not be
subject to backup withholding but will be subject to information reporting,
unless (1) such broker has documentary evidence in its records that the
beneficial owner is a non-U.S. holder and certain other conditions are met or
(2) the beneficial owner otherwise establishes an exemption.
Payment to or through a U.S. office of a broker of the proceeds of a sale of
Common Stock is generally subject to both backup withholding and information
reporting unless the beneficial owner certifies on a Form W-8 (or a suitable
substitute form) under penalties of perjury that it is a non-U.S. holder, or
otherwise establishes an exemption.
Effective for payments after December 31, 1999 (and subject to certain
transition rules), the New Withholding Regulations unify certain certification
procedures and forms and the reliance standards relating to information
reporting and backup withholding.
Any amounts withheld under the backup withholding rules may be allowed as a
refund or a credit against such holder's U.S. federal income tax liability
provided the required information is furnished to the U.S. Internal Revenue
Service.
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LEGAL MATTERS
The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by Hale and Dorr LLP, Boston, Massachusetts, and for the
Underwriters by Ropes & Gray, Boston, Massachusetts.
EXPERTS
The Company's financial statements as of December 31, 1996 and 1997 and for
each of the three years in the period ended December 31, 1997 included in this
Prospectus have been so included in reliance on the report of Deloitte &
Touche Chartered Accountants, given on the authority of said firm as experts
in auditing and accounting.
The financial statements of r/3/ as of December 31, 1996 and 1997 and for
each of the two years in the period ended December 31, 1997 included in this
Prospectus have been so included in reliance on the report of Willi & Partner
AG and Deloitte & Touche Chartered Accountants, given on the authority of said
firms as experts in auditing and accounting.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement (together with all amendments,
exhibits, schedules and supplements thereto) on Form S-1 under the Securities
Act with respect to the shares of Common Stock offered hereby (the
"Registration Statement"). This Prospectus, which constitutes a part of the
Registration Statement, does not contain all of the information set forth in
the Registration Statement, certain parts of which are omitted in accordance
with the rules and regulations of the Commission. Statements made in this
Prospectus as to the contents of any contract, agreement or other document
referred to are materially complete. However, with respect to each such
contract, agreement or other document filed as an exhibit to the Registration
Statement, reference is made to the exhibit for a more complete description of
the matter involved, and each such statement shall be deemed qualified in its
entirety by such reference. The Registration Statement and the exhibits
thereto may be inspected and copied at prescribed rates at the public
reference facilities maintained by the Commission at Room 1024, Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the regional
offices of the Commission located at Seven World Trade Center, 13th Floor, New
York, New York 10048 and Citicorp Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. In addition, the Company is required to file
electronic versions to these documents with the Commission through the
Commission's Electronic Data Gathering, Analysis, and Retrieval (EDGAR)
system. The Commission maintains a World Wide Web site at http://www.sec.gov
that contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission.
The Company intends to distribute to its stockholders annual reports
containing audited consolidated financial statements. The Company also intends
to make available to its stockholders reports containing interim unaudited
financial information for each of the first three quarters of each fiscal
year.
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INDEX TO FINANCIAL STATEMENTS
ENTRUST TECHNOLOGIES INC.
CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Auditors' Report.......................................................... F-2
Consolidated Balance Sheets as of December 31, 1996 and 1997 and
June 30, 1998 (unaudited)................................................ F-3
Consolidated Statements of Operations for the years ended December 31,
1995, 1996 and 1997 and the six months ended June 30, 1997 and 1998
(unaudited).............................................................. F-4
Consolidated Statements of Shareholders' Equity (Deficit) for the years
ended December 31, 1995, 1996 and 1997 and the six months ended June 30,
1998 (unaudited)......................................................... F-5
Consolidated Statements of Cash Flows for the years ended December 31,
1995, 1996 and 1997 and the six months ended June 30, 1997 and 1998
(unaudited).............................................................. F-6
Notes to Consolidated Financial Statements................................ F-7
</TABLE>
R/3/ SECURITY ENGINEERING AG FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of the Statutory Auditors......................................... F-21
Balance Sheets as of December 31, 1996 and 1997.......................... F-22
Income Statements for the years ended December 31, 1996 and 1997......... F-23
Notes to Financial Statements............................................ F-24
ENTRUST TECHNOLOGIES INC.
PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Pro Forma Condensed Consolidated Financial Statements (unaudited)........ F-28
Unaudited Pro Forma Condensed Consolidated Statement of Operations....... F-29
Notes to Pro Forma Condensed Consolidated Financial Statements
(unaudited)............................................................. F-31
</TABLE>
F-1
<PAGE>
AUDITORS' REPORT
To the Directors of Entrust Technologies Inc.
We have audited the consolidated balance sheets of Entrust Technologies Inc.
as at December 31, 1996 and 1997 and the consolidated statements of
operations, shareholders' equity and cash flows for the years ended December
31, 1995, 1996 and 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audits in accordance with generally accepted auditing
standards in the United States of America. Those standards require that we
plan and perform an audit to obtain reasonable assurance whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe our audits provide a
reasonable basis for our opinion.
In our opinion, these consolidated financial statements present fairly, in
all material respects, the financial position of Entrust Technologies Inc. as
at December 31, 1996 and 1997 and the results of its operations and its cash
flows for the years ended December 31, 1995, 1996 and 1997 in conformity with
accounting principles generally accepted in the United States of America.
/s/ DELOITTE & TOUCHE
June 5, 1998
Ottawa, Canada
F-2
<PAGE>
ENTRUST TECHNOLOGIES INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
PRO
DECEMBER 31, FORMA
--------------- JUNE 30, JUNE 30,
1996 1997 1998 1998
------ ------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................. $ -- $ 4,025 $ 2,582
Short-term investments..................... -- 8,613 1,787
Accounts receivable (net of allowance for
doubtful accounts at December 31, 1996--
$129, December 31, 1997--$416, and June
30, 1998--$460)........................... 2,487 7,152 10,606
Other receivables.......................... -- 2,089 1,381
Prepaid expenses........................... 55 455 616
------ ------- -------
Total current assets..................... 2,542 22,334 16,972
Goodwill.................................... -- -- 3,566
Property and equipment, net................. 1,145 1,680 2,583
Deferred income tax benefit................. -- 743 1,031
------ ------- -------
Total assets............................. $3,687 $24,757 $24,152
====== ======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
(DEFICIT)
Current liabilities:
Accounts payable........................... $ 901 $ 1,236 $ 4,106
Accrued liabilities........................ 945 2,066 3,253
Deferred income............................ 1,882 3,068 4,669
Current portion of long-term debt.......... -- -- 11
Due to related party....................... -- 2,257 1,795
------ ------- -------
Total current liabilities................ 3,728 8,627 13,834
Long-term debt.............................. -- 1,449 19
Deferred income tax liabilities............. 19 19 19
------ ------- -------
Total liabilities........................ 3,747 10,095 13,872
------ ------- -------
Redeemable Series A common stock............ -- -- 17,013
------ ------- -------
Shareholders' equity (deficit):
Preferred, par value $.01 per share;
5,000,000 authorized; none issued and
outstanding............................... -- -- -- --
Common stock
Common, par value $.01 per share;
100,000,000 authorized; none issued and
outstanding at December 31, 1996 and
1997 and June 30, 1998 35,693,684
outstanding on a pro forma basis at June
30, 1998................................ -- -- -- 357
Series A common, par value $.01 per
share; 100,000,000 authorized;
20,300,000 issued and outstanding shares
at December 31, 1997 and 20,312,040
issued and outstanding shares at June
30, 1998, and none at December 31, 1996;
none issued and outstanding on a pro
forma basis at June 30, 1998............ -- 203 203 --
Series B common, par value $.01 per
share; convertible and exchangeable;
260,000 authorized; 221,052 issued and
outstanding shares at December 31, 1997
and June 30, 1998, and none at December
31, 1996 and on a pro forma basis at
June 30, 1998........................... -- 2 2 --
Series B, non-voting common, par value
$.01 per share; exchangeable; 260,000
authorized; 38,948 issued and
outstanding shares at December 31, 1997
and June 30, 1998, and none at December
31, 1996 and on a pro forma basis at
June 30, 1998........................... -- -- -- --
Special voting, par value $.01 per share;
exchangeable; 15,000,000 authorized;
7,700,000 issued and outstanding shares
at December 31, 1997 and June 30, 1998,
and none at December 31, 1996; 6,549,480
shares issued and outstanding on a pro
forma basis at June 30, 1998 ............. -- 77 77 65
Additional paid-in capital................. -- 15,744 16,554 33,427
Unearned deferred compensation............. -- -- (733) (733)
Accumulated other comprehensive income
(loss).................................... -- (15) (48) (48)
Accumulated deficit........................ (60) (1,349) (22,788) (22,788)
------ ------- ------- -------
Total shareholders' equity (deficit)..... (60) 14,662 (6,733) $10,280
------ ------- ------- -------
Total liabilities and shareholders'
equity ................................. $3,687 $24,757 $24,152
====== ======= =======
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-3
<PAGE>
ENTRUST TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------- ----------------------
1995 1996 1997 1997 1998
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
License............... $ 1,845 $ 8,689 $ 16,486 $ 5,677 $ 15,845
Services and
maintenance.......... 2,128 4,113 8,520 4,214 5,093
---------- ---------- ---------- ---------- ----------
Total revenues...... 3,973 12,802 25,006 9,891 20,938
---------- ---------- ---------- ---------- ----------
Cost of revenues:
License............... 34 393 502 229 812
Services and
maintenance.......... 950 3,157 4,414 2,111 3,098
---------- ---------- ---------- ---------- ----------
Total cost of
revenues........... 984 3,550 4,916 2,340 3,910
---------- ---------- ---------- ---------- ----------
Gross profit............ 2,989 9,252 20,090 7,551 17,028
---------- ---------- ---------- ---------- ----------
Operating expenses:
Sales and marketing... 1,914 3,858 11,193 3,999 11,008
Research and
development.......... 2,287 2,874 5,692 2,077 5,357
General and
administrative....... 1,212 2,464 3,695 1,479 2,271
Acquired in-process
research and
development.......... -- -- -- -- 20,208
---------- ---------- ---------- ---------- ----------
Total operating
expenses........... 5,413 9,196 20,580 7,555 38,844
---------- ---------- ---------- ---------- ----------
Income (loss) from
operations............. (2,424) 56 (490) (4) (21,816)
Interest income......... -- -- 723 415 217
---------- ---------- ---------- ---------- ----------
Income (loss) before
(provision) benefit for
income taxes........... (2,424) 56 233 411 (21,599)
(Provision) benefit for
income taxes........... 301 331 281 (15) 160
---------- ---------- ---------- ---------- ----------
Net income (loss)....... $ (2,123) $ 387 $ 514 $ 396 $ (21,439)
========== ========== ========== ========== ==========
Net income (loss) per
share
Basic................. -- -- $ 0.02 $ 0.01 $ (0.69)
Diluted............... -- -- $ 0.01 $ 0.01 $ (0.69)
Weighted average common
shares outstanding
Basic................. -- -- 30,700,000 30,700,000 30,848,689
Diluted............... -- -- 41,742,972 41,063,840 46,685,839
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-4
<PAGE>
ENTRUST TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
AND THE SIX MONTHS ENDED JUNE 30, 1998
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SERIES B
SERIES A SERIES B NON-VOTING SPECIAL
COMMON COMMON COMMON VOTING ACCUMULATED
STOCK STOCK STOCK STOCK ADDITIONAL UNEARNED OTHER
----------------- -------------- ------------- ---------------- PAID-IN DEFERRED COMPREHENSIVE
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION INCOME (LOSS)
---------- ------ ------- ------ ------ ------ --------- ------ ---------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at
December 31,
1994............ -- $ -- -- $ -- -- $ -- -- $ -- $ -- $ -- $ --
Change in
shareholder's
net
investment..... -- -- -- -- -- -- -- -- -- -- --
Net income...... -- -- -- -- -- -- -- -- -- -- --
---------- ------ ------- ------ ------ ----- --------- ------ ------- ------ ------
Balances at
December 31,
1995............ -- -- -- -- -- -- -- -- -- -- --
Change in
shareholder's
net
investment..... -- -- -- -- -- -- -- -- -- -- --
Net income...... -- -- -- -- -- -- -- -- -- -- --
---------- ------ ------- ------ ------ ----- --------- ------ ------- ------ ------
Balances at
December 31,
1996............ -- -- -- -- -- -- -- -- -- -- --
Series A common
shares issued.. 20,300,000 203 -- -- -- -- -- -- (173) -- --
Special Voting
shares issued.. -- -- -- -- -- -- 7,700,000 77 (66) -- --
Series B common
shares issued.. -- -- 221,052 2 -- -- -- -- 15,302 -- --
Series B Non-
Voting common
shares issued.. -- -- -- -- 38,948 -- -- -- 2,696 -- --
Share capital
issuance
costs.......... -- -- -- -- -- -- -- -- (2,015) -- --
Translation
adjustment..... -- -- -- -- -- -- -- -- -- -- (15)
Change in
shareholder's
net
investment..... -- -- -- -- -- -- -- -- -- -- --
Net income...... -- -- -- -- -- -- -- -- -- -- --
---------- ------ ------- ------ ------ ----- --------- ------ ------- ------ ------
Balances at
December 31,
1997............ 20,300,000 203 221,052 2 38,948 -- 7,700,000 77 15,744 -- (15)
Series A common
shares issued
(unaudited).... 12,040 -- -- -- -- -- -- -- 26 -- --
Unearned
compensation
related to
stock options
granted
(unaudited).... -- -- -- -- -- -- -- -- 784 (784) --
Deferred
compensation
earned
(unaudited).... -- -- -- -- -- -- -- -- -- 51 --
Translation
adjustment
(unaudited).... -- -- -- -- -- -- -- -- -- -- (33)
Net income
(unaudited).... -- -- -- -- -- -- -- -- -- -- --
---------- ------ ------- ------ ------ ----- --------- ------ ------- ------ ------
Balances at June
30, 1998
(unaudited)..... 20,312,040 $203 221,052 $ 2 38,948 $ -- 7,700,000 $ 77 $16,554 $ (733) $ (48)
========== ====== ======= ====== ====== ===== ========= ====== ======= ====== ======
<CAPTION>
TOTAL
ACCUMULATED SHAREHOLDERS'
INCOME EQUITY
(DEFICIT) (DEFICIT)
----------- -------------
<S> <C> <C>
Balances at
December 31,
1994............ $ 2,095 $ 2,095
Change in
shareholder's
net
investment..... 1,700 1,700
Net income...... (2,123) (2,123)
----------- -------------
Balances at
December 31,
1995............ 1,672 1,672
Change in
shareholder's
net
investment..... (2,119) (2,119)
Net income...... 387 387
----------- -------------
Balances at
December 31,
1996............ (60) (60)
Series A common
shares issued.. -- 30
Special Voting
shares issued.. -- 11
Series B common
shares issued.. -- 15,304
Series B Non-
Voting common
shares issued.. -- 2,696
Share capital
issuance
costs.......... -- (2,015)
Translation
adjustment..... -- (15)
Change in
shareholder's
net
investment..... (1,803) (1,803)
Net income...... 514 514
----------- -------------
Balances at
December 31,
1997............ (1,349) 14,662
Series A common
shares issued
(unaudited).... -- 26
Unearned
compensation
related to
stock options
granted
(unaudited).... -- --
Deferred
compensation
earned
(unaudited).... -- 51
Translation
adjustment
(unaudited).... -- (33)
Net income
(unaudited).... (21,439) (21,439)
----------- -------------
Balances at June
30, 1998
(unaudited)..... $(22,788) $ (6,733)
=========== =============
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-5
<PAGE>
ENTRUST TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------- -----------------
1995 1996 1997 1997 1998
------- ------- -------- ------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating
activities:
Net income (loss).............. $(2,123) $ 387 $ 514 $ 396 $(21,439)
Adjustments to reconcile net
income (loss) to net cash
provided by (used in)
operating activities:
Depreciation and
amortization................. 144 204 360 177 400
Adjustment to cumulative
translation account.......... -- -- (15) (2) (33)
Deferred income taxes......... 10 4 (743) (229) (288)
Deferred compensation earned.. -- -- -- -- 51
Acquired in-process research
and development.............. -- -- -- -- 20,208
Changes in assets and
liabilities:
(Increase) decrease in
accounts receivable......... 398 (967) (4,665) (2,517) (2,805)
(Increase) decrease in other
receivables................. -- -- (2,089) (1,072) 708
(Increase) decrease in
prepaid expenses............ 35 (40) (400) 55 (126)
Increase (decrease) in
accounts payable............ 230 647 335 350 1,674
Increase in accrued
liabilities................. 29 891 1,121 2,963 270
Increase in deferred income.. 113 1,686 1,186 464 1,451
Increase (decrease) due to
related party............... -- -- 2,257 1,531 (1,561)
------- ------- -------- ------- --------
Net cash provided by (used in)
operating activities......... (1,164) 2,812 (2,139) 2,116 (1,490)
------- ------- -------- ------- --------
Cash flows from investing
activities:
Purchases of property and
equipment..................... (536) (693) (895) (438) (995)
Purchases of short-term
investments................... -- -- (12,308) (2,477) (5,052)
Dispositions of short-term
investments................... -- -- 3,695 -- 11,878
Payment on purchase of r/3/
Security
Engineering AG................ -- -- -- -- (4,391)
------- ------- -------- ------- --------
Net cash provided by (used in)
investing activities......... (536) (693) (9,508) (2,915) 1,440
------- ------- -------- ------- --------
Cash flows from financing
activities:
Proceeds from long-term debt... -- -- 1,449 -- --
Repayment of long-term debt.... -- -- -- -- (1,419)
Transfers from Nortel.......... 6,070 9,716 -- -- --
Transfers to Nortel............ (4,370) (11,835) (1,803) (1,803) --
Proceeds from exercise of stock
options....................... -- -- -- -- 26
Proceeds from issuance of
common and special voting
stock, net of issuance costs
of $2,015..................... -- -- 16,026 16,026 --
------- ------- -------- ------- --------
Net cash provided by (used in)
financing activities......... 1,700 (2,119) 15,672 14,223 (1,393)
------- ------- -------- ------- --------
Net change in cash and cash
equivalents.................... -- -- 4,025 13,424 (1,443)
Cash and cash equivalents at
beginning of period............ -- -- -- -- 4,025
------- ------- -------- ------- --------
Cash and cash equivalents at end
of period...................... $ -- $ -- $ 4,025 $13,424 $ 2,582
======= ======= ======== ======= ========
Non-cash investing activities:
Issuance of redeemable Series A
common stock for property and
equipment, current assets, and
technology, net of current li-
abilities and related party
note.......................... -- -- -- -- 17,013
======= ======= ======== ======= ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-6
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)
1. BACKGROUND AND BASIS OF PRESENTATION
BACKGROUND
In January of 1994, Northern Telecom Limited, and its subsidiary Northern
Telecom Inc. (collectively "Nortel"), established the Secure Networks group
(the "Division") to pursue the development and sales of public key
infrastructure ("PKI") products. PKI products combine powerful public key data
encryption technology with transparent, life cycle digital certificate
management to enable users to communicate securely over public and private
networks.
During 1996, Nortel announced its intention to create a separate company,
Entrust Technologies Inc. (the "Company") consisting of the operations of the
Division (the "Separation"). The Company was incorporated in December 1996
with nominal share capital, all of which was contributed by Nortel. At the
close of business on December 31, 1996, Nortel transferred to the Company
certain of the assets and liabilities, intellectual property, rights, licenses
and contracts of the Division of Nortel.
In exchange Nortel received 20,300,000 shares of the Company's Series A
common stock, 7,700,000 shares of the Company's Special Voting stock, and cash
consideration. At the close of business on December 31, 1996, the Company
issued 260,000 shares of its Series B common stock in a private placement for
$100 per share less underwriting costs and commissions of $7.75 per share.
After the completion of the private placement, Nortel owned approximately
73.0% of the outstanding shares of the Company's common stock assuming
conversion of the Series B common stock and Series B Non-Voting common stock
into an aggregate of 13,063,836 shares of Series A common stock.
BASIS OF PRESENTATION
These consolidated financial statements have been prepared for the purpose
of presenting the balance sheets of the Company as at December 31, 1997 and
June 30, 1998 and the related statements of operations, shareholders' equity
and cash flows for the year ended December 31, 1997 and for the six months
ended June 30, 1997 and 1998. The historical comparative year results,
including the balance sheet as at December 31, 1996 and the related statements
of operations, shareholders' equity and cash flows for each of the two years
in the period ended December 31, 1996, represent the operations of the
Division transferred to the Company from Nortel in the Separation (the
"Company Business"). These historical results of the Division present the
financial position of the Division as a separate reporting entity independent
of Nortel and its subsidiaries, as if the Division were a stand-alone entity
for these periods. The 1995 and 1996 consolidated financial statements have
been prepared using the historical basis in the assets and liabilities and
historical results of operations related to the Company Business. Changes in
shareholder's net investment in 1995 and 1996 represent Nortel's contribution
of its net investment after giving effect to the net income (loss) of the
Division and net cash transfers to or from the Division. The shareholder's net
investment was not transferred to the Company as part of the Separation.
The 1995 and 1996 consolidated financial statements, presented here for
comparison purposes, include certain Nortel corporate costs that were
allocated to the Division using procedures deemed appropriate for the nature
of the expenses involved. The procedures utilized various allocation bases
such as invested net assets, number of employees and related payroll costs,
and direct effort expended. Management believes that the allocations reflected
in the 1995 and 1996 consolidated financial statements are reasonable, but
they were not necessarily indicative of the costs that would
F-7
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
have been incurred had the Division functioned as a stand-alone company. No
corporate costs were allocated to the Company, in this way, in the year ended
December 31, 1997 or the six months ended June 30, 1998. After the Separation,
Nortel continued to provide certain "corporate" services to the Company. Fees
charged for such services are based on Nortel's internal usage-based fee
structures where applicable or Nortel's direct cost of services, including
total compensation and out-of-pocket expenses.
INCOME TAX PROVISION
As the Company operated as a division of Nortel in fiscal years 1995 and
1996, it did not file separate income tax returns. Income tax expense has been
estimated based upon an application of Nortel's effective tax rate for those
periods.
CASH BALANCES
Prior to January 1, 1997, the Company, as a division of Nortel, participated
in the Nortel cash management system and, accordingly, did not maintain cash
balances other than minimal amounts.
2. SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The consolidated financial statements of the Company include the accounts of
its majority-owned Canadian subsidiary, Entrust Technologies Limited, its
wholly-owned U.K. subsidiary, Entrust Technologies Limited, its wholly-owned
Swiss subsidiary, r/3/ Security Engineering AG, and its wholly-owned German
subsidiary, Entrust Technologies GmbH. The minority interest in the Canadian
subsidiary has been insignificant to date. All significant intercompany
transactions and accounts are eliminated in consolidation.
TRANSLATION OF FOREIGN CURRENCIES
The accounts of the Company's subsidiaries have been translated into U.S.
dollars. Assets and liabilities have been translated at the exchange rates in
effect at the balance sheet date. Revenues, expenses and cash flow amounts are
translated at average rates for the period. The resultant translation
adjustments are included in comprehensive income as a separate component of
shareholders' equity. Gains and losses from foreign currency transactions are
included in the determination of net income and are not material.
The Company does not use hedging or derivatives and, as a result, may be
exposed to currency translation adjustments in the future. However, the
Company transacts the majority of its international sales in U.S. dollars,
except for Canada where the Company has both significant costs and revenues,
which the Company believes mitigates the potential impact of currency
fluctuations.
UNAUDITED INTERIM FINANCIAL INFORMATION
The consolidated financial statements as of and for the six months ended
June 30, 1997 and 1998 are unaudited but, in the opinion of management,
include all adjustments, consisting only of normal recurring accruals,
necessary for a fair presentation of the results for such periods. The results
of operations for the six months ended June 30, 1998 are not necessarily
indicative of results to be expected for the full fiscal year.
F-8
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
REVENUE RECOGNITION
The Company generates revenues primarily from licensing the rights to its
software products to end-users and from sublicense fees from resellers. The
Company also generates revenues from consulting, training and post-contract
support ("maintenance"). In October 1997, the AICPA issued Statement of
Position ("SOP") No. 97-2, "Software Revenue Recognition", which the Company
adopted, effective January 1, 1998. Such adoption had no effect on the
Company's method of recognizing revenues. Prior to 1998, the Company's revenue
recognition policy was in accordance with the provisions of the preceding
authoritative guidance provided by SOP 91-1 "Software Revenue Recognition".
Revenues from perpetual software license agreements are recognized as
revenue 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 and collection of the
receivable is probable.
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 material basis.
Such services primarily consist of implementation services related to the
installation and deployment of the Company's products and do no include
significant customization or development of the underlying software code.
The Company uses the percentage of completion method to account for large
custom development contracts. Under this method, the Company recognizes
revenue and profit as the work on the contract progresses. Revenue is
recognized by applying the percentage of the total estimated contract cost
incurred to date to the total contract value, and any projected loss is
recognized immediately. The total project cost estimates are reviewed on a
regular basis.
Revenues from maintenance 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 to customers.
COST OF REVENUES
Cost of licenses includes the cost of media, product packaging,
documentation and other production costs and third-party royalties.
Cost of services consists primarily of salaries, benefits and allocated
overhead costs related to consulting, training and customer support personnel,
including the cost of third-party consultants engaged by the Company.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is calculated
generally using the straight-line method over the estimated useful lives of
the assets. The expected useful lives of the furniture and fixtures, computer
and telecom equipment and software is three to five years and the remaining
term of the facility lease for leasehold improvements.
When assets are sold or retired, the cost and related accumulated
depreciation are removed from the accounts and any resulting gain or loss is
included in operations. Maintenance and repairs are charged to operations as
incurred.
GOODWILL
Goodwill is being amortized on a straight-line basis over five years.
F-9
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Assets are reviewed for impairment on the basis of undiscounted cash flows.
If the cash flows are less than the asset's carrying value, the asset is
written down to its fair value.
OTHER RECEIVABLES
Other receivables include federal income tax and Canadian goods and services
tax refunds of $1,644 and $1,156 at December 31, 1997 and June 30, 1998,
respectively.
RESEARCH AND DEVELOPMENT COSTS
To date the Company has not capitalized any development costs under
Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for
the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed". The
Company has defined attainment of technological feasibility as completion of a
working model. The period of time beginning with the establishment of a
working model and ending when a product is offered for sale is typically very
short. Accordingly, costs that were eligible for capitalization were
insignificant.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with original maturities
of three months or less to be cash equivalents. The Company's cash and cash
equivalents are maintained with a bank and a brokerage institution.
SHORT-TERM INVESTMENTS
At December 31, 1997 and June 30, 1998, the Company's investments consisted
of investments in a strategic cash management account which consists primarily
of securities guaranteed by the U.S. government or its agencies and highly
rated municipal bonds with a remaining maturity of not more than 12 months.
The Company has adopted SFAS No. 115 "Accounting for Certain Investments in
Debt and Equity Securities". This statement requires that securities be
classified as "held to maturity", "available for sale" or "trading", and the
securities in each classification be accounted for at either amortized cost or
fair market value, depending upon their classification. The Company has the
intent and ability to hold all investments until maturity. Therefore, all such
investments are classified as held to maturity investments and carried at
amortized cost in the accompanying consolidated financial statements. At
December 31, 1997 and June 30, 1998, the amortized cost of the Company's
investments approximated fair value.
The Company's investments consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 JUNE 30, 1998
--------------------- ---------------------
MATURITY OF MATURITY OF
AMORTIZED SECURITIES AMORTIZED SECURITIES
COST WITHIN ONE COST WITHIN ONE
BASIS YEAR BASIS YEAR
--------- ----------- --------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Foreign debt securities........ $1,011 $1,011 $ -- $ --
Municipal debt securities...... 3,686 3,686 -- --
U.S. government agency debt se-
curities...................... 3,916 3,916 1,787 1,787
------ ------ ------ ------
$8,613 $8,613 $1,787 $1,787
====== ====== ====== ======
</TABLE>
F-10
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
INCOME TAXES
The Company uses the asset and liability method to account for income taxes.
Deferred income tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the carrying amounts of
existing assets and liabilities for accounting purposes, and their respective
tax bases. Deferred income tax assets and liabilities are measured using
statutory tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The
effect on deferred income tax assets and liabilities of a change in statutory
tax rates is recognized in net income in the year of change. A valuation
allowance is recorded for those deferred income tax assets whose
recoverability is not sufficiently likely.
INCOME PER SHARE
Basic income per share is calculated by dividing the net income by the
weighted average number of shares of common stock of all classes outstanding
during the year, after reflecting the right of the Series B common
stockholders to additional shares as described in Note 7. Diluted income per
share is calculated by dividing the net income by the weighted average number
of shares of common stock and potential common stock outstanding, and when
dilutive, exchangeable special voting stock on an as-if converted basis,
additional conversion rights of Series B common shares, and options to
purchase common stock using the treasury stock method.
Net income per share has been calculated as follows:
<TABLE>
<CAPTION>
JUNE 30,
DECEMBER 31, ---------------------
1997 1997 1998
------------ ---------- ----------
(UNAUDITED)
<S> <C> <C> <C>
Net income available to common share-
holders (in thousands)................ $ 514 $ 396 $ (21,388)
========== ========== ==========
Weighted average common shares out-
standing:
Basic:
Series A common stock................. 20,300,000 20,300,000 20,448,689
Series B common stock................. 8,842,080 8,842,080 8,842,080
Series B Non-Voting common stock...... 1,557,920 1,557,920 1,557,920
---------- ---------- ----------
Basic weighted average common shares
outstanding.......................... 30,700,000 30,700,000 30,848,689
========== ========== ==========
Basic net income per share............ $ 0.02 $ 0.01 $ (0.69)
========== ========== ==========
Diluted:
Basic weighted average common shares
outstanding.......................... 30,700,000 30,700,000 30,848,689
Conversion rights on Special Voting
stock................................ 7,700,000 7,700,000 7,700,000
Additional conversion rights of Series
B Voting and Non-Voting common
stock................................ 2,663,836 2,663,836 2,663,836
Net effect of dilutive options using
the treasury stock method............ 679,132 -- 5,473,314
---------- ---------- ----------
Diluted weighted average common shares
outstanding.......................... 41,742,968 41,063,836 46,685,839
========== ========== ==========
Diluted net income per share.......... $ 0.01 $ 0.01 $ (0.69)
========== ========== ==========
</TABLE>
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to market and
credit risk consist principally of cash and cash equivalents, short-term
investments and accounts receivable. The Company has investment policies that
limit the amount of credit exposure to any one issuer and restrict placement
of these investments to issuers evaluated as credit worthy. The Company
maintains its cash and cash equivalents, and short-term investments, with high
quality financial
F-11
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
institutions and investment managers. The Company performs periodic reviews of
the credit standing of its investments and the financial institutions managing
those investments.
The Company's customer base consists primarily of large, well-established
companies or government agencies. Five customers accounted for approximately
88%, 55% and 66% of accounts receivable as of December 31, 1996 and 1997 and
June 30, 1998 respectively. The Company performs ongoing credit evaluations of
its customers, and generally, does not require collateral from its customers
to support accounts receivable. Requests to extend significant credit to
customers are reviewed and approved by senior management. The Company
maintains an allowance for potential losses due to credit risk, but has not
experienced significant write-offs. Management believes that the reserves for
losses are adequate. The following table summarizes the changes in the
allowance for doubtful accounts:
<TABLE>
<CAPTION>
DECEMBER 31,
------------- JUNE 30,
1996 1997 1998
------ ------ -----------
(UNAUDITED)
<S> <C> <C> <C>
Allowance for doubtful accounts, beginning of
period............................................. $ 73 $ 129 $416
Additional provision................................ 56 287 44
------ ------ ----
Allowance for doubtful accounts, end of period...... $ 129 $ 416 $460
====== ====== ====
</TABLE>
In 1995, two customers accounted for an aggregate of 71% of revenues, one of
which accounted for 53% while the other customer accounted for 18% of revenues
for the year. In 1996, three customers accounted for an aggregate of 64% of
revenues for the year, and individually these customers accounted for 29%, 20%
and 15% of revenues for that year. In 1997, three customers accounted for an
aggregate of 42% of revenues. One of these customers was the same customer who
accounted for 29% of 1996 revenues and this customer accounted for 19% of
revenues for 1997. The other two major customers in 1997 accounted for 12% and
11% of revenues, respectively.
The Company is subject to foreign currency exchange risk in the form of
exposures to changes in currency exchange rates between the United States and
Canada and the United Kingdom. Management periodically reviews the potential
financial impact of this risk and currently believes that the Company is not
subject to significant potential losses as a result.
RECENT PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
("FAS 131") and SFAS No. 130, "Reporting Comprehensive Income" ("FAS 130").
FAS 131 redefines how operating segments are determined and requires
disclosure of certain financial and descriptive information regarding those
segments. Management believes that the adoption of SFAS No. 131 will not have
a material impact on the financial statements.
In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income,"
which establishes standards for reporting and displaying comprehensive income,
as defined, and its components in financial statements. The Company's adoption
of SFAS No. 130 had no impact on the consolidated financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which establishes accounting and reporting
standards for derivative instruments. The Company currently does not use
hedging or derivatives and, as a result, does not anticipate any impact on the
financial statements.
F-12
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
UNAUDITED PRO FORMA BALANCE SHEET
Upon the closing of the Company's initial public offering, (i) all of the
outstanding shares of the Company's Series B common stock and Series B Non-
Voting common stock will automatically convert into an aggregate of 13,063,836
shares of common stock, (ii) the repurchase rights of the Redeemable Series A
common stock will expire, (iii) 1,150,520 shares of common stock will be
issued upon the expected surrender of a like number of shares of the Company's
Special Voting stock and the concurrent exchange of a like number of
Exchangeable Shares of Entrust Technologies Limited by Northern Telecom
Limited, a selling stockholder in the initial public offering, and (iv) the
Company is expected to file Amended and Restated Articles of Incorporation
eliminating the Company's Series B common stock and Series B Non-Voting common
stock, redesignating the Series A common stock as common stock and authorizing
100,000,000 shares of common stock. All of the foregoing events have been
reflected in the unaudited pro forma balance sheet as of June 30, 1998.
3. PROPERTY AND EQUIPMENT
Property and equipment, at cost, consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------- JUNE 30,
1996 1997 1998
------ ------ -----------
(UNAUDITED)
<S> <C> <C> <C>
Computer and telecom equipment................ $1,305 $1,491 $2,363
Furniture and fixtures........................ -- 86 469
Leasehold improvements........................ -- 639 808
Software distribution rights.................. 225 218 213
------ ------ ------
1,530 2,434 3,853
Less: accumulated depreciation and amortiza-
tion......................................... (385) (754) (1,270)
------ ------ ------
Total property and equipment, net............. $1,145 $1,680 $2,583
====== ====== ======
</TABLE>
4. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------- JUNE 30,
1996 1997 1998
------------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Payroll and related benefits...................... $ 915 $ 1,532 $1,744
Other............................................. 30 534 1,509
----- ------- ------
$ 945 $ 2,066 $3,253
===== ======= ======
</TABLE>
F-13
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. LONG-TERM DEBT
At December 31, 1997, the Company had an installment note with a financial
institution. This obligation was unsecured with interest at an effective rate
of 6.9% per annum and the maturities under this note are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1997 1998
------------ -----------
(UNAUDITED)
<S> <C> <C>
For the six months ended June 30, 1998............. $ 3 $ --
For the six months ended December 31, 1998......... -- 5
For the year ended December 31, 1999............... 627 12
For the year ended December 31, 2000............... 819 13
------ ------
1,449 30
Less: current portion.............................. -- (11)
------ ------
$1,449 $ 19
====== ======
</TABLE>
6. INCOME TAXES
The following table presents the U.S. and foreign components of income
(loss) before income taxes and the provision for income taxes. 1995 and 1996
figures are estimated on a pro forma basis for comparative purposes.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996 1997
------- ---- -----
<S> <C> <C> <C>
Income (loss) before income taxes
United States....................................... $ (799) $ (8) $ 2
Foreign............................................. (1,625) 64 231
------- ---- -----
$(2,424) $ 56 $ 233
======= ==== =====
(Provision) benefit for income taxes
Current:
Federal........................................... $ -- $-- $(337)
State and local................................... -- -- (76)
Foreign........................................... 301 331 (49)
------- ---- -----
301 331 (462)
------- ---- -----
Deferred:
Federal........................................... -- -- 119
State and local................................... -- -- 28
Foreign........................................... -- -- 596
------- ---- -----
-- -- 743
------- ---- -----
Total benefit for income taxes........................ $ 301 $331 $ 281
======= ==== =====
</TABLE>
The difference between the actual income tax provision and the tax provision
computed by applying the statutory Federal income tax rate to income (loss)
before income taxes is attributable to the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1995 1996 1997
------ ---- ----
<S> <C> <C> <C>
Income tax (provision) benefit at 34%.................. $ 824 $(19) $(79)
State and local taxes, net of Federal benefits......... -- -- (48)
Foreign earnings taxed at different rate............... 257 (6) 15
Unrecorded benefit of tax losses....................... (1,081) -- --
Canadian research and development tax credits
utilized.............................................. 301 331 393
Utilization of tax losses carry forward................ -- 25 --
------ ---- ----
Total benefit for income taxes......................... $ 301 $331 $281
====== ==== ====
</TABLE>
F-14
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The components of the deferred income tax liability classified by the source
of the cumulative temporary differences that gave rise to the credit are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
------------ ------------
<S> <C> <C>
Tax depreciation in excess of accounting
depreciation.................................... $ 19 $ 7
Amortization of Sec. 197 assets not deductible
for accounting purposes......................... -- 212
Accounting provisions not deductible for tax
purposes........................................ -- (200)
----- -----
$ 19 $ 19
===== =====
The components of the deferred income tax benefit classified by source of
the cumulative temporary differences that gave rise to the debit are as
follows:
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
------------ ------------
<S> <C> <C>
Accounting provisions not deductible for tax
purposes........................................ $ -- $ 147
Research and development tax credits............. -- 596
----- -----
$ -- $ 743
===== =====
</TABLE>
As at December 31, 1997, the Company has available for carry-forward to
reduce future Canadian federal income taxes, scientific research and
experimental development investment tax credits of approximately $404. These
tax credits expire in the year 2007.
7. CAPITAL STOCK
On January 24, 1997, the Board of Directors declared a 10-for-1 stock split
effected in the form of a stock dividend, payable to the shareholders of
Series A common stock and Special Voting stock. On June 18, 1998, the Board of
Directors approved an increase in the authorized number of shares of Series A
common stock from 15,000,000 to 100,000,000, Preferred stock from 500,000 to
5,000,000 and Special Voting stock from 2,500,000 to 15,000,000.
The Board of Directors also approved on June 18, 1998 a 4-for-1 stock split,
effected in the form of a stock dividend payable to the shareholders of Series
A common stock and Special Voting stock. In addition, the Board of Directors
approved an amendment to the Company's Articles of Incorporation, which
redesignated the Series A common stock as Common stock effective upon the
completion of a public offering of the Company's Common stock. The
consolidated financial statements have been restated to reflect the increase
in the number of authorized shares and these stock splits.
SERIES A AND SERIES B COMMON STOCK
The holders of Series A and Series B common stock are entitled to one vote
per share and are entitled to dividends when and if declared by the Board of
Directors of the Company. The Series B Non-Voting common stock has the same
rights and privileges as the Series B common stock except for the non-voting
nature of the stock and it is exchangeable at the option of the holder into
Series B common stock. The Company's Series B common stock and Series B Non-
Voting common stock will automatically convert into 13,063,836 shares of
Common stock upon completion of a public offering of the Company's Common
stock.
F-15
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
REDEEMABLE SERIES A COMMON STOCK
The holders of the Redeemable Series A common stock are entitled to the same
rights and privileges as the Series A common stock, except for the special
provisions described in Note 12. At June 30, 1998, there were 1,167, 288 of
these shares issued and outstanding.
SPECIAL VOTING STOCK
The Special Voting stock has a par value of $0.01 per share. The holders of
the Special Voting stock also hold 7,700,000 Exchangeable shares in the
Company's majority owned subsidiary Entrust Technologies Limited. At any time
prior to December 31, 2006, the holders of the Special Voting stock have the
right to exchange their shares of Special Voting stock and their Exchangeable
Shares in Entrust Technologies Limited into 7,700,000 shares of Series A
common stock. The Company generally also has the right to demand such exchange
on or before December 31, 2006.
PREFERRED STOCK
The Company is authorized to issue up to 5,000,000 shares of Preferred stock
in one or more series. Each such series of Preferred stock shall have such
rights, preferences, privileges and restrictions, including voting rights,
dividend rights, conversion rights and liquidation preferences, as shall be
determined by the Board of Directors. As of June 30, 1998, the Company has not
issued any shares of Preferred stock.
8. STOCK OPTIONS
EMPLOYEE STOCK OPTION PLAN
During the year ended December 31, 1997, the Company's shareholders approved
the 1996 Stock Incentive Plan (the "Plan") applicable to the Company's full-
time employees, officers, and consultants and authorized 7,228,920 shares of
Series A common stock for issuance thereunder. In May 1998, the Company's
shareholder's increased the authorized number of Series A common stock
available for issuance under this plan to 7,630,920. On June 18, 1998, the
Company's Board of Directors approved an increase of 2,369,080 in the number
of shares available under the Plan, subject to shareholder approval. The
options under the Plan are granted at the then-current fair market value of
the Series A common stock of the Company and generally may be exercised in
equal proportions during the years following the first and second anniversary
of the date of grant, and expire on the tenth anniversary or upon termination
of employment. With respect to options granted to the key management team, 20%
of the options become exercisable upon grant date, with an additional 20% of
the options exercisable at each successive anniversary of the grant date until
the fourth anniversary of the grant date.
F-16
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A summary of the activity under the Plan is set forth below:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------------
SHARES
AVAILABLE NUMBER OF WEIGHTED AVERAGE
FOR GRANT SHARES EXERCISE PRICE
---------- --------- ----------------
<S> <C> <C> <C>
Balance at December 31, 1996....... -- --
Authorized....................... 7,228,920 --
Granted.......................... (6,628,800) 6,628,800 $2.16
Forfeited........................ 140,720 (140,720) 2.13
---------- ---------
Balance at December 31, 1997....... 740,840 6,488,080 2.16
Authorized....................... 2,771,080 --
Granted.......................... (985,516) 985,516 8.19
Forfeited........................ 75,792 (75,792) 2.81
Exercised........................ -- (12,040) 2.13
---------- ---------
Balance at June 30, 1998
(unaudited)....................... 2,602,196 7,385,764 2.96
---------- ---------
Exercisable at December 31, 1997... -- 658,120 2.15
========== =========
Exercisable at June 30, 1998
(unaudited)....................... -- 2,201,220 2.29
========== =========
</TABLE>
The following table summarizes information concerning currently outstanding
options as at June 30, 1998 (unaudited):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
NUMBER OF AVERAGE AVERAGE NUMBER OF AVERAGE
OPTIONS REMAINING EXERCISE OPTIONS EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE PRICE EXERCISABLE PRICE
- ------------------------ ----------- ---------------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$2.13 to $2.50.......... 6,411,360 8.7 years $ 2.17 2,141,220 $ 2.13
$6.25................... 490,200 9.6 years $ 6.25 0 $ 6.25
$12.08.................. 484,204 9.9 years $12.08 60,000 $12.08
--------- ---------
7,385,764 2,201,220
========= =========
</TABLE>
STOCK BASED COMPENSATION
The Company applies APB Opinion No. 25 and related interpretations in
accounting for its employee stock-based compensation plans. Accordingly,
compensation expense has been recognized for its stock-based compensation
plans in the six months ended June 30, 1998 because the exercise price of some
options granted in that period were determined to be below the fair value of
the underlying stock as of the grant date for such stock options. In
connection with the granting of these options, the Company has recognized
unearned deferred compensation expense of $784 for the six months ended June
30, 1998. This amount will be amortized over the vesting period of four years
from the date of grant. For all other periods disclosed, the exercise price of
each option granted was equal to the fair value of the underlying stock at the
date of grant. Had compensation costs for the Company's Employee Stock Option
Plan been determined based on the fair value at the grant date for awards
under the Plan, consistent with the methodology prescribed under SFAS 123, the
Company's net income and income per share would have been decreased to the
following pro forma amounts.
F-17
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1995 1996 1997
------- ---- -------
<S> <C> <C> <C>
Net income (loss), as reported....................... $(2,123) $387 $ 514
Estimated stock based compensation costs............. -- -- (1,535)
------- ---- -------
Pro forma net income (loss).......................... $(2,123) $387 $(1,021)
======= ==== =======
Basic and diluted net (loss) per share............... -- -- $ (0.03)
======= ==== =======
</TABLE>
The weighted average fair value of all options granted during fiscal 1997
was estimated as of the date of grant using the minimum value model and the
Black-Scholes option pricing model with the following weighted average
assumptions.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1996 1997
------ ------
<S> <C> <C>
Expected option life, in years.......................... -- 6
Risk free interest rate................................. -- 6%
Dividend yield.......................................... -- --
</TABLE>
The weighted average fair value for stock options granted during 1997 was
$0.66 per option.
9. RELATED PARTY TRANSACTIONS
Significant related party transactions with the Company's parent, Nortel,
and affiliated companies, not otherwise disclosed in the financial statements,
include the following (information related to the six month periods ended June
30, 1997 and 1998 is unaudited).
The Company paid $2,872, $3,656 and $273 in the years ended December 31,
1995, 1996, and 1997, respectively, $273 for the six months ended June 30,
1997, and none for the same period in 1998, for research and development
services provided by Bell Northern Research Ltd. ("BNR"), a subsidiary of
Nortel. The research and development services and other costs of revenue were
purchased at cost from BNR. Purchases from BNR are settled through the
intercompany accounting system of Nortel.
Revenues include sales to Nortel for the years ended December 31, 1995, 1996
and 1997 of $323, $300 and $495, respectively and $176 and $172 for the six
months ended June 30, 1997 and 1998, respectively. Also, revenues for the year
ended December 31, 1997 include sales to affiliated companies totaling $332.
Sales to affiliated companies were immaterial in 1995 and 1996. Sales to
affiliated companies were $255 and $1,795 for the six months ended June 30,
1997 and 1998, respectively.
During the year ended December 31, 1997, the Company paid Nortel $299 for
services rendered and $137 and $60 for the six months ending June 30, 1997 and
1998, respectively. These transactions are in the normal course of operations,
and are measured at their exchange amounts, which is the amount of
consideration established and agreed to by the related parties.
Also, during the year ended December 31, 1997, and the six months ended June
30, 1998, the Company reimbursed Nortel for expenses paid by Nortel on behalf
of the Company, net of revenues collected by Nortel on behalf of the Company.
The net expenses reimbursed amounted to $5,610 for fiscal 1997 and $3,155 and
$610 for the six months ended June 30, 1997 and June 30, 1998, respectively.
These amounts have been recorded in these financial statements at the carrying
amount of the transactions involved.
Balances due to/from the related party, arising from the sales of product
and receipt of services referred to above, are payable net 30 days from the
date of the related intercompany invoice.
F-18
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. COMMITMENTS
The Company leases administrative and sales offices and certain property and
equipment under noncancellable operating leases expiring through 2003. Total
rent expense under such leases for the years ended December 31, 1995, 1996 and
1997 were $35, $100, $956, respectively, and for the six month periods ended
June 30, 1997 and 1998 were $272 and $1,206, respectively.
At June 30, 1998 (unaudited), the future minimum lease payments under
operating leases were as follows:
<TABLE>
<S> <C>
1998 (six months)................................................ $1,307
1999............................................................. 2,525
2000............................................................. 2,258
2001............................................................. 1,652
2002............................................................. 821
Thereafter....................................................... 158
------
Total future minimum lease payments.............................. $8,721
======
</TABLE>
11. SEGMENTED INFORMATION
BUSINESS SEGMENT
The Company operates in one business segment: the design, production and
sale of software products for encryption and digital signature.
GEOGRAPHIC SEGMENTS
Identifiable net assets are those net assets of the Company (1996--the
Division) that are identified with the operations in the geographic areas.
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
------------ ------------
<S> <C> <C>
Identifiable net assets
United States................................ $(25) $15,012
Europe....................................... -- 30
Canada....................................... (35) (380)
---- -------
Net assets..................................... $(60) $14,662
==== =======
</TABLE>
Transfers between geographic areas are made at prices based on total cost of
the product to the supplying segment. Customer revenues and income (loss)
before income taxes by destination for the years December 31, 1995, 1996 and
1997 were:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Revenues:
United States.................... $ 1,292 $ 9,758 $14,978
Europe........................... -- 473 1,359
Canada........................... 2,681 2,571 8,669
------- ------- -------
Total revenues..................... $ 3,973 $12,802 $25,006
======= ======= =======
Income (loss) before income taxes:
United States.................... $ (799) $ (8) $ 2
Europe........................... -- -- 231
Canada........................... (1,625) 64 --
------- ------- -------
Total income (loss) before income
taxes............................. $(2,424) $ 56 $ 233
======= ======= =======
</TABLE>
F-19
<PAGE>
ENTRUST TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
12. ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT (UNAUDITED)
On June 8, 1998, the Company completed the acquisition of r/3/ Security
Engineering AG ("r/3/"), a company based in Zurich, Switzerland which provides
consulting, applied research and product development services related to
commercial security and encryption solutions. Pursuant to the Share Purchase
Agreements dated May 30, 1998, entered into between the Company and the
shareholders of r/3/, the Company agreed to acquire all the outstanding shares
of r/3/ in exchange for approximately 1,167,288 shares of the Company's Series
A common stock, valued at $14.58 per share and cash consideration of $4,391.
In the event the Company's Series A common stock (or any common stock into
which it would convert) is not listed on a United States Exchange within one
year of the closing of the acquisition, the r/3/ shareholders have the right
to require the Company to repurchase the Series A common shares at $14.58 per
share. Additionally, if the average closing price of the Company's Series A
common stock after the first 10 days of trading following an initial public
offering of the stock (the "Market Price") is less than $12.08, then the
Company will be required to pay the difference between the Market Price and
$12.08 to the r/3/ shareholders in cash or in additional stock.
This acquisition has been accounted for under the purchase method of
accounting. The aggregate purchase price was $23,774, which included
approximately $4,391 in cash, $17,013 representing 1,167,288 shares of
Redeemable Series A common stock, approximately $994 in assumed liabilities
and acquisition expenses, and approximately $1,376 of adjustments to the June
8, 1998 opening balance sheet of r/3/ to record the acquired assets and
liabilities at fair value. In connection with the purchase price allocation,
the Company obtained an independent appraisal of the intangible assets which
indicated approximately $20,200 of the acquired intangible assets consisted of
in-process product development. The development of these projects had not
reached technological feasibility and the technology has no alternative future
use and, accordingly, the $20,200 was included as an expense in the
consolidated statements of operations for the six months ended June 30, 1998.
13. 1998 EMPLOYEE STOCK PURCHASE PLAN (UNAUDITED)
The Company's 1998 Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Board of Directors in July 1998 and approved by the
stockholders of the Company in August 1998. The Purchase Plan authorizes the
issuance of up to a total of 400,000 shares of common stock to participating
employees.
All employees of the Company, including directors of the Company who are
employees, and all employees of any participating subsidiaries whose customary
employment is more than 20 hours per week and more than five months in any
calendar year are eligible to participate in the Purchase Plan.
The Purchase Plan terminates on July 21, 2000 or such earlier date as the
Board determines. Upon termination of the Purchase Plan all amounts in the
accounts of participating employees will be promptly refunded.
Because participation in the Purchase Plan is voluntary, the Company cannot
presently determine the number of shares of common stock to be purchased by
any particular current executive officer, by all current executive officers as
a group or by non-executive employees as a group.
F-20
<PAGE>
REPORT OF THE STATUTORY AUDITORS
To the general meeting of the shareholders of
r/3/ Security Engineering AG, Aathal-Seegraben
As statutory auditors, we have audited the accounting records and the
financial statements (balance sheet, income statement and notes to the
financial statements) of r/3/ Security Engineering AG, Aathal-Seegraben, for
the years ended December 31, 1997 and 1996.
These financial statements are the responsibility of the board of directors.
Our responsibility is to express an opinion on these financial statements
based on our audit. We confirm that we meet the legal requirements concerning
professional qualification and independence.
Our audit was conducted in accordance with auditing standards recognised by
the profession, which are substantially the same as generally accepted
auditing standards in the United States, which require that an audit be
planned and performed to obtain reasonable assurance about whether the
financial statements are free from material misstatement. We have examined on
a test basis evidence supporting the amounts and disclosures in the financial
statements. We have also assessed the accounting principles used, significant
estimates made and the overall financial statement presentation. We believe
that our audit provides a reasonable basis for our opinion.
In our opinion, the accounting records, the financial statements and the
proposed appropriation of available earnings and free reserves comply with
accounting principles generally accepted in Switzerland, the Swiss law and the
company's articles of incorporation.
Generally accepted accounting principles in Switzerland vary in certain
respects from accounting principles generally accepted in the United States.
The application of the latter would have affected the determination of net
income for the years ended December 31, 1997 and 1996, to the extent
summarized in Note 7 to the financial statements.
We recommend that the financial statements submitted to you be approved.
WILLI & PARTNER AG
/s/ Marco Willi
Auditor in charge /s/DELOITTE & TOUCHE
/s/ Bruno Wust
Auditor in charge Ottawa, Canada
August 5, 1998
Wetzikon, June 2, 1998
F-21
<PAGE>
R/3/ SECURITY ENGINEERING AG
BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- -----------------
CHF CHF
<S> <C> <C>
ASSETS
Current assets:
Cash...................................... 1,653,352.19 1,220,974.97
Securities (incl. treasury stock)......... 10,000.00 49,528.00
Accounts Receivable....................... 1,088,924.20 683,766.40
./. Value Adjustments (Del credere)....... (87,000.00) (87,000.00)
Other Accounts Receivable
Third Parties............................. 29,816.37 28,600.36
Shareholders.............................. 9,176.60 --
Prepaid Expenses & Others................. 132,825.00 95,045.95
Inventory Work in Progress................ 63,410.00 67,445.00
------------ ------------
Total Current Assets.................... 2,900,504.36 2,058,360.68
------------ ------------
Fixed Assets
Financial Investments
Investment in Subsidiary.................. 200,000.00 --
Tangible Fixed Assets
Office Equipment / Computers /
Communication Equipment.................. 316,524.70 374,259.10
Intangible Assets
Development Costs......................... 530,000.00 --
------------ ------------
Total Fixed Assets...................... 1,046,524.70 374,259.10
------------ ------------
Total Assets............................ 3,947,029.06 2,432,619.78
============ ============
LIABILITIES AND EQUITY
Liabilities:
Accounts Payable
Third Parties............................. 126,931.50 122,679.55
Related Companies......................... 19,915.50 --
Banks...................................... -- 9,623.05
Other Accounts Payable (short term)
Third Parties............................. 319,721.27 498,187.34
Shareholders.............................. 68,199.05 183,943.08
Accrued Liabilities & Deferred Income...... 717,117.67 368,199.16
Long Term Liabilities
Third Parties............................. -- 63,484.00
Shareholders.............................. 1,614,662.00 114,662.00
Provisions
Guaranties................................ 55,000.00 55,000.00
Others.................................... 136,000.00 235,275.75
------------ ------------
Total Liabilities....................... 3,057,546.99 1,651,053.93
------------ ------------
Shareholders' Equity:
Share Capital.............................. 400,000.00 400,000.00
Legal Reserve Fund......................... 20,200.00 13,500.00
Reserves for Treasury Stock................ 10,000.00 --
Free Reserves.............................. 351,000.00 235,000.00
Cumulative Profit
Carry Forward............................. 365.85 946.62
Profit Current Year....................... 107,916.22 132,119.23
------------ ------------
Total Shareholders' Equity.............. 889,482.07 781,565.85
------------ ------------
Total Liabilities & Equity.............. 3,947,029.06 2,432,619.78
============ ============
</TABLE>
F-22
<PAGE>
R/3/ SECURITY ENGINEERING AG
INCOME STATEMENT
<TABLE>
<CAPTION>
1997 1996
------------ ------------
CHF CHF
<S> <C> <C>
EARNINGS
Earning Sales...................................... 5,530,705.13 5,213,708.55
./. Value Adjustments Accounts Receivable........ -- (10,000.00)
Adjustments Work in Progress..................... 15,965.00 11,475.00
Activated Development Costs...................... 530,000.00 --
------------ ------------
Total Earnings................................. 6,076,670.13 5,215,183.55
------------ ------------
EXPENSES
Materials & Services............................... 504,691.22 272,824.45
Personnel Expenses................................. 4,653,153.25 3,726,586.47
Rentals & Leasing.................................. 159,367.60 130,599.50
Financial Expenses................................. 36,336.55 10,033.35
Maintenance & Repair............................... 178,657.05 99,697.70
Insurance on Assets................................ 30,309.30 17,490.40
Professional Literature............................ 12,645.65 11,583.05
Office & Administration............................ 222,241.33 203,308.53
Advertising & Exhibitions.......................... 66,184.45 238,308.40
Other Expenses..................................... 8,458.40 16,598.76
Depreciation / Value Adjustments................... 188,130.00 283,555.55
------------ ------------
Total Expenses................................. 6,060,174.80 5,010,586.16
------------ ------------
Operating Result before Taxes...................... 16,495.33 204,597.39
------------ ------------
NON-OPERATIONAL & EXTRAORDINARY EARNINGS
Financial Earnings................................. 5,413.88 1,737.50
Profit on Sales of Assets.......................... 150,000.00 --
------------ ------------
155,413.88 1,737.50
NON-OPERATIONAL & EXTRAORDINARY EXPENSES & TAXES
Government Taxes................................... 63,992.99 74,215.66
------------ ------------
Net Profit/Loss--non-operational, extraordinary and
tax positions..................................... 91,420.89 (72,478.16)
------------ ------------
Net Profit Enterprise.............................. 107,916.22 132,119.23
============ ============
</TABLE>
F-23
<PAGE>
R/3/ SECURITY ENGINEERING AG
NOTES TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
CHF CHF
----------------- -----------------
<S> <C> <C>
1.Liabilities "leasing contracts"...... 28,552 49,319
2.Insurance Value
Fixed Assets......................... 730,000 730,000
3.Liabilities "Employee Benefits
Plan"................................. -- 91,755
4.Investments in Subsidiaries:
Swiss Security Service Laboratory,
CH-Solothurn
Book Value: 200,000 --
Share Capital: 400,000 --
Loss Subsidiary 1997: 102,700 --
Participating Share in %: 50% --
5.Own Shares\Treasury Stock
Purchase as per 06/10/1997 Number of
Shares: 10 --
Sold as per: -- Number of Shares: -- --
Inventory as per 12/31/1997: 10 --
</TABLE>
6. OTHER REMARKS
The foregoing balance sheet and income statement meet the legal requirements
of Swiss law as well as the principles of lawful accounting. The depreciations
and value adjustments were made adequately and within Swiss tax provisions.
7. RECONCILIATION TO GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN THE UNITED
STATES
The financial statements have been prepared in accordance with accounting
principles generally accepted in Switzerland ("Swiss GAAP") which, in certain
respects, differ from accounting principles generally accepted in the United
States ("US GAAP"). The following is a reconciliation of net income and
shareholder's equity from Swiss GAAP to US GAAP, followed by a description of
the accounting principle differences:
<TABLE>
<CAPTION>
1997 1996
CHF CHF
-------- -------
<S> <C> <C>
Reconciliation of Net Income:
Net income per local financial statements............... 107,916 132,119
Description of items having the effect of increasing
reported income:
Excess provisions not required under US GAAP............ -- 23,000
Deferred income tax provided on a US GAAP basis......... 16,800 --
Income tax provided on a statutory full accruals basis.. 18,485 --
Description of items having the effect of decreasing
reported income:
Equity method of accounting for investment.............. (1,350) --
Deferral of future license fees revenue................. (64,939) (72,000)
Recognition of development costs under US GAAP.......... (530,000) --
Income tax provided on a statutory full accruals basis.. -- (25,744)
Deferred income tax provided on a US GAAP basis......... -- (16,800)
Accrued liabilities..................................... (50,623) --
-------- -------
Net income according to generally accepted accounting
principles in the United States........................ (503,711) 40,575
======== =======
</TABLE>
F-24
<PAGE>
R/3/ SECURITY ENGINEERING AG
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
1997 1996
CHF CHF
-------- -------
<S> <C> <C>
Reconciliation of Shareholders' Equity:
Shareholders' equity per local financial statements..... 889,482 781,566
Description of items having the effect of increasing re-
ported shareholders' equity:
Excess provisions not required under US GAAP............ 142,000 142,000
Description of items having the effect of decreasing
reported shareholders' equity:
Equity method of accounting for investment.............. (1,350) --
Deferral of future license fees revenue................. (136,939) (72,000)
Shareholder stock....................................... (10,000) --
Recognition of development costs under US GAAP.......... (530,000) --
Income tax provided on a statutory full accruals basis.. (7,259) (25,744)
Deferred income tax provided on a US GAAP basis......... -- (16,800)
Accrued liabilities..................................... (50,623) --
-------- -------
Shareholders' equity according to generally accepted
accounting principles in the United States............. 295,311 809,022
======== =======
</TABLE>
Excess Provisions
Swiss GAAP provides for the recognition of certain provisions (e.g.,
uncollectable accounts receivable and warranty reserves) based upon income tax
planning schemes. These provisions are provided for under US GAAP based upon
reasonable estimates as determined by management. The adjustments shown as
"excess provisions not required under US GAAP" represent the differences
between the two accounting principles.
Equity Method of Accounting
US GAAP requires that companies record investments in subsidiaries, which it
maintains significant influence over management of the business, using the
equity method of accounting. The adjustment shown as "equity method of
accounting for investment" represents the difference in the accounting for a
subsidiary recorded using the cost method of accounting provided by Swiss GAAP
versus the equity method of accounting required by US GAAP.
Deferral of Future License Fees Revenue
US GAAP requires that revenues, which are not earned, be deferred and
recognized when the earnings process has been completed. The adjustments shown
as "deferral of future license fees revenue" removes from income amounts for
which the earnings process is not complete. The Company will recognize such
future revenues under U.S. GAAP when the related software is delivered, other
remaining vendor obligations are no longer significant and collectibility is
probable.
Development Costs
US GAAP requires that when an asset held for production becomes impaired
that the carrying value of such asset be adjusted to reflect the impairment.
The adjustments shown as "recognition of development costs under US GAAP"
represents charges to income for previously deferred product development costs
of a product that has been discontinued for future production.
F-25
<PAGE>
R/3/ SECURITY ENGINEERING AG
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Accrued Liabilities
US GAAP requires that expenses be recognized in the period incurred. The
adjustment shown as "accrued liabilities" represents costs incurred during the
current period but not recorded until the subsequent period under Swiss GAAP.
Shareholders' Stock
US GAAP requires that investments in stock of the same company be
reclassified to shareholders' equity to offset the shareholders' capital
stock. The adjustment shown as "shareholder stock" represents the
reclassification of an investment in the shareholder stock by the company.
Swiss GAAP does not require that a statement of cash flow be presented as a
basic financial statement. The following is a statement of cash flows for the
years ended December 31, 1997 and 1996 compiled in accordance with US GAAP.
<TABLE>
<CAPTION>
1997 1996
CHF CHF
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income as reconciled under US GAAP........... (503,711.00) 40,575.00
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization.................. 188,130.00 283,556.00
Gain on sale of investment..................... (150,000.00) --
Change in assets and liabilities
(Increase)/decrease in accounts receivable... (354,535.00) 25,711.00
(Increase)/decrease in other debtors......... (10,393.00) 28,839.00
(Increase) in work in progress............... (8,010.00) 42,900.00
Increase in prepaid expenses................. (37,779.00) (79,222.00)
Increase in accounts payable and accrued
expenses.................................... 265,653.00 340,716.00
(Decrease)/increase in interest and income
taxes payable................................. (5,863.00) 59,744.00
(Decrease)/increase in deferred taxes.......... (16,800.00) 16,800.00
(Decrease)/increase in other liabilities....... (236,894.00) 141,379.00
------------ ------------
Total adjustments............................ (366,491.00) 860,423.00
------------ ------------
Net cash (used in) provided by operating
activities.................................. (870,202.00) 900,998.00
Cash flows from investing activities:
Proceeds from sale of investment................. 250,000.00 --
Proceeds from sale of securities................. 49,528.00 --
Purchase of investments.......................... (200,000.00) (664.00)
Purchase of capital assets....................... (233,466.00) (315,420.00)
------------ ------------
Net cash used in investing activities........ (133,938.00) (316,084.00)
Cash flows from financing activities:
Increase in shareholder loans.................... 1,500,000.00 --
Repayment of third party loans................... (63,484.00) (31,056.00)
------------ ------------
Net cash provided by (used in) financing
activities.................................. 1,436,516.00 (31,056.00)
Net increase in cash............................... 432,376.00 553,858.00
Cash at beginning of year.......................... 1,220,975.00 667,117.00
------------ ------------
Cash at end of year................................ 1,653,351.00 1,220,975.00
============ ============
</TABLE>
F-26
<PAGE>
R/3/ SECURITY ENGINEERING AG
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
The amounts paid in interest and income taxes for the years ended December
31, 1997 and 1996 approximate such amounts reported as expensed in the Income
Statement for such periods.
PROPOSED APPROPRIATION OF AVAILABLE EARNINGS AND FREE RESERVES
<TABLE>
<CAPTION>
CHF
----------
<S> <C>
Carry forward..................................................... 365.85
Profit current year............................................... 107,916.22
----------
Cumulative profit December 31, 1997 .............................. 108,282.07
</TABLE>
The board of directors proposes the appropriation of the cumulative profit
as follows:
<TABLE>
<CAPTION>
CHF
----------
<S> <C>
Distribution of profit in form of shares of the Securights AG
(subsidiary, in the process of being founded) during 1998....... 102,500.00
Allocation to the legal reserve fund, according to the
requirements of Swiss law (article 671 I 1 OR).................. 5,400.00
Carry forward.................................................... 382.07
----------
108,282.07
</TABLE>
Proposition of the board of directors to allocate funds of the free reserves
to the legal reserve fund in order to comply with article 671 II 3 OR (payment
of bonus/dividend of CHF 102,500.--out of the current year profit)
<TABLE>
<CAPTION>
CHF
----------
<S> <C>
Free reserves before allocation.................................. 351,000.00
./. allocation to the legal reserve fund......................... (8,250.00)
----------
Free reserves before allocation.................................. 342,750.00
</TABLE>
Further a proposition of the board of directors to distribute a dividend of
CHF 227,500.--during 1998 from the free reserves, in addition the proposition
of the board of directors to allocate funds of the free reserves to the legal
reserve fund in order to comply with article 671 II 3 OR (payment of
bonus/dividend of CHF 227,500.--from the free reserves)
<TABLE>
<CAPTION>
CHF
-----------
<S> <C>
Free reserves before allocation............................... 342,750.00
Distribution of a bonus/dividend during 1998 from the free
reserves..................................................... (227,500.00)
Allocation to the legal reserve fund, according to the
requirements of Swiss law (article 671 II 3 OR).............. (22,750.00)
-----------
Free reserves after distribution of the bonus/dividend and
allocation to the legal reserve fund......................... 92,500.00
</TABLE>
Proposition of the board of directors to distribute the above mentioned
dividend in form of shares of the Securights AG (subsidiary, in the process of
being founded)
F-27
<PAGE>
ENTRUST TECHNOLOGIES INC
PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
On June 8, 1998 the Company completed the acquisition of r/3/ Security
Engineering AG ("r/3/"), a company based in Zurich, Switzerland which provides
consulting, applied research and product development services related to
commercial security and encryption solutions.
The accompanying unaudited condensed consolidated statements of operations
for the six months ended June 30, 1998 and the year ended December 31, 1997
assume the acquisition took place as of the beginning of the periods
presented, and combine the Company's and r/3/'s statements of operations.
Adjustments have been made to r/3/'s statements to conform to the Company's
presentation. The statements of operations for r/3/ were translated at the
average exchange rates for the year ended December 31, 1997 and for the six
months ended June 30, 1998. Adjustments were also made to conform to U.S.
generally accepted accounting principles.
The acquisition has been accounted for as a purchase. The purchase price
allocation reflected in the accompanying pro forma condensed consolidated
financial statements has been prepared on a preliminary basis. The purchase
price allocation will be adjusted based on final valuations of assets
acquired. The purchase price allocation includes a write-off of approximately
$20,208,000 for acquired in-process research and development costs. (See notes
to Pro Forma Condensed Consolidated Financial Statements.)
The method of combining historical financial statements for preparation of
the pro forma condensed consolidated financial statements is for presentation
only. Actual statements of operations of the companies will be combined
commencing on the effective date. The unaudited pro forma information does not
purport to represent what the Company's operations or financial position
actually would have been had the acquisition occurred on the dates specified,
or to project the Company's results of operation or financial position for any
future period or date.
The accompanying pro forma condensed consolidated financial statements
should be read in conjunction with the historical financial statements and
related notes thereto for both the Company and r/3/.
F-28
<PAGE>
ENTRUST TECHNOLOGIES INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1998
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
------------------ ------------------------
R/3/ ENTRUST ADJUSTMENTS ENTRUST
------ ---------- ----------- ----------
<S> <C> <C> <C> <C>
Revenues:
License..................... $ 83 $ 15,845 -- $ 15,928
Services and maintenance.... 1,518 5,093 -- 6,611
------ ---------- ------- ----------
Total revenues............ 1,601 20,938 -- 22,539
------ ---------- ------- ----------
Cost of revenues:
License..................... 3 812 -- 815
Services and maintenance.... 883 3,098 -- 3,981
------ ---------- ------- ----------
Total cost of revenues.... 886 3,910 -- 4,796
------ ---------- ------- ----------
Gross profit.................. 715 17,028 -- 17,743
------ ---------- ------- ----------
Operating expenses:
Sales and marketing......... 415 11,008 -- 11,423
Research and development.... 501 5,357 -- 5,858
General and administrative.. 674 2,271 356 (a) 3,301
Acquired in-process research
and development............ -- 20,208 (20,208)(b) --
------ ---------- ------- ----------
Total operating expenses.. 1,590 38,844 (19,852) 20,582
------ ---------- ------- ----------
Loss from operations.......... (875) (21,816) 19,852 (2,839)
Interest income............... 1 217 (73)(c) 145
------ ---------- ------- ----------
Loss before benefit for income
taxes........................ (874) (21,599) 19,779 (2,694)
Benefit for income taxes...... -- 160 -- 160
------ ---------- ------- ----------
Net income (loss)............. $ (874) $ (21,439) $19,779 $ (2,534)
====== ========== ======= ==========
Net income (loss) per share
Basic....................... $ (0.69) $ (0.08)(d)
Diluted..................... $ (0.69) $ (0.08)(d)
Weighted average common shares
outstanding
Basic....................... 30,848,689 31,873,308 (e)
Diluted..................... 46,685,839 47,710,458 (e)
</TABLE>
F-29
<PAGE>
ENTRUST TECHNOLOGIES INC.
UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
----------------------- -----------------------
R/3/ ENTRUST ADJUSTMENTS ENTRUST
------ ---------- ----------- ----------
<S> <C> <C> <C> <C>
Revenues:
License................ $ 688 $ 16,486 -- $ 17,174
Services and
maintenance........... 2,941 8,520 -- 11,461
------ ---------- ----- ----------
Total revenues....... 3,629 25,006 -- 28,635
------ ---------- ----- ----------
Cost of revenues:
License................ 10 502 -- 512
Services and
maintenance........... 1,581 4,414 -- 5,995
------ ---------- ----- ----------
Total cost of
revenues............ 1,591 4,916 -- 6,507
------ ---------- ----- ----------
Gross profit............. 2,038 20,090 -- 22,128
------ ---------- ----- ----------
Operating expenses:
Sales and marketing.... 582 11,193 -- 11,775
Research and
development........... 866 5,692 -- 6,558
General and
administrative........ 1,024 3,695 710 (a) 5,429
------ ---------- ----- ----------
Total operating
expenses............ 2,472 20,580 710 23,762
------ ---------- ----- ----------
Loss from operations..... (434) (490) (710) (1,634)
Interest income
(expense)............... 2 723 (176)(c) 549
Gain on sale of assets... 99 -- -- 99
------ ---------- ----- ----------
Income (loss) before
benefit for income
taxes................... (333) 233 (886) (986)
Benefit for income
taxes................... -- 281 -- 281
------ ---------- ----- ----------
Net income (loss)........ $ (333)(/3/) $ 514 $(886) $ (705)
====== ========== ===== ==========
Net income (loss) per
share
Basic.................. $ 0.02 $ (0.02)(d)
Diluted................ $ 0.01 $ (0.02)(d)
Weighted average common
shares outstanding
Basic.................. 30,700,000 31,867,288 (e)
Diluted................ 41,742,972 42,910,260 (e)
</TABLE>
F-30
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. PRO FORMA ADJUSTMENTS
Certain pro forma adjustments have been made to the accompanying condensed
consolidated financial statements, based on the acquisition of r/3/ for
approximately $23.8 million ($4.4 million in cash, $17.0 million representing
1,167,288 shares of the Company's Series A common stock, approximately $1
million in assumed liabilities and acquisition expenses, and $1.4 million of
adjustments to the June 8, 1998 balance sheet of r/3/ to record the assets
acquired from r/3/ at fair value) and based on the allocation of $20.2 million
to in-process research and development costs and $3.6 million to goodwill and
the elimination of the r/3/ equity accounts, as described below:
(a) Reflects the preliminary allocation of purchase price to goodwill
being amortized on a straight line basis over 5 years.
(b) Reflects the reversal of the write-off for acquired in-process
research and development in June 1998 of $20.2 million.
(c) Reflects assumed reduction to interest income earned on $4.4 million
in cash paid to r/3/ shareholders as part of the purchase consideration.
(d) The Company's computation of basic earning per share under Statement
of Financial Accounting Standards No. 128, "Earnings per Share," would have
been $(0.02) and $(0.08) for the year ended December 31, 1997 and the six
months ended June 30, 1998, respectively.
(e) Reflects the impact of Series A common stock issued in the
acquisition as if outstanding from the beginning of each period.
2. PURCHASE PRICE ALLOCATION
In connection with the purchase price allocation, the Company received an
independent appraisal of the intangible assets which indicated a substantial
portion of the acquired intangible assets consisted of in-process product
development. The development of these projects had not reached technological
feasibility and the technology has no alternative future use. In accordance
with generally accepted accounting principles, the acquired in-process product
development of $20.2 million is being charged to expense by the Company in its
second quarter ended June 30, 1998 and is reflected as a decrease in retained
earning in the accompanying pro forma condensed consolidated balance sheet and
is excluded from the accompanying condensed consolidated statements of
operations.
3. FOREIGN EXCHANGE
The financial statements of r/3/ have been translated from Swiss francs into
United States dollars at the average rates of .66 for the year ended December
31, 1997 and .67 for the period ended June 30, 1998.
F-31
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Company and the Selling Stockholders have agreed to sell to each of the U.S.
Underwriters named below, and each of such U.S. Underwriters, for whom
Goldman, Sachs & Co., Donaldson, Lufkin & Jenrette Securities Corporation,
NationsBanc Montgomery Securities LLC and Warburg Dillon Read LLC, a
subsidiary of UBS AG,are acting as representatives, has severally agreed to
purchase from the Company and the Selling Stockholders, the respective number
of shares of Common Stock set forth opposite its name below:
<TABLE>
<CAPTION>
NUMBER OF
SHARES OF
COMMON
UNDERWRITER STOCK
----------- ---------
<S> <C>
Goldman, Sachs & Co................................................
Donaldson, Lufkin & Jenrette Securities Corporation................
NationsBanc Montgomery Securities LLC..............................
Warburg Dillon Read LLC, a subsidiary of UBS AG....................
---------
Total............................................................ 5,653,334
=========
</TABLE>
Under the terms and conditions of the Underwriting Agreement, the U.S.
Underwriters are committed to take and pay for all of the shares offered
hereby, if any are taken.
The U.S. Underwriters propose to offer the shares of Common Stock in part
directly to the public at the initial public offering price set forth on the
cover page of this Prospectus and in part to certain securities dealers at
such price less a concession of $ per share. The U.S. Underwriters may
allow, and such dealers may reallow, a concession not in excess of $ per
share to certain brokers and dealers. After the shares of Common Stock are
released for sale to the public, the offering price and other selling terms
may from time to time be varied by the representatives.
The Company and the Selling Stockholders have entered into an underwriting
agreement (the "International Underwriting Agreement") with the underwriters
of the international offering (the "International Underwriters") providing for
the concurrent offer and sale of 1,413,333 shares of Common Stock in an
international offering outside the United States and Canada. The offering
price and aggregate underwriting discounts and commissions per share for the
two offerings are identical. The closing of the offering made hereby is a
condition to the closing of the international offering, and vice versa. The
representatives of the International Underwriters are Goldman Sachs
International, Donaldson, Lufkin & Jenrette International, NationsBanc
Montgomery Securities LLC and Warburg Dillon Read, a division of UBS AG.
Pursuant to an Agreement between the U.S. and International Underwriting
Syndicates (the "Agreement Between") relating to the two offerings, each of
the U.S. Underwriters named herein has agreed that, as a part of the
distribution of the shares offered hereby and subject to certain exceptions,
it will offer, sell or deliver the shares of Common Stock, directly or
indirectly, only in the United States of America (including the States and the
District of Columbia), its territories, its possessions and other areas
subject to its jurisdiction (the "United States"), in Canada, its territories,
its possessions and other areas subject to its jurisdiction ("Canada") and to
U.S. and Canadian persons, which term shall mean, for purposes of this
paragraph: (a) any individual who is a resident of the United States or Canada
or (b) any corporation, partnership or other entity organized in or under the
laws of the United States, Canada or any political subdivision thereof and
whose office most directly involved with the purchase is located in the United
States or Canada. Each of the International Underwriters has agreed pursuant
to the Agreement Between that, as part of the distribution of the shares
offered as a part of the international offering, and subject to certain
exceptions, it will (i) not, directly or indirectly, offer, sell or deliver
shares of Common Stock (a) in the
U-1
<PAGE>
United States or Canada or to any U.S. or Canadian persons or (b) to any
person whom it believes intends to reoffer, resell or deliver the shares in
the United States or Canada or to any U.S. or Canadian persons, and (ii) cause
any dealer to who it may sell such shares at any concession to agree to
observe a similar restriction.
Pursuant to the Agreement Between, sales may be made between the U.S.
Underwriters and the International Underwriters of such number of shares of
Common Stock as may be mutually agreed. The price of any shares so sold shall
be the initial public offering price, less an amount not greater than the
selling concession.
The Selling Stockholders have granted the U.S. Underwriters an option
exercisable for 30 days after the date of this Prospectus to purchase up to an
aggregate of 848,000 additional shares of Common Stock solely to cover over-
allotments, if any. If the U.S. Underwriters exercise their over-allotment
option, the U.S. Underwriters have severally agreed, subject to certain
conditions, to purchase approximately the same percentage thereof that the
number of shares to be purchased by each of them, as shown in the foregoing
table, bears to the 5,653,334 shares of Common Stock offered. The Selling
Stockholders have granted the International Underwriters a similar option to
purchase up to an aggregate of 212,000 additional shares of Common Stock.
The Company, its directors, officers, stockholders, including the Selling
Stockholders, and optionholders have agreed that, during the period beginning
from the date of this Prospectus and continuing to and including the date 180
days after the date of this Prospectus, they will not offer, sell, contract to
sell or otherwise dispose of any securities of the Company (other than
pursuant to employee stock option plans existing, or on the conversion or
exchange of convertible or exchangeable securities outstanding, on the date of
this Prospectus) which are substantially similar to the shares of the Common
Stock or which are convertible into or exchangeable for securities which are
substantially similar to the shares of the Common Stock without the prior
written consent of the representatives, except for the shares of Common Stock
offered in connection with the Offerings. In addition, the Company may issue
shares of Common Stock in connection with any acquisition of another company
if the terms of such issuance provide that such Common Stock shall not be
resold prior to the expiration of the 180-day period referenced in the
preceding sentence.
At the request of the Company, the Underwriters have reserved for sale, at
the initial public offering price and subject to local laws for any
international sales, up to approximately 353,333 shares of Common Stock for
Zeron Capital and Odyssey, which are funds associated with the Company's
Japanese distributor (the "Distributor Funds"). The Distributor Funds have
expressed an interest in purchasing such shares in the Offerings. The
Distributor Funds have also expressed their intention to enter into lock-up
agreements with the Representatives of the Underwriters if such sales take
place, under which they will agree not to sell approximately 176,667 shares
for 180 days and the remaining approximately 176,666 shares for 12 months
after the date of this Prospectus. In addition, at the request of the Company,
the Underwriters have reserved for sale, at the initial public offering price,
346,267 shares of Common Stock for certain employees and associates of the
Company. There can be no assurance that any of the reserved shares will be
purchased. The number of shares available for sale to the general public in
the Offerings will be reduced by the number of reserved shares sold. Any
reserved shares not so purchased will be offered to the general public on the
same basis as the other shares offered hereby.
The representatives of the Underwriters have informed the Company that they
do not expect sales to accounts over which the Underwriters exercise
discretionary authority to exceed five percent of the total number of shares
of Common Stock offered by them.
In connection with the Offerings, the Underwriters may purchase and sell the
Common Stock in the open market. These transactions may include over-allotment
and stabilizing transactions and
U-2
<PAGE>
purchases to cover syndicate short positions in connection with the Offerings.
Stabilizing transactions consist of certain bids or purchases for the purpose
of preventing or retarding a decline in the market price of the Common Stock;
and syndicate short positions involve the sale by the Underwriters of a
greater number of shares of Common Stock than they are required to purchase
from the Company in the Offerings. The Underwriters also may impose a penalty
bid, whereby selling concessions allowed to syndicate members or other broker-
dealers in respect of the securities sold in the Offerings for their account
may be reclaimed by the syndicate if such shares of Common Stock are
repurchased by the syndicate in stabilizing or covering transactions. These
activities may stabilize, maintain or otherwise affect the market price of the
Common Stock, which may be higher than the price that might otherwise prevail
in the open market; and these activities, if commenced, may be discontinued at
any time. These transactions may be effected on the Nasdaq National Market, in
the over-the-counter market or otherwise.
An affiliate of Donaldson, Lufkin & Jenrette Securities Corporation, a
representative of the Underwriters, is the beneficial owner of approximately
500,000 shares of the Company's Common Stock. J.P. Morgan Securities, Inc.,
which is expected to be an Underwriter in the Offerings, is an affiliate of a
customer of the Company and an affiliate of the Morgan Guaranty Trust Company
of New York, which serves as the trustee, and/or investment manager and/or
agent for certain beneficial owners of the Company's Common Stock. Scotia
McLeod Inc., expected to be an Underwriter in the Offerings, is an affiliate
of a customer of the Company.
Prior to the Offerings, there has been no public market for the Shares. The
initial public offering price will be negotiated among the Company and the
representatives of the U.S. Underwriters and the International Underwriters.
Among the factors to be considered in determining the initial public offering
price of the Common Stock, in addition to prevailing market conditions, will
be the Company's historical performance, estimates of the business potential
and earnings prospects of the Company, an assessment of the Company's
management and the consideration of the above factors in relation to market
valuation of companies in related businesses.
The Common Stock has been approved for quotation on the Nasdaq National
Market under the symbol "ENTU".
The Company and the Selling Stockholders have agreed to indemnify the
several Underwriters against certain liabilities, including liabilities under
the Securities Act of 1933.
U-3
<PAGE>
[Inside back cover]
Centered at the top of the page is the caption "Enterprise Security with
Real-World PKI Solutions." Filling the bottom two-thirds of the page is a
photo montage containing various computer-related images and a globe. The
Company's logo is in the lower right-hand corner of the page.
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRE-
SENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY
SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS
UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFOR-
MATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 6
Use of Proceeds.......................................................... 18
Dividend Policy.......................................................... 18
Capitalization........................................................... 19
Dilution................................................................. 20
Selected Consolidated Financial Data..................................... 21
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 22
Business................................................................. 33
Management............................................................... 49
Certain Transactions..................................................... 57
Principal and Selling Stockholders....................................... 59
Description of Capital Stock............................................. 62
Shares Eligible for Future Sale.......................................... 66
Certain U.S. Tax Considerations Applicable to Non-U.S. Holders of the
Common Stock............................................................ 68
Legal Matters............................................................ 71
Experts.................................................................. 71
Additional Information................................................... 71
Index to Financial Statements............................................ F-1
Underwriting............................................................. U-1
</TABLE>
----------------
THROUGH AND INCLUDING , 1998 (THE 25TH DAY AFTER THE DATE OF THIS PRO-
SPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR
NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPEC-
TUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
7,066,667 SHARES
ENTRUST TECHNOLOGIES INC.
COMMON STOCK
(PAR VALUE $.01 PER SHARE)
----------------
LOGO
----------------
GOLDMAN, SACHS & CO.
DONALDSON, LUFKIN & JENRETTE
NATIONSBANC MONTGOMERY SECURITIES LLC
WARBURG DILLON READ LLC
REPRESENTATIVES OF THE UNDERWRITERS
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
SUBJECT TO COMPLETION, DATED AUGUST 17, 1998
7,066,667 SHARES
LOGO
COMMON STOCK
(PAR VALUE $.01 PER SHARE)
-----------
Of the 7,066,667 shares of Common Stock offered, 1,413,333 shares are being
offered hereby in an international offering outside the United States and
5,653,334 shares are being offered in a concurrent United States offering. The
initial public offering price and the aggregate underwriting discount per share
will be identical for both offerings. See "Underwriting".
Of the 7,066,667 shares of Common Stock offered, 5,400,000 shares are being
sold by the Company and 1,666,667 shares are being sold by the Selling
Stockholders. See "Principal and Selling Stockholders". The Company will not
receive any of the proceeds from the sale of the shares being sold by the
Selling Stockholders.
Prior to this offering, there has been no public market for the Common Stock
of the Company. It is currently estimated that the initial public offering
price per share will be between $14.00 and $16.00. For factors to be considered
in determining the initial public offering price, see "Underwriting".
SEE "RISK FACTORS" BEGINNING ON PAGE 6 FOR CERTAIN CONSIDERATIONS RELEVANT TO
AN INVESTMENT IN THE COMMON STOCK.
The Common Stock has been approved for quotation on the Nasdaq National
Market under the symbol "ENTU".
-----------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
-----------
<TABLE>
<CAPTION>
PROCEEDS TO
INITIAL PUBLIC UNDERWRITING PROCEEDS TO SELLING
OFFERING PRICE DISCOUNT(1) COMPANY(2) STOCKHOLDERS
-------------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Per Share.................. $ $ $ $
Total(3)................... $ $ $ $
</TABLE>
- -----
(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933.
(2) Before deducting estimated expenses of $900,000 payable by the Company.
(3) The Selling Stockholders have granted the International Underwriters an
option for 30 days to purchase up to an additional 212,000 shares at the
initial public offering price per share, less the underwriting discount,
solely to cover over-allotments. Additionally, the Selling Stockholders
have granted the U.S. Underwriters a similar option with respect to an
additional 848,000 shares as part of the concurrent U.S. offering. If such
options are exercised in full, the total initial public offering price,
underwriting discount and proceeds to Selling Stockholders will be $ ,
$ and $ , respectively. See "Underwriting".
-----------
The shares offered hereby are offered severally by the International
Underwriters, as specified herein, subject to receipt and acceptance by them
and subject to their right to reject any order in whole or in part. It is
expected that certificates for the shares will be ready for delivery in New
York, New York on or about , 1998, against payment therefor in
immediately available funds.
GOLDMAN SACHS INTERNATIONAL
DONALDSON, LUFKIN & JENRETTE
NATIONSBANC MONTGOMERY SECURITIES LLC
WARBURG DILLON READ
-----------
The date of this Prospectus is , 1998.
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF
ANY SUCH STATE.
<PAGE>
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Company and the Selling Stockholders have agreed to sell to each of the
International Underwriters named below, and each of such International
Underwriters for whom Goldman Sachs International, Donaldson, Lufkin &
Jenrette International, NationsBanc Montgomery Securities LLC and Warburg
Dillon Read, a division of UBS AG, are acting as representatives, has
severally agreed to purchase from the Company and the Selling Stockholders,
the respective number of shares of Common Stock set forth opposite its name
below:
<TABLE>
<CAPTION>
NUMBER OF
SHARES OF
COMMON
UNDERWRITER STOCK
----------- ---------
<S> <C>
Goldman Sachs International........................................
Donaldson, Lufkin & Jenrette International.........................
NationsBanc Montgomery Securities LLC..............................
Warburg Dillon Read, a division of UBS AG..........................
---------
Total............................................................ 1,413,333
=========
</TABLE>
Under the terms and conditions of the Underwriting Agreement, the
International Underwriters are committed to take and pay for all of the shares
offered hereby, if any are taken.
The International Underwriters propose to offer the shares of Common Stock
in part directly to the public at the initial public offering price set forth
on the cover page of this Prospectus and in part to certain securities dealers
at such price less a concession of $ per share. The International
Underwriters may allow, and such dealers may reallow, a concession not in
excess of $ per share to certain brokers and dealers. After the shares of
Common Stock are released for sale to the public, the offering price and other
selling terms may from time to time be varied by the representatives.
The Company and the Selling Stockholders have entered into an underwriting
agreement (the "U.S. Underwriting Agreement") with the underwriters of the
U.S. offering (the "U.S. Underwriters") providing for the concurrent offer and
sale of 5,653,334 shares of Common Stock in an offering in the United States.
The offering price and aggregate underwriting discounts and commissions per
share for the two offerings are identical. The closing of the offering made
hereby is a condition to the closing of the U.S. offering, and vice versa. The
representatives of the U.S. Underwriters are Goldman, Sachs & Co., Donaldson,
Lufkin & Jenrette Securities Corporation, NationsBanc Montgomery Securities
LLC and Warburg Dillon Read LLC, a subsidiary of UBS AG.
Pursuant to an Agreement between the International and U.S. Underwriting
Syndicates (the "Agreement Between") relating to the two offerings, each of
the U.S. Underwriters has agreed that, as a part of the distribution of the
shares offered hereby and subject to certain exceptions, it will offer, sell
or deliver the shares of Common Stock, directly or indirectly, only in the
United States of America (including the States and the District of Columbia),
its territories, its possessions and other areas subject to its jurisdiction
(the "United States"), in Canada, its territories, its possessions and other
areas subject to its jurisdiction ("Canada") and to U.S. and Canadian persons,
which term shall mean, for purposes of this paragraph: (a) any individual who
is a resident of the United States or Canada or (b) any corporation,
partnership or other entity organized in or under the laws of the United
States, Canada or any political subdivision thereof and whose office most
directly involved with the purchase is located in the United States or Canada.
Each of the International Underwriters has agreed pursuant to the Agreement
Between that, as part of the distribution of the shares offered as a part of
the international offering, and subject to certain exceptions, it will (i)
not, directly or indirectly, offer, sell or deliver shares of Common Stock (a)
in the United States or Canada or to any U.S. or Canadian persons or (b) to
any person who it believes intends to reoffer, sell or deliver the shares in
the United States or Canada or to any U.S. or Canadian persons, and (ii) cause
any dealer to whom it may sell such shares at any concession to agree to
observe a similar restriction.
U-1
<PAGE>
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
Pursuant to the Agreement Between, sales may be made between the U.S.
Underwriters and the International Underwriters of such number of shares of
Common Stock as may be mutually agreed. The price of any shares so sold shall
be the initial public offering price, less an amount not greater than the
selling concession.
The Selling Stockholders have granted the International Underwriters an
option exercisable for 30 days after the date of this Prospectus to purchase
up to an aggregate of 212,000 additional shares of Common Stock solely to
cover over-allotments, if any. If the International Underwriters exercise
their over-allotment option, the International Underwriters have severally
agreed, subject to certain conditions, to purchase approximately the same
percentage thereof that the number of shares to be purchased by each of them,
as shown in the foregoing table, bears to the 1,413,333 shares of Common Stock
offered hereby. The Selling Stockholders have granted the U.S. Underwriters a
similar option to purchase up to an aggregate of 848,000 additional shares of
Common Stock.
The Company, its directors, officers, stockholders, including the Selling
Stockholders, and optionholders have agreed that, during the period beginning
from the date of this Prospectus and continuing to and including the date 180
days after the date of this Prospectus, they will not offer, sell, contract to
sell or otherwise dispose of any securities of the Company (other than
pursuant to employee stock option plans existing, or on the conversion or
exchange of convertible or exchangeable securities outstanding, on the date of
this Prospectus) which are substantially similar to the shares of the Common
Stock or which are convertible into or exchangeable for securities which are
substantially similar to the shares of Common Stock, without the prior written
consent of the representatives, except for the shares of Common Stock offered
in connection with the Offerings. In addition, the Company may issue shares of
Common Stock in connection with any acquisition of another company if the
terms of such issuance provide that such Common Stock shall not be resold
prior to the expiration of the 180-day period referenced in the preceding
sentence.
At the request of the Company, the Underwriters have reserved for sale, at
the initial public offering price and subject to local laws for any
international sales, up to an aggregate of approximately 353,333 shares of
Common Stock for Zeron Capital and Odyssey, which are funds associated with
the Company's Japanese distributor (the "Distributor Funds"). The Distributor
Funds have expressed an interest in purchasing such shares in the Offerings.
The Distributor Funds have also expressed their intention to enter into lock-
up agreements with the Representatives of the Underwriters if such sales take
place, under which they will agree not to sell approximately 176,667 shares
for 180 days and the remaining approximately 176,666 shares for 12 months
after the date of this Prospectus. In addition, at the request of the Company,
the Underwriters have reserved for sale, at the initial public offering price,
346,267 shares of Common Stock for certain employees and associates of the
Company. There can be no assurance that any of the reserved shares will be so
purchased. The number of shares available for sale to the general public in
the Offerings will be reduced by the number of reserved shares sold. Any
reserved shares not so purchased will be offered to the general public on the
same basis as the other shares offered hereby.
Each International Underwriter has also agreed that (a) it has not offered
or sold and prior to the date six months after the date of issue of the shares
of Common Stock will not offer or sell any shares of Common Stock to persons
in the United Kingdom except to persons whose ordinary activities involve them
in acquiring, holding, managing or disposing of investments (as principal or
agent) for the purposes of their businesses or otherwise in circumstances
which have not resulted and will not result in an offer to the public in the
United Kingdom within the meaning of the Public Offers of Securities
Regulations 1995, (b) it has complied, and will comply, with all applicable
provisions of the Financial Services Act of 1986 of Great Britain with respect
to anything done by it in relation to the shares of Common Stock in, from or
otherwise involving the United Kingdom, and (c) it has only issued or passed
on and will only issue or pass on in the United Kingdom any document received
by it in connection with the issuance of the shares of Common Stock to a
person who is of a kind
U-2
<PAGE>
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
described in Article 11(3) of the Financial Services Act 1986 (Investment
Advertisements) (Exemptions) Order 1996 of Great Britain or is a person to
whom the document may otherwise lawfully be issued or passed on.
Buyers of shares of Common Stock offered hereby may be required to pay stamp
taxes and other charges in accordance with the laws and practices of the
country of purchase in addition to the initial public offering price.
The representatives of the Underwriters have informed the Company that they
do not expect sales to accounts over which the Underwriters exercise
discretionary authority to exceed five percent of the total number of shares
of Common Stock offered by them.
In connection with the Offerings, the Underwriters may purchase and sell the
Common Stock in the open market. These transactions may include over-allotment
and stabilizing transactions and purchases to cover syndicate short positions
in connection with the Offerings. Stabilizing transactions consist of certain
bids or purchases for the purpose of preventing or retarding a decline in the
market price of the Common Stock; and syndicate short positions involve the
sale by the Underwriters of a greater number of shares of Common Stock than
they are required to purchase from the Company in the Offerings. The
Underwriters also may impose a penalty bid, whereby selling concessions
allowed to syndicate members or other broker-dealers in respect of the
securities sold in the Offerings for their account may be reclaimed by the
syndicate if such shares of Common Stock are repurchased by the syndicate in
stabilizing or covering transactions. These activities may stabilize, maintain
or otherwise affect the market price of the Common Stock, which may be higher
than the price that might otherwise prevail in the open market; and these
activities, if commenced, may be discontinued at any time. These transactions
may be effected on the Nasdaq National Market, in the over-the-counter market
or otherwise.
An affiliate of Donaldson, Lufkin & Jenrette International, a representative
of the Underwriters, is the beneficial owner of approximately 500,000 shares
of the Company's Common Stock. J.P. Morgan Securities, Inc., which is expected
to be an Underwriter in the Offerings, is an affiliate of a customer of the
Company and an affiliate of the Morgan Guaranty Trust Company of New York,
which serves as the trustee, and/or investment manager and/or agent for
certain beneficial owners of the Company's Common Stock. Scotia McLeod Inc.,
expected to be an Underwriter in the Offerings, is an affiliate of a customer
of the Company.
Prior to the Offerings, there has been no public market for the shares. The
initial public offering price will be negotiated among the Company and the
representatives of the U.S. Underwriters and the International Underwriters.
Among the factors to be considered in determining the initial public offering
price of the Common Stock, in addition to prevailing market conditions, will
be the Company's historical performance, estimates of the business potential
and earnings prospects of the Company, an assessment of the Company's
management and the consideration of the above factors in relation to market
valuation of companies in related businesses.
The Common Stock has been approved for quotation on the Nasdaq National
Market under the symbol "ENTU".
The Company and the Selling Stockholders have agreed to indemnify the
several Underwriters against certain liabilities, including liabilities under
the Securities Act of 1933.
U-3
<PAGE>
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
[Inside back cover]
Centered at the top of the page is the caption "Enterprise Security with
Real-World PKI Solutions." Filling the bottom two-thirds of the page is a
photo montage containing various computer-related images and a globe. The
Company's logo is in the lower right-hand corner of the page.
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRE-
SENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY
SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS
UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFOR-
MATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
---------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 6
Use of Proceeds.......................................................... 18
Dividend Policy.......................................................... 18
Capitalization........................................................... 19
Dilution................................................................. 20
Selected Consolidated Financial Data..................................... 21
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 22
Business................................................................. 33
Management............................................................... 49
Certain Transactions..................................................... 57
Principal and Selling Stockholders....................................... 59
Description of Capital Stock............................................. 62
Shares Eligible for Future Sale.......................................... 66
Certain U.S. Tax Considerations Applicable to Non-U.S. Holders of the
Common Stock............................................................ 68
Legal Matters............................................................ 71
Experts.................................................................. 71
Additional Information................................................... 71
Index to Financial Statements............................................ F-1
Underwriting............................................................. U-1
</TABLE>
---------------
THROUGH AND INCLUDING , 1998 (THE 25TH DAY AFTER THE DATE OF THIS PRO-
SPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR
NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPEC-
TUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
7,066,667 SHARES
ENTRUST TECHNOLOGIES INC.
COMMON STOCK
(PAR VALUE $.01 PER SHARE)
---------------
LOGO
---------------
GOLDMAN SACHS INTERNATIONAL
DONALDSON, LUFKIN & JENRETTE
NATIONSBANC MONTGOMERY SECURITIES LLC
WARBURG DILLON READ
REPRESENTATIVES OF THE UNDERWRITERS
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
[ALTERNATE PAGE FOR INTERNATIONAL PROSPECTUS]
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the various expenses, all of which will be
borne by the Registrant, in connection with the sale and distribution of the
securities being registered, other than the underwriting discounts and
commissions. All amounts shown are estimates except for the Securities and
Exchange Commission registration fee, the NASD filing fee and the Nasdaq
National Market listing fee.
<TABLE>
<S> <C>
SEC registration fee............................................... $ 46,030
NASD filing fee.................................................... 16,103
Nasdaq National Market listing fee................................. 95,000
Blue Sky fees and expenses......................................... 15,000
Transfer Agent and Registrar fees.................................. 10,000
Accounting fees and expenses....................................... 150,000
Legal fees and expenses............................................ 400,000
Printing and mailing expenses...................................... 100,000
Miscellaneous...................................................... 67,867
--------
Total.......................................................... $900,000
========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 2-418 of the General Corporation Law of Maryland (the "Maryland
Law") provides that, unless a corporation's charter includes a provision which
restricts or limits the corporation's right to indemnify its officers and
directors, the corporation may indemnify a director or officer with respect to
proceedings instituted against such officer or director by reason of his or
her service in that capacity, unless the act or omission in question was
material and was committed in bad faith or was the result of active and
deliberate dishonesty, unless the director or officer received an improper
personal benefit or unless the director or officer had reasonable cause to
believe that the act or omission was unlawful. The Registrant's Articles of
Incorporation and Bylaws provide that the Registrant shall indemnify and
advance expenses to its currently acting and its former directors to the
fullest extent permitted by the Maryland Law and that the Registrant shall
indemnify and advance expenses to its officers to the same extent as its
directors and to such further extent as is consistent with law. However,
nothing in the Articles of Incorporation or Bylaws of the Registrant protects
or indemnifies a director, officer, employee or agent against any liability to
which he would otherwise be subject by reason of willful misfeasance, bad
faith, gross negligence or reckless disregard of the duties involved in the
conduct of his office. To the extent that a director has been successful in
defense of a proceeding, unless limited by charter, the Maryland Law provides
that he shall be indemnified against reasonable expenses incurred in
connection therewith.
The U.S. Underwriting Agreement and the International Underwriting
Agreement, forms of which are filed at Exhibits 1.1 and 1.2 to this
Registration Statement on Form S-1 (the "Underwriting Agreements"), provide
that the Underwriters are obligated under certain circumstances to indemnify
directors, officers and controlling persons of the Registrant against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended (the "Securities Act"). Reference is made to the form of Underwriting
Agreements.
Three of the directors of the Registrant are also officers of Northern
Telecom Limited ("NTL"), a shareholder of the Registrant, and are serving on
the Registrant's Board of Directors at the request
II-1
<PAGE>
of NTL. Pursuant to NTL's Bylaws, NTL will indemnify its officers when they
are acting at NTL's request as directors of a corporation of which NTL is a
shareholder, provided that such officers acted honestly, in good faith and had
reasonable grounds to believe their conduct was lawful.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Set forth below is information regarding shares of capital stock issued and
options granted by the Registrant since December 30, 1996, the date of its
incorporation (after giving effect to the Company's ten-for-one and four-for-
one stock splits effective as of February 1997 and July 1998, respectively):
(a) Issuances of Capital Stock
In January 1997, in connection with the incorporation of the Registrant, the
Registrant (i) sold 257,500 shares of Series B Common Stock to a group of
private investors for an aggregate sale price of $25,750,000, (ii) issued
20,300,000 shares of Common Stock to Northern Telecom Inc. in exchange for the
issuance of a promissory note in the principal amount of $8,000,000 and the
transfer of certain contracts and intellectual property rights and (iii)
issued 7,700,000 shares of Special Voting Stock to Northern Telecom Limited in
exchange for $891,542 of property and the transfer of certain contracts and
intellectual property rights.
In January 1997, the Registrant sold 2,500 shares of Series B Non-Voting
Common Stock to a private investor for an aggregate sale price of $250,000 and
issued an additional 36,448 shares of Series B Non-Voting Common Stock to such
investor in exchange for an equivalent number of shares of Series B Common
Stock.
In June 1998, the Registrant issued an aggregate of 1,167,288 shares of
Common Stock to the former stockholders of r/3/ Security Engineering AG, a
Swiss company ("r/3/"), as partial consideration in connection with the
acquisition of r/3/.
(b) Grants of Stock Options
The Registrant's Amended and Restated 1996 Stock Incentive Plan (the
"Incentive Plan") was adopted by the Board of Directors and approved by the
stockholders of the Registrant in December 1996 and amended and restated by
the Board of Directors in June 1988, and such amendment and restatement was
approved by the stockholders in July 1998. The Incentive Plan was further
amended by the Board of Directors in July 1998. As of June 30, 1998, options
to purchase 7,397,804 shares of Common Stock had been granted under such plan,
at exercise prices ranging from $2.13 to $12.08 per share. The Registrant's
1998 Employee Stock Purchase Plan (the "Purchase Plan") was adopted by the
Board of Directors in July 1998 and approved by the stockholders of the
Registrant in August 1998. The Purchase Plan will not become effective until
the closing of the Offering.
The Registrant has reserved (i) an aggregate of 9,600,000 shares of Common
Stock for issuance under the Incentive Plan and (ii) an aggregate of 400,000
shares of Common Stock for issuance under the Purchase Plan.
The securities issued in the foregoing transactions were either (i) offered
and sold in reliance upon exemptions from Securities Act registration set
forth in Sections 3(b) and 4(2) of the Securities Act, or any regulations
promulgated thereunder, relating to sales by an issuer not involving any
public offering, (ii) offered and sold in reliance upon an exemption from
Securities Act registration set forth in Regulation S relating to sales to
non-U.S. persons or (iii) in the case of certain options to purchase shares of
Common Stock and shares of Common Stock issued upon the exercise of such
options, such offers and sales were made in reliance upon an exemption from
registration under Rule 701 of the Securities Act. No underwriters were
involved in the foregoing sales of securities.
II-2
<PAGE>
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
1.1* Form of U.S. Underwriting Agreement.
1.2* Form of International Underwriting Agreement.
2.1* Asset Transfer Agreement, dated as of December 31, 1996, between the
Registrant and Northern Telecom Inc.
2.2* Asset Transfer Agreement, dated as of December 31, 1996, between
Entrust Technologies Limited and Northern Telecom Limited.
2.3* Share Purchase Agreement, dated as of May 30, 1998, as amended,
between the Registrant and Rainer A. Rueppel.
2.4* Share Purchase Agreement, dated as of May 30, 1998, as amended,
between the Registrant and Invision AG.
2.5* Form of Share Purchase Agreement between the Registrant and the
minority stockholders of r/3/ Security Engineering AG.
3.1* Articles of Incorporation of the Registrant, as amended.
3.2* Amended and Restated Articles of Incorporation of the Registrant (to
be effective upon the closing of the offering).
3.3* Bylaws of the Registrant.
3.4* Amended and Restated Bylaws of the Registrant (to be effective upon
the closing of the offering).
4.1* Specimen certificate for shares of Common Stock.
5 Opinion of Hale and Dorr LLP.
10.1* Series B Common Stock Purchase Agreement, dated as of December 31,
1996, by and among the Registrant, Northern Telecom Limited and
certain stockholders.
10.2* Series B Non-Voting Common Stock Purchase Agreement, dated as of
January 31, 1997, by and among the Registrant and Societe Generale
Investment Corporation.
10.3* Amended and Restated Registration Rights Agreement, dated as of July
30, 1998, by and among the Registrant and certain stockholders.
10.4* Stockholders' Agreement, dated as of December 31, 1996, by and among
the Registrant, Northern Telecom Inc., Northern Telecom Limited and
certain stockholders, as amended by the Stockholder Agreement and
Waiver, dated as of January 31, 1997, by and among the Registrant and
certain stockholders.
10.5* Strategic Alliance Agreement, dated as of December 31, 1996, between
the Registrant and Northern Telecom Limited.
10.6* Services Agreement, dated as of December 31, 1996, between the
Registrant and Northern Telecom Limited.
10.7* Support Agreement, dated as of December 31, 1996, between the
Registrant and Entrust Technologies Limited.
10.8* Share Exchange Agreement, dated as of December 31, 1996, among the
Registrant, Entrust Technologies Limited and Northern Telecom Limited.
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
10.9* Letter Agreement, dated as of April 21, 1997, between the Registrant
and John A. Ryan.
10.10* Letter Agreement, dated as of November 18, 1996, between Northern
Telecom Limited, on behalf of the Registrant, and Brian O'Higgins.
10.11* Letter Agreement, dated as of November 18, 1996, between Northern
Telecom Limited, on behalf of the Registrant, and Bradley N. Ross.
10.12* Letter Agreement, dated as of June 4, 1997, between the Registrant and
Richard D. Spurr.
10.13* Letter Agreement, dated as of November 14, 1997, between the
Registrant and Hansen Downer.
10.14* Amended and Restated 1996 Stock Incentive Plan.
10.15* Standard Office Building Lease Agreement, dated as of July 11, 1997,
between G&F International, Inc. and the Registrant.
10.16* Lease Agreement, dated as of January 28, 1998, between Colonnade
Development Incorporated and Entrust Technologies Limited.
10.17* 1998 Employee Stock Purchase Plan.
10.18* Letter Agreement, dated as of July 2, 1998, between the Registrant and
Michele L. Axelson.
21* Subsidiaries of the Registrant.
23.1 Consent of Hale and Dorr LLP (included in Exhibit 5).
23.2 Consent of Deloitte & Touche Chartered Accountants.
23.3 Consent of Willi & Partner AG.
24* Power of Attorney.
27 Financial Data Schedule.
</TABLE>
- --------
* Previously filed.
(B) Financial Statement Schedules
All schedules have been omitted because they are not required or because the
required information is given in the Registrant's Financial Statements or
Notes thereto.
ITEM 17. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the provisions contained in the Articles of
Incorporation of the Registrant, the laws of the State of Maryland and the
Bylaws of NTL, or otherwise, the Registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities
being registered, the Registrant will, unless in the opinion of its counsel
the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed
by the final adjudication of such issue.
II-4
<PAGE>
The undersigned Registrant hereby undertakes to provide to the Underwriters
at the closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-5
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
HAS DULY CAUSED THIS AMENDMENT NO. 4 TO REGISTRATION STATEMENT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN RICHARDSON, TEXAS
ON THIS 14TH DAY OF AUGUST, 1998.
Entrust Technologies Inc.
By: /s/ John A. Ryan
----------------------------------
JOHN A. RYAN
President and Chief Executive
Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT
NO. 4 TO REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN
THE CAPACITIES AND ON THE DATES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
/s/ John A. Ryan President and Chief August 14, 1998
- ------------------------------------- Executive Officer
JOHN A. RYAN (Principal
Executive Officer)
* Senior Vice August 14, 1998
- ------------------------------------- President, Business
MICHELE L. AXELSON Development and
Finance and Chief
Financial Officer
(Principal
Financial and
Accounting Officer)
*
- ------------------------------------- Director August 14, 1998
DAVID D. ARCHIBALD
*
- ------------------------------------- Director August 14, 1998
FRANK A. DUNN
* Director August 14, 1998
- -------------------------------------
F. WILLIAM CONNER
* Director August 14, 1998
- -------------------------------------
ROBERT S. MORRIS
*By: /s/ John A. Ryan
- -------------------------------------
JOHN A. RYAN
Attorney-in-Fact
<S> <C>
</TABLE>
II-6
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
1.1* Form of U.S. Underwriting Agreement.
1.2* Form of International Underwriting Agreement.
2.1* Asset Transfer Agreement, dated as of December 31, 1996, between the
Registrant and Northern Telecom Inc.
2.2* Asset Transfer Agreement, dated as of December 31, 1996, between
Entrust Technologies Limited and Northern Telecom Limited.
2.3* Share Purchase Agreement, dated as of May 30, 1998, as amended,
between the Registrant and Rainer A. Rueppel.
2.4* Share Purchase Agreement, dated as of May 30, 1998, as amended,
between the Registrant and Invision AG.
2.5* Form of Share Purchase Agreement between the Registrant and the
minority stockholders of r/3/ Security Engineering AG.
3.1* Articles of Incorporation of the Registrant, as amended.
3.2* Amended and Restated Articles of Incorporation of the Registrant (to
be effective upon the closing of the offerings).
3.3* Bylaws of the Registrant.
3.4* Amended and Restated Bylaws of the Registrant (to be effective upon
the closing of the offerings).
4.1* Specimen certificate for shares of Common Stock.
5 Opinion of Hale and Dorr LLP.
10.1* Series B Common Stock Purchase Agreement, dated as of December 31,
1996, by and among the Registrant, Northern Telecom Limited and
certain stockholders.
10.2* Series B Non-Voting Common Stock Purchase Agreement, dated as of
January 31, 1997, by and among the Registrant and Societe Generale
Investment Corporation.
10.3* Amended and Restated Registration Rights Agreement, dated as of July
30, 1998, by and among the Registrant and certain stockholders.
10.4* Stockholders' Agreement, dated as of December 31, 1996, by and among
the Registrant, Northern Telecom Inc., Northern Telecom Limited and
certain stockholders, as amended by the Stockholder Agreement and
Waiver, dated as of January 31, 1997, by and among the Registrant and
certain stockholders.
10.5* Strategic Alliance Agreement, dated as of December 31, 1996, between
the Registrant and Northern Telecom Limited.
10.6* Services Agreement, dated as of December 31, 1996, between the
Registrant and Northern Telecom Limited.
10.7* Support Agreement, dated as of December 31, 1996, between the
Registrant and Entrust Technologies Limited.
10.8* Share Exchange Agreement, dated as of December 31, 1996, among the
Registrant, Entrust Technologies Limited and Northern Telecom Limited.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
10.9* Letter Agreement, dated as of April 21, 1997, between the Registrant
and John A. Ryan.
10.10* Letter Agreement, dated as of November 18, 1996, between Northern
Telecom Limited, on behalf of the Registrant, and Brian O'Higgins.
10.11* Letter Agreement, dated as of November 18, 1996, between Northern
Telecom Limited, on behalf of the Registrant, and Bradley N. Ross.
10.12* Letter Agreement, dated as of June 4, 1997, between the Registrant and
Richard D. Spurr.
10.13* Letter Agreement, dated as of November 14, 1997, between the
Registrant and Hansen Downer.
10.14* Amended and Restated 1996 Stock Incentive Plan.
10.15* Standard Office Building Lease Agreement, dated as of July 11, 1997,
between G&F International, Inc. and the Registrant.
10.16* Lease Agreement, dated as of January 28, 1998, between Colonnade
Development Incorporated and Entrust Technologies Limited.
10.17* 1998 Employee Stock Purchase Plan.
10.18* Letter Agreement, dated as of July 2, 1998, between the Registrant and
Michele L. Axelson.
21* Subsidiaries of the Registrant.
23.1 Consent of Hale and Dorr LLP (included in Exhibit 5).
23.2 Consent of Deloitte & Touche Chartered Accountants.
23.3 Consent of Willi & Partner AG.
24* Power of Attorney.
27 Financial Data Schedule.
</TABLE>
- --------
* Previously filed.
<PAGE>
Exhibit 5
August 17, 1998
Entrust Technologies Inc.
2323 North Central Expressway
Richardson, Texas 75080
Re: Registration Statement on Form S-1
----------------------------------
Ladies and Gentlemen:
This opinion is furnished to you in connection with a Registration
Statement on Form S-1 (File No. 333-57275) (the "Registration Statement") filed
with the Securities and Exchange Commission (the "Commission") under the
Securities Act of 1933, as amended (the "Securities Act"), for the registration
of shares of Common Stock, $.01 par value per share (the "Shares"), of Entrust
Technologies Inc., a Maryland corporation (the "Company"), with an aggregate
offering price of $156,032,006 of which (i) up to 5,400,000 Shares will be
issued and sold by the Company and (ii) up to 4,600,000 Shares will be sold by
certain stockholders of the Company (the "Selling Stockholders") (including
Shares issuable upon exercise of an over-allotment option granted by the Selling
Stockholders).
The Shares are to be sold by the Company and the Selling Stockholders
pursuant to U.S. and international underwriting agreements (the "Underwriting
Agreements") to be entered into by and among the Company, the Selling
Stockholders and Goldman, Sachs & Co., Donaldson, Lufkin & Jenrette Securities
Corporation, NationsBanc Montgomery Securities LLC and Warburg Dillon Read LLC,
and their respective foreign affiliates, as representatives of the several
underwriters named in the Underwriting Agreements, the forms of which have been
filed as Exhibits 1.1 and 1.2 to the Registration Statement.
We are acting as counsel for the Company in connection with the sale by the
Company and the Selling Stockholders of the Shares. We have examined signed
copies of the Registration Statement as filed with the Commission. We have also
examined and relied upon the Underwriting Agreements, minutes of meetings of the
stockholders and the Board of Directors of the Company as provided to us by the
Company, stock record books of the Company as provided to us by the Company, the
Articles of Incorporation and Bylaws of the Company, each as restated and/or
amended to date, and such other documents as we have deemed necessary for
purposes of rendering the opinions hereinafter set forth.
<PAGE>
Entrust Technologies Inc.
August 17, 1998
Page 2
In our examination of the foregoing documents, we have assumed the
genuineness of all signatures, the authenticity of all documents submitted to us
as originals, the conformity to original documents of all documents submitted to
us as copies, the authenticity of the originals of such latter documents and the
legal competence of all signatories to such documents.
Our opinion in clause (ii) below, insofar as it relates to the Selling
Stockholders' Shares being fully paid, is based solely on a certificate of the
Senior Vice President, Business Development and Finance and Chief Financial
Officer of the Company.
We assume that the appropriate action will be taken, prior to the offer and
sale of the Shares in accordance with the Underwriting Agreements, to register
and qualify the Shares for sale under all applicable state securities or "blue
sky" laws.
We express no opinion herein as to the laws of any state or jurisdiction
other than the state laws of the Commonwealth of Massachusetts and the federal
laws of the United States of America. To the extent that any other laws govern
the matters as to which we are opining herein, we have assumed that such laws
are identical to the state laws of the Commonwealth of Massachusetts, and we are
expressing no opinion herein as to whether such assumption is reasonable or
correct.
Based upon and subject to the foregoing, we are of the opinion that (i) the
Shares to be issued and sold by the Company have been duly authorized for
issuance and, when such Shares are issued and paid for in accordance with the
terms and conditions of the Underwriting Agreements, such Shares will be validly
issued, fully paid and nonassessable and (ii) the Shares to be sold by the
Selling Stockholders have been duly authorized and are validly issued, fully
paid and nonassessable.
It is understood that this opinion is to be used only in connection with
the offer and sale of the Shares while the Registration Statement is in effect.
Please note that we are opining only as to the matters expressly set forth
herein, and no opinion should be inferred as to any other matters. This opinion
is based upon currently existing statutes, rules, regulations and judicial
decisions, and we disclaim any obligation to advise you of any change in any of
these sources of law or subsequent legal or factual developments which might
affect any matters or opinions set forth herein.
<PAGE>
Entrust Technologies Inc.
August 17, 1998
Page 3
We hereby consent to the filing of this opinion with the Commission as an
exhibit to the Registration Statement in accordance with the requirements of
Item 601(b)(5) of Regulation S-K under the Securities Act and to the use of our
name therein and in the related Prospectus under the caption "Legal Matters."
In giving such consent, we do not hereby admit that we are in the category of
persons whose consent is required under Section 7 of the Securities Act or the
rules and regulations of the Commission.
Very truly yours,
/s/ HALE AND DORR LLP
<PAGE>
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Registration Statement of Entrust Technologies
Inc. on Form S-1 of our reports dated June 5, 1998 and August 5, 1998 on the
financial statements of Entrust Technologies Inc. and r/3/ Security
Engineering AG, respectively, appearing in the Prospectus, which is part of
this Registration Statement. We also consent to the reference to us under the
headings "Selected Consolidated Financial Data" and "Experts" in such
Prospectus.
/s/ DELOITTE & TOUCHE
Chartered Accountants
Ottawa, Canada
August 14, 1998
<PAGE>
EXHIBIT 23.3
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Amended Registration Statement of Entrust
Technologies Inc. on Form S-1 of our report dated June 2, 1998, appearing in
the Prospectus, which is part of this Registration Statement. We also consent
to the reference to us under the heading "Experts" in such Prospectus.
Willi & Partner AG
/s/ Bruno Wust
Bruno Wust
Auditor in charge
Wetzikon, Switzerland
August 14, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONSOLIDATED
BALANCED SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR 6-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1998
<PERIOD-START> JAN-01-1997 JAN-01-1998
<PERIOD-END> DEC-31-1997 JUN-30-1998
<CASH> 4,025 2,582
<SECURITIES> 8,613 1,787
<RECEIVABLES> 7,152 10,606
<ALLOWANCES> 416 460
<INVENTORY> 0 0
<CURRENT-ASSETS> 22,334 16,972
<PP&E> 1,680 2,583
<DEPRECIATION> 754 1,270
<TOTAL-ASSETS> 24,757 24,152
<CURRENT-LIABILITIES> 8,627 13,834
<BONDS> 0 0
0 0
0 0
<COMMON> 205 205
<OTHER-SE> 14,457 (6,938)
<TOTAL-LIABILITY-AND-EQUITY> 24,757 24,152
<SALES> 25,006 20,938
<TOTAL-REVENUES> 25,006 20,938
<CGS> 4,916 3,910
<TOTAL-COSTS> 25,496 22,546
<OTHER-EXPENSES> 0 20,208
<LOSS-PROVISION> 287 44
<INTEREST-EXPENSE> 0 0
<INCOME-PRETAX> 233 (21,599)
<INCOME-TAX> (281) (160)
<INCOME-CONTINUING> 514 (21,439)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 514 (21,439)
<EPS-PRIMARY> 0.02 (0.69)
<EPS-DILUTED> 0.01 (0.69)
</TABLE>
