<PAGE>
As filed with the Securities and Exchange Commission on January 25, 2000
Registration No. 333-
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------------
ENTRUST TECHNOLOGIES INC.
(Exact name of registrant as specified in its charter)
Maryland 62-1670648
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
----------------
One Preston Park South
4975 Preston Park Blvd., Suite 400
Plano, TX 75093
(972) 943-7300
(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.
One Preston Park South
4975 Preston Park Blvd., Suite 400
Plano, TX 75093
(972) 943-7300
(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.
JAMES R. BURKE, ESQ. Ropes & Gray
Hale and Dorr LLP One International Place
60 State Street Boston, MA 02110-2624
Boston, Massachusetts 02109 Telephone: (617) 951-7000
Telephone: (617) 526-6000 Telecopy: (617) 951-7050
Telecopy: (617) 526-5000
----------------
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date hereof.
If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the
following box. [_]
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 of
1933, other than securities offered only in connection with dividend or
interest reinvestment plans, please 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, please 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, please 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,
please check the following box. [_]
----------------
CALCULATION OF REGISTRATION FEE
<TABLE>
- ----------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------
<CAPTION>
Proposed Maximum
Title of each Class of Proposed Maximum Aggregate
Securities to be Amount to be Offering Price Per Offering Price Amount of
Registered Registered(1) Share(2) (2) Registration Fee
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, $0.01 par
value per share........ 9,372,500 shares $50.00 $468,625,000 $123,717
- ----------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------
</TABLE>
(1) Includes 1,222,500 shares which the underwriters have the option to
purchase from the registrant and a selling stockholder to cover over-
allotments, if any.
(2) Estimated solely for the purpose of calculating the amount of the
registration fee pursuant to Rule 457(c) under the Securities Act of 1933,
as amended, and based on the average of the high and low sales prices per
share of the common stock on the Nasdaq National Market on January 24,
2000.
----------------
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.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this preliminary prospectus is not complete and may be +
+changed. These securities may not be sold until the registration statement +
+filed with the Securities and Exchange Commission is effective. This +
+preliminary prospectus is not an offer to sell nor does it seek an offer to +
+buy these securities in any jurisdiction where the offer or sale is not +
+permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
Subject to Completion. Dated January 25, 2000.
8,150,000 Shares
[LOGO]
[Entrust logo appears here]
Common Stock
-----------
Entrust Technologies Inc. is offering 2,000,000 of the shares to be sold in
the offering. The selling stockholders identified in this prospectus are
offering an additional 6,150,000 shares. Entrust will not receive any of the
proceeds from the sale of shares being sold by the selling stockholders.
The common stock is quoted on the Nasdaq National Market under the symbol
"ENTU". The last reported sale price of the common stock on January 24, 2000
was $47.875 per share.
See "Risk Factors" on page 7 to read about factors you should consider before
buying shares of the common stock.
-----------
Neither the Securities and Exchange Commission nor any other regulatory body
has approved or disapproved of these securities or passed upon the accuracy or
adequacy of this prospectus. Any representation to the contrary is a criminal
offense.
-----------
<TABLE>
<CAPTION>
Per Share Total
--------- -----
<S> <C> <C>
Initial price to public................................... $ $
Underwriting discount..................................... $ $
Proceeds, before expenses, to Entrust..................... $ $
Proceeds, before expenses, to the selling stockholders.... $ $
</TABLE>
To the extent that the underwriters sell more than 8,150,000 shares of common
stock, the underwriters have the option to purchase up to an additional
1,222,500 shares from Entrust and a selling stockholder at the initial price to
public less the underwriting discount.
-----------
The underwriters expect to deliver the shares against payment in New York,
New York on , 2000.
Goldman, Sachs & Co.
Bear, Stearns & Co. Inc.
Donaldson, Lufkin & Jenrette
SoundView Technology Group
-----------
Prospectus dated , 2000.
<PAGE>
[Inside front cover]
The page is divided in half, horizontally across the center. In the top half of
the page, which is further divided into four quarters, the text, "Embracing the
e-business Reality" overlays 4 pictures. In the top left there is a picture of
people walking. In the top right, there is a picture of a sign with an arrow
pointing to the right and the word "Forward" on it. In the bottom right there is
a picture of people walking, and in the bottom left there is a picture of a
woman typing on a laptop computer. In the bottom half of the page is the text,
"Entrust(R) Technologies" below which is the text, "We Bring Trust to e-
Business(TM)". The text overlays a picture of binary code.
<PAGE>
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information about us and our common stock being sold in this offering and our
consolidated financial statements and the notes to those statements appearing
elsewhere in this prospectus.
Our Business
Entrust Technologies is the leading global provider of public-key
infrastructure, or PKI, products and services to e-businesses and other
organizations. Unlike products and services that focus primarily upon the
issuance of digital certificates, which are similar to electronic passports,
our award-winning solution is a comprehensive, end-to-end PKI framework
designed to assure the security of electronic transactions and communications
over advanced networks, including the Internet. Our open, scalable software
solution operates across multiple platforms, network devices and applications.
According to International Data Corporation, the worldwide market for PKI-based
products and services is expected to grow from $122.7 million in 1998 to $1.3
billion in 2003. Since 1994, we have provided our PKI solution primarily to
global enterprises and government entities, including Citibank, FedEx, MCI
Worldcom, NASA, the United Kingdom Post Office and the Canadian Department of
National Defense. To date, over four million users worldwide have been licensed
to use Entrust products.
Our PKI solution is particularly relevant to organizations in the growing
business-to-business, or B2B, electronic commerce market. We offer B2B
organizations a comprehensive security solution that includes the robust
functionality required to support their increasingly advanced and high-value
electronic transactions and communications. We believe that we are well-
positioned to capitalize on our PKI market leadership to address B2B and other
important markets, such as the business-to-consumer, or B2C, market. We are
also actively developing additional functionality to address emerging
opportunities, such as the growing need to secure e-business transactions
conducted over wireless networks.
Our Market Opportunity
The widespread adoption in recent years of public and private networks has
revolutionized the manner in which organizations communicate and conduct
business. Businesses are increasingly relying on these networks to conduct
complex transactions and communicate confidential information, both internally
and with other businesses. However, there are important information security
concerns relating to these electronic interactions, such as the risk of theft,
alteration, interception or dissemination of confidential data, fraud, loss of
reputation and economic loss.
Although a wide range of products, such as firewalls and password tokens,
were introduced to address network security concerns, the limitations inherent
in these solutions led to the development of public-key encryption and digital
certification systems. However, these systems are only partial solutions and do
not address the management and business issues critical to maintaining an
effective security environment. To address these issues, organizations,
particularly those in the B2B market, must have a robust public-key
infrastructure that provides full life-cycle management of public and private
keys, including issuance, authentication, storage, retrieval, backup, recovery,
updating and revocation. In addition, these functions must operate in an easy-
to-use, scalable and cost-effective manner.
3
<PAGE>
Our Solution
Our PKI solution provides for the flexible management of network security
features, while offering the complete functionality necessary for full life-
cycle management of public keys and digital certificates. Our products and
services support multiple certificate types and configurations, including:
. multi-application certificates for use across a wide range of
applications;
. Web certificates for secure Web transactions;
. virtual private networking certificates, or VPN certificates, for secure
network communications; and
. wireless certificates for devices such as cellular telephones and pagers.
Our products can support large numbers of simultaneous users, while
seamlessly performing complex certification and key management functions that
allow organizations to significantly reduce their overall costs for addressing
security requirements.
Our Strategy
Our objective is to maintain and enhance our position as the leading global
provider of comprehensive, end-to-end PKI products and services that enable
organizations to effectively manage secure transactions and communications
across a wide range of applications. Key elements of our strategy include the
following:
. capitalize on B2B market opportunities;
. pursue wireless opportunities;
. maintain product leadership and increase brand recognition;
. expand and leverage strategic relationships;
. further penetrate B2C market; and
. leverage global presence.
Our History
We were originally established in January 1994 as the Secure Networks group
of Nortel Networks Corporation and its subsidiary, Nortel Networks Inc., to
pursue the development and sale of PKI products and services, and were
incorporated as a Maryland corporation in December 1996. Our principal
executive offices are located at One Preston Park South, 4975 Preston Park
Boulevard, Suite 400, Plano, Texas 75093, and our telephone number at that
location is (972) 943-7300. We also have offices in Canada, the United Kingdom,
Switzerland, Germany and Japan, as well as additional offices in the United
States.
4
<PAGE>
The Offering
<TABLE>
<C> <S>
Shares offered by Entrust....................... 2,000,000 shares
Shares offered by the selling stockholders...... 6,150,000 shares
Shares to be outstanding after this offering.... 52,510,737 shares
Nasdaq National Market symbol................... ENTU
Use of proceeds................................. Working capital and other
general corporate purposes,
including product development
and possible acquisitions and
strategic investments
</TABLE>
The number of shares of our common stock that will be outstanding after
this offering is based on the number outstanding on December 31, 1999. This
number excludes an aggregate of 7,268,653 shares of common stock that were
subject to outstanding options as of December 31, 1999 at a weighted average
exercise price of $14.00 per share.
----------------
Entrust is a registered trademark, and We Bring Trust to e-Business,
Entrust/Access, Entrust.net, Entrust@YourService, Entrust/SecureControl,
Entrust-Ready, the Entrust design (Elmer), Entrust/Authority,
Entrust/Directory, Entrust Electronic Identities, Entrust/Engine,
Entrust/Entelligence, Entrust/Web Connector, Entrust/Commerce Connector,
Entrust/VPN Connector, Entrust/Lite, Entrust/Solo, Entrust/ICE,
Entrust/Express, Entrust/Direct, Entrust/Unity, Entrust/TrueDelete,
Entrust/Toolkit, Entrust/PKI, Entrust InSource, Entrust Partner, Entrust/RA,
Entrust/AutoRA, Entrust/Roaming, Entrust/Timestamp, Entrust/SignOn and Entrust
SecureSummit are trademarks or service marks, of Entrust Technologies Limited,
a majority-owned subsidiary of Entrust Technologies Inc. All other trademarks
and service marks used in this prospectus are the property of their respective
owners.
5
<PAGE>
Summary Consolidated Financial Data
(in thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------
1996 1997 1998 1999
------- ------- -------- -------
<S> <C> <C> <C> <C>
Statement of Operations Data:
Total revenues............................. $12,802 $25,006 $ 48,988 $85,214
Gross profit............................... 9,252 20,090 39,457 69,912
Income (loss) from operations.............. 56 (490) (25,795) 3,943
Net income (loss).......................... 387 514 (23,828) 5,919
Net income (loss) per basic share.......... $ 0.02 $ (0.68) $ 0.13
Net income (loss) per diluted share........ $ 0.01 $ (0.68) $ 0.11
Shares used to compute net income (loss)
per basic share........................... 30,700 35,255 43,847
Shares used to compute net income (loss)
per diluted share......................... 41,743 35,255 54,803
</TABLE>
<TABLE>
<CAPTION>
December 31, 1999
--------------------
Actual As Adjusted
-------- -----------
<S> <C> <C>
Balance Sheet Data:
Cash and marketable investments............................ $ 89,271 $180,640
Working capital............................................ 87,918 179,287
Total assets............................................... 130,520 221,889
Shareholders' equity....................................... 103,155 194,524
</TABLE>
The consolidated financial statements as of and for the year ended December
31, 1999 are unaudited but, in the opinion of management, include all
adjustments, consisting only of normal recurring accruals, necessary for a fair
presentation. The as adjusted balance sheet data give effect to our receipt of
the estimated net proceeds from the sale of 2,000,000 shares of common stock in
this offering, at an assumed offering price of $47.875 per share and after
deducting the estimated underwriting discounts and commissions and estimated
offering expenses.
6
<PAGE>
RISK FACTORS
This offering involves a high degree of risk. You should consider carefully
the risks and uncertainties described below and the other information in this
prospectus, including our consolidated financial statements and related notes,
before deciding to invest in shares of our common stock. If any of the
following risks or uncertainties actually occurs, our business, financial
condition and operating results would likely suffer. In that event, the market
price of our common stock could decline and you could lose all or part of the
money you paid to buy our common stock.
Risks Relating To Our Financial Condition and Business Model
Our quarterly revenues and operating results are subject to significant
fluctuations and such fluctuations may lead to a reduced market price for our
stock
Our quarterly revenues and operating results have varied in the past and
may continue to fluctuate in the future. We believe that period-to-period
comparisons of our operating results are not necessarily meaningful, but
securities analysts and investors often rely upon these comparisons as
indicators of future performance. If our operating results in any future period
fall below the expectations of securities analysts and investors, the market
price of our securities would likely decline. Factors that have caused our
results to fluctuate in the past and which are likely to affect us in the
future include the following:
. length of sales cycles associated with our product offerings;
. the timing, size and nature of our licensing transactions;
. market acceptance of new products or product enhancements by us or our
competitors;
. the relative proportions of revenues derived from licenses and services
and maintenance;
. the timing of new personnel hires and the rate at which new personnel
become productive;
. changes in pricing policies by our competitors;
. changes in our operating expenses; and
. fluctuations in foreign currency exchange rates.
Estimating future revenues is difficult, and our failure to do so accurately
may lead to a reduced market price for our stock and reduced profitability
Estimating future revenues is difficult because we ship our products soon
after an order is received and, as such, we do not have a significant backlog.
Thus, quarterly license revenues depend heavily upon orders received and
shipped within the same quarter. Moreover, we historically have recorded 60% to
80% of our total quarterly revenues in the third month of the quarter, with a
concentration of revenues in the second half of that month. We expect that this
concentration of revenues, which is attributable in part to the tendency of
some customers to make significant capital expenditures at the end of a fiscal
quarter and to sales patterns within the software industry, will continue for
the foreseeable future.
Our expense levels are based, in significant part, upon our expectations as
to future revenues and are largely fixed in the short term. We may be unable to
adjust spending in a timely manner to compensate for any unexpected shortfall
in revenues. Any significant shortfall in revenues in relation to our
expectations could have an immediate and significant effect on our
profitability for that quarter and may lead to a reduced market price for our
stock.
7
<PAGE>
Because of the lengthy and unpredictable sales cycle associated with our large
PKI transactions, we may not succeed in closing transactions on a timely basis
or at all, which would adversely affect our revenues and operating results
Transactions for our PKI solution often involve large expenditures, and the
sales cycles for these transactions are often lengthy and unpredictable.
Factors affecting the sales cycle include:
. customers' budgetary constraints;
. the timing of customers' budget cycles; and
. customers' internal approval processes.
We may not succeed in closing such large transactions on a timely basis or
at all, which could cause significant variability in our revenues and results
of operations for any particular period. If our results of operations and cash
flows fall below the expectations of securities analysts, our stock price may
decline.
A limited number of customers has accounted for a significant percentage of our
revenues, which may decline if we cannot keep or replace these customer
relationships
Historically, a limited number of customers has accounted for a significant
percentage of our revenues. In 1997, three customers accounted for 19%, 12% and
11% of revenues, respectively. In 1998, our three largest customers accounted
for 23% of revenues. In 1999, our three largest customers accounted for 31% of
revenues, with the largest customer accounting for 23% of revenues. We
anticipate that our results of operations in any given period will continue to
depend to a significant extent upon revenues from a small number of customers.
In addition, we anticipate that such customers will continue to vary over time,
so that the achievement of our long-term goals will require us to obtain
additional significant customers on an ongoing basis. Our failure to enter into
a sufficient number of large licensing agreements during a particular period
could have a significant adverse effect on our revenues.
Risks Relating to Our Markets, Products and Strategy
If the e-business security market does not continue to grow, demand for our
products and services will be adversely affected
The market for e-business security solutions is at an early stage of
development. Continued growth of the e-business security market will depend, in
large part, on the following:
. the continued expansion of Internet usage and the number of
organizations adopting or expanding intranets and extranets;
. the ability of network infrastructures to support an increasing number
of users and services;
. the public recognition of the potential threat posed by computer hackers
and other unauthorized users; and
. the continued development of new and improved services for
implementation across the Internet, intranets and extranets.
A decline in the growth of this market could reduce demand for our
products, adversely affecting our revenues and results of operations.
8
<PAGE>
A breach of security at one of our customers, whether or not due to our
products, could harm our reputation and reduce the demand for our products
The processes used by computer hackers to access or sabotage networks and
intranets are rapidly evolving. A well-publicized actual or perceived breach of
network or computer security at one of our customers, regardless of whether
such breach is attributable to our products, or any significant advance in
techniques for decoding or "cracking" encrypted information, could adversely
affect the market's perception of us and our products, and could have an
adverse effect on our reputation and the demand for our products.
If our products contain errors or bugs, sales of our products would likely
decline
Our products may contain errors, failures or bugs that our existing testing
procedures have not detected. The errors may become evident at any time during
the life of our products. The discovery of any errors, failures or bugs in any
products may result in:
. adverse publicity;
. product returns;
. the loss or delay of market acceptance of our products; and
. third-party claims against us.
Accordingly, the discovery of any errors, failures or bugs would have a
significant adverse effect on the sales of our products.
Our revenues may decline if we cannot compete successfully in an intensely
competitive market
We target our products at the rapidly evolving market for e-business
security solutions. Many of our current and potential competitors have longer
operating histories, greater name recognition, larger installed bases and
significantly greater financial, technical, marketing and sales resources than
we do. As a result, they may be able to react more quickly to emerging
technologies and changes in customer requirements, or to devote greater
resources to the promotion and sale of their products. In addition, certain of
our current competitors in particular segments of the security marketplace may
in the future broaden or enhance their offerings to provide a more
comprehensive solution competing more fully with our functionality.
Increased competition, as well as consolidation of competitors, could
result in lower prices, reduced margins or the failure of our products and
services to achieve or maintain market acceptance, any of which could have a
serious adverse effect on our business, financial condition and results of
operations. See "Business--Competition" for a list of our competitors.
Our business will not be successful if we do not keep up with the rapid changes
in our industry
The emerging market for e-business security products and related services
is characterized by rapid technological developments, frequent new product
introductions and evolving industry standards. To be competitive, we have to
continually improve the performance, features and reliability of our products
and services, particularly in response to competitive offerings, and be first
to market with new products and services or enhancements to existing products
and services. Our failure to develop and introduce new products and services
successfully on a timely basis and to achieve market acceptance for such
products and services could have a significant adverse effect on our business,
financial condition and results of operations.
9
<PAGE>
We may have difficulty managing our expanding operations, which could adversely
affect our ability to successfully grow our business
The growth in the size and complexity of our business over the past few
years has placed a significant strain on our managerial, operational and
financial resources. Our ability to manage future growth, if any, will depend
upon our ability to:
. continue to implement and improve operational, financial and management
information systems on a timely basis; and
. expand, train, motivate and manage our work force.
Our personnel, systems, procedures and controls may not be adequate to
support our operations. The geographic dispersal of our operations, including
the separation of our headquarters in Plano, Texas, from our research and
development facility in Ottawa, Canada, may make it more difficult to manage
our growth.
If we fail to continue to attract and retain qualified personnel, our business
may be harmed
Our future success depends upon our ability to continue to attract and
retain highly qualified scientific, technical, sales and managerial personnel.
Competition for such personnel is intense, particularly in the field of
cryptography, and there can be no assurance that we can retain our key
scientific, technical, sales and managerial employees or that we can attract,
motivate or retain other highly qualified personnel in the future. If we cannot
retain or are unable to hire such key personnel, our business, financial
condition and results of operations could be significantly adversely affected.
Future acquisitions or investments could disrupt our ongoing business, distract
our management and employees, increase our expenses and adversely affect our
results of operations
It is possible, as part of our future growth strategy, that we will from
time-to-time acquire or make investments in companies, technologies, product
solutions or professional services offerings. With respect to these
acquisitions, we would face the difficulties of assimilating personnel and
operations from the acquired businesses and the problems of retaining and
motivating key personnel from such businesses. In addition, these acquisitions
may disrupt our ongoing operations, divert management from day-to-day business,
increase our expenses and adversely impact our results of operations. Any
future acquisitions would involve certain other risks, including the assumption
of additional liabilities, potentially dilutive issuances of equity securities
and incurrence of debt. In addition, these types of transactions often result
in charges to earnings for such items as amortization of goodwill or in-process
research and development expenses.
We face risks associated with our international operations and plans for
expansion, which, if not managed properly, could have a significant adverse
effect on our business, financial condition or results of operations
In the future, we may establish additional foreign operations, hire
additional personnel and establish relationships with additional partners
internationally. This expansion would require significant management attention
and financial resources and could have an adverse effect on our business,
financial condition and results of operations. Although our international sales
currently are primarily denominated in U.S. dollars, we may increasingly
denominate sales in foreign currencies in the future. In addition, our
international business may be subject to the following risks:
. difficulties in collecting international accounts receivable;
. difficulties in obtaining U.S. export licenses, especially for products
containing encryption technology;
10
<PAGE>
. potentially longer payment cycles for customer payments;
. increased costs associated with maintaining international marketing
efforts;
. introduction of non-tariff barriers and higher duty rates;
. difficulties in enforcement of contractual obligations and intellectual
property rights;
. difficulties managing personnel and operations in remote locations; and
. increased complexity in global corporate tax structure.
Any one of these could significantly and adversely affect our business,
financial condition or results of operations.
Risks Relating to Legal Uncertainty
If the laws regarding exports of our products further limit or otherwise
restrict our business, we could be prohibited from shipping our products to
restricted countries, which would result in a loss of revenues
Some of our products are subject to export controls under laws of the U.S.,
Canada and other countries. The list of products and countries for which
exports are restricted, and the relevant regulatory policies, are likely to be
revised from time to time. If we cannot obtain required government approvals
under these regulations, we may not be able to sell products abroad or make
products available for sale internationally via computer networks such as the
Internet. Furthermore, U.S. governmental controls on the exportation of
encryption products and technology may in the future restrict our ability to
freely export some of our products with the most powerful information security
encryption technology. See "Business--Regulatory Matters" for a discussion of
our regulatory environment.
We may not be able to protect our intellectual property rights, which could
make us less competitive and cause us to lose market share
Our future success will depend, in part, upon our intellectual property
rights and our ability to protect these rights. We rely on a combination of
patent, copyright, trademark and trade secret laws, nondisclosure agreements,
shrink-wrap licenses and other contractual provisions to establish, maintain
and protect our proprietary rights. Despite our efforts to protect our
proprietary rights, unauthorized third parties may:
. copy aspects of our products;
. obtain and use information that we regard as proprietary; or
. infringe upon our patents.
Policing piracy and other unauthorized use of our products is difficult,
particularly in international markets and as a result of the growing use of the
Internet. In addition, third parties might successfully design around our
patents or obtain patents that we would need to license or design around.
Finally, the protections we have obtained may not be sufficient because:
. some courts have held that shrink-wrap licenses, because they are not
signed by the licensee, are not enforceable;
. our trade secrets, confidentiality agreements and patents may not
provide meaningful protection of our proprietary information; and
11
<PAGE>
. we may not seek additional patents on our technology or products and
such patents, even if obtained, may not be broad enough to protect our
technology or products.
Our inability or failure to protect our proprietary rights could have a
significant adverse effect on our business, financial condition or results of
operations.
We have been subject to, and may in the future become subject to, intellectual
property infringement claims that could be costly and could result in a
diversion of management's attention
As the number of security products in the industry 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.
Surety Technologies, Inc. asserted an unsuccessful patent infringement claim
against us in February 1999, and third parties may assert infringement or
misappropriation claims against us in the future. Defending or enforcing our
intellectual property could be costly and could result in a diversion of
management's attention, which could have a significant adverse effect on our
business, financial condition or results of operations. A successful claim
against us could also have a significant adverse effect on our results of
operations for the period in which damages are paid.
We may lose access to technology that we license from outside vendors, which
loss could adversely affect our ability to sell our products
We rely on outside licensors for patent and/or software license rights in
encryption technology that is incorporated into and is necessary for the
operation of our products. For example, we license encryption technology that
is fundamental to our product from RSA Security Inc., which holds a patent for
this technology that expires in September 2000. We recently received
correspondence from RSA indicating that it believes that, as of November 1999,
we were no longer properly licensed to use this patent. While we strongly
believe that RSA's assertion is without merit, we cannot assure you of the
outcome of our discussions with RSA about this matter. An adverse outcome could
subject us to significant additional licensing fees, money damages or other
legal relief. In January 2000, RSA filed a complaint against us with respect to
this matter but did not serve notice, and subsequently withdrew, the complaint.
There can be no assurance that RSA will not institute litigation against us
with respect to this matter in the future. In addition, our ability to provide
Web server certificates is currently dependent upon a licensing agreement we
have with Thawte Consulting (Pty.) of South Africa, whose sale to VeriSign,
Inc., one of our primary competitors, is pending. Our success will depend in
part on our continued ability to have access to such technologies that are or
may become important to the functionality of our products. Any inability to
continue to procure or use such technology could have a significant adverse
effect on our ability to sell some of our products.
Risks Relating to this Offering
Our management may invest or spend the proceeds of this offering in ways which
may not benefit the business
Our management will retain broad discretion to allocate the proceeds of
this offering. Management's failure to apply these funds effectively could have
an adverse effect on our ability to implement our strategy.
Our stock price is volatile and may continue to be volatile in the future,
which could result in substantial losses for investors purchasing shares in
this offering
The trading price of our common stock has been, and is expected to continue
to be, highly volatile and may be significantly and adversely affected by
factors such as:
. actual or anticipated fluctuations in our operating results;
. announcements of technological innovations;
12
<PAGE>
. new products or new contracts by us or our competitors;
. developments with respect to patents, copyrights or propriety rights;
. conditions and trends in the security industry;
. changes in financial estimates by securities analysts; and
. general market conditions and other factors.
Nortel Networks will be able to exercise substantial influence over all matters
requiring stockholder and board approval and could make decisions about our
business that conflict with the interests of other stockholders
Upon completion of this offering, Nortel Networks Corporation, directly and
indirectly through its subsidiary, Nortel Networks Inc., will beneficially own
approximately 33.5% of our outstanding voting stock, and two of our eight
directors will be representatives of Nortel Networks. Accordingly, Nortel
Networks will continue to have the ability to exert significant influence over
our affairs, including the election of directors and decisions relating to our
strategic and operating activities. This concentration of ownership and board
representation may have the effect of delaying or preventing a change in
control that other stockholders may find favorable.
Provisions of our charter and bylaws may delay or prevent transactions that are
in your best interests
Our charter and bylaws contain provisions, including a staggered board of
directors, that may make it more difficult for a third party to acquire us, or
may discourage bids to do so. These provisions could limit the price that
investors might be willing to pay for shares of our common stock and could make
it more difficult for a third party to acquire, or could discourage a third
party from acquiring, a majority of our outstanding voting stock. Our board of
directors also has the authority to issue up to 5,000,000 shares of preferred
stock and to determine the price, rights, preferences, privileges and
restrictions, including voting rights, of those shares without any further vote
or action by the stockholders. The rights of the holders of common stock will
be subject to, and may be adversely affected by, the rights of the holders of
any preferred stock that may be issued in the future. The issuance of preferred
stock could make it more difficult for a third party to acquire, or may
discourage a third party from acquiring, a majority of our outstanding voting
stock.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995 concerning our business,
operations and financial condition. You can identify these statements by words
such as "expects", "anticipates", "intends", "plans", "believes", "seeks",
"estimates" and similar expressions. Because these forward-looking statements
involve risks and uncertainties, actual results could differ materially from
those expressed or implied by these forward-looking statements for a number of
important reasons, including those discussed under "Risk Factors",
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and elsewhere in this prospectus.
You should read these statements carefully because they discuss our
expectations about our future performance, contain projections of our future
operating results or our future financial condition, or state other "forward-
looking" information. Before you invest in our common stock, you should be
aware that the occurrence of any of the events described in these risk factors
and elsewhere in this prospectus could substantially harm our business, results
of operations and financial condition and that upon the occurrence of any of
these events, the trading price of our common stock could decline, and you
could lose all or part of your investment.
We cannot guarantee any future results, levels of activity, performance or
achievements. We undertake no obligation to update any of the forward-looking
statements in this prospectus after the date of this prospectus.
13
<PAGE>
USE OF PROCEEDS
We estimate that we will receive net proceeds of approximately $91.1
million from our sale of 2,000,000 shares of common stock in this offering, at
an assumed public offering price of $47.875 per share and after deducting the
estimated underwriting discounts and commissions and estimated offering
expenses. If the underwriters' over-allotment option is exercised in full, we
estimate that our net proceeds will be approximately $105.1 million. We will
not receive any proceeds from the sale of shares of common stock by the selling
stockholders.
We intend to use the net proceeds of this offering for working capital and
other general corporate purposes, including product development. We may also
use a portion of the net proceeds to acquire or invest in complementary
companies, product lines, products or technologies. Except as described below,
we do not have any agreements or commitments with respect to any acquisition or
investment and we are not involved in any negotiations with respect to any
acquisition or investment. We are currently in negotiations to acquire a
professional services firm for up to $16.0 million in cash. Any acquisition is
subject to the execution of a definitive purchase agreement and customary
closing conditions. Pending the use of net proceeds described above, we intend
to invest net proceeds in short-term, investment grade, interest-bearing
securities.
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
Our common stock has been quoted on the Nasdaq National Market under the
symbol "ENTU" since August 18, 1998. The following table sets forth, for the
periods indicated, the high and low sales prices per share of our common stock
as reported on the Nasdaq National Market.
<TABLE>
<CAPTION>
High Low
------ ------
<S> <C> <C>
1998
----
Third Quarter (beginning August 18, 1998)..................... $25.13 $12.63
Fourth Quarter................................................ 29.44 9.00
1999
----
First Quarter................................................. $43.06 $20.63
Second Quarter................................................ 34.00 16.88
Third Quarter................................................. 34.88 20.13
Fourth Quarter................................................ 70.63 18.31
2000
----
First Quarter (through January 24, 2000)...................... $64.75 $44.25
</TABLE>
On January 24, 2000, the last reported sale price of our common stock on
the Nasdaq National Market was $47.875 per share. As of the close of business
on January 24, 2000, we had 110 holders of record of our common stock and one
holder of record of our special voting stock.
We have never declared or paid any cash dividends on our shares of common
stock. We intend to retain future earnings, if any, to finance our growth
strategy. We do not anticipate paying cash dividends on our common stock in the
foreseeable future. Payment of future dividends, if any, will be at the
discretion of our board of directors after taking into account various factors,
including our financial condition, our operating results, our current and
anticipated cash needs, restrictions in any future financing agreements and our
plans for expansion. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources".
14
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of December 31, 1999:
. on an actual basis; and
. on an as adjusted basis to reflect:
(a) our receipt of the estimated net proceeds from the sale of
2,000,000 shares of common stock, based upon an assumed public
offering price of $47.875 per share, and after deducting the
estimated underwriting discounts and commissions and estimated
offering expenses payable by us;
(b) the issuance of 150,000 shares of common stock upon the exercise of
stock options held by certain selling stockholders; and
(c) the issuance of 5,157,289 shares of common stock upon the surrender
of a like number of shares of our special voting stock by Nortel
Networks Corporation upon the closing of this offering.
This information excludes 7,268,653 shares of common stock that were
subject to outstanding options, as of December 31, 1999, at a weighted average
exercise price of $14.00 per share.
<TABLE>
<CAPTION>
December 31, 1999
-------------------------------
Actual As Adjusted
------------- ----------------
(in thousands, except share
and per share data)
<S> <C> <C>
Shareholders' equity:
Preferred stock, $.01 par value; 5,000,000
shares authorized, no shares issued or
outstanding.................................. $ -- $ --
Common stock, $.01 par value; 100,000,000
shares authorized; 45,203,448 shares issued
and outstanding, actual; 52,510,737 shares
issued and outstanding, as adjusted.......... 452 526
Special voting stock, $.01 par value;
15,000,000 shares authorized; 5,157,289
shares issued and outstanding, actual; no
shares issued or outstanding, as adjusted.... 52 --
Additional paid-in capital...................... 122,883 214,230
Unearned deferred compensation and other........ (974) (974)
Accumulated deficit............................. (19,258) (19,258)
------------- -------------
Total shareholders' equity...................... 103,155 194,524
------------- -------------
Total capitalization.......................... $ 103,155 $194,524
============= =============
</TABLE>
15
<PAGE>
RECENT FINANCIAL RESULTS
On January 18, 2000, we announced the following unaudited condensed
consolidated financial data for the three months and years ended December 31,
1998 and 1999 and as of December 31, 1998 and 1999. In the opinion of
management, the unaudited condensed consolidated financial data presented below
have been prepared on a basis consistent with our audited consolidated
financial statements and include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of our results of
operations for those periods. The data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations", "Selected Consolidated Financial Data" and our
consolidated financial statements and notes thereto included elsewhere in this
prospectus.
<TABLE>
<CAPTION>
Three Months Ended Year Ended
December 31, December 31,
----------------------- -------------------
1998 1999 1998 1999
----------- ----------- --------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Statement of Operations:
Revenues:
License.......................... $ 11,133 $ 19,426 $ 36,773 $ 61,482
Services and maintenance......... 3,878 6,585 12,215 23,732
---------- ---------- --------- --------
Total revenues................... 15,011 26,011 48,988 85,214
---------- ---------- --------- --------
Cost of revenues:
License.......................... 666 874 1,985 2,286
Services and maintenance......... 2,348 3,540 7,546 13,016
---------- ---------- --------- --------
Total cost of revenues........... 3,014 4,414 9,531 15,302
---------- ---------- --------- --------
Gross profit:
License.......................... 10,467 18,552 34,788 59,196
Services and maintenance......... 1,530 3,045 4,669 10,716
---------- ---------- --------- --------
Total gross profit............... 11,997 21,597 39,457 69,912
---------- ---------- --------- --------
Operating expenses:
Sales and marketing.............. 8,464 12,043 26,802 40,900
Research and development......... 3,814 4,494 12,840 16,605
General and administrative....... 1,419 2,383 5,046 7,752
Acquired in-process R&D and
goodwill amortization........... 178 178 20,564 712
---------- ---------- --------- --------
Total operating expenses......... 13,875 19,098 65,252 65,969
---------- ---------- --------- --------
Income (loss) from operations..... (1,878) 2,499 (25,795) 3,943
Interest income................... 1,073 1,043 1,807 3,776
---------- ---------- --------- --------
Income (loss) before income
taxes............................ (805) 3,542 (23,988) 7,719
(Provision) benefit for income
taxes............................ -- (873) 160 (1,800)
---------- ---------- --------- --------
Net income (loss)................. $ (805) $ 2,669 $ (23,828) $ 5,919
========== ========== ========= ========
Net income (loss) per share
Basic............................ $ (0.02) $ 0.06 $ (0.68) $ 0.13
Diluted.......................... $ (0.02) $ 0.05 $ (0.68) $ 0.11
Weighted average common shares
used in per share computation:
Basic............................ 42,491 44,876 35,255 43,847
Diluted.......................... 42,491 55,416 35,255 54,803
</TABLE>
<TABLE>
<CAPTION>
December 31,
-----------------
1998 1999
-------- --------
(in thousands)
<S> <C> <C>
Balance Sheet Data:
Assets
Cash and marketable investments............................. $ 81,067 $ 89,271
Accounts receivable, net of allowance for doubtful
accounts................................................... 14,013 21,817
Other current assets........................................ 3,096 4,195
Long-term marketable investment............................. -- 2,405
Property and equipment, net................................. 4,874 6,904
Other long-term assets...................................... 4,779 5,928
-------- --------
Total assets............................................... $107,829 $130,520
======== ========
Liabilities And Shareholders' Equity
Accounts payable and accruals............................... $ 12,211 $ 15,805
Deferred income............................................. 7,791 10,761
Due to related party........................................ 768 799
-------- --------
Total liabilities.......................................... 20,770 27,365
Shareholders' equity........................................ 87,059 103,155
-------- --------
Total liabilities and shareholders' equity................. $107,829 $130,520
======== ========
</TABLE>
16
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below for the years
ended December 31, 1996, 1997 and 1998 and as of December 31, 1997 and 1998 are
derived from our consolidated financial statements, which appear elsewhere in
this prospectus, and which have been audited by Deloitte & Touche LLP. The
selected consolidated financial data set forth below for the years ended
December 31, 1994 and 1995 and as of December 31, 1994, 1995 and 1996 are
derived from our audited consolidated financial statements, which are not
included in this prospectus. The selected consolidated financial data for the
nine months ended September 30, 1998 and 1999 are derived from our unaudited
consolidated financial statements which appear elsewhere in this prospectus. In
the opinion of management, the unaudited consolidated financial statements have
been prepared on a basis consistent with our audited consolidated financial
statements and include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of our results of operations for
those periods. The data set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", "Recent Financial Results" and our consolidated financial
statements and notes thereto included elsewhere in this prospectus.
<TABLE>
<CAPTION>
Nine Months Ended
Year Ended December 31, September 30,
---------------------------------------- -------------------
1994 1995 1996 1997 1998 1998 1999
------ ------- ------ ------- -------- --------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues:
License................ $1,194 $ 1,845 $8,689 $16,486 $ 36,773 $ 25,640 $ 42,056
Services and
maintenance........... 2,687 2,128 4,113 8,520 12,215 8,337 17,147
------ ------- ------ ------- -------- --------- --------
Total revenues......... 3,881 3,973 12,802 25,006 48,988 33,977 59,203
------ ------- ------ ------- -------- --------- --------
Cost of revenues:
License................ 6 34 393 502 1,985 1,319 1,412
Services and
maintenance........... 1,179 950 3,157 4,414 7,546 5,198 9,476
------ ------- ------ ------- -------- --------- --------
Total cost of
revenues.............. 1,185 984 3,550 4,916 9,531 6,517 10,888
------ ------- ------ ------- -------- --------- --------
Gross profit............ 2,696 2,989 9,252 20,090 39,457 27,460 48,315
------ ------- ------ ------- -------- --------- --------
Operating expenses:
Sales and marketing.... 1,083 1,914 3,858 11,193 26,802 18,338 28,857
Research and
development........... 898 2,287 2,874 5,692 12,840 9,026 12,111
General and
administrative........ 688 1,212 2,464 3,695 5,046 3,627 5,369
Acquired in-process R&D
and goodwill
amortization.......... -- -- -- -- 20,564 20,386 534
------ ------- ------ ------- -------- --------- --------
Total operating
expenses.............. 2,669 5,413 9,196 20,580 65,252 51,377 46,871
------ ------- ------ ------- -------- --------- --------
Income (loss) from
operations............. 27 (2,424) 56 (490) (25,795) (23,917) 1,444
Interest income......... -- -- -- 723 1,807 734 2,733
------ ------- ------ ------- -------- --------- --------
Income (loss) before
income taxes........... 27 (2,424) 56 233 (23,988) (23,183) 4,177
(Provision) benefit for
income taxes........... 111 301 331 281 160 160 (927)
------ ------- ------ ------- -------- --------- --------
Net income (loss)....... $ 138 $(2,123) $ 387 $ 514 $(23,828) $ (23,023) $ 3,250
====== ======= ====== ======= ======== ========= ========
Net income (loss) per
basic share............ $ 0.02 $ (0.68) $ (0.70) $ 0.07
Net income (loss) per
diluted share.......... $ 0.01 $ (0.68) $ (0.70) $ 0.06
Shares used in basic per
share computation...... 30,700 35,255 32,843 43,504
Shares used in diluted
per share computation.. 41,743 35,255 32,843 54,598
</TABLE>
<TABLE>
<CAPTION>
December 31,
--------------------------------------- September 30,
1994 1995 1996 1997 1998 1999
------ ------ ------- ------- -------- -------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents
and short-term
investments............ -- -- -- $12,638 $ 81,067 $ 85,252
Working capital
(deficit).............. $1,831 $1,016 $(1,186) 13,707 77,438 83,798
Total assets............ 2,231 2,190 3,687 24,757 107,829 122,176
Shareholders' equity
(deficit).............. 2,095 1,672 (60) 14,662 87,059 97,478
</TABLE>
17
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with "Selected Consolidated
Financial Data" and our consolidated financial statements and notes thereto
appearing elsewhere in this prospectus. This discussion and analysis contains
forward-looking statements that involve risks, uncertainties and assumptions.
Our actual results may differ materially from those anticipated in these
forward-looking statements as a result of certain factors, including those set
forth under "Risk Factors" and elsewhere in this prospectus.
Overview
We are the leading global provider of PKI products and services to e-
businesses and other organizations. We are committed to enabling businesses to
conduct e-commerce securely, ensuring they benefit from increased service
efficiency, technology cost savings and the confidence associated with trusted
e-business technologies. Our products and services enable organizations and
their partners to manage trusted, secure electronic transactions and
communications over today's advanced networks, including intranets, extranets
and the Internet.
We were originally established in January 1994 as the Secure Networks group
of Nortel Networks Corporation to pursue the development and sale of PKI
products. During December 1996, Nortel Networks restructured its Secure
Networks group by incorporating Entrust Technologies Inc. in Maryland and
Entrust Technologies Limited in Ontario, Canada. As a result of the
restructuring and concurrent private placement, the assets and business of the
Secure Networks group were transferred to the newly incorporated companies, and
Entrust Technologies Inc. became a majority-owned subsidiary of Nortel Networks
and Entrust Technologies Limited became a majority-owned subsidiary of Entrust
Technologies Inc. In 1998, Entrust Technologies (UK) Limited was incorporated
in the United Kingdom as a wholly owned subsidiary of Entrust Technologies Inc.
In June 1998, we acquired 100% ownership of r3 Security Engineering AG, a
professional services organization specializing in electronic security
consulting, located in Switzerland. We completed our initial public offering of
common stock in August 1998. In 1999, we incorporated two additional, wholly
owned European subsidiaries, Entrust Technologies GmbH in Germany and Entrust
Technologies S.A.R.L. in France. Additionally, at the end of November 1999, we
reorganized our r3 business in Switzerland and formed Entrust Technologies
(Switzerland) Ltd. Liab. Co.
We recognize revenues in accordance with the provisions of the American
Institute of Certified Public Accountants' Statement of Position 97-2 "Software
Revenue Recognition". We generate revenues primarily from licensing the rights
to our software products to end users and, to a lesser extent, from sublicense
fees from resellers. We also generate revenues from consulting, training and
post-contract support, or maintenance, performed for customers who license our
products.
Accordingly, 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, collection
of the receivable is probable and payment is due within twelve months.
Revenues from maintenance services are recognized ratably over the term of
the maintenance period, which is typically one year. If maintenance services
are included free of charge or discounted in a license agreement, such amounts
are unbundled from the license fee at their fair market value based upon the
value established by independent sales of such maintenance services to other
customers. Revenues from the sale of Web server certificates by Entrust.net,
our certification authority service, are also recognized ratably over the term
of the certificate, which is typically one to two years.
18
<PAGE>
Consulting and training revenues are generally recognized as the services
are performed. Consulting services are typically performed under separate
service agreements and are usually performed on a time and materials basis.
Such services primarily consist of implementation services related to the
installation and deployment of our products and do not include significant
customization or development of the underlying software code.
We use the percentage of completion method to account for large custom
development contracts. Under this method, we recognize revenues and profit as
the work on the contract progresses. Revenues are recognized by applying the
percentage of the total cost incurred to date divided by the total estimated
contract cost to the total contract value, and any projected loss is recognized
immediately. The project cost estimates in each case are reviewed on a regular
basis.
Results Of Operations
The following table sets forth certain statement of operations data
expressed as a percentage of total revenues for the periods indicated:
<TABLE>
<CAPTION>
Nine Months Ended
Year Ended December 31, September 30,
-------------------------- -------------------
1996 1997 1998 1998 1999
------- ------- -------- --------- --------
<S> <C> <C> <C> <C> <C>
Revenues:
License..................... 67.9% 65.9% 75.1% 75.5% 71.0%
Services and maintenance.... 32.1 34.1 24.9 24.5 29.0
------- ------- -------- --------- --------
Total revenues............ 100.0 100.0 100.0 100.0 100.0
------- ------- -------- --------- --------
Cost of revenues:
License..................... 3.0 2.0 4.1 3.9 2.4
Services and maintenance.... 24.7 17.7 15.4 15.3 16.0
------- ------- -------- --------- --------
Total cost of revenues.... 27.7 19.7 19.5 19.2 18.4
------- ------- -------- --------- --------
Gross profit.................. 72.3 80.3 80.5 80.8 81.6
------- ------- -------- --------- --------
Operating expenses:
Sales and marketing......... 30.1 44.8 54.7 54.0 48.7
Research and development.... 22.4 22.7 26.2 26.5 20.5
General and administrative.. 19.3 14.7 10.3 10.7 9.1
Acquired in-process research
and development and
goodwill amortization...... -- -- 42.0 60.0 0.9
------- ------- -------- --------- --------
Total operating expenses.. 71.8 82.2 133.2 151.2 79.2
------- ------- -------- --------- --------
Income (loss) from
operations................... 0.5 (1.9) (52.7) (70.4) 2.4
Interest income............... -- 2.9 3.7 2.2 4.6
------- ------- -------- --------- --------
Income (loss) before income
taxes........................ 0.5 1.0 (49.0) (68.2) 7.0
(Provision) benefit for income
taxes........................ 2.5 1.1 0.3 0.5 (1.5)
------- ------- -------- --------- --------
Net income (loss)............. 3.0% 2.1% (48.7)% (67.7)% 5.5%
======= ======= ======== ========= ========
</TABLE>
Nine Months Ended September 30, 1998 and 1999
Revenues
Total Revenues. Total revenues increased 74% from $34.0 million for the
nine months ended September 30, 1998 to $59.2 million for the nine months ended
September 30, 1999. Total revenues derived from North America increased 94%
from $26.1 million for the nine months ended September 30, 1998 to $50.7
million for the nine months ended September 30, 1999, while total revenues
derived from outside of North America increased 8% from $7.9 million for the
nine months
19
<PAGE>
ended September 30, 1998 to $8.5 million for the nine months ended September
30, 1999. Although the majority of the overall growth in total revenues in 1999
has been experienced in North America, we have also focused on growing our
revenue base internationally, particularly in Europe and Asia. However, the
level of non-North American revenues has fluctuated from period to period and
is expected to continue that trend in the foreseeable future.
License Revenues. License revenues increased 64% from $25.6 million for the
nine months ended September 30, 1998 to $42.1 million for the nine months ended
September 30, 1999, representing 76% and 71% of total revenues in the
respective periods. The increase in license revenues in absolute dollars was
primarily due to:
. increasing market awareness and acceptance of our product offerings;
. continued enhancement and increasing breadth of our product offerings;
. expansion of our sales and marketing organization; and
. sales to new industry segments.
The decrease in license revenues as a percentage of total revenues was
primarily a result of the increasing support revenue stream and increased
demand for consulting services.
Services and Maintenance Revenues. Services and maintenance revenues
increased 106% from $8.3 million for the nine months ended September 30, 1998
to $17.1 million for the nine months ended September 30, 1999, representing 25%
and 29% of total revenues in the respective periods. Services and maintenance
revenues have continued to increase in absolute dollars and as a percentage of
total revenues as our installed customer base has grown and as these customers
continue to renew their maintenance agreements. In addition, our increasing
customer base has resulted in an acceleration of demand for consulting services
to assist these customers as they deploy our solutions. We continue to focus on
building our relationships with outside service providers to ensure that we
have adequate resources available to meet the demand of our customers.
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 $1.3
million for the nine months ended September 30, 1998 to $1.4 million for the
nine months ended September 30, 1999, representing 4% and 2% of total revenues
for the respective periods. While the cost of license revenues was relatively
flat for the first nine months of 1999 compared to the first nine months of
1998, the decrease in cost of license revenues as a percentage of total
revenues for the nine months ended September 30, 1999 was primarily the result
of a shift in the mix of third-party software vendor products sold in the first
three quarters of 1999 compared to the same period in 1998. The mix of third-
party products may vary from period to period and our gross margins and,
consequently, our results of operations could be adversely affected.
Cost of Services and Maintenance Revenues. Cost of services and maintenance
revenues consists primarily of personnel costs associated with customer
support, training and consulting services, as well as amounts paid to third-
party consulting firms for those services. Cost of services and maintenance
revenues increased 83% from $5.2 million for the nine months ended September
30, 1998 to $9.5 million for the nine months ended September 30, 1999,
representing 15% and 16% of total revenues for the respective periods. The
increase in costs in absolute dollars and as a percentage of total revenues
during the nine months ended September 30, 1999 reflected the increased costs
associated with the increased levels of services and maintenance revenues
experienced during the period.
20
<PAGE>
The gross margin with respect to services and maintenance revenues was 38%
and 45% for the nine months ended September 30, 1998 and 1999, respectively.
This increase in the services and maintenance margin reflected the shift in the
mix of services revenue toward higher-margin maintenance revenues. In addition,
the services personnel hired in 1998 were achieving higher productivity levels.
Operating Expenses
Sales and Marketing. Sales and marketing expenses increased from $18.3
million for the nine months ended September 30, 1998 to $28.9 million for the
comparable period in 1999. Sales and marketing expenses represented 54% of
total revenues for the nine months ended September 30, 1998, compared to 49%
for the comparable period in 1999. The increase in absolute dollars was
primarily the result of costs associated with the expansion of our sales and
marketing organization, both domestically and internationally, as well as
significant investments in marketing during the first three quarters of 1999 as
we launched a number of new products and marketing programs. We have continued
our strategy of (a) investing in hiring and training our direct sales
organization in anticipation of future market growth, and (b) investing in
marketing efforts in support of new product launches. Failure of these
investments to generate future revenues could have a significant adverse effect
on our operations. The decrease as a percentage of total revenues reflects the
higher revenue base as well as improvements achieved in productivity of sales
and marketing personnel and efficiencies gained in the related processes.
Research and Development. Research and development expenses increased from
$9.0 million for the nine months ended September 30, 1998 to $12.1 million for
the comparable period in 1999. Research and development expenses represented
27% of total revenues for the nine months ended September 30, 1998, compared to
21% for the comparable period in 1999. The increased investment in research and
development expenses in absolute dollars reflects expenses related to increased
staffing of software developers. These employees were added primarily in the
second half of 1998 in connection with the continuing expansion and enhancement
of our product offerings and our commitment to quality assurance and testing,
and as a result of our acquisition of r3 Security Engineering AG in June 1998.
The investment in research and development as a percentage of total revenues
decreased for the nine months ended September 30, 1999 compared to the same
period in 1998, as a result of growth of revenues outpacing our expansion of
the development team in 1999. However, we believe that we must continue to
invest in research and development in order to maintain our technological
leadership position and, thus, expect research and development expenses to
continue to increase in absolute dollars as we hire additional experienced
security experts and software engineers.
In accordance with Statement of Financial Accounting Standards No. 86,
"Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise
Marketed", we have evaluated the establishment of technological feasibility of
our 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 our financial position or results
of operations. Therefore, we charged all product development expenses to
operations in the period incurred.
General and Administrative. General and administrative expenses increased
from $3.6 million for the nine months ended September 30, 1998 to $5.4 million
for the comparable period in 1999. General and administrative expenses
represented 11% of total revenues for the nine months ended September 30, 1998,
compared to 9% for the comparable period in 1999. The increase in general and
administrative expenses in absolute dollars reflected our continued investment
in
21
<PAGE>
increased staffing and related expenses for the enhancement of the
infrastructure necessary to support our growing business, including improved
management information systems and the increased utilization of outside
professional service firms. The decrease as a percentage of total revenues
reflected efficiencies gained throughout our administrative processes as we
have grown as a company.
Acquired In-process Research and Development and Goodwill Amortization. On
June 8, 1998, we completed the acquisition of r3, a company based in Zurich,
Switzerland, which provides consulting, applied research and product
development services related to commercial security and encryption solutions.
In connection with the acquisition in 1998, an appraisal was done of the
intangible assets, resulting in $20.2 million of the purchase price being
allocated to in-process research and development that had not yet reached
technological feasibility and had no alternative future use. This in-process
research and development was expensed in the nine months ended September 30,
1998. We recorded $534,000 of amortization with respect to the goodwill that
arose as a result of this acquisition in the nine months ended September 30,
1999, compared to $178,000 for the nine months ended September 30, 1998.
Interest Income
Interest income increased from $734,000 for the nine months ended September
30, 1998 to $2.7 million for the comparable period in 1999. This increase
reflects the investment income earned on the net proceeds of our initial public
offering in August 1998 and on cash provided by operations in 1999.
Provision for Income Taxes
We recorded an income tax provision of $927,000 for the nine months ended
September 30, 1999 compared with an income tax benefit of $160,000 recognized
for the nine months ended September 30, 1998. We account for income taxes in
accordance with Statement of Financial Accounting Standards No. 109.
Accordingly, the effective income tax rates differed from statutory rates due
to an adjustment to the valuation allowance for net operating loss
carryforwards from prior periods in the first three quarters of 1999, which
resulted in a tax provision of $927,000 for the nine months ended September 30,
1999. For the nine months ended September 30, 1998, the tax benefit of $160,000
arose primarily from Canadian research and development tax credits.
Years Ended December 31, 1996, 1997 and 1998
Revenues
Total Revenues. Total revenues increased 95% from $12.8 million in 1996 to
$25.0 million in 1997 and increased 96% to $49.0 million in 1998.
Geographically, revenues derived from sales outside North America accounted for
4%, 5% and 23% of total revenues for the years ended December 31, 1996, 1997
and 1998, respectively. We invested significantly in expanding our
international operations in 1998 through the acquisition of r3, the formation
of Entrust Japan, and the hiring of additional sales and marketing personnel.
In 1996, three customers accounted for an aggregate of 64% of revenues for that
year, and individually these customers accounted for 29%, 20% and 15% of
revenues, respectively. In 1997, three customers individually accounted for
19%, 12% and 11% of revenues, respectively. In 1998, no single customer
accounted for 10% or more of total revenues.
License Revenues. License revenues increased 90% from $8.7 million in 1996
to $16.5 million in 1997 and increased 123% to $36.8 million in 1998,
representing 68%, 66% and 75% of total revenues in the respective years. The
increase in license revenues in absolute dollars was
22
<PAGE>
primarily due to increasing market awareness and acceptance of our product
offerings, additional product development and increased sales and marketing
activities. The increase in license revenues as a percentage of total revenues
reflected our continued focus on the product side of the business and the
increased use of third-party consulting firms and systems integrators to
provide implementation services to our customers.
Services and Maintenance Revenues. Services and maintenance revenues
increased 107% from $4.1 million in 1996 to $8.5 million in 1997 and increased
44% to $12.2 million in 1998, representing 32%, 34% and 25% 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 increases in maintenance revenues from a larger installed
product base. The decrease in services and maintenance revenues as a percentage
of total revenues from 1997 to 1998 was largely due to our focus on building
the product side of the business and building successful partnering
relationships with third-party service providers to provide services to
customers.
Cost of Revenues
Cost of License Revenues. Cost of license revenues was $393,000 in 1996,
$502,000 in 1997, and $2.0 million in 1998, representing 3%, 2% and 4% of total
revenues for the respective years. The increase in cost of license revenues in
absolute dollars and as a percentage of revenues for 1998 and 1997 was
primarily a result of higher royalty fees paid to third-party software vendors.
We incorporated a higher level of third-party software in our products in 1998.
Cost of Services and Maintenance Revenues. Cost of services and maintenance
revenues was $3.2 million in 1996, $4.4 million in 1997 and $7.5 million in
1998, representing 25%, 18% and 15% of total revenues for the respective years.
The increase in absolute dollars reflects the increased costs associated with
the higher levels of services and maintenance revenues during 1998 and 1997.
The decrease as a percentage of total revenues was primarily a result of
license revenues growing more rapidly than service and maintenance revenues.
The higher percentage of cost of services and maintenance revenues as a
percentage of total cost of revenues in 1997 and 1996 (79% in 1998 compared to
90% in 1997 and 89% in 1996) reflected the cost of hardware components related
to system integration arrangements during those years. We did not have a
significant hardware component of our system integration arrangements in 1998.
Services and maintenance gross profit as a percentage of services and
maintenance revenues was 48% in 1997 and 38% for 1998. This decrease in the
services and maintenance margin reflected the investment made during 1998 in
expanding our customer support organization to support the growing customer
base and the impact on productivity related to the integration of the r3
consulting organization during the third and fourth quarters of 1998. Also,
investments were made in building our consulting organization in order to
prepare for expected future increases in demand for these services.
Operating Expenses
Sales and Marketing. Sales and marketing expenses increased from $3.9
million in 1996 to $11.2 million in 1997 and $26.8 million in 1998,
representing 30%, 45% and 55% of total revenues in the respective periods.
These increases in absolute dollars and as a percentage of total revenues were
primarily the result of costs associated with the expansion of our sales and
marketing organization to support increased revenue targets, both domestically
and internationally. We have continued our strategy of investing in hiring and
training our direct sales organization in anticipation of future market growth,
and investing in marketing efforts in support of new products launches.
23
<PAGE>
Failure of these investments to generate future revenues could have a
significant adverse effect on our operations.
Research and Development. Research and development expenses increased from
$2.9 million in 1996 to $5.7 million in 1997 and $12.8 million in 1998,
representing 22%, 23% and 26% of total revenues in the respective periods. The
increased investment in research and development expenses in absolute dollars
and as a percentage of total revenues in 1997 and 1998 primarily reflected
higher expenses related to increased staffing of software engineers and
contractors. These employees were added in connection with the continuing
expansion and enhancement of our product offerings and our commitment to
quality assurance and testing. In addition, the acquisition of r3 in June 1998
increased the size of our global research and development team.
General and Administrative. General and administrative expenses increased
from $2.5 million in 1996 to $3.7 million in 1997 and $5.0 million in 1998,
representing 19%, 15% and 10% of total revenues in the respective periods. The
increase in general and administrative expenses in absolute dollars reflected
our continued investment in increased staffing and related expenses to enhance
the infrastructure required to support our growth, including investor relation
programs, improved management information systems and support and outside
professional service firms.
Acquired In-process Research and Development and Goodwill Amortization. On
June 8, 1998, we completed the acquisition of r3, a company based in Zurich,
Switzerland that 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 us and
the shareholders of r3, we agreed to acquire all the outstanding shares of r3
in exchange for an aggregate of 1,167,288 shares of our common stock and cash
consideration of approximately $4.4 million. This acquisition was recorded
under the purchase method of accounting, and, therefore, the results of
operations of r3 and the fair value of the acquired assets and liabilities are
included in our financial statements beginning on the acquisition date. Upon
consummation of the acquisition, r3 became a wholly owned subsidiary of Entrust
Technologies Inc.
In connection with the acquisition, we 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 had not yet reached
technological feasibility and had no alternative future use, which was expensed
in the year ended December 31, 1998. In addition, $356,000 of amortization had
been recorded with respect to the goodwill that arose as a result of this
acquisition in 1998.
Interest Income
Interest income increased to $723,000 in 1997 and $1.8 million in 1998,
representing 3% and 4% of total revenues in the respective periods. Interest
income was not significant in 1996. The increase in interest income in 1998
reflected the interest earned on the net proceeds of the initial public
offering in August 1998, while the increase in interest income in 1997
represented interest earned on the net proceeds of the private placement of
shares in January 1997.
Provision for Income Taxes
We recorded income tax benefits of $331,000, $281,000 and $160,000 in 1996,
1997 and 1998, respectively. Income taxes are accounted for in accordance with
Statement of Accounting Standards No. 109. The effective income tax rates
differed from the statutory rates primarily due to the impact of the Canadian
research and development tax credits claimed.
24
<PAGE>
Quarterly Results of Operations
Our 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. In particular, our period-to-period operating results are
significantly dependent upon the completion date of large license agreements.
In this regard, the purchase of our products often requires a significant
capital investment which customers may view as a discretionary cost and,
therefore, a purchase that can be deferred or canceled due to budgetary or
other business reasons. Estimating future revenues is also difficult because we
ship our products soon after an order is received and, therefore, we do not
have a significant backlog. Thus, quarterly license revenues are heavily
dependent upon orders received and shipped within the same quarter. Moreover,
we have generally recorded a significant portion of our total quarterly
revenues in the third month of a quarter, with a concentration of these
revenues in the last half of that third month. This concentration of revenues
is influenced by customer tendencies to make significant capital expenditures
at the end of a fiscal quarter. We expect 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 acceptance. In this
regard, we have from time to time experienced delays in recognizing revenues
with respect to certain orders. In any period a significant portion of our
revenue may be derived from large sales to a limited number of customers.
Despite the uncertainties in its revenue patterns, our 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 delayed or otherwise not realized in a quarter for any reason, our
business, operating results and financial condition would be adversely affected
in a significant way.
The following tables set forth certain unaudited consolidated quarterly
statement of operations data for the eight quarters ended December 31, 1999, as
well as such data expressed as a percentage of our total revenues for the
periods indicated. These data have been derived from unaudited consolidated
financial statements that, in our opinion, include all adjustments, consisting
only of normal recurring adjustments, necessary for a fair presentation of such
information when read in conjunction with our consolidated financial statements
and related notes appearing elsewhere in this prospectus. The operating results
for any quarter are not necessarily indicative of results for any future
period.
25
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended
-----------------------------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31,
1998 1998 1998 1998 1999 1999 1999 1999
-------- -------- --------- -------- -------- -------- --------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues:
License................ $7,681 $ 8,164 $ 9,795 $11,133 $11,626 $13,915 $16,515 $19,426
Services and
maintenance........... 2,243 2,850 3,244 3,878 5,199 5,840 6,108 6,585
------ -------- ------- ------- ------- ------- ------- -------
Total revenues......... 9,924 11,014 13,039 15,011 16,825 19,755 22,623 26,011
------ -------- ------- ------- ------- ------- ------- -------
Cost of revenues:
License................ 342 470 507 666 395 414 603 874
Services and
maintenance........... 1,478 1,620 2,100 2,348 2,847 3,244 3,385 3,540
------ -------- ------- ------- ------- ------- ------- -------
Total cost of
revenues.............. 1,820 2,090 2,607 3,014 3,242 3,658 3,988 4,414
------ -------- ------- ------- ------- ------- ------- -------
Gross profit............ 8,104 8,924 10,432 11,997 13,583 16,097 18,635 21,597
------ -------- ------- ------- ------- ------- ------- -------
Operating expenses:
Sales and marketing.... 4,936 6,072 7,330 8,464 8,610 9,769 10,478 12,043
Research and
development........... 2,285 3,072 3,669 3,814 3,881 4,005 4,225 4,494
General and
administrative........ 1,064 1,207 1,356 1,419 1,494 1,882 1,993 2,383
Acquired in-process R&D
and goodwill
amortization.......... -- 20,208 178 178 178 178 178 178
------ -------- ------- ------- ------- ------- ------- -------
Total operating
expenses.............. 8,285 30,559 12,533 13,875 14,163 15,834 16,874 19,098
------ -------- ------- ------- ------- ------- ------- -------
Income (loss) from
operations............. (181) (21,635) (2,101) (1,878) (580) 263 1,761 2,499
Interest income......... 146 71 517 1,073 914 853 966 1,043
------ -------- ------- ------- ------- ------- ------- -------
Income (loss) before
income taxes........... (35) (21,564) (1,584) (805) 334 1,116 2,727 3,542
(Provision) benefit for
income taxes........... 160 -- -- -- -- (245) (682) (873)
------ -------- ------- ------- ------- ------- ------- -------
Net income (loss)....... $ 125 $(21,564) $(1,584) $ (805) $ 334 $ 871 $ 2,045 $ 2,669
====== ======== ======= ======= ======= ======= ======= =======
Net income (loss) per
share
Basic.................. $ -- $ (0.70) $ (0.04) $ (0.02) $ 0.01 $ 0.02 $ 0.05 $ 0.06
====== ======== ======= ======= ======= ======= ======= =======
Diluted................ $ -- $ (0.70) $ (0.04) $ (0.02) $ 0.01 $ 0.02 $ 0.04 $ 0.05
====== ======== ======= ======= ======= ======= ======= =======
Shares used in per share
computation
Basic.................. 30,700 30,997 36,830 42,491 42,910 43,496 44,106 44,876
====== ======== ======= ======= ======= ======= ======= =======
Diluted................ 45,231 30,997 36,830 42,491 54,642 54,463 54,690 55,416
====== ======== ======= ======= ======= ======= ======= =======
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended
-------------------------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31,
1998 1998 1998 1998 1999 1999 1999 1999
-------- -------- --------- -------- -------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues:
License................ 77.4% 74.1% 75.1% 74.1% 69.1% 70.4% 73.0% 74.7%
Services and
maintenance........... 22.6 25.9 24.9 25.9 30.9 29.6 27.0 25.3
----- ----- ------ ----- ----- ----- ----- -----
Total revenues......... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Cost of revenues:
License................ 3.4 4.3 3.9 4.4 2.4 2.1 2.7 3.4
Services and
maintenance........... 14.9 14.7 16.1 15.6 16.9 16.4 14.9 13.6
----- ----- ------ ----- ----- ----- ----- -----
Total cost of
revenues.............. 18.3 19.0 20.0 20.0 19.3 18.5 17.6 17.0
----- ----- ------ ----- ----- ----- ----- -----
Gross profit............ 81.7 81.0 80.0 80.0 80.7 81.5 82.4 83.0
----- ----- ------ ----- ----- ----- ----- -----
Operating expenses:
Sales and marketing.... 49.8 55.1 56.2 56.4 51.2 49.5 46.3 46.3
Research and
development........... 23.0 27.9 28.1 25.4 23.0 20.3 18.7 17.3
General and
administrative........ 10.7 11.0 10.4 9.5 8.9 9.5 8.8 9.1
Acquired in-process R&D
and goodwill
amortization.......... -- 183.5 1.4 1.2 1.0 0.9 0.8 0.7
----- ----- ------ ----- ----- ----- ----- -----
Total operating
expenses.............. 83.5 277.5 96.1 92.5 84.1 80.2 74.6 73.4
----- ----- ------ ----- ----- ----- ----- -----
Income (loss) from
operations............. (1.8) * (16.1) (12.5) (3.4) 1.3 7.8 9.6
Interest income......... 1.5 0.6 4.0 7.1 5.4 4.3 4.2 4.0
----- ----- ------ ----- ----- ----- ----- -----
Income (loss) before
income taxes........... (0.3) * (12.1) (5.4) 2.0 5.6 12.0 13.6
(Provision) benefit for
income taxes........... 1.6 -- -- -- -- (1.2) (3.0) (3.4)
----- ----- ------ ----- ----- ----- ----- -----
Net income (loss)....... 1.3% * (12.1)% (5.4)% 2.0% 4.4% 9.0% 10.2%
===== ===== ====== ===== ===== ===== ===== =====
</TABLE>
- --------
*Not meaningful
On January 18, 2000, we announced our results for the fourth quarter and
twelve months ended December 31, 1999.
Revenues for the fourth quarter of 1999 increased to $26.0 million from
$15.0 million for the fourth quarter of 1998, an overall increase of 73%.
License revenues of $19.4 million in the fourth quarter of 1999 increased by
75% from $11.1 million during the comparable period in 1998. Services and
maintenance revenues in the fourth quarter of 1999 increased to $6.6 million
from $3.9 million for the comparable period in 1998, an increase of 69%. Net
income for the fourth quarter of 1999 was $2.7 million, representing $0.05 per
diluted share. The $0.05 per share compares to a net loss of $(805,000),
representing a net loss of $(0.02) per basic share in the fourth quarter of
1998.
Total 1999 revenues of $85.2 million increased by 74% from $49.0 million in
1998. License revenues increased by 67% to $61.5 million in 1999, compared with
$36.8 million for 1998. Services and maintenance revenues in 1999 increased by
94% to $23.7 million, compared with $12.2 million for 1998. Net income of $5.9
million for 1999 generated $0.11 per diluted share, compared to a net loss of
$(3.6 million), or $(0.10) per basic share, for 1998, which excludes acquired
in-process research and development write-offs. Including the $20.2 million of
acquired in-process research and development write-offs, the 1998 net loss
increased to $(23.8 million), resulting in a net loss of $(0.68) per basic
share. In 1999, revenues from our three largest customers totaled 31% of
revenues, with the largest customer accounting for 23% of revenues.
27
<PAGE>
Liquidity and Capital Resources
We generated cash of $4.2 million from operating activities during the nine
months ended September 30, 1999. This cash inflow was primarily a result of an
increase in accrued liabilities and deferred income and the net income achieved
over the period. These inflows were partially offset by cash outflows relating
to an increase in accounts receivable, prepaid expenses, and a decrease in
accounts payable. Our average days sales outstanding for the quarter ended
September 30, 1999 was 72 days, which represents an increase over the 58 days
that we reported for the second quarter, but a reduction over the 84 days we
reported in the three quarters previous to that. The overall decrease in days
sales outstanding from the first quarter of 1999 reflects the improved
collection efforts over the quarters and the quality of our relationships with
our customers. For purposes of calculating average days sales outstanding, we
divide ending accounts receivable by the current quarter's revenues and
multiply this amount by 90 days. The level of accounts receivable at each
quarter end will be affected by the concentration of revenues in the final
weeks of each quarter and may be negatively affected by expanded international
revenues in relation to total revenues as licenses to international customers
often have longer payment terms.
During the nine months ended September 30, 1999, cash from investing
activities of $5.5 million was provided by the reduction of our short-term
investments by $10.2 million, net of $87.6 million of short-term investment
purchases, offset by investments of $3.1 million in property and equipment and
$1.5 million in goodwill and other long-term assets. The property and equipment
investments primarily took the form of computer hardware and leasehold
improvements to support our growing organization.
Cash provided by financing activities for the nine months ended September
30, 1999 was $7.0 million, primarily due to the exercise of employee stock
options and the sale of shares under our employee stock purchase plan.
As of September 30, 1999, our cash and short-term investments in the amount
of $85.3 million comprised our principal sources of liquidity. It is our belief
that cash flows from operations, the net proceeds from this offering and
existing cash and cash equivalents and short-term investments will suffice to
meet our needs for at least the next twelve months.
Year 2000 Impact
We have not experienced any problems with our computer systems relating to
such systems being unable to recognize appropriate dates related to the year
2000. We are also not aware of any material problems with our clients or
vendors. Accordingly, we do not anticipate incurring material expenses or
experiencing any material operational disruptions as a result of any Year 2000
issues.
28
<PAGE>
Quantitative and Qualitative Disclosures about Market Risk
Risk Associated with Interest Rates
Our investment policy states that we will invest our cash reserves,
including cash, cash equivalents and marketable investments, in investments
that are designed to preserve principal, maintain liquidity and maximize
return. We actively manage our investments in accordance with these objectives.
Some of these investments are subject to market risk, whereby a change in
market interest rates will cause the principal amount of the underlying
investment to fluctuate. Therefore, a depreciation in principal value of an
investment is possible in situations where the investment is made at a fixed
interest rate and the market interest rate then subsequently increases. We try
to manage this risk by maintaining our cash, cash equivalents and marketable
investments with high quality financial institutions and investment managers.
We also restrict the investments to primarily securities with short-term
maturities, such that, at September 30, 1999, the majority of our marketable
investments had maturities of less than six months from that date. As a result,
we believe that our exposure to market risk related to interest rates is
minimal.
The following table presents the cash, cash equivalents and marketable
investments that we held at December 31, 1998 and September 30, 1999, that
would have been subject to market risk, and the related ranges of maturities as
of that date:
<TABLE>
<CAPTION>
December 31, 1998 September 30, 1999
----------------------------- -----------------------------
Maturity Maturity
----------------------------- -----------------------------
Within Within
3 Months 3-6 Months >6 Months 3 Months 3-6 Months >6 Months
-------- ---------- --------- -------- ---------- ---------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Investments classified
as cash and cash
equivalents............ $ 109 -- -- $12,002 -- --
Investments classified
as marketable
investments............ 27,800 $45,191 $4,364 11,969 $24,381 $30,850
------- ------- ------ ------- ------- -------
Total................. $27,909 $45,191 $4,364 $23,971 $24,381 $30,850
======= ======= ====== ======= ======= =======
Fair Value.............. $27,909 $45,191 $4,364 $23,971 $24,381 $30,850
======= ======= ====== ======= ======= =======
</TABLE>
Risk Associated with Exchange Rates
We are subject to foreign exchange risk as a result of exposures to changes
in currency exchange rates, specifically between the United States and Canada,
the United Kingdom, Germany and Switzerland. However, this exposure is
considered to be minimal due to the fact that the United Kingdom, German and
Swiss operations are not significant, and the Canadian operations are naturally
hedged against exchange rate fluctuations since both revenues and expenses are
denominated in Canadian dollars. Therefore, an unfavorable change in the
exchange rate for the Canadian subsidiary would result in lower revenues when
translated into U.S. dollars, but the expenses would be lowered in a
corresponding fashion.
As a result, we do not engage in formal hedging activities, but we do
periodically review the potential impact of this risk to ensure that the risk
of significant potential losses remains minimal.
29
<PAGE>
BUSINESS
Entrust Technologies is the leading global provider of public-key
infrastructure, or PKI, products and services to e-businesses and other
organizations. Unlike products and services that focus primarily upon the
issuance of digital certificates, which are similar to electronic passports,
our award-winning solution is a comprehensive, end-to-end PKI framework
designed to assure the security of electronic transactions and communications
over advanced networks, including the Internet. Our open, scalable software
solution operates across multiple platforms, network devices and applications.
According to International Data Corporation, the worldwide market for PKI-based
products and services is expected to grow from $122.7 million in 1998 to $1.3
billion in 2003. Since 1994, we have provided our PKI solution primarily to
global enterprises and government entities, including Citibank, FedEx, MCI
Worldcom, NASA, the United Kingdom Post Office and the Canadian Department of
National Defense. To date, over four million users worldwide have been licensed
to use Entrust products.
Our PKI solution is particularly relevant to organizations in the growing
business-to-business, or B2B, electronic commerce market. We offer B2B
organizations a comprehensive security solution that includes the robust
functionality required to support their increasingly advanced and high-value
electronic transactions and communications. We believe that we are well-
positioned to capitalize on our PKI market leadership to address B2B and other
important markets, such as the business-to-consumer, or B2C, market. We are
also actively developing additional functionality to address emerging
opportunities, such as the growing need to secure e-business transactions
conducted over wireless networks.
We are headquartered in Plano, Texas with offices in Canada, the United
Kingdom, Switzerland, Germany and Japan, as well as additional offices in the
United States.
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. These types of
electronic interactions can occur with a variety of audiences, each of which
may have different business requirements for information security because of
the nature and content of their communications and transactions. Electronic
interactions can be divided into two market-based categories: business-to-
business and business-to-consumer.
. Business-to-business transactions and communications occur between
businesses and other organizations, and internally within these
entities. Forrester Research, Inc. estimates that the market for B2B e-
commerce will be $1.3 trillion by the year 2003. B2B transactions
generally require pre-existing or centrally managed relationships
between participants. Goods and services transacted through B2B
relationships are primarily paid for by means other than credit cards
and, therefore, do not receive the fraud protection provided to
consumers by credit card companies. B2B communications can also be
purely informational where the information being sent between parties
is often highly sensitive. For example, product research communications
between a pharmaceutical company and a collaborating university contain
extremely valuable intellectual property or confidential information
that needs to be properly protected. Business processes involved in B2B
transactions and communications are
30
<PAGE>
frequently complex, resulting in a need for sophisticated networking and
software solutions. The B2B market typically requires supply-chain
management software, procurement and payment systems, virtual private
networking and remote access solutions, electronic mail systems,
electronic forms software, sophisticated Web-based solutions, database
systems and human resources applications.
. Business-to-consumer transactions and communications are generally
interactions between a selling organization and the general public.
Forrester Research, Inc. estimates that the market for online consumer
transactions will be $108 billion by the year 2003. B2C interactions
are typically less complex than B2B interactions, often do not require
a pre-existing relationship between buyer and seller and generally have
fewer information security requirements than their B2B counterparts.
Although many B2C interactions are currently executed over the Web
using out-of-the-box Web browser and server software security
capabilities, we anticipate that B2C participants will require more
complete security solutions.
Need For Secure Transactions and Communications
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 transactions and communications that are transmitted across or
stored on them. Key information security concerns relating to electronic
interactions include the risk of theft, alteration, interception or
dissemination of confidential data, fraud, loss of reputation and economic
loss. Threats to information 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. These risks have driven the demand
for effective and robust network and information security products.
The security risks associated with communications and commerce over public
and private networks have accentuated the need for information security
solutions that address six 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 identities of the parties involved in communications
and transactions should be verified.
Authorization. Individuals should only be able to execute transactions or
perform operations for which they have permission.
Nonrepudiation. The parties involved in an electronic exchange should not
be able to deny or repudiate the exchange.
A wide range of products and services has been introduced to address one or
more of these six 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, authorization and nonrepudiation.
Encryption devices and programs provide confidentiality, but are device-
dependent and do not address issues of access control, integrity,
authentication, authorization and nonrepudiation. 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 six critical network security needs.
31
<PAGE>
Public-Key Security
A public-key infrastructure uses encryption algorithms in combination with
authentication and verification technology offered by digital certificates to
provide users 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, authorization
and nonrepudiation are not satisfied.
Digital Certification. In addition to providing confidentiality, digital
certification systems use public and private keys to create digital signatures.
These signatures are encoded using the sender's private key. Upon receipt of
the message, the recipient obtains a copy of the sender's public key, which
verifies that the message originated from the expected sender. Public keys are
maintained in digital certificates issued by a Certification Authority, or CA.
Digital certificates securely bind the owner's identity to his public key.
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 also
ensures the integrity of a message by enclosing an encrypted summary or "hash"
of the message with the sender's digital signature. When the signature and hash
are decrypted using the sender's public key, the system can automatically
detect whether the message was altered since it was signed.
The security benefits of digital certification have led to increasing
market demand particularly in markets where information security is critical,
such as government, finance, health care and telecommunications. This
increasing demand has given rise to numerous products and services that issue
digital certificates or that are able to work with 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 updated, withdrawn or replaced. Indeed, the proliferation of users and
certificates greatly complicates management of these types of issues, which are
critical to maintaining an effective security environment across and between
organizations.
32
<PAGE>
Need For a Comprehensive, End-to-End Public-Key Infrastructure
To address the management and business issues associated with use of
public-key encryption and certificates, organizations, particularly those in
the B2B market, must have a robust public-key infrastructure that supplements
certificate issuance functions with full life cycle management of public and
private keys, including issuance, authentication, storage, retrieval, backup,
recovery, updating and revocation. In addition, these functions must operate in
an easy-to-use, cost-effective manner.
Moreover, unless digital certificates and private keys can be easily
utilized on a consistent and reliable basis across multiple applications,
organizations will face the challenge and cost of maintaining a separate
security infrastructure for each application. Maintaining these different
security infrastructures could result in separate keys and certificates for
each user for different applications, multiple passwords and inconsistent or
incomplete security implementations. Such a disconnected, inconsistent set of
products would be costly to operate and difficult to use. Furthermore, any PKI
must be able to support an organization's security requirements as the
enterprise grows, business functions are altered, and underlying information
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 cohesive, reliable and secure computing environment that meets
the six critical network security needs.
Achieving these goals requires a highly functional and flexible public-key
infrastructure that enables secure communications between and within
organizations. The need for comprehensive, end-to-end public-key infrastructure
solutions is particularly apparent for B2B transactions and communications, the
majority of which have information security requirements that are met only by
complete, end-to-end solutions that are cost-effective to operate and easy to
use.
The Entrust Solution
We are the leading global provider of comprehensive, end-to-end public-key
infrastructure solutions, encompassing both products and services, that enable
e-businesses and other organizations to effectively manage secure transactions
and communications across a wide range of applications. Our PKI solution
addresses the six critical network security needs and allows for consistent
security policy management across and between organizations, and enables any
organization to establish its own flexible, highly reliable PKI. We also offer
users encryption functionality and full digital signature and certification
management in an easy-to-use, integrated and automated solution. Among the
benefits offered by our PKI solution are:
Comprehensive, End-to-End Functionality. We believe that we are the only
provider of a comprehensive, end-to-end PKI solution offering the functionality
necessary for the full life-cycle management of keys and digital certificates,
including:
. certificate issuance;
. certificate authentication;
. key storage and backup;
. key retrieval and recovery;
. support for nonrepudiation;
. authorization management;
. certificate and key updating;
. certificate revocation; and
. cross-certification of PKIs.
33
<PAGE>
Multiple Certificate Types. Our products and services support multiple
certificate types and configurations, including:
. Multi-application certificates that can be used across multiple
applications. A user's single set of multi-application certificates can
be accessed via our single sign-on solution and used across a wide
variety of applications, including e-mail, e-forms, supply-chain
management, payments and procurement, desktop encryption and remote
access. Multi-application certificates enable ease-of-use because users
only have one password to access numerous applications within an
organization. One set of multi-application certificates per user also
reduces operating costs because a single, comprehensive infrastructure
supports a wide variety of applications. Since multi-application
certificates are particularly valuable in the B2B marketplace, we
believe that our solution is well-positioned to take advantage of the
increasing number of e-business transactions and communications in that
market.
. Single-application certificates that allow enterprises to restrict use
of the certificates by a particular user to one application. Customers
can easily convert single-application certificates to multi-application
certificates by extending their license with us. There are no
technology changes required to convert single-application certificates
to multi-application certificates.
. Web certificates, including certificates for Web servers that are
frequently used to secure B2C credit-card transactions.
. Virtual private networking, or VPN, certificates for establishing
secure, real-time communications sessions over networks.
. Wireless application protocol, or WAP, server certificates for
establishing secure, real-time communication sessions with wireless
devices such as cellular telephones.
Our support of multiple certificate types offers flexibility and choice to
customers who can select the types of certificates and solutions that best meet
their current business and information security requirements and provides a
system that is easily adaptable to meet future security requirements.
Open, Versatile Platform. Our PKI operates across a wide range of computing
platforms, including:
. Windows NT and UNIX servers;
. UNIX, Macintosh, Windows (95, 98, NT, 2000) and JAVA clients;
. applications, including e-mail, supply-chain management, payments and
procurement, desktop encryption, secure file erasure, electronic forms
and remote access;
. wireless devices such as cellular telephones and pagers;
. biometric devices, such as fingerprint readers, and smart cards;
. network infrastructure, including firewalls, network operating systems
and directories; and
. open industry standards, such as the lightweight directory access
protocol and well-known encryption algorithms, such as RSA, elliptic-
curve, DES and Triple-DES.
Because many organizations operate numerous platforms for critical business
systems, support for a wide variety of operating systems, devices, applications
and open standards is essential to address B2B information security
requirements. We also believe that support for these platforms makes us
attractive to partners whose products and services work on multiple platforms.
34
<PAGE>
Highly-Scalable Architecture. Our products employ a distributed computing
architecture and directory management techniques that make them highly
scalable. One of our customers has used our products to support over 100,000
users, and we believe that our PKI solution can be configured to handle
millions of users.
Ease Of Use. Our products automatically and transparently enable complex
certification and key management functions without requiring any action by the
user. Users can access most functions via a single user login and simple point
and click graphical interfaces. We believe that our PKI solution enables users
to execute complex information security functions without needing significant
training, and in many cases no training at all is required. Furthermore, we
believe that the ease of use of our PKI solution is a significant benefit to
customers and differentiates our solution from those of other PKI vendors.
Reduced Cost Of Ownership. Our PKI solution enables organizations to
significantly reduce overall costs for addressing information security for the
following types of reasons:
. comprehensive and automated functionality reduces duplication of
personnel;
. its ease of use simplifies or eliminates the need for training; and
. its ability to interact with a wide variety of platforms and
applications avoids the need to purchase multiple security systems.
Full Range of Support Services. We supply a comprehensive set of support
services to organizations using our PKI solution. These services include:
. management of outsourced PKI operation and maintenance provided in
conjunction with partners;
. software upgrades and maintenance;
. telephone support; and
. installation and project management services.
Flexibility. Our PKI solution supports a wide variety of features and
options, allowing customers to easily select the types of functionality they
desire. This flexibility allows customers to allocate resources and tailor
capital expenditures to meet their specific business and information security
requirements. For example, our solution enables customers to begin with a less
complex system and cost-effectively add advanced features as their security
requirements change. In addition, the versatility of our solution allows
customers to choose whether they wish to operate the PKI themselves or
outsource the back-end management of the PKI to us or other third parties. At
the same time, customers are able to change these types of decisions in the
future as their business needs change, and still maintain the value of their
investments in our solution.
Strategy
Our objective is to maintain and enhance our position as the leading global
provider of comprehensive, end-to-end PKI products and services that enable
organizations to effectively manage secure transactions and communications
across a wide range of applications. Key elements of our strategy include the
following:
Capitalize on B2B Market Opportunities. We are focused on developing,
marketing and selling products and services that enable secure B2B transactions
and communications. We believe that our market leadership is founded on our
strength and capabilities in providing an end-to-end, comprehensive solution
required in the B2B market. Although we currently have numerous, large
customers in this market, we believe that the market is still in the early
stages of development and
35
<PAGE>
provides substantial growth opportunities in the future. We are targeting our
sales and marketing activities at Global 2000 organizations and large
government organizations having significant requirements for comprehensive PKI
solutions and the resources to deploy them broadly. In particular, we are
focusing our efforts in the finance, government, health care,
telecommunications and large manufacturing sectors. Organizations in these
markets frequently have thousands of customers, partners, subscribers and
service recipients who will, directly or indirectly, benefit from secure
transactions and communications enabled by our PKI solution.
Pursue Wireless Opportunities. We have developed, and will continue to
develop, PKI products for wireless devices. We intend to aggressively pursue
further extensions of our solution into the wireless market, including
solutions for cellular telephones, pagers and other wireless-enabled devices
such as personal digital assistants, or PDAs. We believe that these devices
will be increasingly used in B2B and B2C transactions and communications.
Maintain Product Leadership and Increase Brand Recognition. Our PKI
solution has been deployed commercially through multiple versions for over five
years. Our technological leadership is attributable in large part to our
research and development team, which includes researchers with international
reputations in their fields. We intend to maintain and enhance our
technological leadership in the e-business security market by continuing to
invest in product research and development, to extend the functionality and
interoperability of our products, and to participate actively in industry
standards-setting organizations. We believe that our current set of products
and technologies provides an extensive, versatile foundation that can be
efficiently extended or modified to address new opportunities as they arise in
the market. We further intend to capitalize on our product leadership by
increasing brand awareness. Our goal is to equate our brand name with trusted
e-business security. We undertake a variety of activities to promote the
recognition of our brand identity and products, including the promotion and
sponsorship of industry groups and conferences such as the Entrust
SecureSummit.
Expand and Leverage Strategic Relationships. To encourage widespread
acceptance of our PKI solution, we have established an Entrust Partner Program
which currently includes:
. Value-added resellers and original equipment manufacturer partners,
such as Compaq, Check Point Software, Newbridge Networks and IBM, which
resell our products with their hardware and networking solutions;
. Consultant and system integration partners, such as
PricewaterhouseCoopers, Ernst & Young and KPMG, which recommend and
implement our Entrust PKI solution as part of their overall service
offerings;
. Application development partners, which have introduced more than 75
off-the-shelf, certified Entrust-Ready products and applications,
including solutions for SAP R/3, PeopleSoft, Documentum, Sybase, Nortel
Networks, Lucent, Adobe, Novell GroupWise, Axent, Jetform and Shana. We
have also announced expected solutions forthcoming from major vendors
such as Intel and Lotus Development;
. Interoperability partners such as Cisco, Netscape, Microsoft and
Network Associates, which offer products that can interoperate with and
utilize the security features of our PKI solution;
. Managed services partners such as First Data Corporation and EDS, which
offer or plan to offer outsourcing services for our customers; and
. Wireless partners such as Nokia and Research In Motion, or RIM, which
offer interoperable security solutions with their devices.
We intend to continue to invest in and enhance the Entrust Partner Program,
which provides services and products to partners, both to offer complete e-
business security solutions to our customers and to broaden adoption of our PKI
solution across markets and geographic areas.
36
<PAGE>
Further Penetrate B2C Market. We intend to continue to expand our product
offerings and customer base by developing, marketing and selling products and
services for secure B2C interactions. In late May 1999, we founded a
certification authority services business, called Entrust.net, which currently
provides certificates for Web servers and wireless servers. From July through
December 1999, Entrust.net sold approximately 4,300 Web server certificates. We
believe that we obtained approximately 5% of the worldwide market for these
certificates in our first two full quarters of operation. Providing B2C
solutions allows us to add significant value to our B2B customers who often
prefer a single provider for all of their PKI solutions. Another element of our
B2C strategy includes embedding our certification authority in popular
applications, such as Microsoft's and Netscape's browsers and Microsoft's
Windows 2000 operating system.
Leverage Global Presence. We intend to leverage and expand our global
operations. We had 53 employees based in Europe as of December 31, 1999. With
our acquisition of r3 Security Engineering in June 1998, we obtained
substantial European research and development expertise for the development of
our PKI solution targeted at the European market. Our distribution partners in
Europe and Japan provide further coverage to address Global 2000 organizations
in target markets.
Products and Product Development
Our PKI solution provides an integrated, open and scalable security
framework that addresses e-business security needs across multiple platforms
and applications. It also includes robust features, such as support of multi-
application certificates, that make it well-suited for high-value, business-to-
business applications. Our solution includes:
. a PKI infrastructure, which provides the requisite networking and
security features to enable secure transactions and communications;
. desktop applications that transparently integrate features of our PKI
into common third-party desktop applications to address business-to-
business and business-to-consumer transactions; and
. application developer toolkits that allow application developers to
quickly and safely develop Entrust-Ready applications because the
toolkits do not require developers to understand the complexities of
information security.
PKI Infrastructure
Our PKI infrastructure comprises software that manages and administers life
cycles of keys and digital certificates throughout an organization and across
multiple applications. The management of keys and digital certificates is
essential to maintain security, ease of use and low-operating costs in a PKI
solution. Critical elements of a PKI system, such as routinely updating keys
prior to expiration and maintaining copies of historical keys to ensure data
"locked" by these expired keys will not be lost, is all handled automatically
by our PKI solution. These and other features are managed transparently to
maintain a system that is easy to use, secure and low-cost to operate.
The PKI infrastructure also includes a directory compliant with the
lightweight directory access protocol, or LDAP, for the storage and retrieval
of certificates and software that enables applications and users to access the
functionality provided by the PKI. The infrastructure is configurable to
support the generation of certificates for virtual private network technologies
and Web browsers and servers. The infrastructure also supports multiple
hardware devices, such as smart cards, PC cards, biometric devices and third-
party key storage systems. Finally, the infrastructure provides a secure
timestamping capability that is valuable in business-to-business transactions
and communications where the tracking of time is an important element of the
interaction.
37
<PAGE>
Our PKI infrastructure is designed with an open and flexible software
architecture that operates on a wide range of client/server platforms,
including:
. Windows NT, HP-UX and Solaris servers;
. Windows (95, 98, NT, 2000), HP-UX, Solaris, AIX, JAVA and Macintosh
clients; and
. wireless devices, including cellular telephones and pagers.
Our software 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. The system uses the LDAP
standard to interoperate with most major directory systems, allowing customers
to utilize existing directory systems and facilitating access to other
directories as required. The system architecture enables us to add
functionality as customer needs evolve and grow and allows the infrastructure
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 as an organization's security needs increase or as
users are added to existing infrastructures.
We released the initial version of our PKI in 1994, with major upgrades in
1996, 1997, 1998 and 1999. Historically, the PKI infrastructure has generated a
major portion of our revenues. The following table lists the products that
constitute our core PKI solution, as well as a brief description of each
product.
<TABLE>
<CAPTION>
Product Name Description
------------ -----------
<C> <S>
Entrust/Authority Provides comprehensive
certification authority and key
recovery capabilities, among
numerous other functions.
Entrust/RA Allows registration authorities, or
RAs, to perform administrative
tasks.
Entrust/AutoRA Allows automated registration and
administration of users.
Entrust/Roaming Provides mobile users with secure
access to their keys and
certificates across multiple
workstations.
Entrust/Timestamp Securely establishes the time at
which data were digitally signed.
Entrust Electronic Identities Enterprise user "accounts" that
authorize use of different types of
certificates, including:
Entrust/Entelligence and Entrust/Engine Enables use of multi-application
and single-application certificates
with Entrust-Ready applications.
Entrust/Web Connector Enables use of digital certificates
with popular browsers and servers,
such as those offered by Microsoft
and Netscape.
Entrust/VPN Connector Enables use of digital certificates
in standards-based VPN devices.
</TABLE>
We license our Entrust/Authority and Entrust/RA products at a combined list
price of $25,000 per server. We offer an LDAP-compliant directory product to
enterprises for a list price of $3,000 for installations of up to 1,000 users
and $3,000 plus a per-user fee for installations of more than 1,000 users. We
charge for Entrust/AutoRA, Entrust/Roaming and Entrust/Timestamp according to
the number of licensed users, starting at $10,000. Entrust Electronic
Identities for multi-application certificates have a list price of $159 per
licensed user. Entrust Electronic Identities are offered on a registered-user
basis. We also offer customers with specialized security needs the ability to
issue Web certificates at a charge of $2 per certificate. Similarly, we allow
customers to issue dedicated
38
<PAGE>
VPN certificates at a charge of $100 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 provides certification authority, or
CA, and other functions that enable an organization to create, issue, manage,
back-up, update and revoke electronic identities. Entrust/Authority also
provides a secure enterprise key recovery system, issues certificate revocation
information and establishes cross-certification relationships with other
trusted certification authorities. A sophisticated audit reporting system
monitors all security aspects of Entrust/Authority operations.
Entrust/RA. Through an easy-to-use graphical interface, registration
authorities perform 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/AutoRA. Entrust/AutoRA allows customers to securely automate
initial registration and administration of users. Automated registration is
particularly important for highly-scalable customer environments to ensure that
operating costs are minimized.
Entrust/Roaming. Entrust/Roaming allows mobile users to securely access
their keys and certificates across multiple workstations without having to
manually transport their keys and certificates on a device such as a smart card
or floppy disk.
Entrust/Timestamp. Entrust/Timestamp allows users to securely associate the
current date and time with an e-business transaction or communication.
Entrust Electronic Identities. Our Electronic Identity is an individual
user's "account" or profile within the PKI. We offer Electronic Identities for
multi-application or single-application use, or for more limited Web or virtual
private networking use. Each multi- and single-application Electronic Identity
can support numerous key pairs and certificates over its lifetime. Multi-
application Electronic Identities may be used across multiple Entrust-Ready
applications whereas single-application Electronic Identities are licensed for
use with one application. Our multi- and single-application Electronic
Identities include software, known as Entrust/Entelligence and Entrust/Engine,
that enables users and applications to access essential functionality within
our PKI. A Web Electronic Identity enables a user to use certificates with
popular Web browsers and Web servers. VPN Electronic Identities enable
standards-compliant virtual private network technologies to establish secure
electronic communications over public networks like the Internet.
Entrust Applications
Our PKI infrastructure supports a wide variety of applications from
multiple vendors that enhance the flexibility and usefulness of our PKI. We
have also developed a number of applications in order to meet specific customer
demands and facilitate the implementation of our PKI solution. These products
both complement and interact with the PKI infrastructure to offer users
enhanced functionality and increased interoperability with third-party
applications, or they can operate as independent products, offering distinct
functionality.
39
<PAGE>
The following table lists applications that we offer, including a brief
description. Pricing for these products ranges from $15 to $39 per user. Some
of these applications are bundled together with other products.
<TABLE>
<CAPTION>
Product Name Description
------------ -----------
<C> <S>
Entrust/ICE Provides security for files and folders
Entrust/Express Provides security for popular e-mail
applications, such as Microsoft's Exchange and
Outlook products, and Qualcomm's Eudora
Entrust/Direct Provides Entrust's automated key and
certificate management features to secure Web
sessions
Entrust/Unity Provides Entrust's automated key and
certificate management features to Netscape
and Microsoft products
Entrust/SecureControl Provides administration and use of
authorization privileges for users of Web-
based applications
Entrust/TrueDelete Securely erases files from disks
Entrust/SignOn Allows single sign-on to Entrust-Ready
applications and Windows operating systems
Entrust/Access Provides secure virtual private networking for
remote access over public networks like the
internet
Entrust Security for SAP R/3 Provides PKI security for SAP systems and
applications. Certified by SAP
Entrust Security for PeopleSoft Provides PKI security for PeopleSoft systems
and applications. Certified by PeopleSoft
</TABLE>
Application Developer Toolkits
Our toolkits are a family of open, easy-to-integrate programming interfaces
that provide security services, including full key life cycle management, to a
broad range of applications. These toolkits operate across a variety of
operating systems and support multiple programming languages. Because key and
certificate management represents the most difficult aspect of adding security
to an application, we provide toolkits to enable application developers to make
their applications Entrust-Ready. The toolkits allow developers to rapidly make
their applications secure but do not require developers to understand the
complexities of information security. Our toolkits reduce the operating costs
of their applications because customers only have to operate a single PKI and
their Entrust-Ready applications operate in a consistent, cohesive manner.
New Product Development
We devote significant resources to the development of new and enhanced
product functionality to maintain our technology and product leadership. We
employ a number of different methods for identifying product extension
opportunities and new product candidates, 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 the PKI Forum.
Some of our current and planned product development efforts include:
. additional products and services to secure transactions and
communications over wireless devices such as cellular telephones, pagers
and PDAs;
. attribute certificates for privilege management;
. electronic notary products and services; and
. monitoring and assessment systems.
40
<PAGE>
We are also continuing to increase the number of third-party applications
and services that our PKI solution can manage, including VPN devices and
routers and other popular user applications. Our scientists are also actively
engaged in the development and improvement of the advanced cryptographic
algorithms for use in our products.
Services and Support
Professional Services
We believe that a high level of service and support is critical to our
success, and that a close and active service and support relationship is
important to facilitate rapid implementation of our solution, assure customer
satisfaction and provide us with important information regarding evolving
customer requirements. Toward these ends, we have made a significant investment
in expanding our services and support organization, which, as of December 31,
1999, consisted of 97 employees. Our services personnel have a broad range of
experience in network security and include mathematicians, cryptographers and
system designers. Furthermore, we are supplementing our traditional services
and support revenue streams with additional service-based revenue streams, such
as the revenue we receive through Entrust.net.
Our professional services organization provides consulting and systems
integration services to support customers in designing, implementing and
running our PKI solution. Activities of the professional services organization
are supplemented with a professional services partner program that includes
PricewaterhouseCoopers, Ernst & Young and KPMG. To facilitate the integration
of PKI management into the customer's business operations, we also offer our
Entrust InSource service, in which we provide on-site PKI management for
customers on a long-term basis, or while the customer implements and trains
personnel.
Our support offerings also include:
. direct telephone consulting support by experienced technical account
representatives;
. 24-hour pager access, e-mail and fax support;
. Internet access to our knowledge repository; and
. discussion group access.
Payment of an annual maintenance fee also entitles customers to receive
software enhancements to their licensed versions of our solution.
Certification Authority Services
In May 1999, we launched a certification authority services business called
Entrust.net. Entrust.net manages the issuance of multiple types of
certificates, including Web server certificates that are frequently used to
secure Web-based, B2C transactions. The list price for a one-year Web server
certificate is $299 and for a two-year certificate is $499. Entrust.net also
provides certificates to secure wireless transactions between cellular
telephones and WAP servers. The list price for a one-year WAP certificate is
$695 and for a two-year WAP certificate is $1,195.
Entrust@YourService
We recently announced Entrust@YourService, a managed services model for
delivering outsourced security solutions for B2B and B2C transactions and
communications. As part of the launch of Entrust@YourService, we entered into a
strategic alliance with Cash Tax, Inc., a subsidiary of First Data Corporation,
a large electronic commerce and payment services company. Through this
alliance, we plan to address the growing needs of customers that want to enable
e-business solutions but choose to outsource the ongoing operational tasks.
Entrust@YourService is designed to quickly and efficiently provide customers
with comprehensive, end-to-end security solutions while still allowing these
customers to retain control of the system implementation.
41
<PAGE>
The full range of solutions available to customers operating their own
PKI's are available to customers taking advantage of Entrust@YourService.
Moreover, because both the in-house and managed services model use the same
technology, customers have the flexibility to easily transition between the two
models to support their evolving business needs. We expect to make
Entrust@YourService commercially available during the first quarter of 2000.
Research and Development
Our research and development efforts are focused on developing new
products, core technologies and enhancements to existing product lines to
maintain and extend our technology and product leadership position. We spent
approximately $5.7 million, $12.8 million and $16.6 million on research and
development in 1997, 1998 and 1999, respectively.
As of December 31, 1999, our research and development staff consisted of
166 employees. With the addition of r3, we added significant research and
development capabilities in Europe and expanded our internationally-recognized
team of professional cryptographers.
Our 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 standards in the Internet and data
security areas. We believe that we are 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
Our customers are generally domestic and foreign government entities and
Global 2000 companies, including financial, health care, telecommunications and
large manufacturing organizations. As of December 31, 1999, we had licensed our
software to more than 1,300 customers. The following is a representative list
of our current customers that have accounted for more than $200,000 of revenues
each:
Banca Nazionale del Lavoro Industry Canada Royal Canadian Mounted
Bell Emergis Interpay Police
Canadian Dept. of National Defense SECOM
J.P. Morgan
Citibank S.W.I.F.T.
Kansas Bureau of Investigation
Columbia/HCA Healthcare Corporation Schlumberger
Lucent Technologies
Digital Medical Systems MCI Worldcom Science Applications
FDIC NASA International
FedEx Nortel Networks United Kingdom Post
Government of Ontario Royal Bank of Scotland Office
U.S. Coast Guard
U.S. Patent and Trade
Office
Historically, a limited number of customers have accounted for a
significant percentage of our revenues. In 1997, our three largest customers
accounted for 19%, 12% and 11% of our total revenues. In 1998, our three
largest customers accounted for an aggregate of 23% of total revenues, with no
individual customer accounting for more than 10% of revenues. In 1999, our
three largest customers accounted for an aggregate of 31% of revenues, with the
largest customer accounting for 23% of revenues. Although our largest customers
have varied from period to period, we anticipate that our results of operations
in any given period will continue to depend to a significant extent upon
revenues from a small number of customers.
U.S. Postal Service
Sales, Marketing and Business Development
We offer our products and services through a multi-tiered approach
reflecting the characteristics and buying behavior of the markets we cover. As
of December 31, 1999, we had 212 employees in sales, marketing and business
development.
42
<PAGE>
Direct Sales
To address our target market of Global 2000 organizations, we sell our
products and services in North America, the United Kingdom and Germany
primarily through a direct sales force. We believe that direct coverage by our
sales force is necessary in light of the early stage of PKI adoption and the
sophisticated requirements of our targeted customer base, and that a direct
sales force gives us a competitive advantage in responding to customer needs as
they evolve. Our direct sales force is divided into five North American
regions, the United Kingdom and Germany. We assign teams within each region to
specific accounts as their exclusive responsibility. We have also focused our
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.
We also established a General Markets Sales Group responsible for
identifying and pursuing customer opportunities outside the defined
responsibilities of the regional sales teams. The direct sales organization is
also supplemented by targeted direct mail and telemarketing campaigns developed
by our marketing organization. Finally, the direct sales organization is
actively involved in selling all of our products and services, including those
available from Entrust.net.
Indirect Sales
To supplement our direct sales force, we have 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 our
functionality. These partners include Compaq, Hewlett-Packard and IBM,
which resell our products with their hardware and networking solutions,
as well as Check Point Software and Newbridge Networks, which bundle our
PKI solution with their own software products;
. distributors and agents that promote and sell our products in defined
geographic markets;
. 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
PricewaterhouseCoopers, Ernst & Young and KPMG; and
. referral partners that refer their consulting and integration customers
in designated markets to our PKI solution.
Marketing
To support our sales force, we have a marketing group whose goals are to
create a consistent, focused communication strategy that increases awareness of
our 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. We
have organized a number of major trade shows, including the annual Entrust
SecureSummit to be held this year in Dallas, Texas in May. We also provide
frequent Web updates, search engine registration, online advertising and
product downloads.
Business Development
To identify and develop strategic relationships with targeted industry
partners more effectively, we have a business development organization of 17
persons as of December 31, 1999 that pursues
43
<PAGE>
selected business development activities, including the administration and
promotion of our Entrust Partner Program. These activities permit us to
strengthen our relationships with existing strategic partners and identify and
encourage new providers of software, network, computing and communications
products to make their products Entrust-Ready. Our business development
personnel are divided into three distinct teams that focus on B2B, B2C and
general application partners.
Competition
The e-business security solutions market is intensely competitive, subject
to rapid change and significantly affected by new product and service
introductions, consolidation and other market activities by industry
participants.
Because of the broad functionality of our e-business security solution, we
compete currently or may in the future compete with vendors offering a wide
range of security products and services as follows:
. companies offering commercial certification authority products and
services such as VeriSign, Xcert and IBM in the market for issuing and
maintaining digital certificates for use on public and private networks,
some of whom, such as IBM and XCert, provide a product-based solution,
while others, such as VeriSign, are primarily service providers;
. companies, such as RSA Security and Baltimore Technologies, which offer
PKI product solutions for enterprises;
. established companies developing new e-business security offerings, such
as 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 a certificate server and other PKI-compatible products based
on its Windows 2000 security framework;
. other major networking vendors who may bundle digital certificates with
their product offerings, with whom we compete on the basis of our
ability to provide a centrally managed, real-time, comprehensive
infrastructure with the features and functionality to support enterprise
applications; and
. companies in the emerging market for providing security across VPNs with
major networking device companies, such as Lucent Technologies and
Cisco, as well as firewall vendors such as AXENT and Check Point
Software.
We believe that the principal competitive factors affecting the market for
e-business security technology include technical features, ease of use,
quality/reliability, level of security, scalability, customer service and
support, and price. Although we believe that our products currently compete
favorably with respect to such factors, there can be no assurance that we can
maintain our competitive position against current and potential competitors.
Regulatory Matters
Our products are subject to special export restrictions administered by the
governments of the United States, Canada and other countries. Our products are
also subject to import restrictions and/or use restrictions imposed by
countries such as France. Consequently, our ability to export our products to
destinations outside of the U.S. and Canada is subject to a variety of
government approvals or licensing requirements. 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
44
<PAGE>
provisions of the U.S. and/or Canadian export control laws which apply to re-
exports. In light of these restrictions, depending on the country of
destination, industry sector, and/or end user, some of our 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 we will continue to be able to export our products to any
destinations outside of the U.S. and Canada. Such restrictions could
potentially have an adverse effect on our business, financial condition or
results of operations.
On January 14, 2000, the United States Department of Commerce issued new
export regulations that apply to products that contain or use cryptography.
These regulations generally make it substantially easier to sell U.S.
encryption products abroad. In general, the new rules eliminate the constraints
on the strength of the encryption that may be exported, after a one-time review
of the product, and greatly broaden the endusers who may receive the products
without a license.
This change should allow our products that are under the export license
authority of the U.S. to be more competitive with products of foreign
producers. However, we believe that some of our products are exempt from U.S.
export authorization and they have been marketed accordingly. U.S. producers of
products that compete with our non-U.S. products may now be able to market more
aggressively in foreign countries, offering stronger encryption and offering
products to broader industry groups.
In substance, the new rules are as follows: software products still cannot
be exported to Cuba, Iran, Iraq, Libya, North Korea, Serbia, Sudan, Syria and
Taliban-controlled areas of Afghanistan. However, after a one-time government
review, encryption products of any key length will be exportable to non-
governmental endusers worldwide, except for the embargoed countries. Thus, it
is generally no longer necessary to follow separate rules based on encryption
key length, "recoverability", or the type of enduser or enduse. Encryption
items may be exported to foreign subsidiaries of U.S. companies without any
prior review or licensing, but new products developed from the exported
products are still subject to a one-time government technical review.
If the government determines that an encryption product is a retail
product, then it may be exported to any user, including foreign government
endusers, in non-embargoed countries. Retail certification requires a new
application to the Commerce Department, except that previously-reviewed 56-bit
products and "finance-specific" products are considered to be retail products
without additional review.
Export licenses are still required for exports of non-retail encryption
products to Internet and telecommunications service providers if the products
are used to provide services specifically to a foreign government or provide
non-subscriber-based bulk backbone encryption.
Any mass market encryption product previously authorized for export under
License Exception "TSU" may be upgraded to 64-bit encryption without a new
technical review.
The government has imposed new post-export semi-annual reporting
requirements for most export products, but this should not affect our export
sales.
We believe, and have informed the U.S. government, that certain of our
products are exempt from U.S. encryption export restrictions under these
criteria. However, we have not obtained any formal U.S. government ruling that
any of our 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
our 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
our products outside the U.S. and Canada, having a potentially significant
adverse effect on our business, financial condition and results of operations.
45
<PAGE>
Intellectual Property
We rely on a combination of patent, copyright, trademark and trade secret
laws, nondisclosure agreements and other contractual provisions to establish,
maintain and protect our proprietary rights. We own 11 issued U.S. patents,
along with corresponding, pending foreign patent applications, and 58 pending
U.S. patent applications relating to our products. The issued patents are and
will continue to be subject to certain license grants to others, including
Nortel Networks and its cross licensees, under patent cross license agreements.
We have copyright and trade secret rights for our products, consisting mainly
of source code and product documentation. We use a printed "shrink-wrap"
license for users of our products in order to protect certain of our copyrights
and trade secrets. We attempt to protect our trade secrets and other
proprietary information through agreements with suppliers, non-disclosure and
non-competition agreements with employees and consultants and other security
measures. See "Risk Factors".
Employees
As of December 31, 1999, we had 545 full-time employees, 408 of whom were
employed by Entrust Technologies Limited, our Canadian subsidiary. Of our
employees, 166 were involved in research and development, 212 in sales,
marketing and business development, 97 in professional and customer support
services and 70 in administration and finance. No employees are covered by any
collective bargaining agreements, and we believe that our relationship with our
employees is good.
Properties
Our U.S. headquarters, including our executive offices and administrative
facilities, is located in Plano, Texas, where we lease approximately 8,716
square feet of office space. We also lease approximately 69,000 square feet of
office space at our Canadian headquarters in Ottawa, Ontario, Canada, with an
additional 29,149 square feet of office space in the Ottawa area to accommodate
expected growth in administrative, sales and marketing, research and
development and operations personnel. In addition, we are currently under a
development and leasing agreement to construct additional office space in
Kanata, Ontario of approximately 145,000 square feet to accommodate future
growth. It is anticipated that this facility will be completed in the fourth
quarter of 2000. We also have offices located in London, England and Zurich,
Switzerland.
We have sales offices in Chicago, Illinois, McLean, Virginia, Montreal,
Quebec, 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. We lease a sales and support office
in Bad Homburg, Germany.
Legal Proceedings
We are subject to various legal proceedings and claims, either asserted or
unasserted, which arise in the ordinary course of business. While the outcome
of these claims cannot be predicted with certainty, management does not believe
that the outcome of any of these legal matters will have a significant adverse
effect on our consolidated results of operations or consolidated financial
position.
46
<PAGE>
MANAGEMENT
Executive Officers and Directors
Our executive officers and directors and their respective ages and
positions as of December 31, 1999, are as follows:
<TABLE>
<CAPTION>
Name Age Position with Entrust
- ---- --- ---------------------
<S> <C> <C>
John A. Ryan............ 43 President, Chief Executive Officer and Director
Brian O'Higgins......... 44 Executive Vice President and Chief Technology Officer
Richard D. Spurr........ 46 Executive Vice President, Global Sales And Services
David L. Thompson....... 46 Senior Vice President, Finance and Chief Financial Officer
Hansen Downer........... 47 Vice President, Professional Services
F. William Conner....... 40 Chairman of the Board
Butler C. Derrick, Jr... 63 Director
Jawaid Ekram............ 49 Director
Terrell B. Jones........ 50 Director
Michael P. Ressner...... 51 Director
Christopher M. Stone.... 42 Director
James A. Thomson........ 54 Director
</TABLE>
John A. Ryan has served as our President and Chief Executive Officer and as
a director since our 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 Networks. Prior to
that time, from August 1992 until October 1995, he served as Assistant Vice
President, Marketing for the Enterprise Network group of Nortel Networks. Since
joining Nortel Networks in 1981, he has also served in various senior positions
in marketing, customer service and finance.
Brian O'Higgins has served as our Executive Vice President and Chief
Technology Officer since our founding in December 1996. Mr. O'Higgins co-
founded the Nortel Networks Secure Networks business unit in 1994, which became
Entrust Technologies Inc. in December 1996. Previously, he was employed by Bell
Northern Research Ltd., the research and development subsidiary of Nortel
Networks, which he joined in 1979.
Richard D. Spurr has served as our Executive Vice President, Global Sales
and Services since December 1999 and was our Senior Vice President, Sales and
Marketing from March 1998 until December 1999. From June 1997 until March 1998,
he served as our Senior Vice President of Global Sales. 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.
David L. Thompson has served as our Senior Vice President, Finance and
Chief Financial Officer since October 1999. From September 1996 to September
1999, he served as Vice President of Finance of Nortel Networks' Enterprise
Solutions global business, which comprises customer premise data and voice
equipment research, manufacturing, sales and service. From January 1994 to
August 1996, he served as Vice President of Finance of Nortel Networks World
Trade, the marketing, sales and service organization for Nortel Networks' suite
of products outside North America. From January 1992 to December 1994, he
served as Vice President of Finance for Nortel Networks' Asia/Pacific business.
Hansen Downer has served as our Vice President, Professional Services since
December 1997. From February 1997 to November 1997, Mr. Downer served as Vice
President of Sales,
47
<PAGE>
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.
F. William Conner has served on our board of directors since July 1997 and
as Chairman of the Board since October 1998. He has served as Executive Vice
President and President, Enterprise Solutions of Nortel Networks since November
1999. From July 1999 to October 1999, Mr. Conner served as Executive Vice
President and Chief Marketing Officer of Nortel Networks. He served as
Executive Vice President of Nortel Networks Corporate Marketing and
Communications from September 1998 until August 1999. Mr. Conner served as
Senior Vice President and President of Nortel Networks' Enterprise Data
Networks line of business from February 1998 until September 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 Networks.
Prior to that time, from 1992 until July 1995, Mr. Conner held a variety of
sales and marketing executive positions in the voice and data enterprise lines
of business of Nortel Networks.
Butler C. Derrick, Jr. has served on our board of directors since May 1999.
Since August 1998, Mr. Derrick has been a Partner at the law firm of Power,
Goldstein, Frazer & Murphy LLP, Washington, D.C. From January 1995 to July
1998, Mr. Derrick was a Partner at the law firm of Williams & Jensen,
Washington, D.C. Mr. Derrick served in Congress as a United States
Representative from South Carolina from January 1975 to January 1995. While in
Congress, Mr. Derrick held numerous posts, including Deputy Majority Whip and
Vice Chairman of the House Rules Committee.
Jawaid Ekram has served on our board of directors since May 1999. Since
December 1994, Mr. Ekram has been a Senior Vice President of Visa International
Incorporated in various capacities. Currently Mr. Ekram is responsible for
International Network & Global Access Technology Services. This worldwide
online network supports the world's largest payment system for credit card
authorization and settlement.
Terrell B. Jones has served on our board of directors since November 1998.
He has served as Chief Information Officer and Senior Vice President of the
SABRE Group Holdings, Inc., an information technology company, as well as
President of SABRE Interactive since July 1996. He previously served as
President of the SABRE Computer Services for American Airlines from 1993 to
1996.
Michael P. Ressner has served on our board of directors since May 1999. He
has served as the Vice President of Finance of Nortel Networks Enterprise
Solutions group since February 1999. From May 1994 to January 1999, Mr. Ressner
served as Vice President of Finance for the Carrier Solutions business unit of
Nortel Networks. Prior to these assignments, Mr. Ressner held a number of
senior finance management posts within various business units of Nortel
Networks.
Christopher M. Stone has served on our board of directors since May 1999.
He founded Tilion.com Inc., a company which builds B2B Internet infrastructure
for Web intelligence, and has served as its Chief Executive Officer since
November 1999. From 1989 to October 1999, he served as Senior Vice President of
Strategy and Corporate Development at Novell, Inc., a network software
provider. Prior to joining Novell in 1989, Mr. Stone founded Object Management
Group, Inc., a not-for-profit corporation that develops specifications for the
software industry, and served as its Chairman, President and Chief Executive
Officer.
James A. Thomson has served on our board of directors since May 1999. He
has served as President and Chief Executive Officer of RAND Corporation, a non-
profit, non partisan research and
48
<PAGE>
analysis institution, since August 1989. Prior to joining RAND Corporation in
1981, Dr. Thomson was a member of the National Security Council staff at the
White House.
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 our directors or executive officers.
49
<PAGE>
SELLING STOCKHOLDERS
The following table sets forth the beneficial ownership of our common stock
as of December 31, 1999, and as adjusted to reflect the sale of the shares
offered by this prospectus, by the selling stockholders.
The number of shares beneficially owned by each selling stockholder is
determined in accordance with SEC rules, 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 person has sole or
shared voting power or investment power and also any shares which the person
has the right to acquire within 60 days after December 31, 1999 through the
exercise of any stock option or other right. The inclusion of such shares in
the table below, however, does not constitute an admission that the named
stockholder is a direct or indirect beneficial owner of such shares. 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 Shares To Be
Owned Beneficially Owned
Prior to Offering After Offering
-----------------------Shares to be ------------------
Name of Selling Stockholder Number Percent Sold Number Percent
- --------------------------- ------------ ---------------------- ---------- -------
<S> <C> <C> <C> <C> <C>
Nortel Networks
Corporation(1)......... 23,567,789 46.8% 6,000,000 17,567,789 33.5%
John A. Ryan(2)......... 942,103 2.0% 125,000 817,103 1.5%
Richard D. Spurr(3)..... 183,000 * 25,000 158,000 *
</TABLE>
- --------
* less than 1%
(1) The 23,567,789 shares beneficially owned by Nortel Networks Corporation
consist of (a) 18,410,500 shares of common stock held of record by Nortel
Networks Inc., a wholly owned subsidiary of Nortel Networks Corporation, and
(b) 5,157,289 shares of common stock issuable upon the exchange of 5,157,289
exchangeable shares of Entrust Technologies Limited, a majority-owned
subsidiary, held by Nortel Networks Corporation. Nortel Networks Corporation
also holds 5,157,289 shares of special voting stock. At any time prior to
December 31, 2006, Nortel Networks Corporation may exchange one exchangeable
share, together with one share of special voting stock, for one share of our
common stock. The number of shares of common stock offered for sale consists of
(a) 5,157,289 shares of common stock issuable upon the exchange of the
exchangeable shares of Entrust Technologies Limited held by Nortel Networks
Corporation and (b) 842,711 shares of common stock held by Nortel Networks Inc.
Nortel Networks Corporation has sole voting and investment power with respect
to the shares of common stock held by Nortel Networks Inc. In addition to the
number of shares shown as offered for sale in the table, Nortel Networks
Corporation has granted the underwriters an option to purchase up to an
additional 916,875 shares pursuant to the underwriters' over-allotment option.
In the event the underwriters' over-allotment option is exercised in full,
Nortel Networks Corporation will beneficially own 16,650,914 shares, or 31.5%
after the offering.
(2) Includes 936,037 shares issuable pursuant to options.
(3) Consists of 183,000 shares issuable pursuant to options.
LEGAL MATTERS
The validity of the shares of common stock offered hereby will be passed
upon for us by Hale and Dorr LLP, Boston, Massachusetts. Ropes & Gray, Boston,
Massachusetts, has represented the underwriters.
50
<PAGE>
EXPERTS
The financial statements included in this prospectus as of December 31,
1997 and 1998 and for each of the three years in the period ended December 31,
1998 have been audited by Deloitte & Touche LLP, independent auditors, as
stated in their report appearing herein, and are included in reliance upon the
report of such firm, given upon their authority as experts in auditing and
accounting.
WHERE YOU CAN FIND MORE INFORMATION
We file reports, proxy statements and other documents with the Securities
and Exchange Commission. You may read and copy any document we file at the
SEC's public reference room at Room 1024, Judiciary Plaza Building, 450 Fifth
Street, N.W., Washington, D.C. 20549 and at the regional offices of the SEC
located at Seven World Trade Center, 13th Floor, New York, New York 10048 and
500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You can request
copies of these documents upon payment of a duplicating fee, by writing to the
SEC. Please call the SEC at 1-800-SEC-0330 for further information on the
operation of the public reference rooms. Our SEC filings are also available to
you on the SEC's Internet site at http://www.sec.gov.
This prospectus is part of a registration statement that we filed with the
SEC. The registration statement contains more information than this prospectus
regarding us and our common stock, including certain exhibits and schedules.
You can obtain a copy of the registration statement from the SEC at the
addresses listed above or from the SEC's Internet site.
The SEC allows us to "incorporate" into this prospectus information that we
file with the SEC in other documents. This means that we can disclose important
information to you by referring to other documents that contain that
information. The information incorporated by reference is considered to be part
of this prospectus. Information contained in this prospectus and information
that we file with the SEC in the future and incorporate by reference in this
prospectus automatically updates and supersedes previously filed information.
We are incorporating by reference the documents listed below and any future
filings we make with the SEC under Sections 13(a), 13(c), 14 or 15(d) of the
Securities Exchange Act of 1934 prior to the sale of all the shares covered by
this prospectus:
. Our Annual Report on Form 10-K for the year ended December 31, 1998,
filed with the SEC on March 30, 1999;
. Our Quarterly Report on Form 10-Q for the quarter ended March 31, 1999,
filed with the SEC on May 17, 1999;
. Our Quarterly Report on Form 10-Q for the quarter ended June 30, 1999,
filed with the SEC on August 13, 1999;
. Our Quarterly Report on Form 10-Q for the quarter ended September 30,
1999, filed with the SEC on November 12, 1999;
. Our Proxy Statement dated April 16, 1999, relating to our 1999 Annual
Meeting of Stockholders;
. The description of our common stock contained in our Registration
Statement on Form 8-A filed with the SEC on August 3, 1998; and
. All of our filings pursuant to the Exchange Act after the date of the
initial filing of this registration statement and prior to its
effectiveness.
You may request a copy of these documents, which will be provided to you at
no cost, by contacting: Entrust Technologies, One Preston Park South, 4975
Preston Park Boulevard, Suite 400, Plano, Texas 75093, Attention: Investor
Relations, (972) 943-7300.
51
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Reports............................................. F-2
Consolidated Balance Sheets at December 31, 1997 and 1998 and September
30, 1999 (unaudited)..................................................... F-3
Consolidated Statements of Operations for the years ended December 31,
1996, 1997 and 1998 and the nine months ended September 30, 1998 and 1999
(unaudited).............................................................. F-4
Consolidated Statements of Stockholders' Equity and Comprehensive Income
for the years ended December 31, 1996, 1997 and 1998 and the nine months
ended September 30, 1999 (unaudited)..................................... F-5
Consolidated Statements of Cash Flows for the years ended December 31,
1996, 1997 and 1998 and the nine months ended September 30, 1998 and 1999
(unaudited).............................................................. F-7
Notes to Consolidated Financial Statements................................ F-8
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Directors and Shareholders of Entrust Technologies Inc:
We have audited the consolidated balance sheets of Entrust Technologies
Inc. as of December 31, 1997 and 1998, and the related consolidated statements
of operations, shareholders' equity and comprehensive income, and cash flows
for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about 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 that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Entrust Technologies Inc. at
December 31, 1997 and 1998, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
Dallas, Texas
February 5, 1999
(November 4, 1999 as to Note 11, third paragraph)
F-2
<PAGE>
ENTRUST TECHNOLOGIES INC.
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars, except share data)
<TABLE>
<CAPTION>
December 31, September 30,
----------------- -------------
1997 1998 1999
------- -------- -------------
(unaudited)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................... $ 4,025 $ 3,712 $ 20,436
Short-term marketable investments............ 8,613 77,355 64,816
Accounts receivable (net of allowance for
doubtful accounts of $416 in 1997, $753 in
1998, and $659 at September 30, 1999)....... 7,152 14,013 18,154
Other receivables............................ 2,089 2,102 3,318
Prepaid expenses............................. 455 994 1,756
------- -------- --------
Total current assets....................... 22,334 98,176 108,480
Long-term marketable investment............... -- -- 2,384
Goodwill, net................................. -- 3,210 3,126
Property and equipment, net................... 1,680 4,874 6,323
Other long-term assets........................ 743 1,569 1,863
------- -------- --------
Total assets............................... $24,757 $107,829 $122,176
======= ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable............................. $ 1,236 $ 7,187 $ 5,672
Accrued liabilities.......................... 2,066 4,992 8,523
Deferred income.............................. 3,068 7,791 9,698
Due to related party......................... 2,257 768 789
------- -------- --------
Total current liabilities.................. 8,627 20,738 24,682
Long-term debt and other long-term
liabilities.................................. 1,468 32 16
------- -------- --------
Total liabilities.......................... 10,095 20,770 24,698
------- -------- --------
Shareholders' equity:
Preferred stock, par value $0.01 per share;
none issued and outstanding................. -- -- --
Common stock:
Common, par value $0.01 per share; no
issued and outstanding shares at December
31, 1997, 42,492,681 and 44,548,100 issued
and outstanding shares at December 31,
1998 and September 30, 1999,
respectively.............................. -- 425 445
Series A and Series B common, par value
$0.01 per share; 20,560,000 issued and
outstanding shares at December 31, 1997,
none issued and outstanding at December
31, 1998 and September 30, 1999........... 205 -- --
Special voting stock, par value $0.01 per
share; exchangeable; 7,700,000 issued and
outstanding shares at December 31, 1997,
5,157,289 issued and outstanding shares at
December 31, 1998 and September 30, 1999.... 77 52 52
Additional paid-in capital................... 15,744 112,483 119,491
Unearned deferred compensation............... -- (635) (488)
Accumulated other comprehensive loss......... (15) (89) (95)
Accumulated deficit.......................... (1,349) (25,177) (21,927)
------- -------- --------
Total shareholders' equity................. 14,662 87,059 97,478
------- -------- --------
Total liabilities and shareholders'
equity.................................... $24,757 $107,829 $122,176
======= ======== ========
</TABLE>
See accompanying notes to consolidated financial statements
F-3
<PAGE>
ENTRUST TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands of dollars, except share and per share data)
<TABLE>
<CAPTION>
Nine Months Ended
Year Ended December 31, September 30,
----------------------------- ----------------------
1996 1997 1998 1998 1999
------ ---------- ---------- ---------- ----------
(unaudited)
<S> <C> <C> <C> <C> <C>
Revenues:
License............... $8,689 $ 16,486 $ 36,773 $ 25,640 $ 42,056
Services and
maintenance.......... 4,113 8,520 12,215 8,337 17,147
------ ---------- ---------- ---------- ----------
Total revenues...... 12,802 25,006 48,988 33,977 59,203
------ ---------- ---------- ---------- ----------
Cost of revenues:
License............... 393 502 1,985 1,319 1,412
Services and
maintenance.......... 3,157 4,414 7,546 5,198 9,476
------ ---------- ---------- ---------- ----------
Total cost of
revenues........... 3,550 4,916 9,531 6,517 10,888
------ ---------- ---------- ---------- ----------
Gross profit............ 9,252 20,090 39,457 27,460 48,315
------ ---------- ---------- ---------- ----------
Operating expenses:
Sales and marketing... 3,858 11,193 26,802 18,338 28,857
Research and
development.......... 2,874 5,692 12,840 9,026 12,111
General and
administrative....... 2,464 3,695 5,046 3,627 5,369
Acquired in-process
research and
development and
goodwill
amortization......... -- -- 20,564 20,386 534
------ ---------- ---------- ---------- ----------
Total operating
expenses........... 9,196 20,580 65,252 51,377 46,871
------ ---------- ---------- ---------- ----------
Income (loss) from
operations............. 56 (490) (25,795) (23,917) 1,444
Interest income......... -- 723 1,807 734 2,733
------ ---------- ---------- ---------- ----------
Income (loss) before
income taxes........... 56 233 (23,988) (23,183) 4,177
(Provision) benefit for
income taxes........... 331 281 160 160 (927)
------ ---------- ---------- ---------- ----------
Net income (loss)....... $ 387 $ 514 $ (23,828) $ (23,023) $ 3,250
====== ========== ========== ========== ==========
Net income (loss) per
share:
Basic................. -- $ 0.02 $ (0.68) $ (0.70) $ 0.07
Diluted............... -- $ 0.01 $ (0.68) $ (0.70) $ 0.06
Weighted average common
shares used in per
share computations:
Basic................. -- 30,700,000 35,254,735 32,842,941 43,503,972
Diluted............... -- 41,742,972 35,254,735 32,842,941 54,598,234
</TABLE>
See accompanying notes to consolidated financial statements
F-4
<PAGE>
ENTRUST TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
for the years ended December 31, 1996, 1997 and 1998 and
the nine months ended September 30, 1999
(in thousands of dollars, except share data)
<TABLE>
<CAPTION>
Series B
Series A Series B Non-Voting Special
Common Stock Common Stock Common Stock Common Stock Voting Stock Additional
----------------- ------------------- ---------------- --------------- ------------------ Paid-In
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Capital
---------- ------ ----------- ------ -------- ------ ------- ------ ---------- ------ ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at
December 31,
1995............ -- $-- -- $ -- -- $-- -- $-- -- $-- $ --
Change in
shareholder's
net
investment..... -- -- -- -- -- -- -- -- -- -- --
Comprehensive
income:
Net income and
total
comprehensive
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)
Change in
shareholder's
net
investment..... -- -- -- -- -- -- -- -- -- -- --
Comprehensive
income (loss):
Net income...... -- -- -- -- -- -- -- -- -- -- --
Translation
adjustment..... -- -- -- -- -- -- -- -- -- -- --
---------- ---- ----------- ----- -------- ---- ------- ---- ---------- ---- --------
Balances at
December 31,
1997............ -- -- 20,300,000 203 221,052 2 38,948 -- 7,700,000 77 15,744
Series A common
shares issued
on option
exercise....... -- -- 14,346 -- -- -- -- -- -- -- 31
Unearned
compensation
related to
stock options
granted........ -- -- -- -- -- -- -- -- -- -- 784
Deferred
compensation
earned......... -- -- -- -- -- -- -- -- -- -- --
Series A common
shares
converted...... 20,314,346 203 (20,314,346) (203) -- -- -- -- -- -- --
Series B common
shares
converted...... 13,063,836 131 -- -- (221,052) (2) (38,948) -- -- -- (129)
Special voting
shares
exchanged...... 2,542,711 25 -- -- -- -- -- -- (2,542,711) (25) --
Redeemable
series A common
shares issued
and converted.. 1,167,288 12 -- -- -- -- -- -- -- -- 17,001
Common shares
issued......... 5,400,000 54 -- -- -- -- -- -- -- -- 86,346
Common shares
issuance
costs.......... -- -- -- -- -- -- -- -- -- -- (7,302)
Common shares
issued on
option
exercise....... 4,500 -- -- -- -- -- -- -- -- -- 8
Comprehensive
income (loss):
Net income...... -- -- -- -- -- -- -- -- -- -- --
Translation
adjustment..... -- -- -- -- -- -- -- -- -- -- --
---------- ---- ----------- ----- -------- ---- ------- ---- ---------- ---- --------
Balances at
December 31,
1998............ 42,492,681 425 -- -- -- -- -- -- 5,157,289 52 112,483
Deferred
compensation
earned
(unaudited).... -- -- -- -- -- -- -- -- -- -- --
Common shares
issued on
option exercise
(unaudited).... 1,981,248 20 -- -- -- -- -- -- -- -- 5,707
Employee Stock
Purchase Plan
shares issued
(unaudited).... 74,171 -- -- -- -- -- -- -- -- -- 1,301
Comprehensive
income (loss):
Net income
(unaudited).... -- -- -- -- -- -- -- -- -- -- --
Translation
adjustment
(unaudited).... -- -- -- -- -- -- -- -- -- -- --
---------- ---- ----------- ----- -------- ---- ------- ---- ---------- ---- --------
Balances at
September 30,
1999
(unaudited)..... 44,548,100 $445 -- $ -- -- $-- -- $-- 5,157,289 $52 $119,491
========== ==== =========== ===== ======== ==== ======= ==== ========== ==== ========
</TABLE>
See accompanying notes to consolidated financial statements
F-5
<PAGE>
ENTRUST TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND
COMPREHENSIVE INCOME--(Continued)
for the years ended December 31, 1996, 1997 and 1998 and the
nine months ended September 30, 1999
(in thousands of dollars, except share data)
<TABLE>
<CAPTION>
Accumulated
Unearned Other Accumulated Comprehensive Total
Deferred Comprehensive Income Income Shareholders'
Compensation Loss (Deficit) (Loss) Equity
------------ ------------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Blanaces at December 31,
1995................... $ -- $-- $ 1,672 $ 1,672
Change in shareholder's
net investment........ -- -- (2,119) (2,119)
Comprehensive income:
Net income and total
comprehensive income.. -- -- 387 $ 387 287
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)
Change in shareholder's
net investment........ -- -- (1,803) (1,803)
Comprehensive income
(loss):
Net income............. -- -- 514 $ 514 514
Translation
adjustment............ -- (15) -- (15) (15)
----- ---- -------- -------- -------
Total comprehensive
income................ $ 499
========
Balances at December 31,
1997................... -- (15) (1,349) 14,662
Series A common shares
issued on option
exercise.............. -- -- -- 31
Unearned compensation
related to stock
options granted....... (784) -- -- --
Deferred compensation
earned................ 149 -- -- 149
Series A common shares
converted............. -- -- -- --
Series B common shares
converted............. -- -- -- --
Special voting shares
exchanged............. -- -- -- --
Redeemable series A
common shares issued
and converted......... -- -- -- 17,013
Common shares issued... -- -- -- 86,400
Common shares issuance
costs................. -- -- -- (7,302)
Common shares issued on
option exercise....... -- -- -- 8
Comprehensive income
(loss):
Net income............. -- -- (23,828) $(23,828) (23,828)
Translation
adjustment............ -- (74) -- (74) (74)
----- ---- -------- -------- -------
Total comprehensive
loss.................. $(23,902)
========
Balances at December 31,
1998................... (635) (89) (25,177) 87,059
Deferred compensation
earned (unaudited).... 147 -- -- -- 147
Common shares issued on
option exercise
(unaudited)........... -- -- -- -- 5,727
Employee Stock Purchase
Plan shares issued
(unaudited)........... -- -- -- -- 1,301
Comprehensive income
(loss):
Net income
(unaudited)........... -- -- 3,250 $ 3,250 3,250
Translation adjustment
(unaudited)........... -- (6) -- (6) (6)
----- ---- -------- -------- -------
Total comprehensive
income................ $ 3,244
========
Balances at September
30, 1999 (unaudited)... $(488) $(95) $(21,927) $97,478
===== ==== ======== =======
</TABLE>
See accompanying notes to consolidated financial statements
F-6
<PAGE>
ENTRUST TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
<TABLE>
<CAPTION>
Nine Months Ended
Year Ended December 31, September 30,
----------------------------- -------------------
1996 1997 1998 1998 1999
-------- -------- --------- --------- --------
(unaudited)
<S> <C> <C> <C> <C> <C>
Cash flows from operating
activities:
Net income (loss)......... $ 387 $ 514 $ (23,828) $ (23,023) $ 3,250
Adjustments to reconcile
net income (loss) to net
cash provided by (used
in) operating
activities:
Depreciation and
amortization........... 204 360 1,261 843 2,229
Adjustment to cumulative
translation account.... -- (15) (74) 4 (6)
Deferred income taxes... 4 (743) (143) (257) (33)
Deferred compensation
earned................. -- -- 149 100 147
Acquired in-process
research and
development............ -- -- 20,208 20,208 --
Changes in operating
assets and liabilities:
Increase in accounts
receivable........... (967) (4,665) (6,212) (4,556) (4,141)
Decrease (increase) in
other receivables.... -- (2,089) (125) 414 (521)
Increase in prepaid
expenses............. (40) (400) (504) (567) (669)
Increase in other
assets............... -- -- (178) -- --
Increase (decrease) in
accounts payable..... 647 335 4,755 2,425 (1,515)
Increase in accrued
liabilities.......... 891 1,121 1,998 1,553 3,542
Increase in deferred
income............... 1,686 1,186 4,573 3,627 1,907
Increase (decrease)
due to related
party................ -- 2,257 (2,588) (2,576) 21
-------- -------- --------- --------- --------
Net cash provided by
(used in) operating
activities........... 2,812 (2,139) (708) (1,805) 4,211
-------- -------- --------- --------- --------
Cash flows from investing
activities:
Purchases of marketable
investments.............. -- (12,308) (145,188) (52,227) (87,603)
Dispositions of
marketable investments... -- 3,695 76,446 21,531 97,758
Purchases of property and
equipment................ (693) (895) (3,791) (1,345) (3,144)
Increase in goodwill and
other long-term assets... -- -- (393) -- (1,518)
Payment on purchase of r3
Security Engineering
AG....................... -- -- (4,391) (4,391) --
-------- -------- --------- --------- --------
Net cash provided by
(used in) investing
activities........... (693) (9,508) (77,317) (36,432) 5,493
-------- -------- --------- --------- --------
Cash flows from financing
activities:
Proceeds from long-term
debt..................... -- 1,449 -- -- --
Repayment of long-term
debt..................... -- -- (1,425) (1,422) (8)
Transfers from Nortel..... 9,716 -- -- -- --
Transfers to Nortel....... (11,835) (1,803) -- -- --
Proceeds from exercise of
stock options and
employee stock purchase
plan..................... -- -- 39 31 7,028
Proceeds from issuance of
5,400,000 common shares,
net of issuance costs of
$7,302................... -- -- 79,098 79,098 --
Proceeds from issuance of
common and special
voting stock, net of
issuance costs of
$2,015................... -- 16,026 -- -- --
-------- -------- --------- --------- --------
Net cash provided by
(used in) financing
activities........... (2,119) 15,672 77,712 77,707 7,020
-------- -------- --------- --------- --------
Net change in cash and cash
equivalents............... -- 4,025 (313) 39,470 16,724
Cash and cash equivalents
at beginning of period.... -- -- 4,025 4,025 3,712
-------- -------- --------- --------- --------
Cash and cash equivalents
at end of period.......... $ -- $ 4,025 $ 3,712 $ 43,495 $ 20,436
======== ======== ========= ========= ========
Non-cash investing and
financing activities:
Issuance of redeemable
Series A common stock
(and subsequent
conversion into common
stock) related to the
acquisition of r3
Security Engineering
AG....................... $ -- $ -- $ 17,013 $ 17,013 $ --
======== ======== ========= ========= ========
</TABLE>
See accompanying notes to consolidated financial statements
F-7
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands of dollars, except share and per share data)
1. Background and Basis of Presentation
Background
In January 1994, Nortel Networks Corporation, and its subsidiary Nortel
Networks 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.
On August 21, 1998, the Company closed its initial public offering
("IPO"), issuing 5,400,000 shares of its Common stock at an initial public
offering price of $16 per share. The net proceeds to the Company from the
offering, after deducting underwriting discounts and commissions and offering
expenses incurred by the Company, were approximately $79.1 million. See note 8
for further detail regarding changes in the issued capital of the Company.
Immediately following the IPO, Nortel owned approximately 55.3% of the
Company's Common stock.
At September 30, 1999, Nortel owned approximately 51.2% of the Company's
Common stock.
Basis of presentation
The historical comparative year results, comprising the statements of
operations, shareholders' equity and cash flows for the year 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 that period. The 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 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 1996 consolidated financial statements, presented here for comparison
purposes, include certain Nortel corporate costs that were allocated to the
Division using procedures deemed
F-8
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
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 1996 consolidated financial statements are
reasonable, but they were not necessarily indicative of the costs that would
have been incurred had the Division functioned as a stand-alone company. No
Nortel corporate costs were allocated to the Company, in this way, in the years
ended December 31, 1997 and 1998 or the nine months ended September 30, 1999.
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.
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 (UK) Limited, its wholly-
owned German subsidiary, Entrust Technologies GmbH, and, its wholly-owned Swiss
subsidiary, r/3/ Security Engineering AG. 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 resulting 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.
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, Germany, Switzerland 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.
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 American Institute of Certified
Public Accountants ("AICPA") issued Statement of Position ("SOP") No. 97-2,
"Software Revenue Recognition", which the Company adopted, effective January 1,
1998. Such
F-9
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
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, collection of the
receivable is probable and payment is due within twelve months.
Revenues from maintenance services are recognized ratably over the term of
the maintenance period, which is typically one year. If maintenance services
are included free of charge or discounted in a license agreement, such amounts
are unbundled from the license fee at their fair market value based upon the
value established by independent sales of such maintenance to customers.
Revenues from the sale of Entrust.net Web server certificates are also
recognized ratably over the term of the certificate (typically one to two
years).
Consulting and training revenues are generally recognized as the services
are performed. Consulting services are typically performed under separate
service agreements and are usually performed on a time and materials basis.
Such services primarily consist of implementation services related to the
installation and deployment of the Company's products and do not 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. Revenues are recognized by
applying the percentage of the total cost incurred to date divided by the total
estimated contract cost to the total contract value, and any projected loss is
recognized immediately. The total project cost estimates are reviewed on a
regular basis.
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 and maintenance 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.
Research and development costs
To date the Company has not capitalized any software 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.
F-10
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
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.
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.
Marketable investments
Marketable investments consist of investments in a strategic cash
management account. This account is invested primarily in highly rated
corporate securities, in securities guaranteed by the U.S. government or its
agencies and highly rated municipal bonds primarily with a remaining maturity
of not more than 12 months. The Company has the intent and ability to hold all
investments until maturity. Therefore, all such investments are classified as
held to maturity investments and stated at amortized cost. At December 31, 1997
and 1998 and September 30, 1999 (unaudited) the amortized cost of the Company's
investments approximated fair value.
The Company's marketable investments consist of the following:
<TABLE>
<CAPTION>
December 31, 1998 September 30, 1999
---------------------- ------------------------------------
Maturity of Maturity of Maturity of
Total Securities Total Securities Securities
Amortized Within One Amortized Within One Greater Than
Cost Basis Year Cost Basis Year One Year
---------- ----------- ----------- ----------- ------------
(unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C> <C>
U.S. government agency
debt securities........ $ 7,825 $ 7,825 $13,394 $13,394 $ --
Corporate debt
securities............. 69,530 69,530 53,806 51,422 2,384
------- ------- ------- ------- ------
$77,355 $77,355 $67,200 $64,816 $2,384
======= ======= ======= ======= ======
</TABLE>
Accounts receivable
The Company's customer base consists primarily of large, well-established
companies or government agencies. Five customers accounted for approximately
55% and 45% of accounts receivable as of December 31, 1997 and 1998,
respectively, and approximately 44% as of September 30, 1999 (unaudited). 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, September 30,
------------- -------------
1997 1998 1999
------ ------ -------------
(unaudited)
<S> <C> <C> <C>
Allowance for doubtful accounts, beginning of
period...................................... $ 129 $ 416 $753
Additional provision......................... 287 450 290
Amounts written-off.......................... -- (113) (384)
------ ------ ----
Allowance for doubtful accounts, end of
period...................................... $ 416 $ 753 $659
====== ====== ====
</TABLE>
F-11
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
Other receivables
Other receivables include federal income tax and Canadian goods and
services tax refunds of $1,644 and $973 at December 31, 1997 and 1998,
respectively, and $1,139 at September 30, 1999 (unaudited). Other receivables
also includes work-in-process relating to a long-term percentage-of-completion
contract of $432 and $826 at December 31, 1997 and 1998, respectively, and
$1,199 at September 30, 1999 (unaudited).
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.
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.
Goodwill and other assets
Goodwill is stated net of accumulated amortization of $356 and $890 at
December 31, 1998 and September 30, 1999 (unaudited), respectively. Goodwill is
being amortized on a straight-line basis over five years. Included in other
long- term assets is an investment of $393 at December 31, 1998 and September
30, 1999 (unaudited), which represents a 10% ownership interest in Entrust
Japan. Other long-term assets also include costs incurred of $1,068 at
September 30, 1999 (unaudited) primarily for licenses used by the Company to
provide services. These costs are amortized straight-line over three to four
years and are stated net of accumulated amortization of $56 at September 30,
1999 (unaudited).
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. As the Company operated as a division of Nortel in 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 that
period.
Stock-based compensation
Stock-based compensation arising from stock option grants is accounted for
by the intrinsic value method under Accounting Principles Board ("APB") Opinion
No. 25. Statement of Financial Accounting Standards ("SFAS") No. 123 encourages
(but does not require) the cost of stock-based
F-12
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
compensation arrangements with employees to be measured based on the fair value
of the equity instrument awarded. As permitted by SFAS No. 123, the Company
applies APB Opinion No. 25 to its stock-based compensation awards to employees
and discloses in Note 9 the required pro forma effect on net income and
earnings per share.
Net income (loss) per share
Basic net income (loss) per share is computed by dividing the net income
(loss) by the weighted average number of shares of Common stock of all classes
outstanding during the period. Diluted net income (loss) per share is computed
by dividing the net income (loss) by the weighted average number of shares of
Common stock and potential Common stock outstanding, and when dilutive,
exchangeable Special Voting stock on an as-if exchanged basis, and options to
purchase Common stock using the treasury stock method. The dilutive effect of
the exchangeable Special Voting stock and the options to purchase Common stock
are excluded from the computation of diluted net income (loss) per share if
their effect is antidilutive. For the year ended December 31, 1998, the
antidilutive effect excluded from the diluted net loss per share computation
due to the exchangeable Special Voting stock outstanding was 6,767,673 shares,
conversion rights of Series B was 1,687,096 shares, and options to purchase
Common stock was 5,437,769 shares. For the nine months ended September 30, 1998
(unaudited) the antidilutive effect excluded from the diluted net loss per
share computation due to the exchangeable Special Voting stock outstanding was
7,304,467 shares, conversion rights of Series B was 2,249,600 shares, and the
option to purchase Common stock was 5,156,750 shares.
Net income (loss) per share has been calculated as follows:
<TABLE>
<CAPTION>
December 31, September 30,
----------------------- ------------------------
1997 1998 1998 1999
----------- ----------- ----------- -----------
(unaudited)
<S> <C> <C> <C> <C>
Net income (loss) available
to common shareholders (in
thousands).................. $ 514 $ (23,828) $ (23,023) $ 3,250
=========== =========== =========== ===========
Weighted average common
shares outstanding:
Basic:
Basic weighted average
common shares
outstanding............... 30,700,000 35,254,735 32,842,941 43,503,972
----------- ----------- ----------- -----------
Basic net income (loss) per
share..................... $ 0.02 $ ( 0.68) $ (0.70) $ 0.07
=========== =========== =========== ===========
Diluted:
Basic weighted average
common shares
outstanding............... 30,700,000 35,254,735 32,842,941 43,503,972
----------- ----------- ----------- -----------
Exchange rights on Special
Voting stock.............. 7,700,000 N/A N/A 5,157,289
Additional conversion
rights of Series B Voting
and Non-Voting common
stock..................... 2,663,836 N/A N/A --
Net effect of dilutive
options using the treasury
stock method.............. 679,136 N/A N/A 5,936,973
----------- ----------- ----------- -----------
Subtotal................. 11,042,972 N/A N/A 11,094,262
----------- ----------- ----------- -----------
Diluted weighted average
common shares
outstanding............... 41,742,972 35,254,735 32,842,941 54,598,234
=========== =========== =========== ===========
Diluted net income (loss)
per share................. $ 0.01 $ (0.68) $ (0.70) $ 0.06
=========== =========== =========== ===========
</TABLE>
F-13
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
Concentration of credit risk
Financial instruments that potentially subject the Company to market and
credit risk consist principally of cash equivalents, marketable 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 equivalents, and marketable investments, with high quality financial
institutions and investment managers. The Company performs periodic reviews of
the credit standing of its investments and the financial institutions managing
those investments.
Recent pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS No.
133"), which establishes accounting and reporting standards for derivative
instruments. SFAS No. 133 is effective beginning in 2000. The Company currently
does not use hedging or derivatives and, as a result, does not anticipate any
impact on the financial statements.
In December 1998, the AICPA issued SOP No. 98-9, "Modifications of SOP 97-
2, Software Revenue Recognition, with Respect to Certain Transactions" ("SOP
No. 98-9"). SOP No. 98-9 requires recognition of revenue using the "residual
method" in a multiple-element software arrangement, whereby the total fair
value of undelivered elements is deferred and recognized in accordance with the
provisions of SOP No. 97-2, "Software Revenue Recognition". The Company will be
required to implement the provisions of SOP No. 98-9 beginning in 2000. The
Company does not expect the adoption of SOP No. 98-9 to have a material impact
on its results of operations.
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 interim financial information
The consolidated financial statements as of and for the nine months ended
September 30, 1998 and 1999 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 nine months ended September 30, 1999 are not necessarily
indicative of results to be expected for the full fiscal year.
F-14
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
3. Acquisition of r/3/ Security Engineering AG and Acquired
In-Process Research and Development
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 Company acquired all the
outstanding shares of r/3/ for an aggregate purchase price of $23,774, which
included approximately $4,391 in cash, $17,013 representing 1,167,288 shares
of Redeemable Series A common stock (subsequently converted into Common stock
upon the closing of the Company's initial public offering), approximately $994
in assumed net 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.
This acquisition has been accounted for under the purchase method of
accounting. In connection with the purchase price allocation, the Company
obtained an independent appraisal of the intangible assets which indicated
approximately $20,208 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.
Further, management estimates that related development costs will continue to
be incurred and, accordingly, the $20,208 was included as an expense in the
consolidated statement of operations for the year ended December 31, 1998.
Goodwill of $3,566 and $450 was recorded as a result of this acquisition, in
1998 and 1999 (unaudited), respectively.
The following unaudited pro forma data summarize the combined results of
operations of Entrust Technologies Inc. and r/3/ as if the acquisition had
taken place as of the beginning of the years presented, and accordingly,
excludes the $20,208 write-off of in-process research and development in 1998
as it would have been a charge to beginning retained earnings, and includes a
full year of goodwill amortization for each year presented.
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1997 1998
----------- -----------
<S> <C> <C>
Revenues........................................... $ 28,635 $ 50,589
=========== ===========
Net loss........................................... (705) (4,923)
=========== ===========
Basic and diluted net loss per share............... (0.02) (0.14)
=========== ===========
</TABLE>
F-15
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
4. Property and Equipment
Property and equipment, at cost, consist of the following:
<TABLE>
<CAPTION>
December 31, September 30,
---------------- -------------
1997 1998 1999
------- ------- -------------
(unaudited)
<S> <C> <C> <C>
Computer and telecom equipment............. $ 1,491 $ 3,345 $ 4,390
Furniture and fixtures..................... 86 1,180 1,795
Leasehold improvements..................... 639 1,504 1,914
Internal-use software...................... 218 668 1,209
------- ------- -------
2,434 6,697 9,308
Less: accumulated depreciation and
amortization.............................. (754) (1,823) (3,518)
------- ------- -------
Subtotal................................... 1,680 4,874 5,790
Assets to be placed in service............. -- -- 533
------- ------- -------
Total property and equipment, net.......... $ 1,680 $ 4,874 $ 6,323
======= ======= =======
5. Accrued Liabilities
Accrued liabilities consist of the following:
<CAPTION>
December 31, September 30,
---------------- -------------
1997 1998 1999
------- ------- -------------
(unaudited)
<S> <C> <C> <C>
Payroll and related benefits............... $ 1,532 $ 3,127 $ 3,079
Stock option witholding taxes payable...... -- -- 2,886
Other...................................... 534 1,865 2,558
------- ------- -------
$ 2,066 $ 4,992 $ 8,523
======= ======= =======
</TABLE>
6. Long-Term Debt
At December 31, 1997, the Company had an installment note with a financial
institution for $1,449. This obligation was unsecured with interest at an
effective rate of 6.9% per annum and was retired in 1998.
F-16
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
7. Income Taxes
The following table presents the U.S. and foreign components of income
(loss) before income taxes and the provision for income taxes. 1996 figures are
estimated on a pro forma basis for comparative purposes.
<TABLE>
<CAPTION>
Year ended
December 31,
---------------------
1996 1997 1998
---- ----- --------
<S> <C> <C> <C>
Income (loss) before income taxes
United States...................................... $ (8) $ 2 $(22,108)
Foreign............................................ 64 231 (1,880)
---- ----- --------
$ 56 $ 233 $(23,988)
==== ===== ========
(Provision) benefit for income taxes
Current:
Federal.......................................... $-- $(337) $ 140
State and local.................................. -- (76) 79
Foreign.......................................... 331 (49) (202)
---- ----- --------
331 (462) 17
---- ----- --------
Deferred:
Federal.......................................... -- 119 (52)
State and local.................................. -- 28 7
Foreign.......................................... 596 188
---- ----- --------
-- 743 143
---- ----- --------
Total benefit for income taxes....................... $331 $ 281 $ 160
==== ===== ========
</TABLE>
A reconciliation between income taxes computed at the federal statutory
rate and income tax benefit is shown below:
<TABLE>
<CAPTION>
Year ended
December 31,
------------------
1996 1997 1998
---- ---- ------
<S> <C> <C> <C>
Income tax (provision) benefit at federal statutory
rate.................................................. $(19) $(79) $8,156
State and local taxes, net of federal benefits......... -- (48) 57
Foreign earnings benefit (tax) at different rate....... (6) 15 80
Acquired in-process research and development and other
expenses not deductible for tax purposes.............. -- -- (6,913)
Valuation allowances on benefit of tax losses.......... -- -- (1,220)
Foreign research and development tax credits utilized.. 331 393 --
Utilization of tax loss carry-forwards................. 25 -- --
---- ---- ------
Total benefit for income taxes......................... $331 $281 $ 160
==== ==== ======
</TABLE>
F-17
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
Deferred income taxes represent the net tax effects of (a) temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes, and
(b) net operating loss (NOL) and tax credit carry-forwards. The tax effects of
significant items comprising the Company's net deferred tax benefits
(liabilities) are as follows:
<TABLE>
<CAPTION>
December
31,
------------
1997 1998
---- ------
<S> <C> <C>
Current asset:
Accruals and valuation
allowances not currently
deductible............... $-- $ 157
Deferred income currently
taxable.................. 347 426
---- ------
Total................... 347 583
---- ------
Non-current asset
(liability):
Accelerated depreciation
for tax purposes......... (7) (34)
United States and Foreign
NOL carry-forwards....... -- 1,220
Valuation allowance....... -- (1,220)
Foreign research and
development tax credit
carry-forwards........... 384 1,307
Valuation allowance....... -- (989)
---- ------
Total................... 377 284
---- ------
Net deferred tax asset...... $724 $ 867
==== ======
</TABLE>
As at December 31, 1998, the Company has available the following income tax
carry-forwards to reduce future income tax liabilities:
<TABLE>
<CAPTION>
Period
Amount Expiring
------ ---------
<S> <C> <C>
Net operating losses (tax benefits):
United States............................................. $ 598 2013
Foreign................................................... 622 2005
------
1,220
Foreign research and development tax credits................ 1,307 2007-2008
------
$2,527
======
</TABLE>
8. 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 the Company's initial public offering. The consolidated financial
statements have been restated to reflect the increase in the number of
authorized shares and these stock splits.
F-18
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
Concurrent with the closing of the initial public offering on August 21,
1998, each of the 20,314,346 outstanding shares of the Company's Series A
common stock and each of the 1,167,288 outstanding shares of the Company's
Redeemable Series A common stock were automatically converted into one share of
Common stock. Also, the 260,000 outstanding shares of the Company's Series B
(including non-voting) common stock were automatically converted into
13,063,836 shares of Common stock. Furthermore, the majority shareholder of the
Company exercised its option to exchange 2,542,711 shares of the Company's
Special Voting stock into the equivalent number of shares of Common stock.
After this exchange, the remaining number of issued and outstanding Special
Voting shares was 5,157,289.
Common Stock
The holders of 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 Company is authorized to issue up to 100,000,000 shares of Common
stock.
Series A and Series B Common Stock
The holders of Series A and Series B common stock were entitled to one vote
per share and were entitled to dividends when and if declared by the Board of
Directors of the Company. The Series B Non-Voting common stock had 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 were automatically converted into 13,063,836 shares of
Common stock upon completion of the public offering of the Company's Common
stock. Also, the Company's Series A common stock was converted to Common stock
upon completion of the public offering. As of December 31, 1998, there were no
issued and outstanding shares of the Company's Series A and Series B common
stock.
Redeemable Series A Common Stock
The holders of the Redeemable Series A common stock were entitled to the
same rights and privileges as the Series A common stock. The 1,167,288 of these
issued and outstanding shares were converted to an equivalent number of shares
of Common stock upon completion of the public offering of the Company's Common
stock. As of December 31, 1998, there were no issued and outstanding shares of
the Company's Redeemable Series A common stock.
Special Voting Stock
The holders of the Special Voting stock also hold an equivalent number of
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
5,157,289 shares of Common stock. The Company generally also has the right to
demand such exchange on or before December 31, 2006.
F-19
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
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 December 31, 1998, the Company had
not issued any shares of Preferred stock.
9. 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, directors, and consultants and authorized
7,228,920 shares of Series A common stock (Common stock following the Company's
public offering) for issuance thereunder. In May 1998, the Company's
shareholders increased the authorized number of shares 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. In July 1998, 400,000 of the
shares available for issuance under the Plan were transferred to the Employee
Stock Purchase Plan. On December 10, 1999, the Company's Board of Directors
approved an increase of 2,500,000 in the number of shares available under the
Plan. The options under the Plan are granted at the then-current fair market
value of the Series A common stock (Common stock following the Company's public
offering) of the Company and generally may be exercised in equal proportions
over the defined vesting period for each grant, generally two to four years,
and expire on the tenth anniversary or upon termination of employment.
A summary of the activity under the Plan is set forth below:
<TABLE>
<CAPTION>
Options Outstanding
--------------------
Weighted
Shares Average
Available Number of Exercise
for Grant Shares 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.............. 2,371,080 --
Granted................. (1,673,016) 1,673,016 11.79
Forfeited............... 121,324 (121,324) 4.44
Exercised............... -- (18,846) 2.13
---------- ----------
Balance at December 31,
1998..................... 1,560,228 8,020,926 4.13
Granted (unaudited)..... (1,230,030) 1,230,030 24.59
Forfeited (unaudited)... 178,738 (178,738) 16.18
Exercised (unaudited)... -- (1,981,248) 3.00
---------- ----------
Balance at September 30,
1999 (unaudited)......... 508,936 7,090,970 7.70
========== ==========
</TABLE>
F-20
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
The number of outstanding options exercisable into common stock was
4,042,662 at September 30, 1999 (unaudited). The weighted average exercise
price of these exercisable outstanding options was $2.95.
The following table summarizes information concerning currently outstanding
options as at September 30, 1999 (unaudited):
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------- --------------------
Weighted Weighted
Number of Weighted 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.......... 4,577,890 7.4 years $ 2.17 3,677,671 $ 2.16
$6.25................... 524,059 8.4 years $ 6.25 167,893 6.25
$12.08 to $17.63........ 672,251 8.8 years $14.35 186,598 14.34
$19.50 to $26.25........ 1,030,670 9.5 years $22.55 10,500 22.88
$26.50 to $34.13........ 286,100 9.6 years $29.72 -- N/A
--------- ---------
7,090,970 4,042,662
========= =========
</TABLE>
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 authorized 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.
Under the terms of the Purchase Plan, the price per share paid by each
participant on the last day of the Offering Period is an amount equal to 90% 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. On December 10, 1999, the
Company's Board of Directors made a change in the Purchase Plan to lower the
price per share paid to an amount equal to 85% of the fair market value of the
Common stock on either the first day or last day of the Offering Period,
whichever is lower, effective for the next Offering Period beginning February
1, 2000.
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.
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 year ended December 31, 1998 because the exercise price of some options
granted in that period were determined, for accounting purposes, 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
recorded unearned deferred
F-21
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
compensation of $784 for the year ended December 31, 1998. This amount is being
amortized over the vesting period of four years from the date of grant, with
$149 amortized into compensation expense as of December 31, 1998 and an
additional $147 amortized into compensation expense in the nine months ended
September 30, 1999 (unaudited). 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 Stock
Incentive 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 (loss) and net income (loss) per share would have
been as follows, on a pro forma basis.
<TABLE>
<CAPTION>
Year ended December
31,
----------------------
1996 1997 1998
---- ------- --------
<S> <C> <C> <C>
Net income (loss), as reported..................... $387 $ 514 $(23,828)
Estimated additional stock based compensation costs
under SFAS 123.................................... -- (1,535) (2,687)
---- ------- --------
Pro forma net income (loss)........................ $387 $(1,021) $(26,515)
==== ======= ========
Basic and diluted net income (loss) per share...... -- $ (0.03) $ (0.75)
==== ======= ========
</TABLE>
The fair value of all options granted prior to the Company's initial public
offering on August 17, 1998 were estimated as of the date of grant using the
minimum value model. The fair value of all options granted subsequent to the
Company's initial public offering were estimated as of the date of grant using
the Black-Scholes option pricing model. The following weighted average
assumptions were used in the calculations.
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Expected option life, in years.................. -- 6 6
Risk free interest rate......................... -- 6.22% 5.37%
Dividend yield.................................. -- -- --
Volatility...................................... -- -- 108%
</TABLE>
The weighted average fair value for stock options granted during 1997 and
1998 was $0.66 and $5.47 per option, respectively.
10. 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:
The Company paid $3,656 and $273 in the years ended December 31, 1996 and
1997, respectively, 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, 1996,
1997, and 1998 of $300, $495, and $1,916, respectively and $386 and $1,247 for
the nine months ended
F-22
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
September 30, 1998 and 1999 (unaudited), respectively. Revenues for the years
ended December 31, 1997 and 1998 include sales to Nortel-affiliated companies
totaling $332 and $2,076, respectively, and $1,949 and $221 for the nine months
ended September 30, 1998 and 1999 (unaudited), respectively. Sales to Nortel-
affiliated companies were immaterial in 1996.
During the years ended December 31, 1997 and 1998 and the nine months ended
September 30, 1999 (unaudited), 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 and
$1,390 for the years ended December 31, 1997 and 1998, respectively, and $946
and $437 for the nine months ended September 30, 1998 and 1999 (unaudited),
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 typically payable net 30 days
from the date of the related intercompany invoice. At December 31, 1998,
accounts receivable included $1,724 related to Nortel. At September 30, 1999
(unaudited), there were no amounts receivable from Nortel and $32 receivable
from Nortel-affiliated companies.
11. Commitments and Contingencies
Lease commitments
The Company leases administrative and sales offices and certain property
and equipment under noncancellable operating leases expiring through 2003 with
certain renewal options. Total rent expense under such leases for the years
ended December 31, 1996, 1997 and 1998 were $100, $956 and $3,083,
respectively, and for the nine months ended September 30, 1998 and 1999
(unaudited) were $1,952 and $3,473, respectively. At September 30, 1999
(unaudited), the future minimum lease payments under operating leases were as
follows:
<TABLE>
<S> <C>
1999 (three months)................................................. $ 1,102
2000................................................................ 4,372
2001................................................................ 2,854
2002................................................................ 1,408
2003................................................................ 672
-------
Total future minimum lease payments................................. $10,408
=======
</TABLE>
Legal proceedings
The Company is subject to various legal proceedings and claims, either
asserted or unasserted, which arise in the ordinary course of business. While
the outcome of these claims cannot be predicted with certainty, management does
not believe that the outcome of any such legal matters will have a material
adverse effect on the consolidated results of operations or consolidated
financial position.
On February 19, 1999, Surety Technologies, Inc. (Surety) filed Civil Action
99-203 against the Company alleging that the Entrust/Timestamp product
infringed various claims of U.S. Patent Re 34,954 (the "954 Patent"). In a
verdict returned on November 3, 1999, a federal jury found that all of
F-23
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
the claims of the 954 Patent asserted by Surety against the Company were
invalid for reasons of both anticipation and obviousness. As a result of the
jury's decision, Surety's complaint has been dismissed with prejudice. On
November 4, 1999, judgment was entered in favor of the Company in the United
States District Court for the Eastern District of Virginia in Civil Action 99-
203.
12. Employee Savings Plan
The Company has a defined contribution retirement savings plan covering
substantially all of its full-time employees. This plan qualifies under Section
401(k) of the Internal Revenue Code for participating U.S. based employees. The
Company matches 50% of employee contributions up to 3% of their individual
compensation. Matching contributions made by the Company totaled $183 and $383
for the years ended December 31, 1997 and 1998, respectively, and $442 for the
nine months ended September 30, 1999 (unaudited).
13. Segment, Geographic and Major Customer Information
Segment information
The Company conducts business in one operating segment; namely, the design,
production and sale of software products and related services for encryption
and digital signature. The nature of the Company's different products and
services is similar and, in general, the type of customers for those products
and services is not distinguishable.
The Company does, however, prepare information for internal use by the
Chief Operating Decision Maker ("CODM"), the President and Chief Executive
Officer, on a geographic basis. Accordingly, under SFAS 131, the Company has
included a summary of the segment financial information reported to the CODM as
follows in the next section regarding geographic information. The Company's
CODM does not view geographic segment results below net income (loss) before
income taxes and, therefore, the provision for income taxes is not broken out
by geographic segment below. The accounting policies of the reportable
geographic segments are the same as those described in the summary of
significant accounting policies.
Geographic information
Revenues are attributed to specific geographical areas based on where the
sales order originated. Long-lived assets and total assets of the Company are
those that are identified with operations in the respective geographic areas.
F-24
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
The Company operates in three main geographic areas as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1996 1997 1998
------- ------- --------
<S> <C> <C> <C>
Revenues:
United States................................ $ 9,758 $14,978 $ 25,861
Canada....................................... 2,571 8,669 11,832
Europe and Asia.............................. 473 1,359 11,295
------- ------- --------
Total revenues............................. $12,802 $25,006 $ 48,988
======= ======= ========
Segment operating income (loss):
United States................................ $ (8) $ (720) $ (3,297)
Canada....................................... 268 356 (167)
Europe and Asia.............................. -- 234 (862)
------- ------- --------
Total segment operating income (loss)...... 260 (130) (4,326)
------- ------- --------
Depreciation and amortization expense:
United States................................ -- 1 410
Canada....................................... 204 356 573
Europe and Asia.............................. -- 3 278
------- ------- --------
Total depreciation and amortization........ 204 360 1,261
------- ------- --------
Interest income:
United States................................ -- 723 1,807
------- ------- --------
Acquired in-process research and development:
United States................................ -- -- 20,208
------- ------- --------
Net income (loss) before income taxes:
United States................................ (8) 2 (22,108)
Canada....................................... 64 -- (740)
Europe and Asia.............................. -- 231 (1,140)
------- ------- --------
Total net income (loss) before income
taxes..................................... $ 56 $ 233 $(23,988)
======= ======= ========
<CAPTION>
December 31,
--------------------------
1996 1997 1998
------- ------- --------
<S> <C> <C> <C>
Long-lived assets (generally depreciated
over three to five years):
United States................................ $ -- $ 118 $ 4,323
Canada....................................... 1,145 1,540 3,510
Europe and Asia.............................. -- 40 775
------- ------- --------
Total long-lived assets.................... $ 1,145 $ 1,698 $ 8,608
======= ======= ========
Total assets:
United States................................ $ 2,025 $18,637 $ 95,110
Canada....................................... 1,662 4,689 8,244
Europe and Asia.............................. -- 1,431 4,475
------- ------- --------
Total...................................... $ 3,687 $24,757 $107,829
======= ======= ========
</TABLE>
F-25
<PAGE>
ENTRUST TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands of dollars, except share and per share data)
Major customer information
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. In 1998, no individual customer accounted for 10% or more of
revenues. For the nine months ended September 30, 1999 (unaudited) there was a
single customer which accounted for 26% of revenues, and no other customers
accounted for 10% or more of revenues.
F-26
<PAGE>
UNDERWRITING
We, the selling stockholders and the underwriters for the offering named
below have entered into an underwriting agreement with respect to the shares
being offered. Subject to the terms of the underwriting agreement, each
underwriter has severally agreed to purchase the number of shares indicated in
the following table. Goldman, Sachs & Co., Bear, Stearns & Co. Inc., Donaldson,
Lufkin & Jenrette Securities Corporation and SoundView Technology Group, Inc.
are the representatives of the underwriters.
<TABLE>
<CAPTION>
Number of
Underwriters Shares
------------ ---------
<S> <C>
Goldman, Sachs & Co................................................
Bear, Stearns & Co. Inc............................................
Donaldson, Lufkin & Jenrette Securities Corporation................
SoundView Technology Group, Inc....................................
---------
Total............................................................ 8,150,000
=========
</TABLE>
If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have an option to buy up to an additional 305,625
and 916,875 shares from us and a selling stockholder, respectively, to cover
such sales. They may exercise that option for 30 days. If any shares are
purchased pursuant to this option, the underwriters will severally purchase
shares in approximately the same proportion as set forth in the table above.
The following tables show the per share and total underwriting discounts
and commissions to be paid to the underwriters by us and the selling
stockholders. Such amounts are shown assuming both no exercise and full
exercise of the underwriters' option to purchase 1,222,500 additional shares.
<TABLE>
<CAPTION>
Paid by Entrust
-------------------------
No Exercise Full Exercise
----------- -------------
<S> <C> <C>
Per Share.......................................... $ $
Total.............................................. $ $
</TABLE>
<TABLE>
<CAPTION>
Paid by Selling
Stockholders
-------------------------
No Exercise Full Exercise
----------- -------------
<S> <C> <C>
Per Share.......................................... $ $
Total.............................................. $ $
</TABLE>
Shares sold by the underwriters to the public will initially be offered at
the initial price to public set forth on the cover of this prospectus. Any
shares sold by the underwriters to securities dealers may be sold at a discount
of up to $ per share from the initial price to public. Any of those
securities dealers may resell any shares purchased from the underwriters to
other brokers or dealers at a discount of up to $ per share from the initial
price to public. If all the shares are not sold at the initial price to public,
the representatives may change the offering price and the other selling terms.
We and the selling stockholders have agreed with the underwriters not to
dispose of or hedge any of our common stock or securities convertible into or
exchangeable for shares of common stock during the period from the date of this
prospectus continuing through the date 90 days after the date of this
prospectus, except with the prior written consent of the representatives. This
agreement does not apply to any existing employee benefit plans.
U-1
<PAGE>
In connection with the offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in this offering.
Stabilizing transactions consist of certain bids or purchases made for the
purpose of preventing or retarding a decline in the market price of the common
stock while the offering is in progress.
The underwriters also may impose a penalty bid. This occurs when a
particular underwriter repays to the underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares
sold by or for the account of such underwriter in stabilizing or short covering
transactions.
These activities by the underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the
open market. If these activities are commenced, they may be discontinued by the
underwriters at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.
As permitted by Rule 103 under the Securities Exchange Act of 1934, some
underwriters and selling group members that, if any, may act as "passive" are
market makers in the common stock, which means they may make bids for or
purchases of common stock in the Nasdaq National Market until a stabilizing bid
has been made. Rule 103 generally provides that:
. a passive market maker's net daily purchases of the common stock may not
exceed 30% of its average daily trading volume in such securities for
the two full consecutive calendar months, or any 60 consecutive days
ending within the 10 days, immediately preceding the filing date of the
registration statement of which this prospectus forms a part;
. a passive market maker may not effect transactions or display bids for
common stock at a price that exceeds the highest independent bid for the
common stock by persons who are not passive market makers; and
. bids made by passive market makers must be identified as such.
We estimate that the total expenses of this offering, excluding
underwriting discounts and commissions, will be approximately $750,000. We will
pay for all of such expenses.
We and the selling stockholders have agreed to indemnify the several
underwriters against certain liabilities, including liabilities under the
Securities Act of 1933.
U-2
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
No dealer, salesperson or other person is authorized to give any
information or to represent anything not contained in this prospectus. You
must not rely on any unauthorized information or representations. This
prospectus is an offer to sell only the shares offered hereby, but only under
circumstances and in jurisdictions where it is lawful to do so. The
information contained in this prospectus is current only as of its date.
---------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 7
Cautionary Note Regarding Forward-Looking Statements..................... 13
Use of Proceeds.......................................................... 14
Price Range of Common Stock
and Dividend Policy..................................................... 14
Capitalization........................................................... 15
Recent Financial Results................................................. 16
Selected Consolidated Financial Data..................................... 17
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 18
Business................................................................. 30
Management............................................................... 47
Selling Stockholders..................................................... 50
Legal Matters............................................................ 50
Experts.................................................................. 51
Where You Can Find More Information...................................... 51
Index to Consolidated Financial Statements............................... F-1
Underwriting............................................................. U-1
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
8,150,000 Shares
Entrust Technologies Inc.
Common Stock
---------------
[Logo]
---------------
Goldman, Sachs & Co.
Bear, Stearns & Co. Inc.
Donaldson, Lufkin & Jenrette
SoundView Technology Group
Representatives of the Underwriters
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 14. Other Expenses of Issuance and Distribution
The following table sets forth the various expenses, all of which will be
borne by us, 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............................................... $123,717
NASD filing fee.................................................... 47,363
Nasdaq National Market listing fee................................. 17,500
Blue Sky and similar fees and expenses............................. 10,000
Transfer Agent and Registrar fees.................................. 5,000
Accounting fees and expenses....................................... 150,000
Legal fees and expenses............................................ 250,000
Printing and mailing expenses...................................... 100,000
Miscellaneous...................................................... 46,420
--------
Total............................................................ $750,000
========
</TABLE>
Item 15. 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 Underwriting Agreement, a form of which is filed as Exhibit 1 to this
Registration Statement on Form S-3, provides 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. Reference is made to
the form of Underwriting Agreement.
Two of the directors of the Registrant are also officers of Nortel Networks
Corporation ("NNC"), a shareholder of the Registrant, and are serving on the
Registrant's Board of Directors at the request of NNC. Pursuant to NNC's
Bylaws, NNC will indemnify its officers when they are acting at NNC's
II-1
<PAGE>
request as directors of a corporation of which NNC is a shareholder, provided
that such officers acted honestly, in good faith and had reasonable grounds to
believe their conduct was lawful.
Item 16. Exhibits
<TABLE>
<CAPTION>
Exhibit
No. Description
------- -----------
<C> <S>
1* Form of Underwriting Agreement.
4.1** Specimen Certificate for shares of Common Stock, $.01 par value, of
the Registrant.
5* Opinion of Hale and Dorr LLP with respect to the validity of the
securities being offered.
23.1 Consent of Hale and Dorr LLP (included in Exhibit 5).
23.2 Consent of Deloitte & Touche LLP.
24 Powers of Attorney (included on page II-3).
</TABLE>
- --------
* To be filed by amendment.
** Incorporated herein by reference to the Registrant's Registration Statement
on Form S-1 (File No. 333-57275).
Item 17. Undertakings
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, 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 will 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 of 1933, 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.
The Registrant hereby undertakes that, for purposes of determining any
liability under the Securities Act of 1933, each filing of the Registrant's
annual report pursuant to Section 13(a) or 15(d) of the Securities Exchange Act
of 1934 (and, where applicable, each filing of an employee benefit plan's
annual report pursuant to Section 15(d) of the Securities Exchange Act of 1934)
that is incorporated by reference in this Registration Statement shall be
deemed to be a new registration statement relating to the securities offered
therein and the offering of such securities at the time shall be deemed to be
the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the indemnification provisions described herein, 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-2
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in Plano, Texas, on this 25th day of January, 2000.
Entrust Technologies Inc.
/s/ John A. Ryan
By: _________________________________
John A. Ryan
President and Chief Executive
Officer
POWER OF ATTORNEY AND SIGNATURES
We, the undersigned officers and directors of Entrust Technologies Inc.,
hereby severally constitute and appoint John A. Ryan, David L. Thompson, James
D. Kendry and James R. Burke and each of them singly, our true and lawful
attorneys with full power to them and each of them singly, to sign for us and
in our names in the capacities indicated below, the Registration Statement on
Form S-3 filed herewith and any and all pre-effective and post-effective
amendments to said Registration Statement and any subsequent Registration
Statement for the same offering which may be filed under Rule 462(b) and
generally to do all such things in our names and on our behalf in our
capacities as officers and directors to enable Entrust Technologies Inc. to
comply with the provisions of the Securities Act of 1933, and all requirements
of the Securities and Exchange Commission, hereby ratifying and confirming our
signatures as they may be signed by our said attorneys, or any of them, to said
Registration Statement and any and all amendments thereto or to any subsequent
Registration Statement for the same offering which may be filed under Rule
462(b).
II-3
<PAGE>
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ John A. Ryan - President, Chief Executive January 25, 2000
______________________________________ Officer and Director
John A. Ryan
/s/ David L. Thompson - Senior Vice President and January 25, 2000
______________________________________ Chief Financial Officer
David L. Thompson (Principal Financial and
Accounting Officer)
/s/ F. William Conner - Director January 24, 2000
______________________________________
F. William Conner
/s/ Butler C. Derrick, Jr. Director January 25, 2000
______________________________________
Butler C. Derrick, Jr.
/s/ Jawaid Ekram Director January 24, 2000
______________________________________
Jawaid Ekram
/s/ Terrell B. Jones Director January 23, 2000
______________________________________
Terrell B. Jones
/s/ Michael P. Ressner Director January 24, 2000
______________________________________
Michael P. Ressner
/s/ Christopher M. Stone Director January 25, 2000
______________________________________
Christopher M. Stone
/s/ James A. Thomson Director January 24, 2000
______________________________________
James A. Thomson
</TABLE>
II-4
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No. Description
------- -----------
<C> <S>
1* Form of Underwriting Agreement.
4.1** Specimen Certificate for shares of Common Stock, $.01 par value, of
the Registrant.
5* Opinion of Hale and Dorr LLP with respect to the validity of the
securities being offered.
23.1 Consent of Hale and Dorr LLP (included in Exhibit 5).
23.2 Consent of Deloitte & Touche LLP.
24 Powers of Attorney (included on page II-3).
</TABLE>
- --------
* To be filed by amendment.
** Incorporated herein by reference to the Registrant's Registration Statement
on Form S-1 (File No. 333-57275).
<PAGE>
Exhibit 23.2
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Registration Statement of Entrust Technologies
Inc. on Form S-3 of our report dated February 5, 1999 (November 4, 1999 as to
Note 11, third paragraph) 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 LLP
Dallas, Texas
January 24, 2000
