| ENTRUST INC ITEM 1A RISK FACTORS CERTAIN FACTORS THAT MAY AFFECT OUR BUSINESS Our revenues and operating results are subject to significant fluctuations and such fluctuations may lead to a reduced market price for our stock |
| Our 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, or the guidance that we provide, 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: • reduced capital expenditures for software; • length of sales cycles associated with our product offerings; • the timing, size and nature of our licensing transactions; • the increased dependency on partners for end user fulfillment; • market acceptance of new products or product enhancements by us; • market acceptance of new products or product enhancements by 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; • fluctuations in foreign currency exchange rates; and • reduced spending by critical vertical markets |
| 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 order backlog |
| Thus, quarterly license revenues depend heavily upon orders received and shipped within the same quarter |
| Moreover, we historically have recorded 50prca to 60prca 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 |
| 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 15 ______________________________________________________________________ [52]Table of Contents 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 |
| Because of the lengthy and unpredictable sales cycle associated with our large software transactions, we may not succeed in closing transactions on a timely basis or at all, which would adversely affect our revenues and operating results |
| Transactions for our solutions often involve large expenditures, and the sales cycles for these transactions are often lengthy and unpredictable |
| Factors affecting the sales cycle include: • customers’ budgetary constraints, particularly in a soft economic environment where technology spending is often deferred; • 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, or below the targeted guidance range that we have provided, 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 maintain or replace these customer relationships, and for a significant percentage of our accounts receivable |
| Historically, a limited number of customers have accounted for a significant percentage of our revenues |
| In 2005, 2004 and 2003, our three largest customers accounted in the aggregate for 31prca, 32prca and 29prca of revenues, respectively |
| 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 large 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 material adverse effect on our revenues |
| In addition, our accounts receivable include material balances from a limited number of customers, with five customers accounting in the aggregate for 36prca of gross accounts receivable at December 31, 2005, compared to 31prca of gross accounts receivable at December 31, 2004 |
| One customer individually accounted for 10prca or more of net accounts receivable at December 31, 2005, at 17prca |
| As of December 31, 2005, the total accounts receivable is dlra20dtta3 million, net of an allowance for doubtful accounts of dlra0dtta5 million |
| Changes in the financial condition of these customers could result in a different assessment of the existing credit risk of our accounts receivable and thus, a different required allowance, which could have a material impact on our reported earnings |
| The US and Canadian Federal Governments account for a significant percentage of our revenues, which may decline or be subject to delays, which would adversely affect our operating results |
| The extended government vertical (Governments, including Healthcare) accounted for 55prca of our product revenue in 2005 and 24prca of product revenue in 2004 |
| The US and Canadian governments represented 17prca and 10prca of total revenues, respectively, in 2005, which includes revenues sold through resellers to these government end users |
| Sustaining and growing revenues in the government market will depend, in large part, on the following: • the adoption rate of our products within government departments and agencies; • the timing and amount of budget appropriations for information technology and specifically information security; 16 ______________________________________________________________________ [53]Table of Contents • the timing of adoption of information security policies and regulations, including, but not limited to the Health Insurance Portability and Accountability Act of 1996 (HIPAA), the Gramm-Leach-Bliley Act and the California Breach Disclosure Law (SB1386); and • our ability to develop and maintain the appropriate business relationships with partners with whom the government contracts for information security projects |
| A decline, or delay in the growth of this market could reduce demand for our products, adversely affecting our revenues and results of operations |
| In addition, changes in Government officials as a result of elections could have an impact on our prospects in the Government market |
| Our ability to sell to the Government may also be impacted by changes to, or termination of, the supply agreement(s) we have in place with the Government, which from time to time come up for renewal and renegotiation |
| Finally, failure to properly monitor pricing on government contracts could result in liability for penalties to the government for non-compliance |
| We sometimes enter into complex contracts, which require ongoing monitoring and administration |
| Failure to monitor and administer these contracts properly could result in liability or damages |
| We sometimes enter into complex contracts with our Government customers that contain clauses that provide that if a customer who falls within a specific category (known as a Relevant Customer) is offered better terms on the Company’s software products and related services that had been offered to the Government customer, then the Government customer will be able to buy additional quantities of those software products and services for the same length of time, from the same effective date and on the better terms that were offered to the Relevant Customer |
| The Company monitors compliance with these contracts on a continuous basis |
| The Company also conducts periodic self-assessments to ensure that the contracts are being properly administered and that there are no accruing liabilities for non-compliance |
| If these contracts are not properly monitored and administered, they may be breached and could result in damages payable by us which, depending on their magnitude, could have a material adverse effect on our business, financial condition and results of operations |
| War, the significant threat of war, or a terrorist act could adversely affect our business |
| Historically, the economy has been adversely affected by war, the significant threat of war and terrorist acts |
| Any of these factors could cause one or more of the following to occur: • government spending could be reprioritized to wartime activities; • global enterprise spending budgets could be cut or delayed resulting in lower demand for our products; or • widespread and unprecedented acts of cyber-terrorism could cause disruption of communications and technology infrastructures, which could impact our customers or products and could have unforeseen economic impacts |
| A decline or delay in economic spending due to war, the significant threat of war or a terrorist act could reduce demand for our products, materially adversely affecting our revenues and results of operations |
| A widespread outbreak of an illness or other health issue could negatively affect our business, making it more difficult and expensive to meet our obligations to our customers, and could result in reduced demand from our customers |
| A number of countries in the Asia/Pacific region have experienced outbreaks of SARS and/or bird flu |
| As a result of such an outbreak, businesses can be shut down temporarily and individuals can become ill or quarantined |
| Outbreaks of infectious diseases such as these, particularly in North America, Europe or other locations significant to our operations, could adversely affect general commercial activity, which could have a material adverse effect on our financial condition, results of operations, business or prospects |
| If our operations 17 ______________________________________________________________________ [54]Table of Contents are curtailed because of health issues, we may need to seek alternate sources of supply for services and staff and these alternate sources may be more expensive |
| Alternate sources may not be available or may result in delays in shipments to our customers, each of which would affect our results of operations |
| In addition, a curtailment of our product design operations could result in delays in the development of new products |
| Further, if our customers’ businesses are affected by health issues, they might delay or reduce purchases from us, which could adversely affect our results of operations |
| If the enterprise information technology budgets and the digital identity security market do not continue to grow, demand for our products and services will be adversely affected |
| The market for digital identity and information security solutions is at an early stage of development |
| Continued growth of the digital identity security market will depend, in large part, on the following: • the continued increase in the number of organizations adopting or expanding intranets and extranets; • the rate of adoption of Internet-based business applications such as Web Services; • the ability of network infrastructures to support an increasing number of users and services; • the public recognition of the potential threat posed by computer hackers and other unauthorized users; and • the continued development of new and improved services for implementation across the Internet, intranets and extranets |
| A decline in the growth of this market could reduce demand for our products, adversely affecting our revenues and results of operations |
| A breach of security at one of our customers, whether or not due to our products, could harm our reputation and reduce the demand for our products |
| The processes used by computer hackers to access or sabotage networks and intranets are rapidly evolving |
| A well-publicized actual or perceived breach of network or computer security at one of our customers, regardless of whether such breach is attributable to our products, third-party technology used within our products or any significant advance in techniques for decoding or “cracking” encrypted information, could adversely affect the market’s perception of us and our products, and could have an adverse effect on our reputation and the demand for our products |
| In addition, the security level of our products is dependent upon the processes and procedures used to install and operate our products |
| Failure on the part of our customers to properly install and operate our products, could cause a security breach, which 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 |
| Our existing testing procedures may not detect errors, failures or bugs in our software products |
| Such errors may become evident at any time during the life of our products |
| The discovery of any errors, failures or bugs in any products, including third-party technology incorporated into our products, may result in: • adverse publicity; • product returns; • the loss or delay of market acceptance of our products; and • third-party claims against us |
| Accordingly, the discovery of any errors, failures or bugs may have a significant adverse effect on the sales of our products and our results of operations |
| 18 ______________________________________________________________________ [55]Table of Contents We have invested in technology companies in the start-up or development stage whose products and technology may not succeed, which may result in a loss of all or substantially all of our investment |
| We have invested in several privately held companies, including Asia Digital Media and ADML Holdings, Ltd, including its affiliate, Ohana Wireless, Inc |
| (collectively, “Ohana”) |
| Most of these companies are technology companies in the start-up or development stage, or are companies with technologies and products that are targeted at geographically distant markets |
| If the demand for the technologies and products offered by these privately held companies materializes slowly, to a minimum extent, or not at all in relevant markets, we could lose all or substantially all of our investment in these companies, which would have an adverse effect on our business, financial condition and results of operations |
| Our revenues may decline if we cannot compete successfully in an intensely competitive market |
| We target our products at the rapidly evolving market for digital identity and information 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 and increased market volatility in our industry 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 |
| The emerging market for digital identity and information security products and related services is characterized by rapid technological developments, frequent new product introductions and evolving industry standards |
| To be competitive, we have to continually improve the performance, features and reliability of our products and services, particularly in response to competitive offerings, and be first to market with new products and services or enhancements to existing products and services |
| Our failure to develop and introduce new products and services successfully on a timely basis and to achieve market acceptance for such products and services could have a significant adverse effect on our business, financial condition and results of operations |
| We may have difficulty managing our operations, which could adversely affect our ability to successfully grow our business |
| 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 may make it more difficult to manage our growth |
| We depend on our key personnel for the success of our business and the loss of one or more of our key personnel could have an adverse effect on our ability to manage our business or could be negatively perceived in the capital markets |
| Our success and our ability to manage our business depend, in large part, upon the efforts and continued service of our senior management team |
| The loss of one or more of our key personnel could have a material 19 ______________________________________________________________________ [56]Table of Contents adverse effect on our business and operations |
| It could be difficult for us to find replacements for our key personnel, as competition for such personnel is intense |
| Further, such a loss could be negatively perceived in the capital markets, which could reduce the market value of our securities |
| 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 information security, 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 |
| These challenges are made more severe by our history of operating losses, the employment reductions from our restructurings, and the fact that the exercise price of a majority of outstanding stock options is below the current market price of our stock |
| 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 |
| 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 |
| Finally, the protections we have obtained may not be sufficient because: • some courts have held that shrink-wrap licenses, because they are not signed by the licensee, are not enforceable; • our trade secrets, confidentiality agreements and patents may not provide meaningful protection of our proprietary information; and • we may not seek additional patents on our technology or products, and such patents, even if obtained, may not be broad enough to protect our technology or products |
| Our inability or failure to protect our proprietary rights could have a significant adverse effect on our business, financial condition or results of operations, while actions taken to enforce our intellectual property rights could substantially increase our quarterly expenses |
| We have been subject to, and may in the future become subject to, intellectual property infringement claims that could be costly and could result in a diversion of management’s attention |
| As the number of security products in the industry and the functionality of these products further overlaps, software developers and publishers may increasingly become subject to claims of infringement or misappropriation of the intellectual property or proprietary rights of others |
| From time to time, we have received notices from third parties either soliciting our interest in obtaining a license under one or more patents owned or licensed by these third parties or suggesting that our products may be infringing one or more patents owned or licensed by these third parties |
| 20 ______________________________________________________________________ [57]Table of Contents From time to time, we have received notices from various customers stating that we may be responsible for indemnifying such customers pursuant to indemnification obligations in product license agreements with such customers for alleged infringement of patents assigned to third parties |
| To date, we are not aware that any customer has filed an action against us for indemnification |
| In addition, third parties may assert infringement or misappropriation claims against us in the future |
| Defending or enforcing our intellectual property could be costly and could result in a diversion of management’s attention, which could have a significant adverse effect on our business, financial condition or results of operations |
| A successful claim against us could also have a significant adverse effect on our results of operations for the period in which damages are paid |
| Additionally, as a result of a successful claim, we could potentially be enjoined from using technology that is required for our products to remain competitive, which could in turn have an adverse effect on our results of operations for subsequent periods |
| We may lose access to technology that we license from outside vendors, which loss could adversely affect our ability to sell our products |
| We rely on outside licensors for patent and/or software license rights in technology that is incorporated into and is necessary for the operation of our products |
| 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 |
| We rely on partners to integrate our products with their products and to resell our products |
| Changes in these relationships could adversely affect our ability to sell our products |
| We rely on partners to integrate our products with their products or to maintain adherence to industry standards so that our products will be able to work with them to provide enhanced security attributes |
| For example, our ability to provide digital signatures on Adobe forms is dependent upon Adobe continuing to allow Entrust to have access to their private Application Programming Interfaces in future releases |
| In addition, we have resale relationships with companies such as Critical Path, Pointsec and Sun Microsystems/Waveset |
| Inability to maintain these relationships could have a material adverse effect on our results of operations |
| 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 |
| For example, in June 2004, we acquired intellectual property and certain other assets of AmikaNow! |
| In addition, in September 2004, we acquired majority ownership of Entrust Japan for dlra1dtta7 million |
| While management expects to successfully integrate the newly acquired technology and operations, each of the above risks apply to these acquisitions |
| As a result of our June 2001 and May 2003 restructuring plans, we have made certain assumptions in estimating the accrued restructuring charges |
| If these assumptions change, they could have a material effect on our reported results |
| In recent periods, we announced two major restructuring plans in June 2001 and in May 2003 as a result of the slowdown in the global electronics industry and the worldwide economy |
| The restructuring plans included a 21 ______________________________________________________________________ [58]Table of Contents workforce reduction, the consolidation of excess facilities, the reassessment of the value of related excess long-lived assets and the discontinuance of non-core products and programs |
| As a result of the June 2001 restructuring plan, we recorded restructuring and other non-recurring charges, excluding goodwill impairment, of dlra106dtta6 million in the second quarter of 2001 |
| Our assessment of the accounting effects of the June 2001 restructuring plan required assumptions in estimating the original accrued restructuring charges, including estimating future recoveries of sublet income from excess facilities, liabilities from employee severances, and costs to exit business activities |
| Changes in these assumptions, with respect to the accrued restructuring charges for the June 2001 restructuring plan of dlra25dtta5 million at December 31, 2005, could have a material effect on our reported results |
| As a result of the May 2003 restructuring plan, we recorded restructuring charges, excluding impairments, of dlra8dtta9 million |
| Our assessment of the accounting effect of the May 2003 restructuring plan required assumptions in estimating the original incurred and expected restructuring charges of dlra8dtta9 million, including estimating liabilities from employee severances, future recoveries of sublet income from excess facilities, and other costs to exit activities |
| Changes in these assumptions, with respect to the accrued restructuring charges for the May 2003 restructuring plan of dlra0dtta4 million at December 31, 2005, could have a material effect on our reported results |
| We face risks associated with our international operations, which, if not managed properly, could have a significant adverse effect on our business, financial condition or results of operations |
| In the future, we may establish additional foreign operations, hire additional personnel and establish relationships with additional partners internationally |
| This expansion would require significant management attention and financial resources and could have an adverse effect on our business, financial condition and results of operations |
| Although our international sales currently are primarily denominated in US 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 US export licenses, especially for products containing encryption technology; • potentially longer payment cycles for customer payments; • increased costs associated with maintaining international marketing efforts; • introduction of non-tariff barriers and higher duty rates; • difficulties in enforcement of contractual obligations and intellectual property rights; • difficulties managing personnel, partners and operations in remote locations; and • increased complexity in global corporate tax structure |
| Any one of these risks could significantly and adversely affect our business, financial condition or results of operations |
| We face risks associated with our investment in Asia, which could have a significant adverse effect on our business, financial condition or results of operations |
| In total we have invested dlra3dtta7 million in Asia Digital Media and dlra1dtta5 million in Ohana, including loans to Ohana that converted into equity in that company |
| Asia Digital Media and Ohana are joint ventures in the start-up or development stage, and may lack the financial resources, licenses, technology and governmental approvals necessary to import, develop or offer for sale in China any commercial product or service |
| Joint ventures, such as these, also carry risks as a result of potentially conflicting objectives between the joint venture owners including, but not limited to, agreement on business plans, budgets, and key staffing decisions |
| The success of Asia Digital Media and Ohana depends in large part on conditions in the Chinese market and receipt of government approvals 22 ______________________________________________________________________ [59]Table of Contents required to export into China and conduct business there |
| As such, Asia Digital Media and Ohana face several risks including technological risk, competitive risk, risks pertaining to governmental approvals, political risks, currency risks, funding risks and risks of end-user acceptance |
| For example, if the demand for the technologies and products developed or offered by Asia Digital Media and Ohana materialize slowly, if the businesses fail to achieve important technical development milestones, fail to achieve necessary governmental approvals and licensing requirements, or fail to raise additional money to continue its development plan, we could lose all or substantially all of our investment in Asia Digital Media and Ohana |
| 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, United States governmental controls on the export of encryption products and technology may in the future restrict our ability to export some of our products |
| Our stock price is volatile and may continue to be volatile in the future |
| The trading price of our Common stock has been, and is expected to continue to be, highly volatile and may be significantly and adversely affected by factors such as: • actual or anticipated fluctuations in our operating results; • announcements of technological innovations; • new products introduced by, or new contracts entered into 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 |
| Provisions of our charter and bylaws may delay or prevent transactions that are in our shareholders’ 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 |
| We think these measures enable us to review offers for our shares of Common stock to determine if they are in the best interests of our stockholders |
| 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 5cmam000cmam000 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 |