-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Borsr5ZQN7iFGKHUQ6b3e70jjtH6tG1fw2X/PDTl/zyELj4Sb8FKrZ3Jhdyq+ZDe c42sfvfZHPmsG0XpcGj0vQ== /in/edgar/work/20000914/0000950005-00-000979/0000950005-00-000979.txt : 20000922 0000950005-00-000979.hdr.sgml : 20000922 ACCESSION NUMBER: 0000950005-00-000979 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000731 FILED AS OF DATE: 20000914 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CERTICOM CORP CENTRAL INDEX KEY: 0001075710 STANDARD INDUSTRIAL CLASSIFICATION: [7371 ] FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-15010 FILM NUMBER: 723083 BUSINESS ADDRESS: STREET 1: 200 MATHESON BOULEVARD WEST CITY: MISSISSAUGA STATE: A6 BUSINESS PHONE: 9055074220 10-Q 1 0001.txt 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended July 31, 2000 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ___ to ___ Commission File Number: 001-15010 CERTICOM CORP. -------------------------------------------------------------- (Exact name of registrant as specified in its charter) Yukon Territory, Canada Not Applicable - ----------------------- ------------------- (Province or other (I.R.S. Employer jurisdiction of Identification No.) incorporation) 25801 Industrial Boulevard Hayward, California 94545 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (510) 780-5400 ----------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No ___ As of September 11, 2000, there were 25,853,749 of registrant's common shares, no par value, outstanding. TABLE OF CONTENTS
Page Exchange Rate Information................................................................................ 1 Special Note Regarding Forward-Looking Statements........................................................ 1 PART I. FINANCIAL INFORMATION Item 1. Financial Statements............................................................................. 2 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............ 7 Factors That May Affect Operating Results.................................................... 12 Item 3. Quantitative and Qualitative Disclosure About Market Risk........................................ 22 PART II. OTHER INFORMATION Item 1. Legal Proceedings................................................................................ 23 Item 2. Changes in Securities and Use of Proceeds........................................................ 23 Item 6. Exhibits and Reports on Form 8-K................................................................. 24 Signatures............................................................................................... 25
All information in this Form 10-Q gives effect to the 2-for-1 split of our outstanding common shares which was effective on July 12, 2000. Certicom(R), certicom encryption(TM), SSL Plus(TM), SSL Plus for Embedded Systems(TM), WTLS Plus(TM), Certifax(TM), Certilock(TM), Security Builder(R), MobileTrust(TM), and Trustpoint(TM) are trademarks of Certicom. In this Form 10-Q, the terms "Certicom," "we," "us," and "our" refer to Certicom Corp., a Yukon Territory corporation, and/or its subsidiaries. EXCHANGE RATE INFORMATION Unless otherwise indicated, all dollar amounts in this Form 10-Q are expressed in United States dollars. References to "$" or "U.S.$" are to United States dollars, and references to "Cdn.$" are to Canadian dollars. The following table sets forth, for each period indicated, information concerning the exchange rates between U.S. dollars and Canadian dollars based on the noon buying rate in the City of New York on the last business day of each month during the period for cable transfers as certified for customs purposes by the Federal Reserve Bank of New York (the "Noon Buying Rate"). The table illustrates the portion of a U.S. dollar it would take to buy one Canadian dollar. U.S.$ per Cdn.$ Noon Buying Rate ---------------- Average(1) Low High Period End ---------- --- ---- ---------- Twelve months ended ------------------- April 30, 2000 0.6804 0.6969 0.6607 0.6756 Three months ended ------------------ July 31, 1999 0.6787 0.6891 0.6607 0.6639 July 31, 2000 0.6740 0.6831 0.6629 0.6720 - ------------- (1) The average of the daily Noon Buying Rates on the last business day of each month during the period. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Certain statements contained in this Form 10-Q constitute "forward-looking statements" within the meaning of the United States Private Securities Litigation Reform Act of 1995. When used in this document, the words "may," "would," "could," "will," "intend," "plan," "anticipate," "believe," "estimate," "expect" and similar expressions, as they relate to us or our management, are intended to identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions. Many factors could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements, including, among others, those which are discussed in "Factors That May Affect Operating Results" beginning on page 12 of this Form 10-Q, in our Annual Report on Form 10-K and in other documents that we file with the Securities and Exchange Commission and Canadian securities regulatory authorities. Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking statements prove incorrect, actual results may vary materially from those described herein as intended, planned, anticipated, believed, estimated or expected. We do not intend, and do not assume any obligation, to update these forward-looking statements. 1 PART I. FINANCIAL INFORMATION Item 1. Financial Statements CERTICOM CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands of U.S. dollars, except number of shares)
April 30, July 31, 2000 2000 -------------- -------------- (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 10,508 $ 50,251 Marketable securities, available for sale 2,550 3,585 Accounts receivable (net of allowance for doubtful accounts of $161 and $211, respectively) 3,862 3,525 Unbilled receivables 2,115 2,198 Inventories 218 250 Prepaid expenses and deposits 1,740 1,281 - ------------------------------------------------------------------------------------------------------------------- Total current assets 20,993 61,090 Property and equipment, net 5,213 5,794 Patents 873 953 Acquired intangibles (net of accumulated amortization of $10,586 and $12,662, respectively) 24,437 22,361 - ------------------------------------------------------------------------------------------------------------------- Total assets $ 51,516 $ 90,198 =================================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 974 $ 2,437 Accrued liabilities 2,107 2,742 Income taxes payable 430 516 Deferred revenue 909 1,122 Note payable 10,000 - - ------------------------------------------------------------------------------------------------------------------- Total current liabilities 14,420 6,817 Lease inducements 1,105 1,064 - ------------------------------------------------------------------------------------------------------------------- Total liabilities 15,525 7,881 Shareholders' equity: Common shares, no par value; shares authorized: unlimited; shares issued and outstanding: 23,087,866 and 25,747,549, respectively (1) 80,859 133,386 Additional paid-in capital 11,922 13,851 Deferred compensation expense - (1,516) Accumulated other comprehensive loss (2,497) (2,464) Deficit (54,293) (60,940) - ------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 35,991 82,317 - ------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 51,516 $ 90,198 =================================================================================================================== (1) Number of shares has been retroactively adjusted to reflect the 2-for-1 stock split which was effective on July 12, 2000. See accompanying notes to condensed consolidated financial statements.
2 CERTICOM CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands of U.S. dollars, except number of shares and per share data)
Three months ended July 31, 1999 2000 ---------------- -------------- (Unaudited) (Unaudited) Revenues $ 2,148 $ 5,053 - --------------------------------------------------------------------------------------------------------------- Costs and expenses: Selling and marketing 1,272 3,139 Research and development 810 2,428 Depreciation and amortization 1,730 2,748 General and administrative (including deferred compensation amortization of $0 and $111, respectively) 1,533 2,583 Consulting and systems integration 322 1,019 Cost of hardware sold 9 232 - --------------------------------------------------------------------------------------------------------------- Total costs and expenses 5,676 12,149 Operating loss (3,528) (7,096) Non-cash interest income (expense) - (423) Interest income (expense), net (70) 952 - --------------------------------------------------------------------------------------------------------------- Loss before income taxes (3,598) (6,567) Income taxes 78 80 - --------------------------------------------------------------------------------------------------------------- Net loss (3,676) (6,647) Other comprehensive income: Unrealized gain on marketable securities, available for sale - 33 - --------------------------------------------------------------------------------------------------------------- Comprehensive loss $ (3,676) $ (6,614) - --------------------------------------------------------------------------------------------------------------- Basic and diluted net loss per share (1) $ (0.17) $ (0.26) =============================================================================================================== Shares used in computing basic and diluted net loss per share (1) 21,842,677 25,571,708 =============================================================================================================== (1) Number of shares and per share data have been retroactively adjusted to reflect the 2-for-1 stock split which was effective on July 12, 2000. See accompanying notes to condensed consolidated financial statements.
3 CERTICOM CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands of U.S. dollars)
Three months ended July 31, 1999 2000 ---------------- --------------- (Unaudited) (Unaudited) Cash flows from operating activities: Net loss $ (3,676) $ (6,647) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 280 672 Amortization of acquired intangibles 1,478 2,076 Stock compensation 80 190 Non-cash interest expense - 423 Changes in non-cash working capital items (1,385) 3,071 - --------------------------------------------------------------------------------------------------------------- Net cash used in operating activities (3,223) (215) - --------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Purchase of property and equipment (659) (1,247) Patents (79) (86) Purchase of marketable securities, available for sale (5,334) (1,035) Sales and maturities of marketable securities, available for sale 8,914 - - --------------------------------------------------------------------------------------------------------------- Net cash (used in) provided by investing activities 2,842 (2,368) - --------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Issuance of common shares 33 52,326 Note payable - (10,000) - --------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 33 42,326 - --------------------------------------------------------------------------------------------------------------- (Decrease) increase in cash and equivalents (348) 39,743 Cash and equivalents, beginning of period 1,400 10,508 - --------------------------------------------------------------------------------------------------------------- Cash and equivalents, end of period $ 1,052 $ 50,251 =============================================================================================================== Supplemental disclosure of cash flow information: Income taxes paid $ 193 - Interest paid $ 2 $ 33 Non-cash investing and financing activities: Deferred compensation expense $ - $ 1,627 See accompanying notes to condensed consolidated financial statements.
4 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 1. Basis of Presentation The condensed consolidated financial statements included in this document are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of our management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods shown. These condensed consolidated financial statements should be read in conjunction with our consolidated financial statements and notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended April 30, 2000. The results of operations for the three months ended July 31, 2000 are not necessarily indicative of the results for the entire fiscal year ending April 30, 2001. Revenue Recognition and Deferred Revenues We recognize revenue in accordance with applicable accounting regulations, including American Institute of Certified Public Accountants Statement of Position 97-2, "Software Revenue Recognition," as amended. Revenue from sales of products is recognized when a contract has been executed, the product has been delivered, the sales price is fixed and determinable, and collection of the resulting receivable is probable. Revenue earned on software arrangements involving multiple elements (i.e., software products, upgrades/enhancements, post contract customer support, installation, training) is allocated to each element based on vendor specific objective evidence of relative fair value of the elements. The revenue allocated to post contract support is recognized ratably over the term of the support and revenue allocated to service elements (such as training and installation) is recognized as the services are performed. When arrangements contain multiple elements and vendor specific objective evidence exists for all undelivered elements, we recognize revenue for the delivered elements using the residual method. For arrangements containing multiple elements for which vendor specific objective evidence does not exist for all undelivered elements, revenue for the delivered and undelivered elements is deferred until vendor specific objective evidence exists or all elements have been delivered. Research and Product Development Cost We expense all research and development costs as they are incurred. Scientific research tax credits are recognized at the time the related costs are incurred and recovery is reasonably assured. We have capitalized certain costs associated with the filing of approximately fifty patent applications in various jurisdictions. These patent filings relate to Elliptic Curve Cryptography, or ECC, various mathematical computational methodologies, security protocols and other cryptographic inventions. Once granted, we amortize the individual patent cost over three years. We capitalize patents not yet granted at their cost less a provision for the possibility of the patent not being granted or abandoned. Note 2. Net Loss per Common Share Basic net loss per common share is computed using the weighted average number of common shares outstanding during the period. Diluted net loss per common share is computed using the weighted average number of common shares outstanding during the period and, when dilutive, potential common shares from options and warrants to purchase common shares, using the treasury stock method. The following potential common shares have been excluded from the calculation of diluted net loss per share for all periods presented because the effect would have been anti-dilutive (in thousands): Three months ended July 31, --------------------------- 1999 2000 ---- ---- Shares issuable under stock options 1,181,063 5,729,350 Shares issuable pursuant to warrants - 30,000 5 The weighted average exercise price of stock options was $4.28 and $9.04 at July 31, 1999 and 2000, respectively. The weighted average exercise price of warrants was $25.77 at July 31, 2000. Note 3. Note Payable On April 27, 2000, we entered into an agreement with Sand Hill Capital II, LP for a line of credit of $15,000,000 bearing interest at the prime rate of interest plus 3%. As of the end of fiscal year 2000, we had borrowed $10,000,000 against this line. In connection with this financing, we also issued a warrant which entitles Sand Hill to purchase 30,000 of our common shares for Cdn$38.13 per share (U.S.$25.74 based on the exchange rate on September 11, 2000) until April 27, 2005. The amount borrowed was repaid in May 2000, and the line of credit facility was terminated. The warrant was valued at $423,000 at the time of issuance based on the Black-Scholes option valuation model. The value of the warrant was charged to interest expense in the first quarter of fiscal 2001 as the note payable was paid off with proceeds from the public offering. Note 4. Comprehensive Income (Loss) Other comprehensive income refers to revenues, expenses, gains and losses that under U.S. generally accepted accounting principles are recorded as an element of shareholders' equity but are excluded from net income. In the first quarter of fiscal 2001, we incurred unrealized gains of approximately $33,000 on our available-for-sale marketable securities. Note 5. Disclosure About Segments We operate in one reportable segment. We are a developer, manufacturer and vendor of digital information security products, technologies and services within the industry segment of electronic commerce. Information about our revenues is as follows (in thousands of U.S. dollars): Three months ended July 31, --------------------------- 1999 2000 ---- ---- Software license revenue $1,731 $4,401 Consulting revenue 367 355 Hardware revenue 50 297 ------------------ -------------- $2,148 $5,053 Information about our geographic operations is given below (in thousands of U.S. dollars): Three months ended July 31, --------------------------- 1999 2000 ---- ---- United States revenue $2,048 $4,403 Canada revenue 71 30 Europe and other revenue 29 620 ------------------ -------------- $2,148 $5,053 Note 6. Public Offering and Stock Split On May 3, 2000, we completed a public offering of 2,500,000 common shares in the United States and Canada for net proceeds of approximately U.S. $51,500,000. On July 12, 2000, we completed a two-for-one split of our outstanding common shares. All share and per share amounts in this document have been adjusted to give effect to this split. Note 7. Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting 6 Standards No. 133 ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes new accounting and reporting standards for derivative financial instruments and for hedging activities. SFAS No. 133 requires us to measure all derivatives at fair value and to recognize them on the balance sheet as an asset or liability, depending on our rights or obligations under the applicable derivative contract. In June 1999, the FASB issued SFAS No. 137, which deferred the effective date of the adoption of SFAS No. 133 for one year. We will adopt SFAS No. 133 no later than the first quarter of fiscal year 2002. Adoption of the new method of accounting for derivatives and hedging activities is not expected to have a material impact on our financial position. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition," which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the SEC. SAB 101 outlines the basic criteria that must be met in order to recognize revenue and provides guidance for disclosures related to revenue recognition policies. In June 2000, the SEC issued SAB 101B, "Second Amendment: Revenue Recognition in Financial Statements" which extended the effective date of SAB 101 to the fourth fiscal quarter of fiscal years commencing after December 15, 1999. Although we have not fully assessed the implications of SAB 101, management does not believe the adoption of the statement will have a significant impact on our consolidated financial position, results of operations or cash flows. Note 8. Stock Option Repricing In March 2000, the FASB issued Interpretation No. 44, "Accounting for Certain Transactions involving Stock Compensation," an interpretation of APB Opinion No. 25, "Accounting for Stock Issued to Employees," which, among other things, requires variable-award accounting for repriced options from the date the options are repriced until the date of exercise. This interpretation became effective on July 1, 2000 to cover specific events that occur after December 15, 1998. On March 17, 1999, our Board of Directors approved the exchange of options to acquire an aggregate of 1,106,240 of our common shares for options having a right to acquire 382,914 common shares. The average exercise price of the newly issued options was $5.44 per common share, the quoted market price of the shares, compared to an average exercise price of $10.19 for the original options. Deferred compensation amortization expense of $111,462 was recorded to reflect the FASB Interpretation No. 44 in the first quarter of fiscal 2001. Deferred compensation expense, a contra-equity account, of $1.516 million was booked on the balance sheet to reflect the intrinsic value of the repricing of the options. Note 9. Subsequent Events On September 12, 2000, we acquired DRG Resources Group, Inc., an eCommerce security consulting company located in Redwood City, California in exchange for 397,595 Certicom common shares and the assumption of options exercisable to acquire a total of 103,100 Certicom common shares. The acquisition was accounted for using the purchase method of accounting. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation Overview Certicom is an encryption technology company specializing in security solutions for mobile computing and wireless data markets, including mobile eCommerce, or mCommerce. Our solutions often use less processing power and bandwidth than conventional encryption technologies, and are therefore more suitable for many mobile and wireless environments. Our original equipment manufacturer, or OEM, customers incorporate our patented technology into their applications for handheld computers, mobile phones, two-way pagers and other Internet information appliances. As these devices communicate increasingly sensitive and valuable information, we believe the demand for stronger security will increase. Our product line includes cryptographic toolkits, information security protocol toolkits, public-key infrastructure, or PKI, products, and certificate authority, or CA, services. We have announced for availability later this year a virtual private network, or VPN, client application. In addition to licensing our security products, we provide consulting and systems integration services to assist our customers in designing and implementing efficient security solutions. Our customers include 724 Solutions, Aether Systems, BellSouth Wireless Data, Motorola, Palm, 7 Inc., PUMATECH, Inc., QUALCOMM, Sony, Research In Motion, Oracle, Sybase, AvantGo and Schlumberger Systems. We were founded in 1985 and are governed by the laws of the Yukon Territory, Canada. We determined that commencing May 1, 1999 our functional currency was the U.S. dollar and, accordingly, we began measuring and reporting our results of operations in U.S. dollars from that date. We changed our functional currency as we derive a majority of our revenues and incur a significant portion of our expenses in U.S. dollars. Our consolidated financial statements contained in this Form 10-Q are reported in U.S. dollars and are presented in accordance with U.S. generally accepted accounting principles, or GAAP. The following discussion and analysis relates to our financial statements that have been prepared in accordance with U.S. GAAP. Sources of Revenue and Revenue Recognition Policy We derive our revenues from a variety of sources, which we generally classify as software licensing, consulting and systems integration and hardware. We earn software licensing revenues from one-time base license fees or technology access fees, royalties based upon per unit or per usage charges or a percentage of the revenue from licensees' products containing our technology and annual maintenance and support fees. In addition, a small amount of our revenue comes from annual license fees under licenses entered into by Consensus Development Corporation, or Consensus, prior to our acquisition of Consensus. Our license agreements may permit the licensee to sublicense without us receiving any revenue from the sublicensees. Consulting and systems integration revenue is derived from the performance of contracted services to licensees and can be based upon a time-and-materials framework or a fixed contract for a complete solution. Hardware revenues comprise sales of products manufactured by third parties to our specifications, and components procured by third parties and resold by us. We generally negotiate sales contracts with our customers and we generally do not use standardized contracts. However, each of our contracts (other than our contracts for consulting and systems integration or hardware sales) includes provisions for us to receive an up-front license fee and royalties. Our royalties for mobile and wireless devices generally range from $1.00 to $5.00 per unit, with other amounts if the royalties are calculated on a per user or usage basis or as a percentage of revenue. In the first quarter of fiscal 2001, our software licensing revenue, consulting and systems integration revenue and hardware revenue represented approximately 87%, 7% and 6%, respectively, of our total revenue. In the same period, approximately 87% of our total revenue was derived from sales in the United States, while 1% and 12% of our total revenue was derived from sales in Canada and international sales, respectively. In the first quarter of fiscal 2000, our software licensing revenue, consulting and systems integration revenue and hardware revenue represented approximately 81%, 17% and 2%, respectively, of our total revenue. In the same period, approximately 95% of our total revenue was derived from sales in the United States, while 3% and 2% of our total revenue were derived from sales in Canada and international sales, respectively. We recognize software licensing revenue in accordance with all applicable accounting regulations including the American Institute of Certified Public Accountants Statement of Position 97-2 ("SOP 97-2"), "Software Revenue Recognition," as amended. Following the requirements of SOP 97-2, we recognize license revenues when all the following conditions are met: o we have signed a non-cancelable license agreement with the customer; o we have delivered the software product to the customer; o the amount of the fees to be paid by the customer are fixed or determinable; and o we believe that collection of these fees is probable. Maintenance and support services revenue is recognized ratably over the period, usually one year. Revenue derived from consulting and systems integration is recognized upon performance of the related services. 8 In the first quarter of fiscal 2001, approximately 99.8% of our revenue was generated in U.S. dollars. In the same period, approximately 32.8% of our expenses were incurred in Canadian dollars, and the balance was incurred in U.S. dollars and other currencies. We expect that a substantial majority of our revenue will continue to be generated in U.S. dollars for the foreseeable future and that a portion of our expenses, including labor costs as well as capital and operating expenditures, will continue to be denominated in Canadian dollars. If the Canadian dollar appreciates against the U.S. dollar, our results of operations could be materially adversely affected. Costs and Expenses Our costs and expenses consist of selling and marketing, research and development, depreciation and amortization, general and administrative, consulting and systems integration and cost of hardware sold. Our selling and marketing expenses consist primarily of employee salaries and commissions, and include related travel, public relations and corporate communications costs and trade shows, marketing programs and market research. Research and development expenses consist primarily of employee salaries, sponsorship of cryptographic research activities at various universities, participation in various cryptographic, wireless and eCommerce standards associations and related travel and other costs. Depreciation and amortization represents the allocation to income of the cost of fixed assets and intangibles over their estimated useful lives. General and administrative expenses consist primarily of salaries and other personnel-related expenses for executive, financial and administrative personnel. Deferred compensation amortization represents the expense of the repricing of options to acquire common shares. Consulting and systems integration expenses consist primarily of salaries and travel. Our cost of hardware sold consists primarily of the component cost of our hardware products manufactured by third parties to our specifications as well as the procured costs of third-party hardware. In anticipation of business growth, we expect to incur significantly higher selling and marketing, research and development and general and administrative expenses and capital expenditures in subsequent periods. We may not grow at a pace that will support these costs and expenditures. To the extent that our revenue does not increase at a rate commensurate with these additional costs and expenditures, our results of operations and liquidity would be materially adversely affected. Net Losses We have incurred significant annual and quarterly net losses and operating losses from our operations since our inception, and we expect to incur significant net losses and operating losses on both an annual and quarterly basis for at least the next year as we grow our business by hiring additional personnel and increasing marketing and capital expenditures. Additionally, given the rapidly evolving nature of our business and fluctuations in the timing of our sales, our operating results are difficult to forecast and, accordingly, our historical financial results may not be meaningful assessments of our future business operations or prospects. We believe that other factors may be better indicators of our future business operations or prospects, including the pace of deployment of mCommerce products and services, the acceptance of Elliptic Curve Cryptography as a cryptographic standard and the extent and timing of our royalty revenues. We pay taxes in accordance with U.S. federal, state and local tax laws and Canadian federal, provincial and municipal tax laws. We do not expect to pay any significant corporate income taxes in Canada in the foreseeable future because we have significant Canadian tax credits and loss carry-forwards. Results of Operations Although we have experienced substantial growth in revenues in recent periods, we have incurred substantial operating losses since our inception and we may incur substantial operating losses in the foreseeable future. As of July 31, 2000, we had an accumulated deficit of approximately $60.9 million. We expect to incur additional losses for at least the next year, and we may never achieve profitability. We intend to invest heavily in sales and marketing and the development and enhancement of our product and service offerings. 9 The following table sets out, for the periods indicated, selected financial information from our consolidated financial statements as presented in accordance with U.S. generally accepted accounting principles as a percentage of revenue. Three months ended July 31, --------------------------- 1999 2000 ---- ---- Consolidated Statement of Operations Data: (%) (%) Revenues 100 100 Costs and expenses: Selling and marketing 59 62 Research and development 38 48 Depreciation and amortization 81 54 General and administrative 71 51* Consulting and systems integration 15 20 Cost of hardware sold 0 5 Interest income (expense), net (3) 19 Non-cash interest income (expense) - (8) Loss before income taxes (168) (130) Income taxes (4) (2) Net loss (171) (132) * Including the percentage of non-cash expense related to the repricing of stock options under FASB Interpretation No. 44. First quarter of fiscal 2001 compared to first quarter of fiscal 2000 Revenue. Revenue for the three months ended July 31, 2000 was $5.1 million, a 135% increase from $2.1 million in the first quarter of fiscal 2000. The increase was primarily attributable to increased software licensing, which grew to approximately $4.4 million, a 154% increase over $1.7 million in the first quarter of fiscal 2000. The increase in software licensing revenue was primarily a result of a growing market awareness of our products and, to a lesser extent, an expanded sales force. In addition, consulting and systems integration revenue was approximately $0.4 million in each of the first quarter of fiscal 2000 and the first quarter of fiscal 2001. We have added resources in this area in the first quarter of fiscal 2001 and focused our activities on internal projects. Hardware sales grew 494% to $0.3 million for the first quarter of fiscal 2001, and increased as a percentage of revenue to 6% versus 2% in the first quarter of fiscal 2000. Selling and Marketing. Selling and marketing expenses were $3.1 million for the three months ended July 31, 2000 versus $1.3 million for the same period in fiscal 2000, an increase of 147%. This increased expense was primarily due to an increase in personnel costs. We are in the process of adding marketing personnel and expanding our marketing operations into Europe and the Asia Pacific region and anticipate that expenses in this area will continue to increase. Research and Development. Our research and development expenses for the first quarter of fiscal 2001 increased 200% compared to the first quarter of fiscal 2000, to $2.4 million as a result of new product development in the public-key infrastructure area. We expect that these expenses will continue to increase in the foreseeable future as we add additional engineering resources and continue to grow our technical capabilities to support the growth of our business. Depreciation and Amortization. Depreciation and amortization increased 59% to $2.7 million in the first quarter of fiscal 2001 compared to $1.7 million in the first quarter of fiscal 2000. The primary reason for the increase was that our results for the first quarter of fiscal 2001 included amortization expenses relating to our acquisition of TrustPoint, which occurred during the third quarter of fiscal 2000. General and Administrative. General and administrative expenses increased 68% in the first quarter of 10 fiscal 2001 to $2.6 million from $1.5 million for the first quarter of fiscal 2000. This increase resulted from growth in personnel and office space in California, additional support for research and development and sales and marketing, and amortization related to the repricing of stock options. Deferred compensation expense, a contra-equity account, of $1.516 million was booked on the balance sheet to reflect the intrinsic value of the repricing of the options. Consulting and Systems Integration. Consulting and systems integration expenses were $1.0 million for the first quarter of fiscal 2001, a 216% increase over $0.3 million for the first quarter of fiscal 2000. This increase was primarily as a result of increasing the number of engineers in this group in order to keep up with growing customer and internal demands. We expect that this trend will continue as we add resources to these groups through both internal hiring and acquisitions of other entities, if any. Cost of Hardware Sold. Cost of hardware sold increased 2478% in the first quarter of fiscal 2001 to approximately $0.2 million from $9,000 in the first quarter of fiscal 2000. This increase was primarily due to higher hardware sales. This increase is also attributable to a shift in product mix with a greater proportion of hardware sales being generated by sales of higher cost third-party procured hardware. Interest and Other Income (Expense). For the first quarter of fiscal 2001, interest income was $0.5 million compared to an interest expense of $0.1 million for the first quarter of fiscal 2000. This increase consists of an increase in the amount of cash and marketable securities invested during the first quarter of fiscal 2001, as well as currency adjustments, primarily Canadian dollars to U.S. dollars. This increase is net of the one-time non-cash interest expense of $0.4 million from the warrants issued to Sand Hill Capital II, LP. Income Taxes. Income tax expense was $0.1 million for the first quarter of fiscal 2001 compared to $0.1 million in the first quarter of fiscal 2000. The income tax expense for the first quarter of fiscal 2001 was estimated based on 25% of the income tax for fiscal 2000. Net Loss. Our net loss increased 81% in the first quarter of fiscal 2001 to $6.6 million ($0.26 per share basic and diluted) compared to $3.7 million ($0.17 per share basic and diluted) for the same period of the previous fiscal year. This increase was predominately attributable to the amortization of acquisition-related intangibles as well as the increased expense for personnel and office space in California. The loss before interest, depreciation and amortization and taxes amounted to $4.3 million in the first quarter of fiscal 2001 ($0.17 per share basic and diluted), a 142% increase over $1.8 million ($0.08 per share basic and diluted) for the first quarter of fiscal 2000. Financial Condition, Liquidity and Capital Resources In May 2000, we completed a public offering of 2,500,000 common shares in the United States and Canada. Our net proceeds from the offering were approximately $51.5 million. On April 27, 2000, we borrowed $10 million from Sand Hill Capital II, LP, or Sand Hill, at the prime rate of interest plus 3%. As partial consideration for making advances to us under this credit facility, we granted Sand Hill a warrant to purchase 30,000 of our common shares with an exercise price of Cdn. $38.13 per share (U.S.$25.74 based on the exchange rate on September 11, 2000) for a period of five years from the date of grant. We repaid the loan and interest on May 5, 2000, using a portion of the proceeds received from our public offering, and terminated this facility. Total cash increased $39.7 million during the first quarter of fiscal 2001. Our cash and cash equivalents and marketable securities at July 31, 2000 were $53.8 million. We lease all of our office premises and certain furniture and equipment under operating leases which require, in the aggregate, minimum payments of $2.1 million in fiscal 2001. The leases for our offices in the United States and Canada expire in 2006 and 2009, respectively. Our equipment leases expire in 2009. We believe that, in the future, it may be advisable to augment our cash in order to fund our activities. Therefore, we will consider raising cash whenever market conditions are favorable. Capital may be raised through additional public or private financing, as well as collaborative relationships, borrowings and other available sources. Our future capital requirements may be substantial and will depend on, and could increase as a result of, many factors, including: costs associated with facility expansion and the build-up of our Mobile Trust Certificate 11 Authority service; progress of our research and development programs; whether we acquire interests in products currently held by third parties; whether we acquire and/or merge with other entities; the time and costs involved in obtaining regulatory approvals; costs involved in filing, prosecuting and enforcing patent claims; competing technological and market developments; our success in entering into collaborative agreements; and administrative and legal expenses. However, we believe our cash and cash equivalents and marketable securities position at July 31, 2000 is sufficient to meet our short-term liquidity needs. There can be no assurance that additional or sufficient financing will be available, or, if available, that it will be available on acceptable terms. If we raise additional funds by issuing additional equity securities, dilution to then existing shareholders may result. If adequate funds are not available, we may be required to significantly curtail one or more of our research and development programs or commercialization efforts or obtain funds through arrangements with collaborative partners or others on less favorable terms than might otherwise be available. Factors That May Affect Operating Results We operate in a dynamic and rapidly changing environment that involves risks and uncertainties. You should carefully consider the risks described below and the other information in this Form 10-Q. If any of the following risks occur, our business, financial condition or results of operations could be materially harmed. This section should be read in conjunction with our annual report on Form 10-K for the fiscal year ended April 30, 2000. Risks Related to Our Business We have historically incurred losses and will for the foreseeable future. We have experienced substantial net losses in each fiscal period since we were formed. As of July 31, 2000, we had an accumulated deficit of approximately $60.9 million and, in addition, an accumulated other comprehensive loss of $2.5 million. The risks described in this Form 10-Q, among other factors, make predicting our future operating results difficult. We expect to incur additional losses for the next few years, and we may never achieve profitability. If we do, we may not be able to sustain it. Because we may be unable to sustain our revenue growth, you should not consider our historical growth indicative of our future revenue levels or operating results. Our business depends on continued development of the Internet, the acceptance of mobile and wireless devices and the continued growth of eCommerce and mCommerce. Our future success is substantially dependent upon continued growth in the use of the Internet and the acceptance of mobile and wireless devices and their use for mobile eCommerce, or mCommerce. The adoption of the Internet for commerce and communications, particularly by individuals and companies that have historically relied upon alternative means of commerce and communication, generally requires the understanding and acceptance of a new way of conducting business and exchanging information. In particular, companies that have already invested substantial resources in other means of conducting commerce and exchanging information may be particularly reluctant or slow to adopt a new, Internet-based strategy that may make their existing personnel and infrastructure obsolete. To the extent that individuals and businesses do not consider the Internet to be a viable commercial and communications medium, and do not increase their use of mobile and wireless devices, our business may not grow. In addition, our business may be materially adversely affected if the number of users of mobile and wireless devices does not increase, or if eCommerce and mCommerce do not become more accepted and widespread. The projections, estimates and forecasts in this regard of third parties that we cite in this Form 10-Q could prove to be overly optimistic. The use and acceptance of the Internet and of mobile and wireless devices may not increase for any number of reasons, including: o actual or perceived lack of security for sensitive information, such as credit card numbers; o congestion of traffic or other usage delays on the Internet; o inconsistent quality of service or the lack of availability of cost-effective, high-speed service; 12 o lack of high-speed modems and other communications equipment; o competing technologies; o possible outages or other damage to the Internet; o governmental regulation; and o uncertainty regarding intellectual property ownership. Published reports have indicated that capacity constraints caused by growth in the use of the Internet may impede further development of the Internet to the extent that users experience delays, transmission errors and other difficulties. If the necessary infrastructure, products, services or facilities are not developed, or if the Internet does not become a viable and widespread commercial and communications medium, and if individuals and businesses do not increase their use of mobile and wireless devices for mCommerce, our business, financial condition and operating results could be materially adversely affected. Unless the demand for mutual authentication in mCommerce transactions increases, our growth prospects will be materially adversely affected. Most of the advantages of our Elliptic Curve Cryptography-based technology for mobile and wireless devices over conventional security technology are not applicable to a transaction that does not involve the mutual authentication of both parties to the transaction. The vast majority of eCommerce and mCommerce transactions currently do not involve mutual authentication. Participants in mCommerce have only recently begun to require mutual authentication in some applications, such as enterprise data access and certain high-value transactions. Unless the number of mCommerce transactions involving mutual authentication increases, the demand for our products and services, and our growth prospects, will be materially adversely affected. Our success depends on Elliptic Curve Cryptography ("ECC") technology becoming accepted as an industry standard. To date, ECC technology has not been broadly accepted. In order for our business to be successful, ECC technology must become accepted as an industry standard, which may never happen. The technology of our principal competitor, RSA Security, is, and has been for the past several years, the de facto standard for such security over open networks like the Internet. RSA Security owns a patent relating to its algorithm that expires on September 20, 2000. This patented technology should be freely available after that date and may become commoditized. The inexpensive or free availability of such security technology could significantly delay or prevent the acceptance of ECC as a security standard. Our quarterly operating results are subject to fluctuations and if we fail to meet the expectations of securities analysts or investors in any quarter, our share price could decline significantly. Our quarterly operating results have historically fluctuated and may fluctuate significantly in the future. Accordingly, our operating results in a particular period are difficult to predict and may not meet the expectations of securities analysts or investors. If this occurs, our share price would likely decline significantly. Factors that may cause our operating results to fluctuate include: o the level of demand for our products and services as well as the timing of new releases of our products; o our dependence in any quarter on the timing of a few large sales, as described below; o our ability to maintain and grow a significant customer base; o the fixed nature of a significant proportion of our operating expenses, particularly personnel, research 13 and development and facilities; o costs related to the opening or expansion of our facilities; o unanticipated product discontinuation, exchange or deferrals by our original equipment manufacturer, or OEM, customers; o changes in our pricing policies or those of our competitors; o competition from sources that provide products similar to ours for free; o currency exchange rate fluctuations and other general economic factors; o our effectiveness at integrating acquisitions with existing operations; and o timing of acquisitions and related costs. Accordingly, we believe that quarter-to-quarter comparisons of our results of operations are not necessarily meaningful. You should not rely on the results of one fiscal quarter as an indication of our future performance. Our revenues are difficult to predict. We derive our revenue primarily from sales of our products and services to our original equipment manufacturer, or OEM, customers. Our sales vary in frequency, and OEM customers may or may not purchase our products and services in the future. In addition, our customers may defer the purchase of, or cease using, our products and services at any time, and certain license agreements may be terminated by the customer at any time. Our customer contracts typically provide for base license fees or technology access fees and/or royalties based on a per unit or per usage charge or a percentage of revenue from licensees' products containing our technology, and a number of our large contracts provide that we will not earn additional royalty revenues from those contracts until these customers' shipments exceed certain thresholds specified in the contracts. As a result, our revenues are not recurring from period to period, which makes them more difficult to predict. In addition, estimating future revenue is difficult because we generally ship our products soon after an order is received and, as such, we do not have a significant backlog. Our expense levels are based, in part, on our expectations of future revenues and are largely fixed in the short term. We may not be able to adjust spending in a timely manner to compensate for any unexpected shortfall in revenues. We may be unable to protect our intellectual property rights, which would materially adversely affect our business. We rely on one or more of the following to protect our proprietary rights: patents, trademarks, copyrights, trade secrets, confidentiality procedures and contractual provisions. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy and may succeed in copying aspects of our product designs and products, or obtain and use information we regard as proprietary. Preventing the unauthorized use of our proprietary technology may be difficult because it may be difficult to discover such use. Stopping unauthorized use of our proprietary technology may be difficult, time-consuming and costly. In addition, the laws of some countries in which our products are licensed do not protect our products and services and related intellectual property to the same extent as the laws of Canada, the United States and the European Union. While we believe that at least some of our products are covered by one or more of our patents and these patents are valid, a court may not agree if the matter is litigated. There can be no assurance that we will be successful in protecting our proprietary rights and, if we are not, our business, financial condition and operating results could be materially adversely affected. Enforcement of intellectual property rights is time consuming and costly and entails the possibility that some or all of our intellectual property rights may be invalid or unenforceable or subject to adverse claims of ownership. None of our patents has faced a challenge in the courts or in front of an administrative body. There is always the possibility that some or all of our patents could be found invalid or unenforceable. Likewise, no one has challenged our trade secrets or copyrights, but there is a possibility that some or all of the rights we believe that we 14 have could be adversely affected by litigation. We are engaged in joint development projects with certain companies. One of these projects has resulted in the issuance of jointly owned patents. There is always a risk that the companies with which we are working could decide not to commercialize the joint technology and that we may be unable to commercialize joint technology without their consent and/or involvement. We are members of organizations which set standards. As such, we may be required to license patents that we own which are necessary for practice of the standard. Further, to provide products that are compliant with standards that have been adopted or will be adopted in the future, we may have to license patents owned by others. Such licensing requirements may adversely affect the value of our products. If the sales of our customers' products decline, our royalty revenue would also decline. Our licenses to our original equipment manufacturer, or OEM, customers generally provide that royalty payments are not due to us until such time as the licensee both incorporates our technology into its products and ships those products for sale to third parties. Accordingly, our royalty license revenue is linked to our OEM customers' sales, and if those customers' product shipments decline, then our royalty license revenue would also decline. We depend on sales of our principal products. We currently derive substantially all our revenue from sales of our cryptographic toolkits and protocol information security toolkits. As a result, any factor adversely affecting sales of these products would have a material adverse effect on our business, financial condition and operating results. Our future financial performance will depend in part on the successful development, introduction and customer acceptance of new and enhanced versions of our cryptographic toolkits and protocol information security toolkits. There can be no assurance that we will continue to be successful in marketing our products or any new or enhanced versions of our products. Our recently announced products and services may generate little or no revenue. We recently announced our public-key infrastructure tools products, our certificate authority service and our virtual private network client application. We cannot accurately predict the future level of acceptance, if any, of these new products by our customers and we may not be able to generate anticipated, or any, revenue from these products. If we cannot successfully control our product defects and our product liability, our business, financial condition and operating results would be materially adversely affected. Our products are highly complex and, from time to time, may contain design defects that are difficult to detect and correct. Errors, failures or bugs may be found in our products after commencement of commercial shipments. Even if these errors are discovered, we may not be able to correct such errors in a timely manner or at all. The occurrence of errors and failures in our products could result in adverse publicity and the loss of, or delay in achieving, market acceptance of our products, and correcting such errors and failures in our products could require significant expenditure of capital by us. Our products are integrated into our customers' products. The sale and support of these products may entail the risk of product liability or warranty claims based on damage to such equipment. In addition, the failure of our products to perform to customer expectations could give rise to warranty claims. The consequences of such errors, failures and claims could have a material adverse effect on our business, financial condition and operating results. The lengthy sales and implementation cycles of our products and services could materially adversely affect us. We market many of our products and services directly to original equipment manufacturers, or OEMs. The sale to, and implementation by, OEMs of our products and services typically involve a lengthy education process and a significant technical evaluation and commitment of capital and other resources by them. This process is also subject to the risk of delays associated with their internal budgeting and other procedures for approving capital 15 expenditures, deploying new technologies within their networks and testing and accepting new technologies that affect key operations. As a result, the sales and implementation cycles associated with many of our products and services are generally lengthy, and we may not succeed in closing transactions on a timely basis, or at all. If orders expected for a specific customer for a particular period are not realized, our business, financial condition and operating results could be materially adversely affected. We anticipate increased operating expenses, which would materially adversely affect our business, financial condition and operating results if we do not correspondingly increase our revenue. We expect to increase our operating expenses significantly as we: o expand our sales and marketing operations and develop new distribution channels; o enhance existing or build additional software development centers; o enhance our operational and financial systems; o broaden our customer support capabilities; and o fund greater levels of research and development. If we do not significantly increase our revenue to meet these increased operating expenses, our business, financial condition and operating results would be materially adversely affected. We have only a limited operating history, which makes it difficult to evaluate an investment in our common shares. We have only a limited operating history. In particular, in 1997 we shipped our first commercial toolkit and entered the U.S. market. Accordingly, our business operations are subject to all the risks inherent in the establishment and maintenance of a new business enterprise, such as competition and viable operations management. Most of our competitors and their products have greater market recognition and acceptance than we or our products do. Our ability to market our products profitably is currently unproven. We may never be able to achieve and sustain profitable operations. Acquisitions could harm our financial condition and operations. We acquired Consensus Development Corporation and Uptronics Incorporated in fiscal 1999 and we acquired Trustpoint in fiscal 2000. We may acquire additional businesses, technologies, product lines or services in the future. Acquisitions involve a number of risks, including: o the difficulty of assimilating the operations and personnel of the acquired business; o the potential disruption of our business; o our inability to integrate, train, retain and motivate key personnel of the acquired business; o the diversion of our management from our day-to-day operations; o our inability to incorporate acquired technologies successfully into our products and services; o the additional expense associated with completing an acquisition and amortizing any acquired intangible assets; o increased demands for liquidity; o the potential impairment of relationships with our employees, customers and strategic partners; and 16 o the inability to maintain uniform standards, controls, procedures and policies. In addition, we may not be able to maintain the levels of operating efficiency that any acquired companies had achieved or might have achieved separately. Successful integration of each of their operations would depend upon our ability to manage those operations and to eliminate redundant and excess costs. As a result of difficulties associated with combining operations, we may not be able to achieve the cost savings and other benefits that we would hope to achieve with these acquisitions. Given that our management will have to devote time and attention to integrate the technology, operations and personnel of the businesses we acquire, we may not be able to serve our current customers properly or attract new customers. Also, our management faces the difficult and potentially time consuming challenge of implementing uniform standards, controls, procedures and policies throughout our various offices. Any difficulties in this process could disrupt our ongoing business, distract our management, result in the loss of key personnel or customers, increase our expenses and otherwise materially adversely affect our business, financial condition and operating results. In the event of any future acquisitions, we could issue equity shares, which would dilute our existing shareholders' equity interests, incur debt or assume liabilities. We cannot assure you that we would be able to obtain any additional financing on satisfactory terms, or at all, and this failure would have a material adverse effect on our business, financial condition and operating results. Additional indebtedness would make us more vulnerable to economic downturns and may limit our ability to withstand competitive pressures. The terms of any additional indebtedness may include restrictive financial and operating covenants, which would limit our ability to compete and expand. Our business strategy also includes strategic investments and joint ventures with other companies. These transactions are subject to many of the same risks identified above for acquisitions. We depend on key personnel for our future success and we have no protection if they leave us. Our success is largely dependent on the performance of our key employees, particularly Scott A. Vanstone, our Chief Cryptographer. Most of our key technical and senior management personnel are not bound by employment agreements. Loss of the services of any of these key employees could have a material adverse effect on our business, financial condition and operating results. We do not maintain key person life insurance policies on any of our employees. We may not be able to attract or retain qualified personnel. Competition for qualified personnel in the digital information security industry is intense, and finding and retaining qualified and experienced personnel in the San Francisco Bay Area is difficult. We believe there are only a limited number of individuals with the requisite skills to serve in many of our key positions, and it is becoming increasingly difficult to hire and retain these persons. Competitors and others have in the past and may attempt in the future to recruit our employees. A major part of our compensation to our key employees is in the form of stock option grants. A prolonged depression in our share price could make it difficult for us to retain employees and recruit additional qualified personnel. In addition, the volatility and current market price of our common shares may make it difficult to attract and retain personnel. If we are unable to manage our growth, our business would be disrupted. We have experienced a period of significant growth in our sales and personnel that has placed strain upon our management systems and resources. Our sales increased from $2.1 million in the first quarter of fiscal 2000 to $5.1 million in the first quarter of fiscal 2001. During the three months ended July 31, 2000, the number of our full-time, part-time and contract employees increased from 165 to 240. We intend to continue to grow in the foreseeable future and to pursue existing and potential market opportunities, including acquisitions. Our growth has placed, and will continue to place, significant demands on our management and operational resources, particularly with respect to: 17 o recruiting and retaining skilled technical, marketing and management personnel in an environment where there is intense competition for skilled personnel; o managing a larger, more complex international organization; o expanding our facilities and other infrastructure in a timely manner to accommodate a significantly larger global workforce; o maintaining and expanding a cutting edge research and development staff; o expanding our sales and marketing efforts; o providing adequate training and supervision to maintain our high quality standards; o expanding our treasury and accounting functions to meet the demands of a growing company; o strengthening our financial and management controls in a manner appropriate for a larger enterprise; and o preserving our culture, values and entrepreneurial environment. Our management has limited experience managing a business of our size and, in order to manage our growth effectively, we must concurrently develop more sophisticated operational systems, procedures and controls. If we fail to develop these systems, procedures and controls on a timely basis, our business, financial condition and operating results could be materially adversely affected. If we do not successfully transition our financial, accounting and treasury systems from Canada to California on a timely basis, our business could be materially adversely affected. Since November 30, 1999, we have appointed a new Chief Executive Officer and a new Chief Financial Officer, both of whom are located in our Hayward, California office rather than our Mississauga, Ontario office. We are in the process of moving our internal financial, accounting and treasury functions from Mississauga to Hayward. There is a risk that these changes could cause significant disruption in our company and adversely affect these critical functions. If that were to occur, our business, financial condition and operating results could be materially adversely affected. If we fail to develop and maintain our strategic relationships, our business would be materially adversely affected. One of our business strategies has been to enter into strategic or other collaborative relationships with many of our OEM customers to develop new technologies and leverage their sales and marketing organizations. We may need to enter into additional relationships to execute our business plan. We may not be able to enter into additional, or maintain our existing, strategic relationships on commercially reasonable terms. In such case, we may have to devote substantially more resources to the development of new technology and the distribution, sales and marketing of our digital information security products and services than we would otherwise. Failure of one or more of our strategic relationships could materially adversely affect our business, financial condition and operating results. We do not insure against all potential losses and we could be seriously harmed and our reputation damaged by unexpected liabilities. Many of our products provide benefits to our clients' businesses that are difficult to quantify. Any failure in a client's system could adversely affect our reputation and result in a claim for substantial damages against us, regardless of our responsibility for such failure. Although we generally attempt to limit our contractual liability for damages arising from negligent acts, errors, mistakes or omissions in rendering our services, we have not been, and cannot assure you that we will be, able to do so in all cases or that any limitations of liability set forth in our 18 agreements will be enforceable in all instances or will otherwise protect us from liability for damages. In addition, our failure to meet client expectations or to deliver error free services may result in adverse publicity for us and damage to our reputation. We maintain general liability insurance coverage, including coverage for errors or omissions. However, we cannot assure you that: o insurance coverage will be available to us in sufficient amounts to cover one or more significant claims that are successfully asserted against us; o insurance coverage will continue to be available to us in the future on reasonable terms, including reasonable premium, deductible and co-insurance requirements; or o our insurer will not disclaim coverage of any future claim. Our business, financial condition and operating results could be materially adversely affected if any of these developments were to occur. Our share price is, and likely will continue to be, volatile. We expect that the market price of our common shares may fluctuate substantially as a result of variations in our quarterly operating results. These fluctuations may be exaggerated if the trading volume of our common shares is low. In addition, due to the technology-intensive and emerging nature of our business, the market price of our common shares may fall dramatically in response to a variety of factors, including: o announcements of technological or competitive developments; o acquisitions or entry into strategic alliances by us or our competitors; o the gain or loss of a significant customer or strategic relationship; o changes in estimates of our financial performance or changes in recommendations by securities analysts regarding us, our industry or our customers' industries; and o general market or economic conditions. This risk may be heightened because our industry is new and evolving, characterized by rapid technological change and susceptible to the introduction of new competing technologies or competitors. In addition, equity securities of many technology companies have experienced significant price and volume fluctuations. These price and volume fluctuations often have been unrelated to the operating performance of the affected companies. Volatility in the market price of our common shares could result in securities class action litigation. This type of litigation, regardless of the outcome, could result in substantial costs to us and a diversion of our management's attention and resources. In May 2000, we listed and began trading on The Nasdaq National Market. We cannot predict the extent to which investor interest in our common shares will continue to support a trading market in the United States or how liquid that market might become. As discussed earlier, our financial results are difficult to predict and could fluctuate significantly. System interruptions and security breaches could materially adversely affect our business. We plan to construct what we believe will be a secure data center. We will depend on the uninterrupted operation of that data center. We will need to protect this center and our other systems from loss, damage or interruption caused by fire, power loss, telecommunications failure or other events beyond our control. In addition, 19 most of our systems and the data center may be located, and most of our customer information may be stored, in the San Francisco, California area, which is susceptible to earthquakes. Any damage or failure that causes interruptions in our data center and our other computer and communications systems could materially adversely affect our business, financial condition and operating results. Our success also depends upon the scalability of our systems. Our systems have not been tested at the usage volumes that we expect will be required in the future. Thus, a substantial increase in demand for our products and services could cause interruptions in our systems. Any such interruptions could affect our ability to deliver our services and our business, financial condition and operating results. Although we periodically perform, and retain accredited third parties to perform, evaluations of our operational controls, practices and procedures, we may not be able to remain in compliance with our internal standards or those set by these third parties. If we fail to maintain these standards, we may have to expend significant time and money to return to compliance and our business, financial condition and operating results could be materially adversely affected. We will retain certain confidential customer information in our planned data center. It is important to our business that our facilities and infrastructure remain secure and be perceived by the marketplace to be secure. Despite our security measures, our infrastructure may be vulnerable to physical break-ins, computer viruses, attacks by hackers or similar disruptive problems. It is possible that we may have to expend additional financial and other resources to address these problems. Any physical or electronic break-ins or other security breaches or compromises of the information stored at our planned data center may jeopardize the security of information stored on our premises or in the computer systems and networks of our customers. In such an event, we could face significant liability and customers could be reluctant to use our products and services. Such an occurrence could also result in adverse publicity and adversely affect the market's perception of our products and services, which would materially adversely affect our business, financial condition and operating results. We have limited financial resources and will likely require additional financing that may not be available. Our financial resources are substantially smaller than the financial resources of our current principal and potential competitors. We will likely require additional equity or debt financing in the future. There can be no assurance that we will be able to obtain the additional financial resources required to successfully compete in our markets on satisfactory terms or at all. Failure to obtain such financing could result in the delay or abandonment of some or all of our plans for development, which could have a material adverse effect on our business, financial condition and operating results. Risks Related to the Digital Information Security Industry Public-key cryptography technology is subject to the risk that it will be successfully attacked or decoded. Our digital information security products and services are largely based on public-key cryptography technology. With public-key cryptography technology, a user has both a public key and a private key. The security afforded by this technology depends on the integrity of a user's private key and on it not being stolen or otherwise compromised. The integrity of private keys also depends in part on the application of certain mathematical principles such as factoring and elliptic curve discrete logarithms. This integrity is predicated on the assumption that solving problems based on these principles is difficult. Should a relatively easy solution to these problems be developed, then the security of encryption products using public-key cryptography technology would be reduced or eliminated. Furthermore, any significant advance in techniques for attacking cryptographic systems could also render some or all of our products and services obsolete or unmarketable. Even if no breakthroughs in methods of attacking cryptographic systems are made, factoring problems or elliptic curve discrete logarithm problems can theoretically be solved by computer systems significantly faster and more powerful than those currently available. In the past, there have been public announcements of the successful decoding of certain cryptographic messages and of the potential misappropriation of private keys. Such publicity could also adversely affect the public perception as to the safety of public-key cryptography technology. Furthermore, an actual or perceived breach of security at one of our customers, whether or not due to our products, could result in adverse publicity for us and damage to our reputation. Such adverse public perception or any of these other risks, if they actually occur, could materially 20 adversely affect our business, financial condition and operating results. Product development and technological change could materially adversely affect us. The digital information security industry is an emerging industry that is characterized by rapid technological change and frequent new product introductions. Accordingly, we believe that our future success depends upon our ability to enhance our current products and develop and introduce new products offering enhanced performance and functionality at competitive prices. In addition, technological innovation in the marketplace, such as in the areas of mobile processing power or, wireless bandwidth, or the development of new cryptosystems, may reduce the comparative benefits of our products and could materially adversely affect our business, financial condition and operating results. Our inability, for technological or other reasons, to enhance, develop and introduce products in a timely manner in response to changing market conditions, industrial standards, customer requirements or competitive offerings could result in our products becoming obsolete, or could otherwise have a material adverse effect on our business, financial condition and operating results. Our ability to compete successfully will depend in large measure on our ability to maintain a technically competent research and development staff and to adapt to technological changes and advances in the industry, including providing for the continued compatibility of our products with evolving industry standards and protocols. We face intense competition that could materially adversely affect us. We operate in a dynamic and evolving industry that is highly competitive. We anticipate that the quality, functionality and breadth of our competitors' product offerings will improve. Most of our competitors have greater name recognition, larger customer bases and significantly greater financial, technical, marketing, public relations, sales, distribution and other resources than we do. We compete in a new and rapidly evolving market and there can be no assurance that we will be able to compete effectively with such companies. In addition, we could face competition from our OEMs in the event that some or all of them develop and distribute their own systems. We also could be materially adversely affected if there were a significant movement towards the acceptance of open source solutions that compete with our products. We expect that additional competition will develop, both from existing businesses in the digital information security industry and from new entrants, as demand for digital information products and services expands and as the market for these products and services becomes more established. We may not be able to compete successfully and competitive pressures may harm our business. Our largest competitors include RSA Security, Inc., which licenses the de facto Internet security standard, VeriSign, Inc., Baltimore Technologies plc and Entrust Technologies, Inc. The technology and wireless industry may fail to grow significantly, which would materially adversely affect our growth. There can be no assurance that the market for our existing products and services will continue to grow, that firms within the industry will adopt our products and services, or that we will be successful in independently establishing markets for our products and services. If the various markets in which our, and our OEM customers', products and services compete fail to grow, or grow more slowly than we currently anticipate, or if we are unable to establish markets for our new products and services, our revenue and net income may be lower than expected. Disputes over intellectual property rights are common in our industry and, if we become involved in such a dispute, we could be materially adversely affected. The industry in which we compete has many participants who own, or claim to own, intellectual property. We indemnify our licensees against third-party intellectual property claims based on our technology. Claims relating to intellectual property by any third-party business, individual or university, whether or not with merit, could be time-consuming to evaluate, result in costly litigation, cause product shipment delays for products or the cessation of the use and sale of products or services, or require us to enter into licensing agreements that may require the payment of a license fee and/or royalties to the owner of the intellectual property. Such licensing agreements, if required, may not be available on royalty or other licensing terms acceptable to us. Any of these situations would materially adversely affect our business, financial condition and operating results. We also currently license third party technology for use in our products and services. These third-party technology licenses may not continue to be 21 available on commercially reasonable terms or may not be available at all. Our business could be materially harmed if we lose the rights to certain technology. We could be materially adversely affected by government regulation. The digital information security industry is governed by regulations that could have a material adverse effect on our business. The export of strong cryptographic equipment and software, including many of our products, is regulated by both the U.S. and Canadian governments. Governments could seek to impose taxes on companies that engage in electronic commerce or which are involved in other markets where we sell our products and services. It is also possible that laws could be enacted covering issues such as user privacy, pricing, content and quality of products and services in these markets. Such regulations, taxes and laws could materially adversely affect our sales and our OEM customers' sales. Foreign governments could adopt regulations that are detrimental to our interests. Such regulations could cause us to compromise our source code protection, minimize our intellectual property protection, negatively impact our plans for global expansion and consequently materially adversely affect our business, financial condition and operating results. Risks Related to Our Corporate Charter; Limitations on Dividends We have a shareholder rights plan that could delay or prevent an acquisition of us even if an acquisition would be beneficial to our shareholders. We have adopted a shareholder rights plan. The provisions of this plan could make it more difficult for a third party to acquire a majority of our outstanding voting shares, the effect of which may be to deprive our shareholders of a control premium that might otherwise be realized in connection with an acquisition of us. The anti-takeover effect of certain of our charter provisions could delay or prevent an acquisition of us even if an acquisition would be beneficial to our shareholders. Our authorized capital consists of an unlimited number of common shares and an unlimited number of preference shares issuable in one or more series. Our board of directors has the authority to issue preference shares and determine the price, designation, rights, preferences, privileges, restrictions and conditions, including voting and dividend rights, of these shares without any further vote or action by shareholders. The rights of the holders of common shares will be subject to, and may be adversely affected by, the rights of holders of any preference shares that may be issued in the future. The issuance of preference shares, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, or the issuance of additional common shares could make it more difficult for a third party to acquire a majority of our outstanding voting shares, the effect of which may be to deprive our shareholders of a control premium that might otherwise be realized in connection with an acquisition of our company. We do not currently intend to pay any cash dividends on our common shares in the foreseeable future. We have never paid or declared any cash dividends on our common shares and we currently intend to retain any future earnings to finance the development and expansion of our business. We do not anticipate paying any cash dividends on our common shares in the foreseeable future. In addition, any dividends paid to residents of the United States would be subject to Canadian withholding tax, generally at the rate of 15%. Item 3. Quantitative and Qualitative Disclosure About Market Risk Foreign Exchange Risk Currency fluctuations may materially adversely affect us. A substantial portion of our operating expenses are paid in currencies other than U.S. dollars. Fluctuations in the exchange rate between the U.S. dollar and such other currencies may have a material adverse effect on our business, financial condition and operating results. In particular, we may be materially adversely affected by a significant strengthening of the Canadian dollar against the U.S. dollar. Operating expenses incurred in the first quarter of fiscal 2001 in currencies other than the U.S. dollar 22 represented approximately 33% of our total operating expenses. Interest Rate Risk We hold a significant portion of our cash in interest-bearing instruments and are exposed to the risk of changing interest rates and their effect on future earnings. Generally, if interest rates decrease, our interest income would also decrease. We do not use any derivative instruments to reduce our exposure to interest rate fluctuations. PART II. OTHER INFORMATION Item 1. Legal Proceedings We are not currently a defendant or co-defendant in any legal proceeding. We have received a letter on behalf of Carnegie Mellon University asserting that it owns the trademark "CERT", and that it believes our use of the stock symbol "CERT" on The Nasdaq National Market will cause confusion with and/or dilute its trademark. Although we intend to defend our use of the stock symbol "CERT" vigorously, there can be no assurance that we will be successful in doing so, or that this dispute with the university will not have a material adverse impact on us. We have also received a letter on behalf of Geoworks, Inc. asserting that it holds a patent on certain aspects of technology which are part of the WAP standard, and that it believes that our WTLS Plus toolkit implements such technology. After an internal investigation, it is our belief that we do not implement any validly patented technology. We have also become aware of a letter circulated on behalf of a Mr. Bruce Dickens asserting that he holds a patent on certain aspects of technology which are implemented within certain aspects of the Secure Sockets Layer standard. After an internal investigation, it is our belief that we do not implement any validly patented technology. Although we intend to vigorously defend any litigation that may arise on these matters, there can be no assurance that we will be successful in doing so, or that such disputes will not have a material adverse impact on us. In addition, we recently became aware of a letter on behalf of a Mr. Leon Stambler asserting that he holds a patent on certain aspects of technology which are implemented within the Secure Sockets Layer standard. This latter matter is currently undergoing internal review of the technological and legal issues to determine an appropriate response, therefore there can be no assurance that such asserted patent will not have a material adverse impact upon us. Item 2. Changes in Securities and Use of Proceeds On May 3, 2000, we completed the public offering of 2,500,000 common shares in the United States and Canada at a per share price of U.S.$23.15, for aggregate proceeds of U.S.$57,875,000. The shares were offered pursuant to a Form F-10 Registration Statement filed with the U.S. Securities and Exchange Commission under Registration No. 333-11586, and began trading on The Nasdaq National Market on May 2, 2000. Our placement agent for the offering was FleetBoston Robertson Stephens, Inc. After deducting underwriting discounts and commissions and offering expenses, our net proceeds from the offering were approximately U.S.$51,500,000. On May 5, 2000, we used a portion of the proceeds of the offering to repay a $10 million loan obtained from Sand Hill Capital II, LP in April, 2000. We intend to use the remaining net proceeds from the offering for the expansion of our sales and marketing activities, including hiring additional sales personnel and opening new sales offices in Europe and the Asia Pacific region, the development and enhancement of our products and services, working capital and general corporate purposes. In connection with the $10 million loan obtained from Sand Hill Capital II, LP mentioned above, we also issued a warrant which entitles Sand Hill to purchase 30,000 of our common shares for Cdn$38.13 per share (U.S.$25.74 based on the exchange rate on September 11, 2000) until April 27, 2005. The amount borrowed was repaid in May 2000, and the line of credit facility was terminated. The warrant was valued at $423,000 at the time of issuance based on the Black-Scholes option valuation model. The value of the warrant was charged to interest expense in the first quarter as the note payable was paid off with proceeds from the public offering. On July 12, 2000, we completed a two-for-one split of our outstanding common shares. All share and per share amounts in this document have been adjusted to give effect to this split. 23 Item 6. Exhibits and Reports on Form 8-K (a) Index to Exhibits Exhibit Number Description -------------- ----------------------- 27.1 Financial Data Schedule (b) Reports on Form 8-K None 24 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 14th day of September, 2000. Certicom Corp. By: /s/ Richard P. Dalmazzi ----------------------- Richard P. Dalmazzi President, Chief Executive Officer and Director (Principal Executive Officer) /s/ Richard D. Brounstein ------------------------- Richard D. Brounstein Senior Vice President, Finance, Chief Financial Officer and Secretary (Principal Financial and Accounting Officer) 25 EX-27.1 2 0002.txt FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from this Form 10-Q and is qualified in its entirety by reference to such financial statements. 1,000 3-MOS APR-30-2000 JUL-31-2000 50,251 3,538 5,934 211 250 61,090 10,431 3,684 90,198 6,816 0 0 0 133,386 (51,069) 90,198 5,053 5,053 0 12,149 0 0 (529) (6,567) 80 (6,647) 0 0 0 (6,647) (0.26) (0.26)
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