##### Table of Contents




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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





---




FORM 10-Q





(Mark One)





|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------




For the Quarterly Period Ended June 30, 2002 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 000-31109





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Valicert, Inc.


(Exact name of registrant as specified in this charter)





Delaware

94-3297861(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)





1215 Terra Bella Avenue


Mountain View, CA 94043


(Address of principal executive offices, including zip code)





(650) 567-5400


(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  þ    No  ̈





Indicate the number of shares outstanding of each issuers classes of common
stock, as of the latest practicable date.





Class

Outstanding at July 31,
2002Common Stock, $0.001 par value

25,553,935 shares





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##### Table of Contents




VALICERT, INC.





TABLE OF CONTENTS





PagePART I. FINANCIAL INFORMATIONItem 1.

Financial Statements

3Condensed Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001

3Condensed Consolidated Statements of Operations and Comprehensive Loss for the three and six months ended June 30, 2002 and 2001

4Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001

5Notes to Condensed Consolidated Financial Statements

6Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

10Item 3.

Quantitative and Qualitative Disclosures About Market Risk

28PART II. OTHER INFORMATIONItem 1.

Legal Proceedings

29Item 2.

Changes in Securities and Use of Proceeds

29Item 3.

Defaults upon Senior Securities

29Item 4.

Submission of Matters to Vote of Security Holders

29Item 5.

Other Information

29Item 6.

Exhibits and Reports on Form 8-K

30




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##### Table of Contents




PART I





ITEM 1.    FINANCIAL STATEMENTS





VALICERT, INC. AND SUBSIDIARIES





CONDENSED CONSOLIDATED BALANCE SHEETS


(Unaudited)


(In thousands)





June 30, 2002


December 31, 2001ASSETSCurrent assets:Cash, cash equivalents and short-term investments

$
10,250


$
23,717Accounts receivable, net


2,715



3,441Prepaid expenses and other current assets


631



1,214Total current assets


13,596



28,372Property and equipment, net


2,415



4,508Goodwill, net


7,352



7,352Intangible assets, net


449



755Other assets


792



945Total assets

$
24,604


$
41,932LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable and accrued liabilities

$
4,260


$
6,623Deferred revenue


3,041



3,782Current portion of long-term debt


1,493



1,546Total current liabilities


8,794



11,951Long-term debt


873



1,547Total liabilities


9,667



13,498Commitments and contingencies (Note 8)Stockholders equity:Common stock


107,232



108,193Deferred stock compensation


(2,032
)


(3,732
)Notes receivable from stockholders






(1,523
)Accumulated other comprehensive income


20



73Accumulated deficit


(90,283
)


(74,577
)Total stockholders equity


14,937



28,434Total liabilities and stockholders equity

$
24,604


$
41,932





See accompanying notes to these condensed consolidated financial
statements.




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VALICERT, INC. AND SUBSIDIARIES





CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE LOSS


(In thousands, except per share amounts)


(Unaudited)





Three Months Ended June 30,


Six Months Ended June 30,2002


2001


2002


2001Revenue:Software license

$
1,773


$
4,320


$
2,913


$
7,695Subscription fees and other services


1,598



1,688



3,791



3,382Total revenues


3,371



6,008



6,704



11,077Cost of revenues:Software license


50



164



303



429Subscription fees and other services


898



2,213



2,173



4,501Total cost of revenues


948



2,377



2,476



4,930Gross profit


2,423



3,631



4,228



6,147Operating expenses:Research and development


1,990



3,091



4,328



6,654Sales and marketing


2,764



6,213



6,179



11,850General and administrative


966



1,269



2,222



2,565Amortization of goodwill and intangible assets


153



802



306



1,588Stock compensation *


1,576



518



2,005



1,089Restructuring and impairment charges










4,736



Total operating expenses


7,449



11,893



19,776



23,746Operating loss


(5,026
)


(8,262
)


(15,548
)


(17,599
)Interest and other income (expense), net


16



178



(158
)


320Net loss


(5,010
)


(8,084
)


(15,706
)


(17,279
)Other comprehensive loss:Unrealized loss on short-term investments


(41
)






(94
)


Comprehensive loss

$
(5,051
)

$
(8,084
)

$
(15,800
)

$
(17,279
)Basic and diluted net loss per share

$
(0.20
)

$
(0.37
)

$
(0.62
)

$
(0.79
)Shares used in computation of basic and diluted net loss per share


25,329



21,993



25,215



21,887*    Stock compensationCosts of subscription fees and other services

$
33


$
65


$
71


$
124Research and development


316



122



407



263Sales and marketing


861



121



953



281General and administrative


366



210



574



421Total

$
1,576


$
518


$
2,005


$
1,089





See accompanying notes to these condensed consolidated financial
statements.




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VALICERT, INC. AND SUBSIDIARIES





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(In thousands)


(Unaudited)





Six Months Ended June 30,2002


2001Cash flows from operating activities:Net loss

$
(15,706
)

$
(17,279
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


809



1,347Stock compensation


2,005



1,089Amortization of goodwill and intangible assets


306



1,587Issuance of common stock and options for services


40



148Interest on stockholder notes


(27
)


(27
)Amortization of warrants issued in connection with debt financing


25



Non-cash restructuring and impairment charges


1,258



Impairment of software


147



Changes in assets and liabilities:Accounts receivable


726



(574
)Prepaid expenses and other current assets


558



Other assets


(48
)


(98
)Accounts payable and accrued liabilities


(1,774
)


(573
)Deferred revenue


(741
)


1,398Net cash used in operating activities


(12,422
)


(12,982
)Cash flows from investing activities:Purchases of property and equipment


(355
)


(1,375
)Proceeds from sale of short-term investments


3,919



Net cash provided by (used in) investing activities


3,564



(1,375
)Cash flows from financing activities:Proceeds from issuance and repurchase of common stock, net


19



418Collection of notes receivable from stockholders


71



58Repayment of borrowings


(727
)


(536
)Proceeds from borrowings






1,177Net cash provided by (used in) financing activities


(637
)


1,117Net decrease in cash and equivalents


(9,495
)


(13,240
)Cash and cash equivalentsbeginning of period


14,747



37,523Cash and cash equivalentsend of period

$
5,252


$
24,283Noncash financing activities:Deemed conversion of full-recourse notes receivable from stockholders to non-recourse

$
539


$
Supplemental disclosure of cash flow informationcash paid during the period for interest

$
199


$
211





See accompanying notes to these condensed consolidated financial
statements.




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VALICERT, INC. AND SUBSIDIARIES





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





Note
1.    Basis of Presentation





The accompanying unaudited interim condensed consolidated
financial statements of Valicert, Inc. and its subsidiaries (the Company) reflect all adjustments that, in the opinion of management, are necessary for a fair presentation of the results of the interim periods presented in conformity
with accounting principals generally accepted in the United States of America (GAAP) for the interim financial information. Such adjustments are of a normal recurring nature. Intercompany balances and transactions have been eliminated in
consolidation.





The statements have been prepared in accordance with the regulations of the Securities and
Exchange Commission. Accordingly, they do not include all information and footnotes required by GAAP. The results of operations for the three and six month periods ended June 30, 2002 are not necessarily indicative of the operating results to be
expected for the full fiscal year or future operating periods. The information included in this report should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Companys Annual Report on
Form 10-K for the year ended December 31, 2001 filed with the Securities and Exchange Commission on April 1, 2002.





Note
2.    Equity Line of Credit





In June 2001, the Company entered into a common stock
purchase agreement (equity line) with an investor for up to $50.0 million in equity financing over a 36-month period. Use of the equity line is subject to a number of terms and conditions. At June 30, 2002, we did not meet the minimum
draw amount. As such, no amounts were available under the line. Related to the equity line, the Company granted the investor and a third party warrants to buy 200,000 shares of common stock at an exercise price of $2.92 per share. The warrants
expire three years from the issuance date and had a fair market value of $282,000, which will be offset against the proceeds of any future drawdowns under the equity line. The fair value of the warrants was determined by using the Black-Scholes
model with the following assumptions: expected life of 10 years; risk-free interest of 6.06%; volatility of 100%; and no dividends during the expected term.





Note 3.    Segment Information





The Company operates in one
operating and reportable segment: the development and marketing of internet cryptographic software products. The Companys chief operating decision maker is its Chief Executive Officer.





Note 4.    Common Stock and Net Loss Per Share





Basic net loss per share is computed by dividing net loss attributable to common stockholders by the weighted-average common shares outstanding for the period. Diluted net loss per share reflects the weighted-average common
shares outstanding plus the potential effect of dilutive securities or contracts which are convertible to common shares such as options and warrants (using the treasury stock method) and shares issuable in future periods, except in cases where the
effect would be anti-dilutive.





The following is a reconciliation of the numerators and denominators used in
computing basic and diluted net loss per share (in thousands, except per share amounts):





Three Months Ended June 30,


Six Months Ended June 30,2002


2001


2002


2001Net loss (numerator), basic and diluted

$
(5,010
)

$
(8,084
)

$
(15,706
)

$
(17,279
)Shares (denominator):Weighted average common shares outstanding


25,509



22,750



25,464



22,770Weighted average common shares subject to repurchase and held in escrow


(180
)


(757
)


(249
)


(883
)Shares used in computation, basic and diluted


25,329



21,993



25,215



21,887Net loss per share, basic and diluted

$
(0.20
)

$
(0.37
)

$
(0.62
)

$
(0.79
)




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At June 30, 2002 and 2001, options to purchase 4,658,615 and 3,463,692 shares of
common stock, respectively, and warrants to purchase 1,244,396 and 653,387 shares of common stock, respectively, were excluded from the calculation of diluted net loss per share, as their inclusion would be antidilutive.





Note 5.    Recent Accounting Pronouncements





In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, and SFAS No. 142,
Goodwill and Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 must be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other
intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets
subsequent to their acquisition.





The Company adopted SFAS No. 142 on January 1, 2002. SFAS No. 142 provides that
intangible assets with indefinite useful lives will not be amortized, but will be tested at least annually for impairment. Since adopting SFAS No. 142, the Company no longer amortizes goodwill and acquired workforce with a net carrying value of $7.5
million at January 1, 2002, resulting in a reduction in annual amortization expense of $2.5 million The Company performed the required transitional impairment tests and determined that there was no impairment upon adoption of SFAS No. 142. The
Company will perform goodwill impairment tests on an annual basis and when circumstances suggest impairment may have occurred.





Three Months Ended June 30,


Six Months Ended June 30,2002


2001


2002


2001Net loss:As reported

$
(5,010
)

$
(8,084
)

$
(15,706
)

$
(17,279
)add: goodwill amortization, net of taxes






613







1,210add: acquired workforce amortization, net of taxes






36







72As adjusted

$
(5,010
)

$
(7,435
)

$
(15,706
)

$
(15,997
)Basic and diluted net loss per share:As reported

$
(0.20
)

$
(0.37
)

$
(0.62
)

$
(0.79
)As adjusted

$
(0.20
)

$
(0.34
)

$
(0.20
)

$
(0.73
)





In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of, it retains many of the fundamental provisions of SFAS No. 121. SFAS No. 144 also supersedes the accounting and reporting provisions of APB No. 30, Reporting the Results of
OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. However, it retains the requirement in APB
No. 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. The Company adopted
SFAS 144 on January 1, 2002. The adoption of this statement did not have a material impact on the Companys financial position or results of operations.





In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses accounting for restructuring and similar costs. SFAS No. 146
supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3. The Company will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the
liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost was recognized at the date of the Companys commitment to an exit plan. SFAS No. 146
also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized.




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Note 6.    Stock Compensation





During the three months ended June 30, 2002, management determined that certain full-recourse notes, which had originally been issued to
employees to exercise stock options, may not be pursued or collected. Under the provisions of Emerging Issues Task Force Issue No. 00-23, Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No.
44, this determination required the Company to consider all outstanding full-recourse notes to be converted, for accounting purposes, to non-recourse notes. All stock options previously exercised under full-recourse notes were deemed, for
accounting purposes, to have been cancelled and replaced with new stock option awards under non-recourse notes. Accordingly, the Company recorded a charge of $938,000 related to the excess of the outstanding principal and interest balance of the
notes over the fair value of the underlying stock at June 30, 2002. In addition, the Company expensed $250,000 of unamortized deferred stock compensation related to the unvested portion of the original stock options. Subsequent to June 30, 2002,
1,008,725 shares of common stock underlying these notes will be subject to variable accounting.





Note
7.    Restructuring Charges





In April 2002, the Company completed a reduction in
workforce, which resulted in the termination of 34 employees, or approximately 28% of the Companys workforce. The affected employees included full-time regular employees across all departments. Employee separation expenses were primarily
comprised of severance pay. All of the affected employees were terminated as of June 30, 2002, and the Company paid approximately $216,000 in separation benefits. The employee separation expenses were classified as salaries and other
personnel-related costs and allocated to the appropriate functional department. There are no remaining cash payments related to these actions.





In January 2002, the Company completed a reduction in workforce, which resulted in the termination of 47 employees, or approximately 24% of the Companys workforce. The affected employees included
full-time regular employees across all departments. Employee separation expenses were primarily comprised of severance pay. All of the affected employees were terminated as of March 31, 2002, and the Company paid approximately $250,000 in separation
benefits. The employee separation expenses were classified as salaries and other personnel-related costs and allocated to the appropriate functional department. There are no remaining cash payments related to these actions.





During the three months ended March 31, 2002, the Company recorded restructuring and impairment charges of approximately $4.7 million in
accordance with EITF 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), SFAS No. 144, Accounting for the Impairment or Disposal
of Long-Lived Assets, and SAB 100, Restructuring and Impairment Charges. The Companys restructuring initiatives involved strategic decisions to cease providing certain services and to consolidate its corporate facilities. Of the
$4.7 million, approximately $1.0 million related to equipment charges resulting from managements decision to exit its application service provider business. The remaining $3.7 million related to consolidation of the Companys corporate
facilities and termination of the long-term facility lease contract for an unutilized facility located in Mountain View, California. The facility charge is comprised of $3.2 million for settlement costs and forfeiture expenses associated with the
building and abandonment of leasehold improvements, furniture and fixtures, partially offset by previously recorded deferred rent of approximately $434,000. During the three months ended March 31, 2002, the security deposit of approximately $201,000
was forfeited and $50,000 was paid for consulting fees. During the three months ended June 30, 2002, the Company paid $3.0 million in contract termination costs, approximately $127,000 in legal, consulting and administrative fees and $135,000 for
building maintenance and abandonment of fixed assets. In addition, the Company issued $40,000 in common stock to a consultant for services in lieu of cash payment. At June 30, 2002, the following remained unpaid: $30,000 in legal, consulting and
administrative fees and approximately $95,000 for building maintenance and abandonment of fixed assets.





Note
8.    Contingencies





A class action lawsuit was filed on December 3, 2001 in the United
States District Court for the Southern District of New York on behalf of purchasers of Valicert common stock alleging violations of federal securities laws. Lachance v. Valicert, Inc. et al., No. 01-CV-10889 (SAS) (S.D.N.Y.), related to In re
Initial Public Offerings Securities Litigation, No. 21 MC 92 (SAS). The case is brought purportedly on behalf of all persons who purchased the Companys common stock from July 27, 2000 through December 6, 2000. The complaint names as defendants
the Company, its Chief Executive Officer and Chief Financial Officer, members of the Board of Directors, and an investment banking firm that served as an underwriter for the Companys initial public offering in July 2000.




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The complaint alleges that the prospectus incorporated in the registration
statement for the offering failed to disclose, among other things, that (i) the underwriter had solicited and received excessive and undisclosed commissions from certain investors in exchange for which the underwriter allocated to those investors
material portions of the shares of the Companys stock sold in the initial public offering, and (ii) the underwriter had entered into agreements with customers whereby the underwriter agreed to allocate shares of the Companys stock sold
in the initial public offering to those customers in exchange for which the customers agreed to purchase additional shares of the Companys stock in the aftermarket at pre-determined prices. No specific damages are claimed. The Company believes
that the allegations are without merit and intends to contest them vigorously. Because management believes that it is not possible at the current time to estimate the amount of the probable loss, if any, that might result from this matter, no
provision for this matter has been made in the Companys consolidated financial statements.





In addition, the
Company is occasionally involved in other legal proceedings arising in the normal course of its business. Failure to prevail could have a material adverse effect on our financial position, results of operation and cash flows in the future.





Note 9.    Subsequent Events





In July 2002, the Company completed an additional reduction in force, resulting in the termination of 23 employees. These actions will result in additional charges during
the quarter ending September 30, 2002.




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|ITEM 2. |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- |  | -------------------------------------------------------------------------------------




This report contains forward-looking statements within the meaning of the U.S. federal securities laws that involve risks and
uncertainties. The statements contained in this report that are not purely historical, including, without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding the future, are forward-looking statements. In
this report, the words anticipate, believe, expect, intend, may, will, should, plan, estimate, predict, potential,
future, continue, or similar expressions also identify forward-looking statements. These statements are only predictions. We make these forward-looking statements based upon information available on the date hereof, and we
have no obligation (and expressly disclaim any such obligation) to update or alter any such forward-looking statements, whether as a result of new information, future events, or otherwise. Our actual results could differ materially from those
anticipated in this report as a result of certain factors including, but not limited to, those set forth in this section entitled Managements Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in
this report, including Factors That May Impact Future Results.





Business





We are a leading provider of software solutions that enable companies to confidentially connect with their business partners and customers
via the Internet for secure document delivery, collaboration and business process integration. Our customers use our products and services to help transfer costly or inefficient business processes to the Internet, while maintaining trust and
security in the process. We believe that by utilizing our products and services, our customers are able to realize cost savings and achieve operating efficiencies by migrating existing networks, processes and systems onto the Internet rather than
using dedicated leased lines for communications. We believe that our products and services reduce the costs of fraudulent transactions and security breaches, including direct losses, damage to reputation and productivity losses resulting from
downtime. From 1996 through 1998, we primarily focused our activities on conducting research and development, raising capital, recruiting personnel, and establishing distribution channels for our software products.





We started commercial shipments of our validation authority software products during the first quarter of 1999. Our validation authority
software products and services verify the status of digital certificates and establish the authority of a party before conducting a transaction. We also offer secure data transfer products and services, which we obtained from our acquisition of
Receipt.com in December 1999. Our secure data transfer software products enable the confidential, reliable and tamper-proof transmission of data during a transaction. We completed an initial public offering of common stock in July 2000.





We provide our products and services to enterprise end users who use them to conduct business within their
organization and with their trading partners. Customers normally enter into perpetual license arrangements for an up front fee and contract for annual maintenance and support.





Critical Accounting Policies





We have identified the
policies below as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout Managements Discussion
and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. Note that our preparation of the Condensed Consolidated Financial Statements required us to make estimates and
assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amount of revenue and expenses during the reported period. There can be
no assurance that actual results will not differ from these estimates.





Valuation of long-lived
assets.    Our long-lived assets include goodwill and other intangible assets. At June 30, 2002, we had $7.8 million of goodwill and other intangible assets, accounting for 31.7% of our total assets. In assessing the
recoverability of our goodwill and other intangibles, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in
the future, we may be required to record impairment charges for these assets. On January 1, 2002, we adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, and are required to analyze our goodwill
for impairment on an annual basis and when circumstances suggest impairment may have occurred. We performed the required transitional impairment tests during the quarter ended June 30, 2002 and determined that there was no impairment upon adoption
of SFAS NO. 142.




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Revenue recognition.    We derive our revenues from
software license fees, subscription fees, consulting services, and maintenance and support. Software license revenues are comprised of upfront fees for the use of our software products. We recognize revenue from license fees when:





| |  |  | an agreement has been signed,
| | - |  | -----------------------------




| |  |  | the product has been delivered,
| | - |  | -------------------------------




| |  |  | vendor-specific objective evidence of fair value exists to allocate a portion of the total fee to any undelivered elements of the arrangement,
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | the fee is fixed or determinable, and
| | - |  | -------------------------------------




| |  |  | collectability is probable.
| | - |  | ---------------------------




When we deliver our software products electronically, we consider the sale complete when we provide the customer with the access codes for immediate possession of the software. When contracts contain multiple product and
service elements, we account for the revenue related to these elements using the residual method as current accounting standards require. We recognize revenues when the fees are fixed and determinable. On occasion, we have in the past, and may in
the future, offer extended payment terms beyond our normal business practice. In such cases, we recognize revenue when the fee becomes due. If we do not consider collectability probable, we recognize revenue when the fee is collected.





If maintenance and support or consulting services are included in a license agreement, amounts related to these services are
allocated based on vendor-specific objective evidence. We recognize such fees ratably over the related service period. Customer contracts that require delivery of unspecified additional software products in the future are accounted for as
subscriptions, and we recognize this revenue ratably over the term of the arrangement beginning with the delivery of the first product. We recognize consulting revenue as these services are provided to the customer. We recognize revenue from
maintenance and support arrangements on a straight-line basis over the life of the agreement, which is typically one year.





Our consulting business derives a significant portion of its revenue from fixed-price, fixed-time contracts, which require the accurate estimation of the cost, scope and duration of each engagement. If we do not accurately estimate
the resources required or the scope of work to be performed, or do not manage our projects properly within the planned periods of time or satisfy our obligations under the contracts, then future consulting margins may be significantly and negatively
affected or we may need to recognize losses on existing contracts. Any such resulting reductions in margins or the recognition of contract losses could materially adversely affect our consolidated results of operations.





Although the terms of our software licenses provide for a free warranty period, we do not record a provision for estimated warranty costs,
as such costs have historically been immaterial. If the historical data we use to calculate these estimates does not properly reflect future returns, or, if we experience significant, unexpected warranty costs with respect to a new product or a new
version of an existing product, our future margins could be negatively affected.





Equity Line of
CreditIn June 2001, Valicert entered into a common stock purchase agreement (equity line) with an investor for up to $50.0 million in equity financing over a 36-month period. Use of the equity line is subject to a number of
terms and conditions. Related to the equity line, we incurred $452,000 in financing costs, including the cost of warrants granted to the investor and a third party. The costs were deferred to be offset against the proceeds of any future drawdowns
under this agreement. If management determines that recoverablity of the deferred costs is unlikely, the deferred costs would be expensed at that time.





Results of Operations





The following table sets forth, as a percentage of revenues, certain
consolidated statement of operations data for the periods indicated.




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Three Months Ended June 30,


Six Months Ended June 30,2002


2001


2002


2001Revenue:Software license

52.6
%

71.9
%

43.5
%

69.5
%Subscription fees and other services

47.4
%

28.1
%

56.5
%

30.5
%Total revenues

100.0
%

100.0
%

100.0
%

100.0
%Cost of revenues:Software license

1.5
%

2.7
%

4.5
%

3.9
%Subscription fees and other services

26.6
%

36.8
%

32.4
%

40.6
%Total cost of revenues

28.1
%

39.6
%

36.9
%

44.5
%Gross profit

71.9
%

60.4
%

63.1
%

55.5
%Operating expenses:Research and development

59.0
%

51.4
%

64.6
%

60.1
%Sales and marketing

82.0
%

103.4
%

92.2
%

107.0
%General and administrative

28.7
%

21.1
%

33.1
%

23.2
%Amortization of goodwill and intangible assets

4.5
%

13.3
%

4.6
%

14.3
%Stock compensation

46.8
%

8.6
%

29.9
%

9.8
%Restructuring and impairment charges


%


%

70.6
%


%Total operating expenses

221.0
%

198.0
%

295.0
%

214.4
%Operating loss

(149.1
)%

(137.5
)%

(231.9
)%

(158.9
)%Interest and other income (expense), net

0.5
%

3.0
%

(2.4
)%

2.9
%Net loss

(148.6
)%

(134.6
)%

(234.3
)%

(156.0
)%





Three Months Ended June 30, 2002 and 2001





Net Loss





Our net loss decreased to $5.0 million for the three months ended June 30, 2002 from $8.1 million for the three months ended June 30, 2001. The decrease was due lower operating expenses and cost of revenues, primarily due to
multiple reductions in workforce. We have incurred cumulative losses of $90.3 million as of June 30, 2002.





Revenues





Total revenues decreased to $3.4 million for the three months ended June
30, 2002 from $6.0 million for the three months ended June 30, 2001. We believe the decrease in revenues was generally due to delayed information technology spending and a slowdown in public key infrastructure spending. In particular, delayed
spending by our international customers adversely impacted us, and we also experienced a slowdown in license revenue from service provider customers who remain cautious about making the significant up-front investment needed to enter this business.





Software license revenues accounted for 52.6% of our total revenues for the three months ended June 30, 2002
compared to 71.9% for the three months ended June 30, 2001. Subscription fees and other service revenues accounted for 47.4% of our total revenues for quarter ended June 30, 2002 compared to 28.1% for the quarter ended June 30, 2001. The increase in
subscription fees and other service revenues as a percentage of total revenues, was primarily due to the decrease in software license revenues.





The current economic environment both in the United States and globally provides us with limited insight into visibility regarding future revenues. If economic conditions worsen, wide acceptance of
electronic commerce may be adversely affected. As a consequence, the market for our products and services may fail to develop and grow and we may be unable to achieve our financial targets.





Cost of Revenues





Cost of software license revenues.    Cost of software license revenues was $50,000 for the three months ended June 30, 2002 compared to $164,000 for the three months ended June 30, 2001. These costs, as a
percentage of total revenue, were 1.5% for the quarter ended June 30, 2002 and 2.7% for the quarter ended June 30, 2001. The decrease in cost of software revenues was primarily due to reduced utilization of royalty-bearing technology we licensed
from third parties.





Cost of subscription fees and other service
revenues.    Cost of subscription fees and other services relate to operating our secure data center and providing consulting and support services. These costs include salaries and other personnel-related costs, depreciation,
telecommunications and other costs of operating and maintaining our secure data center. Our cost of subscription fees and other services revenues decreased to $898,000 for the three months ended June 30, 2002 from $2.2 million for the three months
ended June 30, 2001. The decrease of $1.3 million was primarily due to the fact that in January 2002 we completed a reduction in workforce, which resulted in the termination of approximately 75% of the secure data center workforce, and the
actions taken to close the customer data center. In April 2002, we completed an additional reduction in workforce that resulted in the termination of 35% of our consulting and support services workforce.





As a percentage of total revenues, cost of subscription fees and other services revenues was 26.6% for the three months ended June 30,
2002, as compared to 36.8% for the three months ended June 30, 2001. This decreased percentage is primarily due to lower costs for the three months ended June 30, 2001 as compared to the three months ended June 30, 2002.




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We expect that the cost of subscription fees and other service revenue will
continue to decrease throughout 2002, primarily due to the closure of our secure data center in the first quarter of 2002 and additional reductions of the workforce during the quarters ending June 30, 2002 and September 30, 2002.





Operating Expenses





Research and development.    Research and development expenses consist of salaries and other personnel-related costs, third-party consulting services, and the cost of
facilities and computer equipment. Research and development expenses decreased to $2.0 million for the three months ended June 30, 2002 from $3.1 million for the three months ended June 30, 2001, a decrease of 35.6%. Of this decrease, $257,000
related to facilities costs, $134,000 related to the decrease in use of third-party consultants and contractors, and $955,000 related to salaries and other personnel-related costs due to a decrease in average headcount in the quarter ended June 30,
2002, as compared to the same quarter in 2001. Research and development expenses as a percentage of total revenues were at 59.0% for the quarter ended June 30, 2002, compared to 51.4% for the quarter ended June 30, 2001. We expect that research and
development expenses will continue to decline in fiscal 2002, primarily as a result of our workforce reductions in the first, second and third quarters of the year.





Sales and marketing.    Sales and marketing expenses consist of salaries and other personnel-related costs, sales commissions, tradeshows,
marketing programs, travel, facilities and computer equipment. Sales and marketing expenses decreased to $2.8 million for the three months ended June 30, 2002 from $6.2 million for the three months ended June 30, 2001, a decrease of 55.5%. Of this
decrease, caused primarily by a reduction in the sales and marketing headcount, $2.3 million related to reduced salaries and other personnel related costs, $389,000 related to reduced tradeshows and marketing programs, and $218,000 related to lower
facilities costs. We experienced a 43.9% decrease in revenues from the quarter ended June 30, 2001, as compared to the quarter ended June 30, 2002, which resulted in a significant decrease in commission expense for the quarter ended June 30, 2002,
reflected in the salaries and other personnel related costs. Sales and marketing costs as a percentage of total revenues were 82.0% for the three months ended June 30, 2002, compared to 103.4% for the three months ended June 30, 2001. During the
second quarter of 2002, we closed our international sales offices in Hong Kong and Spain. We expect that sales and marketing expenses will decline in absolute dollars in 2002 primarily due to reductions in workforce, but will fluctuate as a
percentage of total revenues for the foreseeable future.





General and
administrative.    General and administrative expenses consist of salaries and other personnel-related costs for our administrative, finance, and human resources employees; legal and accounting services; and facilities costs.
General and administrative expenses decreased to $966,000 for the three months ended June 30, 2002 from $1.3 million for the three months ended June 30, 2002, a decrease of 23.9%. Of this decrease, $319,000 related to a decrease in use of
third-party consultants and contractors $186,000 related to lower salaries and other personnel related costs as a result of the reduction in the general and administrative headcount. General and administrative costs as a percentage of total revenues
were 28.7% for the three months ended June 30, 2002, compared to 21.1% for the three months ended June 30, 2001. This increase was a result of our lower revenues in 2002 . We expect that general and administrative expenses will not decrease
significantly in absolute dollars, but will fluctuate as a percentage of total revenue for the foreseeable future.





Amortization of goodwill and intangibles.    Amortization of intangibles, related to the acquisition of Receipt.com, was $153,000 for the three months ended June 30, 2002 as compared to amortization of
goodwill and intangibles of $802,000 for the three months ended June 30, 2001. The decrease in this expense is due to our adoption of Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Intangible Assets. As
of January 1, 2002, and in accordance with SFAS No. 142, we no longer amortize goodwill or certain intangibles.No impairment charges related to goodwill have been taken as of June 30, 2002.





Stock compensation.    Deferred stock compensation represents the difference between the exercise price of
stock options granted and the estimated fair market value of the underlying common stock on the date of the grant. As of July 2000, we had recorded deferred stock compensation of $3.7 million for stock options we assumed as part of our acquisition
of Receipt.com and an additional $6.0 million related to the grant of other employee stock options (net of $2.0 million reversed due to the cancellation of options of terminated employees). Deferred stock compensation is being amortized over the
vesting period of the underlying options (generally four years) through September 30, 2004, which resulted in an expense of $388,000 for the quarter ended June 30, 2002 and $518,000 for the quarter ended June 30, 2001. We expect amortization of
deferred stock compensation to decrease in 2002 due to the cancellation of additional options as a result of our recent reductions in workforce.





During the three months ended June 30, 2002, we determined that certain full-recourse notes, which had originally been issued to employees to exercise stock options, may not be pursued
or collected. Under the provisions of Emerging Issues Task Force Issue No. 00-23, Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44, this determination required us to consider all
outstanding full-recourse notes to be converted, for accounting purposes, to non-recourse notes. All stock options previously exercised under full-recourse notes were deemed, for accounting purposes, to have been cancelled and replaced with new
stock option awards under non-recourse notes. Accordingly, we recorded a charge of $938,000 related to the excess of the outstanding principal and interest balance of the notes over the fair value of the underlying stock at June 30, 2002. In
addition, during the quarter ended June 30, 2002 we expensed $250,000 of unamortized deferred stock compensation related to the unvested portion of original stock options. Subsequent to June 30, 2002, 1,008,725 shares of common stock underlying
these notes will be subject to variable accounting.




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In July 2002, President Bush signed the Sarbanes-Oxley Act. Among other things,
this act prohibits amending or in any way changing the terms of promissory notes to executive officers outstanding as of July 30, 2002. If we fail to pursue or collect, from our executive officers, the amounts owed under these outstanding notes, it
may be deemed a violation of the new legislation.





Restructuring and impairment
charges.    In April 2002, we completed a reduction in workforce, which resulted in the termination of 34 employees, or approximately 28% of our workforce. The affected employees included full-time regular employees across
all departments. Employee separation expenses were primarily comprised of severance pay. All of the affected employees were terminated as of June 30, 2002, and we paid approximately $216,000 in separation benefits. The employee separation expenses
were classified as salaries and other personnel-related costs and allocated to the appropriate functional department. There are no remaining cash payments related to these actions.





There can be no assurance that our restructuring activities will be sufficient to allow us to generate improved operating results in future periods. It is possible that
additional changes in our business or in our industry may necessitate additional restructuring expenses in the future. The necessity for additional restructuring activities may result in expenses that adversely affect reported results of operations
in the period the restructuring plan is adopted, and require incremental cash payments.





Interest and other
income (expense).    During the quarter ended June 30, 2002, we recorded a net income, for interest and other income, of $16,000, as compared to $178,000 for the quarter ended June 30, 2001, primarily due to a decrease in our
cash and investment balances and lower interest rates earned on our investments, partially offset by a decrease in interest costs on our equipment loans and leases.





Six Months Ended June 30, 2002 and 2001





Net Loss





Our net loss decreased to $15.7 million for the six months ended June 30, 2002 from $17.3 million for the
six months ended June 30, 2001. The decrease was due to lower operating expenses and cost of revenues, primarily due to multiple reductions in workforce, partially offset by a decrease in revenues.





Revenues





Total revenues decreased to $6.7 million for the six months ended June 30, 2002 from $11.1 million for the six months ended June 30, 2001. We believe the decrease in revenues was primarily due to delayed information
technology spending and a slowdown in public key infrastructure spending. In particular, delayed spending by our international customers adversely impacted us, and we also experienced a slowdown in license revenue from service provider customers,
who remain cautious about making the significant up-front investment needed to enter this business.





Software
license revenues accounted for 43.5% of our total revenues for the six months ended June 30, 2002 compared to 69.5% for the six months ended June 30, 2001. Subscription fees and other service revenues accounted for 56.5% of our total revenues for
six months ended June 30, 2002 compared to 30.5% for the six months ended June 30, 2001. The increase in subscription fees and other service revenues, as a percentage of total revenues, was primarily due to a decrease in software license revenues
and a slight increase in maintenance and support renewals.





Cost of Revenues





Cost of software license revenues.    Cost of software license revenues was $303,000 for the six
months ended June 30, 2002 compared to $429,000 for the six months ended June 30, 2001. These costs, as a percentage of total revenue, were 4.5% for the six months ended June 30, 2002 and 3.9% for the six months ended June 30, 2001. The slight
decrease in cost of software revenues as a percentage of total revenues for the six months ended June 30, 2002 compared to the same six month period in 2001 was primarily due to the our reduced utilization of royalty-bearing technology that we
licensed from third parties, partially offset by a charge of approximately $147,000 taken during the period for licensed software deemed obsolete.





Cost of subscription fees and other service revenues.    Our cost of subscription fees and other services revenues decreased to $2.2 million for the six months ended June 30,
2002 from $4.5 million for the six months ended June 30, 2001. The decrease of $2.3 million was primarily due to the fact that in January 2002 we completed a reduction in workforce, which resulted in the termination of approximately 75% of the
secure data center workforce, and the subsequent actions taken to close the customer data center. In April 2002, we completed an additional reduction in workforce that resulted in the termination of 35% of our consulting and support services
workforce.




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As a percentage of total revenues, cost of subscription fees and other services
revenues was 32.4% for the six months ended June 30, 2002 as compared to 40.6% for the six months ended June 30, 2001. This decrease can be attributed to growth in maintenance and support and subscriptions fee revenues that exceeded the respective
cost from the six months ended June 30, 2001 to 2002.





Operating Expenses





Research and development.    Research and development expenses decreased to $4.3 million for the six months
ended June 30, 2002, from $6.7 million for the six months ended June 30, 2001, a decrease of 35.0%. Of this decrease, $343,000 related to the reduction in use of third-party consultants and contractors, $408,000 related to facilities costs and $1.8
million related to salaries and other personnel-related costs due to a decrease in headcount in the six months ended June 30, 2002, as compared to the same period in 2001. Research and development expenses as a percentage of total revenues increased
slightly to 64.6% for the six months ended June 30, 2002 compared to 60.1% for the six months ended June 30, 2001. The increase is due to the fact that our revenues decreased at a greater rate than our expenses.





Sales and marketing.    Sales and marketing expenses decreased to $6.2 million for the six months ended June
30, 2002 from $11.9 million for the six months ended June 30, 2001, a decrease of 47.9%. Of this decrease, caused primarily by reductions in sales and marketing headcount, $3.6 million related to reduced salaries and other personnel related costs,
$904,000 related to reduced tradeshows and marketing programs and $492,000 related to a decrease in use of third-party consultants and contractors. We experienced a 39.5% decrease in total revenues from the six months ended June 30, 2001 to the same
period in 2002, which resulted in a significant decrease in commission expense for the six months ended June 30, 2002. Sales and marketing costs as a percentage of total revenues were 92.2% for the six months ended June 30, 2002, compared to 107.0%
for the six months ended June 30, 2001. During the six months ended June 30, 2002, we closed international sales offices in Argentina, Canada, Hong Kong, Singapore and Spain.





General and administrative.    General and administrative expenses decreased slightly to $2.2 million for the six months ended June 30, 2002
compared to $2.6 million for the six months ended June 30, 2001. General and administrative costs as a percentage of total revenues were 33.1% for the six months ended June 30, 2002, compared to 23.2% for the six months ended June 30, 2001. The
increase in general and administrative expenses as a percentage of total revenues increased for the first six months of 2002 because our revenues decreased at a greater rate than our expenses.





Amortization of goodwill and intangibles.    Amortization of intangibles, related to the acquisition of Receipt.com, was $306,000 for the
six months ended June 30, 2002 as compared to amortization of goodwill and intangibles of $1.6 million for the six months ended June 30, 2001. The decrease in this expense was due to our adoption of Statement of Financial Accounting Standards
(SFAS) No. 142, Goodwill and Intangible Assets. As of on January 1, 2002, and in accordance with SFAS No. 142, we no longer amortize goodwill or certain intangibles. No impairment charges related to goodwill have been taken as of
June 30, 2002.





Stock compensation.    Deferred stock compensation represents the
difference between the exercise price of stock options granted and the estimated fair market value of the underlying common stock on the date of the grant. As of July 2000, we had recorded deferred stock compensation of $3.7 million for stock
options we assumed as part of our acquisition of Receipt.com and an additional $6.0 million related to the grant of other employee stock options (net of $2.0 million reversed due to the cancellation of options of terminated employees). Deferred
stock compensation is being amortized over the vesting period of the underlying options (generally four years) through September 30, 2004, which resulted in an expense of $817,000 for the six months ended June 30, 2002 and $1.1 million for the six
months ended June 30, 2001.





Restructuring and impairment charges.    In April 2002, we
completed a reduction in workforce, which resulted in the termination of 34 employees, or approximately 28% of our workforce. The affected employees included full-time regular employees across all departments. Employee separation expenses were
primarily comprised of severance pay. All of the affected employees were terminated as of June 30, 2002, and we paid approximately $216,000 in separation benefits. The employee separation expenses were classified as salaries and other
personnel-related costs and allocated to the appropriate functional department. There are no remaining cash payments related to these actions.





In January 2002, we completed a reduction in workforce, which resulted in the termination of 47 employees, or approximately 24% of our workforce. The affected employees included full-time regular
employees across all departments. Employee separation expenses were primarily comprised of severance pay. All of the affected employees were terminated as of March 31, 2002, and we paid approximately $250,000 in separation benefits. The employee
separation expenses were classified as salaries and other personnel-related costs and allocated to the appropriate functional department. There are no remaining cash payments related to these actions.




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During the six months ended June 30, 2002, we recorded restructuring and
impairment charges of approximately $4.7 million in accordance with EITF 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) , SFAS
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, and SAB 100, Restructuring and Impairment Charges. Our recent restructuring initiatives involved strategic decisions to cease providing certain services and
consolidate its corporate facilities. Approximately $1.0 million related to equipment charges resulting from our decision to exit our application service provider business. The remaining $3.7 million related to consolidation of our corporate
facilities and termination of the long-term facility lease contract for an unutilized facility located in Mountain View, California. The facility charge is comprised of $3.2 million for settlement costs and forfeiture expenses associated with the
building and abandonment of leasehold improvements, furniture and fixtures, partially offset by previously recorded deferred rent of approximately $434,000. During the six months ended June 30, 2002, the security deposit of approximately $201,000
was forfeited, we paid $3.0 million in contract termination costs and approximately $177,000 in legal, consulting and administrative fees and $135,000 for building maintenance and abandonment of fixed assets. In addition, we issued $40,000 in common
stock to a consultant for services in lieu of cash payment. At June 30, 2002, the following remained unpaid: $30,000 in legal, consulting and administrative fees and approximately $95,000 for building maintenance and abandonment of fixed assets.





There can be no assurance that our restructuring activities will be sufficient to allow us to generate improved
operating results in future periods. It is possible that additional changes in our business or in our industry may necessitate additional restructuring expenses in the future. The necessity for additional restructuring activities may result in
expenses that adversely affect reported results of operations in the period the restructuring plan is adopted, and require incremental cash payments.





Interest and other income (expense).    During the six months ended June 30, 2002, we recorded a net expense, for interest and other income, of $158,000 compared to net
income of $320,000 for the six months ended June 30, 2001, primarily due to a decrease in our cash and investment balances and lower interest rates earned on our investments coupled with losses on foreign exchange, partially offset by a decrease in
interest costs on our equipment loans and leases.





Liquidity and Capital Resources





Funding to date





At June 30, 2002, we had cash and cash equivalents and short-term investments of $10.3 million compared to $23.7 million at December 31, 2001.





In June 2001, we entered into a $50.0 million common stock equity line with Rellian Investments Limited, pursuant to which, in the event we draw down on the equity line, we
may be required to issue up to 4,520,449 shares of our common stock. In the same transaction, we issued a warrant to Rellian Investments Limited for 100,000 shares of our common stock and a warrant to Pacific Crest Securities, Inc. for 100,000
shares of our common stock. We are able to draw down on the common stock equity line on a monthly basis, subject to certain conditions. The formula used to calculate the amount available includes a specified percentage of the total trading volume
and volume weighted average price of our stock over the 60 calendar days prior to the draw, less a 7% discount. At June 30, 2002, we did not meet the minimum draw amount. As such, no amounts were available under the line.





Uses and sources of cash





Net cash used in operating activities was $12.4 million for the six months ended June 30, 2002 and $13.0 million for the six months ended June 30, 2001, and was primarily used to fund our net losses.
Net cash used for operating activities during the six months ended June 30, 2002 related primarily to a net loss of $15.7 million partially offset by the non-cash portion of restructuring and impairment charges of $1.4 million and non-cash expenses
for depreciation, amortization and stock compensation of $3.1 million, and other changes in working capital. Net cash used for operating activities during the six months ended June 30, 2001 related primarily to a net loss of $17.3 million partially
offset by non-cash expenses for depreciation, amortization and stock compensation of $4.0 million and other changes in working capital.





Net cash provided by investing activities was $3.6 million for the six months ended June 30, 2002 and net cash used in investing activities was $1.4 million for the six months ended June 30, 2001. Net cash provided by
investing activities during the six months ended June 30, 2002 related primarily to the sale of short-term assets of $3.9 million, partially offset by purchase of capital equipment expenditures of $355,000. Net cash used during the six months ended
June 30, 2001 related to the purchase of capital equipment expenditures, primarily relating to the purchase of computer hardware and software, office furniture and equipment, and leasehold improvements. We do not expect to substantially increase our
capital expenditures in the foreseeable future, nor do we anticipate incurring any significant new lease commitments.




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Net cash used in financing activities was $637,000 for the six months ended June
30, 2002 and net cash provided by financing activities was $1.1 million for the six months ended June 30, 2001. Net cash used in financing activities for the six months ended June 30, 2002 related primarily to repayment of borrowings of $727,000
partially offset by issuance of common stock and collection of notes receivable from stockholders of $71,000. Net cash provided by financing activities for the six months ended June 30, 2001 related primarily to borrowings of $1.2 million under
certain equipment leases and issuance of common stock of $418,000 partially offset by repayment of borrowings of $536,000.





We anticipate using available cash to provide working capital and otherwise fund our operations and to purchase capital equipment and make leasehold improvements.





Future funding requirements





During the first quarter of 2002, we consolidated our corporate facilities and discontinued our secure data center operations. As a result, we reduced our workforce from 194 to 147 as of June 30, 2002. Accordingly, we do not expect
operating expenses to increase significantly over the next several quarters. We anticipate that our operating expenses and planned capital expenditures will constitute the most significant use of our cash resources. We may also utilize cash
resources to fund acquisitions of, or investments in, complementary businesses, technologies and product lines.





We believe that our existing cash, cash equivalents and short-term investments together with the expected cash receipts from future revenues will be sufficient to meet our working capital needs for at least the next 12 months.
However, if for any reason demand for our products does not meet our expectations, we may need to raise additional funds before then. Even if not required, we may seek additional financing at any time over the next 12 months to improve our overall
financial position. We may not be able to obtain adequate or favorable financing at these times. Any additional financing may dilute your ownership interest in Valicert. New equity securities could have rights senior to those of our common
stockholders.





Recent Accounting Pronouncements





In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, Business
Combinations, and SFAS No. 142, Goodwill and Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 must be accounted for under the purchase method and addresses the initial recognition and
measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill
and other intangible assets subsequent to their acquisition.





We adopted SFAS No. 142 on January 1, 2002. SFAS No.
142 provides that intangible assets with indefinite useful lives will not be amortized, but will be tested at least annually for impairment. Since adopting SFAS No. 142, we no longer amortize goodwill and acquired workforce with a net carrying value
of $7.5 million at January 1, 2002, resulting in a reduction in annual amortization expense of $2.5 million. We performed the required transitional impairment tests during the quarter ended June 30, 2002 and determined that there was no impairment
upon adoption of SFAS. No. 142. We will perform goodwill impairment tests on an annual basis and when circumstances suggest impairment may have occurred.





In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of
long-lived assets. While SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, it retains many of the fundamental provisions of SFAS No. 121. SFAS No. 144 also
supersedes the accounting and reporting provisions of APB No. 30, Reporting the Results of OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, for the disposal of a segment of a business. However, it retains the requirement in APB No. 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by
sale, abandonment, or in a distribution to owners) or is classified as held for sale. We adopted SFAS 144 on January 1, 2002. The adoption of this statement did not have a material impact on our financial position or results of operations.





In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities, which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3. We will adopt the provisions of SFAS No. 146 for
restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost
was recognized at the date of our commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future
restructuring costs as well as the amounts recognized.




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Factors That May Impact Future Results





Risks Related to Compliance with NASDAQ Requirements





If
our common stock price remains under $1.00, or if we otherwise fail to comply with Nasdaq Rules, our common stock may be delisted from The Nasdaq National Market, which could eliminate the trading market for our common stock.





If the market price for our common stock remains below $1.00 per share through September 9, 2002 or we otherwise fail to meet
certain criteria for continued listing on The Nasdaq National Market, we have been notified by Nasdaq that our common stock may be delisted. Should our common stock be delisted from The Nasdaq National Market, our common stock would trade on either
The Nasdaq SmallCap Market or Over-the-Counter (OTC). If the market price for our common stock remains below $1.00 through December 9, 2002 or we otherwise fail to meet criteria for listing, our common stock would not be eligible to trade on The
Nasdaq SmallCap Market. If our common stock is traded OTC, you likely would find it more difficult to trade in or obtain accurate quotations for the market price of our common stock.





If our common stock is considered penny stock under Section 15(g) of the Securities Exchange Act of 1934, as amended, it would be subject to rules that impose
additional sales practices in broker-dealers who sell our securities. For example, broker-dealers must make a special suitability determination for the purchaser and have received the purchasers written consent to the transaction prior to
sale. Also, a disclosure schedule must be prepared prior to any transaction involving a penny stock and disclosure is required about sales commissions payable to both the broker-dealer and the registered representative and current quotations for the
securities. Monthly statements are also required to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stock. Because of these additional obligations, some brokers may
be unwilling to effect transactions in penny stocks. This could have an adverse effect on the liquidity of our common stock and the ability of investors to sell the common stock.





The market price per share of our common stock following a reverse split may drop and may not remain in excess of the $1.00 minimum bid price as required by Nasdaq, as downward pressure may be
created by such split or other factors may arise.





As a means to conform to the Nasdaq minimum price rule, we
may request stockholders to approve a reverse stock split for the purpose of increasing our stock price above $1.00 per share We cannot predict whether a reverse stock split, if completed, will increase the market price for our common stock.
The history of similar stock split combinations for companies in like circumstances is varied. There is no assurance that the market price per share of our common stock following the reverse stock split will remain in excess of the $1.00 minimum bid
price as required by Nasdaq or that we will otherwise meet the requirements of Nasdaq for continued inclusion for trading on The Nasdaq National Market. A reverse stock split could negatively impact the value of our common stock by allowing
additional downward pressure on the stock price as its relative value becomes greater following the reverse split. In other words, the stock, at its new higher price, has farther to fall and therefore more room for investors to short or otherwise
trade the value of the stock downward. Similarly, a delisting may negatively impact the value of the stock as stocks trading on the OTC market are typically less liquid and trade with larger variations between bid and ask price. The market price of
our common stock will also be based on our performance and other factors, some of which are unrelated to the number of shares outstanding. If a reverse split is effected and the market price of our common stock declines, the percentage decline as an
absolute number and as a percentage of our overall market capitalization may be greater than would occur in the absence of a reverse stock split. Furthermore, liquidity of our common stock could be adversely affected by the reduced number of shares
that would be outstanding after the reverse stock split.





Risks Related to Our Business





Because we have a limited operating history, it is difficult for us to evaluate our prospects.





We introduced our first commercial product in the first quarter of 1999 and have generated only limited revenues. Because we have a limited operating history with our
products and services, and because our sources of potential revenue may continue to shift as our business develops, our future operating results and our future stock prices are difficult to predict. Our success also depends in part on:





| |  |  | the rate and timing of the growth and use of the Internet for electronic commerce and communications;
| | - |  | -----------------------------------------------------------------------------------------------------




| |  |  | the acceptance of existing security measures as adequate for electronic commerce and communications over the Internet;
| | - |  | ----------------------------------------------------------------------------------------------------------------------




| |  |  | the rate and timing of the growth and use of specific technologies such as public key infrastructure and electronic payments and other Internet security
technologies;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------






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| |  |  | our ability to maintain our current, and enter into additional, strategic relationships; and
| | - |  | --------------------------------------------------------------------------------------------




| |  |  | our ability to effectively manage our growth and to attract and retain skilled professionals.
| | - |  | ---------------------------------------------------------------------------------------------




If any of these risks develop, our business could be seriously harmed.





Our sales cycle causes unpredictable variations in our operating results which could cause our stock price to decline.





The length of our sales cycle is uncertain, which makes it difficult to accurately forecast the quarter in which our sales will occur. This may cause our revenues and
operating results to vary from quarter-to-quarter. We spend considerable time and expense providing information to prospective customers about the use and benefits of our products and services without generating corresponding revenue. Our expense
levels are relatively fixed and we do not know when particular sales efforts will begin to generate revenues.





Prospective customers of our products and services often require long testing and approval processes before making a purchase decision. The process of entering into a licensing arrangement with a potential customer may involve
lengthy negotiations. In the past, our sales cycle has ranged from one to nine or more months. Our sales cycle is also subject to delays because we have little or no control over customer-specific factors, including customers budgetary
constraints and internal acceptance procedures. Because our technology must often be integrated with the products and services of other vendors, there may be a significant delay between the use of our software and services in a pilot system and its
commercial deployment by our customers.





Because the length of our sales cycle is uncertain, we believe that
period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as indicators of future performance. Our failure to meet these expectations would likely cause the market price of our common stock to
decline.





Our quarterly results depend on a number of factors, many of which are beyond our control.





Our quarterly results depend on a number of factors, many of which are beyond our control. Our quarterly results may fluctuate in the
future as a result of many factors, including the following:





| |  |  | The size, timing, cancellation or delay of customer orders;
| | - |  | -----------------------------------------------------------




| |  |  | The timing of releases of our new software products;
| | - |  | ----------------------------------------------------




| |  |  | The number of transactions conducted using our products and services;
| | - |  | ---------------------------------------------------------------------




| |  |  | the long sales cycles for, and complexity of, our software products and services;
| | - |  | ---------------------------------------------------------------------------------




| |  |  | the timing and execution of large individual contracts;
| | - |  | -------------------------------------------------------




| |  |  | the impact of changes in the pricing models for our software products and services or our competitors products and services; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------




| |  |  | the continued development of our direct and indirect distribution channels.
| | - |  | ---------------------------------------------------------------------------




Due to these and other factors, our operating results in some future quarter or quarters may fall below the expectations of securities analysts who might follow our stock.





We have not been profitable, and if we do not achieve profitability, our business may fail.





We have incurred significant net losses. We incurred net losses of $15.7 million during the six months ended June 30, 2002 and $17.3
million during the six months ended June 30, 2001. As of June 30, 2002, we had incurred cumulative losses of $90.3 million. Recovery of the current economic environment in the United States and globally provide us with little insight into the
foreseeable future. If economic conditions worsen, wide acceptance of electronic commerce may be adverse affected. As a consequence, the market for our products and services may fail to develop and grow and we may be unable to achieve our financial
targets.





We will need to generate significantly higher revenues in order to achieve profitability. Even if we do
achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis in the future. If our gross margins do not improve, or if our operating expenses exceed our expectations, our operating results will suffer
and our stock price may fall.




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If we do not successfully develop new products and services to respond to rapid market changes due to
changing technology and evolving industry standards, our business will be harmed.





Our success will depend to
a substantial degree on our ability to offer products and services that incorporate leading technology and to respond to technological advances. If we fail to offer products and services that incorporate leading technology and respond to
technological advances and emerging standards, we may not generate sufficient revenues to offset our development costs and other expenses, which will hurt our business. The development of new or enhanced products and services is a complex and
uncertain process that requires the accurate anticipation of technological and market trends. We may experience development, marketing and other technological difficulties that may delay or limit our ability to respond to technological changes,
evolving industry standards, competitive developments or customer requirements. You should also be aware that:





| |  |  | our technology or systems may become obsolete upon the introduction of alternative technologies;
| | - |  | ------------------------------------------------------------------------------------------------




| |  |  | we may incur substantial costs if we need to modify our products and services to respond to these alternative technologies;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------




| |  |  | we may not have sufficient resources to develop or acquire new technologies or to introduce new products or services capable of competing with future
technologies;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | we may be unable to acquire the rights to use the intellectual property necessary to implement new technology; and
| | - |  | ------------------------------------------------------------------------------------------------------------------




| |  |  | when introducing new or enhanced products or services, we may be unable to manage effectively the transition from older products and services.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------




We rely on, and expect to continue to rely on, a limited number of customers for a significant percentage of our revenues, and
if any of these or other significant customers stops licensing our software products and services, our revenues could decline.





A limited number of customers have accounted for a significant portion of our revenues. For the three months ended June 30, 2002, five customers accounted for 39.0% of total revenues. For the three months ended June 30,
2002, five customers accounted for 51.1% of total revenues. We anticipate that our operating results in any given period will continue to depend to a significant extent upon revenues from a small number of customers. We do not have long-term
contracts with our customers that obligate them to license our software products or use our services. We cannot be certain that we will retain our customers or that we will be able to obtain new customers. If we were to lose one or more customers,
our revenues could decline.





The length of our sales cycle is uncertain, which may cause our revenues and operating results to vary
significantly from quarter to quarter.





Any failure of our sales efforts to generate revenues at the times and
in the amounts we anticipate could cause significant variations in our operating results. During our sales cycle, we spend considerable time and expense providing information to prospective customers about the use and benefits of our products and
services without generating corresponding revenue. Our expense levels are relatively fixed in the short term and there is substantial uncertainty as to when particular sales efforts will begin to generate revenues.





One of our significant business strategies has been to enter into strategic or other similar collaborative alliances to increase the
adoption of our products and services. Prospective customers of our products and services often require long testing and approval processes before making a purchase decision. In general, the process of entering into a licensing arrangement with a
potential customer may involve lengthy negotiations. As a result, our sales cycle has been and may continue to be unpredictable. In the past, our sales cycle has ranged from one to nine or more months. Our sales cycle is also subject to delays as a
result of customer-specific factors over which we have little or no control, including budgetary constraints and internal acceptance procedures. In addition, because our technology must often be integrated with the products and services of other
vendors, there may be a significant delay between the use of our software and services in a pilot system and its commercial deployment by our customers. The length of the sales cycle makes it difficult to accurately forecast the timing and amount of
our sales. This may cause our revenues and operating results to vary significantly from quarter to quarter and could harm our business.





Our international business exposes us to additional risks.





Products and services provided
to our international customers accounted for 56.7% of our revenues during the three months ended June 30, 2002 and 74.1% of our revenues during the three months ended June 30, 2001. Conducting business outside of the United States subjects us to
additional risks, including:





| |  |  | changes in regulatory requirements;
| | - |  | -----------------------------------



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| |  |  | reduced protection of intellectual property rights;
| | - |  | ---------------------------------------------------




| |  |  | evolving privacy laws;
| | - |  | ----------------------




| |  |  | tariffs and other trade barriers;
| | - |  | ---------------------------------




| |  |  | difficulties in staffing and managing foreign operations;
| | - |  | ---------------------------------------------------------




| |  |  | problems in collecting accounts receivables; and
| | - |  | ------------------------------------------------




| |  |  | difficulties in authenticating customer information.
| | - |  | ----------------------------------------------------




We must maintain and enter into new strategic alliances, and any failure to do so could harm our business.





One of our significant business strategies has been to enter into strategic or other similar collaborative alliances in order to reach a larger customer base than we could reach through our direct sales and marketing
efforts. We will need to maintain or enter into additional strategic alliances to execute our business plan. However, if we are unable to maintain our strategic alliances or enter into additional strategic alliances, our business could be materially
harmed. We may not be able to enter into additional strategic alliances or maintain our existing strategic alliances. If we do not, we would have to devote substantially more resources to the distribution, sales and marketing of our security
products and services than we would otherwise.





We have entered into technology, marketing and distribution
agreements with several companies. However, we may be unable to leverage the brand and distribution power of these strategic alliances to increase the adoption rate of our technology. We have been establishing strategic alliances to ensure that
third-party solutions are interoperable with our software products and services. To the extent that our products are not interoperable or our strategic allies choose not to integrate our technology into their offerings, this failure would inhibit
the adoption of our software products and outsourced services. Furthermore, as a result of our emphasis on these strategic alliances, our success will depend in part on the ultimate success of other parties to these alliances. Failure of one or more
of our strategic alliances to achieve any of these objectives could materially harm our business.





Our existing
strategic alliances do not, and any future strategic alliances may not, grant us exclusive marketing or distribution rights. In addition, the other parties may not view their alliances with us as significant for their own businesses. Therefore, they
could reduce their commitment to us at any time in the future. These parties could also pursue alternative technologies or develop alternative products and services, either on their own or in collaboration with others, including our competitors.
Should any of these developments occur, our business will be harmed.





Any future acquisitions of companies or technologies may not be
successful and as a result, could harm our business.





We may acquire businesses, technologies, product lines
or service offerings which may need to be integrated with our business in the future. Acquisitions involve a number of risks including, among others:





| |  |  | the difficulty of assimilating the operations and personnel of the acquired businesses;
| | - |  | ---------------------------------------------------------------------------------------




| |  |  | to the extent the acquisitions are financed with our common stock, dilution to our existing stockholders;
| | - |  | ---------------------------------------------------------------------------------------------------------




| |  |  | our inability to integrate, train, retain and motivate key personnel of the acquired business;
| | - |  | ----------------------------------------------------------------------------------------------




| |  |  | the diversion of our management from our day-to-day operations;
| | - |  | ---------------------------------------------------------------




| |  |  | our inability to incorporate acquired technologies successfully into our software products and services;
| | - |  | --------------------------------------------------------------------------------------------------------




| |  |  | the additional expense associated with completing an acquisition and amortizing any acquired intangible assets;
| | - |  | ---------------------------------------------------------------------------------------------------------------




| |  |  | the potential impairment of relationships with our employees, customers and strategic third-parties; and
| | - |  | --------------------------------------------------------------------------------------------------------




| |  |  | the inability to maintain uniform standards, controls, procedures and policies.
| | - |  | -------------------------------------------------------------------------------




If we are unable to successfully address any of these risks, our business could be materially harmed.




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Our headquarters are located in Northern California where natural or other disasters may occur that
could disrupt our operations and our business.





Our corporate headquarters are located in Silicon Valley in
Northern California. Historically, this region has been vulnerable to natural disasters and other risks, such as earthquakes, fires and floods, which at times have disrupted the local economy and posed physical risks to our and our
manufacturers property.





In addition, terrorist acts or acts of war targeted at the
United States, and specifically Silicon Valley, could cause damage or disruption to us, our employees, facilities, partners, suppliers, distributors and resellers, and customers which could have a material adverse effect on our operations and
financial results.





Our success depends on our ability to grow and develop our direct sales and indirect distribution channels.





Our failure to grow and develop our direct sales channel and increase the number of our indirect distribution
channels could have a material adverse effect on our business, operating results and financial condition. We must increase the number of strategic and other third-party relationships with vendors of Internet-related systems and application software,
resellers and systems integrators. Our existing or future channel partners may choose to devote greater resources to marketing and supporting the products of other companies.





We depend upon certificate status data made available by third parties; if our access to that data is limited or denied, our revenues could decline.





Our business depends upon our continuing access to data for the issuance and revocation of digital certificates by certificate authorities
and other third parties, including businesses and governmental entities. We depend upon our ability to negotiate arrangements with these certificate authorities, some of which are our competitors, and other third parties to make this data available
to us. If our access to this data is limited or denied by one or more certificate authorities or other third parties, our ability to verify and validate digital certificates would be impaired, perhaps severely, which could cause a decline in our
revenues and in the value of your investment.





Since we sell through multiple channels and distribution channels, we may have to
resolve potential conflicts between these channels.





Since we sell through multiple channels and distribution
networks, we may have to resolve potential conflicts between these channels. For example, these conflicts may result from the different discount levels offered by multiple channel partners to their customers or, potentially, from our direct sales
force targeting the same accounts as our indirect channel partners. Such conflicts may harm our business or reputation.





We are
dependent on technologies provided by third parties, and any termination of our right to use these technologies could increase our costs, delay product development and harm our reputation.





We have developed our products and services partially based on technology we license on a non-exclusive basis from third parties. Our inability to continue to license
these third-party technologies on commercially reasonable terms will harm our business. We expect that, in the future, we will continue to have to license technologies from third parties. Our inability to continue to license on commercially
reasonable terms, one or more of the technologies that we currently use or our failure to obtain the right to use future technologies could increase our costs and delay or possibly prevent product development. Our existing licensing agreements may
be terminated by the other parties to these contracts, or may not be renewed on favorable terms or at all. In addition, we may not be able to license new technologies on favorable terms, if at all.





If we lose the services of our senior management or key personnel, our ability to develop our business and secure customer relationships will suffer.





We are substantially dependent on the continued services and performance of our senior management and other
key personnel. We do not maintain key person insurance on any of our executive officers. The loss of the services of any of our executive officers or other key employees, particularly Joseph (Yosi) Amram, our president and chief executive officer,
and Srinivasan (Chini) Krishnan, our founder and chairman, could significantly delay or prevent the achievement of our development and strategic objectives.





We may be unable to retain qualified personnel, which could harm our business and product development.





We also must continue to train, retain, and motivate highly skilled technical, managerial, sales and marketing and professional services personnel. Due to the various workforce
reductions that we completed, the moral of our remaining employees may decrease, and we may be unable to retain them. In addition, if our stock price decreases substantially, it may be more difficult to retain employees who consider stock options an
important part of their compensation package. If we encounter difficulties retaining software engineering personnel at a critical stage of product development, our relationship with existing and future customers could be harmed. The failure to
retain necessary technical, managerial, sales, marketing and professional services personnel could harm our business and our ability to obtain new customers and develop new products.




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Our business will suffer if we are unable to protect our intellectual
property.





We rely upon copyrights, trade secrets, know-how, patents, continuing technological innovations and
licensing opportunities to maintain and further develop our market position. We rely on outside licensors for patent and software license rights in encryption technology that is incorporated into and is necessary for the operation of our products
and services. Our success will depend in part on our continued ability to have access to technologies that are or may become important to the functionality of our products and services. Any inability to continue to procure or use this technology
could be materially adverse to our operations.





Our success will also depend in part on our ability to protect our
intellectual property rights from infringement, misappropriation, duplication and discovery by third parties. We cannot assure you that others will not independently develop substantially equivalent proprietary technology or gain access to our trade
secrets or disclose our technology or that we can meaningfully protect our trade secrets. Attempts by others to utilize our intellectual property rights could undermine our ability to retain or secure customers. In addition, the laws of some foreign
countries do not protect proprietary rights to the same extent as do the laws of the United States. Our attempts to enforce our intellectual property rights could be time consuming and costly.





We cannot assure you that our pending or future patent applications will be granted or that any patents that are issued will be enforceable or valid. Additionally, the
coverage claimed in a patent application can be significantly reduced before the patent is issued. We cannot be certain that we were the first inventor of inventions covered by our issued patent or pending patent applications or that we are the
first to file patent applications for such inventions. Moreover, we may have to participate in interference proceedings before the United States Patent and Trademark Office to determine priority of invention, which could result in substantial cost
to us. An adverse outcome could subject us to significant liabilities to third parties, require disputed rights to be licensed from or to third parties or require us to cease using the technology in dispute.





Any claim of infringement by third parties could be costly to defend, and if we are found to be infringing upon the intellectual property rights of third
parties, we may be required to pay substantial licensing fees.





We may increasingly become subject to claims
of intellectual property infringement by third parties as the number of our competitors grows and the functionality of their products and services increasingly overlaps with ours. Because we are in a new and evolving field, customers may demand
features which will subject us to a greater likelihood of claims of infringement.





We are aware of pending and
issued United States and foreign patent rights owned by third parties that relate to cryptography technology. Third parties may assert that we infringe their intellectual property rights based upon issued patents, trade secrets or know-how that they
believe cover our technology. In addition, future patents may issue to third parties which we may infringe. It may be time consuming and costly to defend ourselves against any of these claims and we cannot assure you that we would prevail.





Furthermore, parties making such claims may be able to obtain injunctive or other equitable relief that could
block our ability to further develop or commercialize some or all of our products in the United States and abroad. In the event of a claim of infringement, we may be required to obtain one or more licenses from or pay royalties to third parties. We
cannot assure you that we will be able to obtain any such licenses at a reasonable cost, if at all. Defense of any lawsuit or failure to obtain such license could hurt our business.





Defects in our software products and services could diminish demand for our products and services, which may harm our business.





Because our products and services are complex and may contain errors or defects that are not found until after they are used by our customers, any undiscovered errors or
defects could seriously harm our reputation and our ability to generate sales to new or existing customers.





Our
software products and services are complex and are generally used in systems with other vendors products. They can be adequately tested only when they are successfully integrated with these systems. Errors may be found in new products or
releases after shipment and our products and services may not operate as expected. Errors or defects in our products and services could result in:





| |  |  | loss of revenues and increased service and warranty costs;
| | - |  | ----------------------------------------------------------




| |  |  | delay in market acceptance;
| | - |  | ---------------------------




| |  |  | loss of salaries; and
| | - |  | ---------------------




| |  |  | injury to our reputation.
| | - |  | -------------------------



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If we are unable to raise additional capital when needed, we may be unable to develop or enhance our
products, services and markets.





We may need to seek additional funding in the future. If we cannot raise
funds on acceptable terms, we may be unable to develop or enhance our products and services, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements. We may also be required to reduce operating costs
through lay-offs or reduce our sales and marketing or research and development efforts. If we issue equity securities, stockholders may experience additional dilution or the new equity securities may have rights, preferences or privileges senior to
those of our common stock.





Failure to increase our brand awareness could limit our ability to compete effectively.





If the marketplace does not associate us with high-quality, end-to-end secure infrastructure software products and services, it
may be difficult for us to keep our existing customers, attract new customers or successfully introduce new products and services. Competitive and other pressures may require us to increase our expenses to promote our brand name, and the benefits
associated with brand creation may not outweigh the risks and costs associated with establishing our brand name. Our failure to develop a strong brand name or the incurrence of excessive costs associated with establishing our brand name may harm our
business.





We rely on public key cryptography and other security techniques that could be breached, resulting in reduced demand for
our products and services.





A requirement for the continued growth of electronic commerce is the secure
transmission of confidential information over public networks. We rely on public key cryptography, an encryption method that utilizes two keys, a public and private key, for encoding and decoding data, and on digital certificate technology, to
provide the security and authentication necessary for secure transmission of confidential information. Regulatory and export restrictions may prohibit us from using the strongest and most secure cryptographic protection available, and thereby may
expose us or our customers to a risk of data interception. A party who is able to circumvent our security measures could misappropriate proprietary information or interrupt our or our customers operations. Any compromise or elimination of our
security could result in risk of loss or litigation and possible liability and reduce demand for our products and services.





If we are
not able to continue to include our public root keys within software applications, our customers may not use our services.





If we are not able to continue to include our public root keys within software applications, including Microsoft Windows 2000, the Microsoft Internet Explorer browser and the Netscape browser, customers might perceive our software
products as too cumbersome to use and our business may be harmed. Our public root keys are used by applications to insure that digitally signed objects which are generated by our Enterprise VA and Digital Receipt Solutions are trustworthy and have
not been tampered with or corrupted. The term of our root key agreement with Netscape ends in November 2002 and we cannot assure you that this agreement will be renewed. In addition, our root key agreement with Microsoft may not be extended to cover
subsequent releases of Microsoft Windows 2000 or the Microsoft Internet Explorer browser.





The covenants and restrictions in our
existing and future debt facilities could have a negative effect on our business.





The covenants and
restrictions in our existing and future debt instruments could have a negative effect on our business, including impairing our ability to obtain additional financing and reducing our operational flexibility and ability to respond to changing
business and economic conditions.





A default under any debt facility could, under cross-default provisions, result
in defaults under other debt instruments, entitling other lenders to declare all debt outstanding under those other facilities to be immediately due and payable. If any declaration of acceleration were to occur, we might be unable to make those
required payments or to raise sufficient funds from other sources to make those payments. In addition, we have pledged substantially all of our assets to secure our credit facilities. If a default occurs with respect to secured indebtedness, the
holders of that indebtedness would be entitled to foreclose on their collateral, which would harm our business.





We could incur
substantial costs resulting from product liability claims relating to our customers use of our products and services.





Any disruption to a customers website or application caused by our products or services could result in a claim for substantial damages against us, regardless of our responsibility for the failure. Our existing insurance
coverage may not continue to be available on reasonable terms or in amounts sufficient to cover one or more large claims. Our insurer may also disclaim coverage as to any claims, which could result in substantial costs to us.




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We have been named as a defendant in a stockholder class action lawsuit that is now pending and which
arose out of our public offering of securities in 2000. If we do not prevail in this lawsuit, our business may suffer.





A class action lawsuit was filed on December 3, 2001 in the United States District Court for the Southern District of New York on behalf of purchasers of Valicert common stock alleging violations of federal securities laws. Lachance
v. Valicert, Inc. et al., No. 01-CV-10889 (SAS) (S.D.N.Y.), related to In re Initial Public Offerings Securities Litigation, No. 21 MC 92 (SAS). The case is brought purportedly on behalf of all persons who purchased our common stock from July 27,
2000 through December 6, 2000. The complaint names as defendants the Company; Joseph (Yosi) Amram, President, Chief Executive Officer, and member of the Board of Directors; Timothy Conley, Vice President, Finance and Chief Financial Officer; and an
investment banking firm that served as an underwriter for the our initial public offering in July 2000.





The
complaint alleges violations of Section 11 and 15 of the Securities Act of 1933 against all defendants, and Section 10(b) of the Securities Exchange Act of 1934 against the underwriter, on the grounds that the prospectus incorporated in the
registration statement for the offering failed to disclose, among other things, that (i) the underwriter had solicited and received excessive and undisclosed commissions from certain investors in exchange for which the underwriter allocated to those
investors material portions of the shares of our stock sold in the initial public offering, and (ii) the underwriter had entered into agreements with customers whereby the underwriter agreed to allocate shares of our stock sold in the initial public
offering to those customers in exchange for which the customers agreed to purchase additional shares of our stock in the aftermarket at pre-determined prices. No specific damages are claimed. We believe that the allegations are without merit and we
intend to contest them vigorously. We cannot assure you, however, that we will prevail in this lawsuit. Failure to prevail could have a material adverse effect on our financial position, results of operations and cash flows in the future.





In addition, we may become subject to other types of litigation in the future. Litigation is often expensive and
diverts managements attention and resources, which could materially and adversely affect our business.





Additional government
regulation relating to the Internet may increase our costs of doing business.





We are subject to regulations
applicable to businesses generally and laws or regulations directly applicable to companies utilizing the Internet. Although there are currently few laws and regulations directly applicable to the Internet, it is possible that a number of laws and
regulations may be adopted with respect to the Internet. These laws could cover issues like user privacy, pricing, content, intellectual property, distribution, antitrust, legal liability and characteristics and quality of products and services. The
adoption of any additional laws or regulations could decrease the demand for our products and services and increase our cost of doing business, or otherwise could harm our business or prospects.





Moreover, the applicability to the Internet of existing laws in various jurisdictions governing issues like property ownership, sales and other taxes, libel and
personal privacy is uncertain. For example, tax authorities in a number of states are currently reviewing the appropriate tax treatment of companies engaged in online commerce. New state tax regulations may subject us to additional state sales and
income taxes. Any new legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently apply to our business, or the application of existing laws and regulations to the Internet and commercial online
services could harm our ability to conduct business and our operating results.





Our reported results may be adversely affected by
changes in accounting principles generally accepted in the United States of America.





We prepare our financial
statements in conformity with accounting principles generally accepted in the United States of America (GAAP). GAAP is subject to interpretation by the American Institute of Certified Public Accountants, the Securities and Exchange
Commission and various bodies formed to interpret and create appropriate accounting policies. A change in these policies or interpretations could have a significant effect on our reported results, and may even affect the reporting of transactions
completed prior to the announcement of a change.





We may be required to record impairment charges related to our goodwill in future
quarters.





At June 30, 2002, we had recorded goodwill with a net book value of $7.4 million related to our
1999 acquisition of Receipt.com. We test goodwill for impairment at least annually and when evidence of an impairment exists. We do not believe that any events have occurred to indicate that an impairment exists at June 30, 2002. However, if future
financial performance or other events indicate that the value of our recorded goodwill is impaired, we may be required to record impairment charges which could have a material adverse effect on our reported results.





Legislative actions and potential new accounting pronouncements are likely to cause our general and administrative expenses to increase and impact our future
financial position and results of operations.





In order to comply with the newly
adopted Sarbanes-Oxley Act of 2002, as well as proposed changes to listing standards by Nasdaq, and proposed accounting changes by the Securities and Exchange Commission, we may be required to increase our internal controls, hire additional
personnel and additional outside legal, accounting and advisory services, all of which could cause our general and administrative costs to increase. Proposed changes in the accounting rules, including legislative and other proposals to account for
employee stock options as compensation expense among others, could increase the expenses that we report under GAAP and adversely affect our operating results.




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Risks Related to Our Industry





The markets for secure online transaction products and services generally, and our products and services specifically, are new and may not develop, which
would harm our business.





The market for our products and services is new and evolving rapidly. If the market
for our products and services fail to develop and grow, or if our products and services do not gain broad market acceptance, our business and prospects will be harmed. In particular, our success will depend upon the adoption and use by current and
potential customers and their end-users of secure online transaction products and services. Our success will also depend upon acceptance of our technology as the standard for providing these products and services. The adoption and use of our
products and services will involve changes in the manner in which businesses have traditionally completed transactions. We cannot predict whether our products and services will achieve any market acceptance. Our ability to achieve our goals also
depends upon rapid market acceptance of future enhancements of our products. Any enhancement that is not favorably received by customers and end-users may not be profitable and, furthermore, could damage our reputation or brand name.





The intense competition in our industry could reduce our market share or eliminate the demand for our software products and services, which could
harm our business.





Competition in the security infrastructure market is intense. If we are unable to compete
effectively, our ability to increase our market share and revenue will be harmed. We compete with companies that provide individual products and services that are similar to certain aspects of our software products and services. Certificate
authority software vendors and vendors of other security products and services could enter the market and provide end-to-end solutions which might be more comprehensive than our solutions. Many of our competitors have longer operating histories,
greater name recognition, larger installed customer bases and significantly greater financial, technical and marketing resources. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer
requirements, or to devote greater resources to the promotion and sale of their products. We anticipate that the market for security products and services that enable valid, secure and provable electronic commerce and communications over the
Internet will remain intensely competitive. We expect that competition will increase in the near term and increased competition could result in pricing pressures, reduced margins or the failure of our Internet-based security products and services to
achieve or maintain market acceptance, any of which could materially harm our business.





In addition, current and
potential competitors have established or may in the future establish collaborative relationships among themselves or with third parties, including third parties with whom we have strategic alliances, to increase the ability of their products to
address the security needs of our prospective customers. Accordingly, it is possible that new competitors or alliances may emerge and rapidly acquire significant market share. If this were to occur, our business could be materially affected.





Our business depends on the wide adoption of the Internet for conducting electronic commerce.





In order for us to be successful, the Internet must be widely adopted as a medium for conducting electronic commerce. Because electronic
commerce over the Internet is new and evolving, it is difficult to predict the size of this market and its sustainable growth rate. To date, many businesses and consumers have been deterred from utilizing the Internet for a number of reasons,
including but not limited to:





| |  |  | potentially inadequate development of network infrastructure;
| | - |  | -------------------------------------------------------------




| |  |  | security concerns including the potential for merchant or user impersonation and fraud or theft of stored data and information communicated over the Internet;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | inconsistent quality of service;
| | - |  | --------------------------------




| |  |  | lack of availability of cost-effective, high-speed service;
| | - |  | -----------------------------------------------------------




| |  |  | limited numbers of local access points for corporate users;
| | - |  | -----------------------------------------------------------




| |  |  | inability to integrate business applications on the Internet;
| | - |  | -------------------------------------------------------------




| |  |  | the need to operate with multiple and frequently incompatible products; and
| | - |  | ---------------------------------------------------------------------------




| |  |  | a lack of tools to simplify access to and use of the Internet.
| | - |  | --------------------------------------------------------------




The adoption of the Internet will require a broad acceptance of new methods of conducting business and exchanging information. Companies and government agencies that
already have invested substantial resources in other methods of conducting business may be reluctant to adopt new methods. Also, individuals with established patterns of purchasing goods and services and effecting payments may be reluctant to
change.




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The use of the Internet may not increase or may increase more slowly than we
expect because the infrastructure required to support widespread use may not develop. The Internet may continue to experience significant growth both in the number of users and the level of use. However, the Internet infrastructure may not be able
to continue to support the demands placed on it by continued growth. Continued growth may also affect the Internets performance and reliability. In addition, the growth and reliability of the Internet could be harmed by delays in development
or adoption of new standards and protocols to handle increased levels of activity or by increased governmental regulation. Changes in, or insufficient availability of, communications services to support the Internet could result in poor performance
and adversely affect its usage. Any of these factors could materially harm our business.





Public key cryptography security, on which
our products and services are based, may become obsolete, which would harm our business.





The technology used
to keep private keys confidential depends in part on the application of mathematical principles and relies on the difficulty of factoring large numbers into their prime number components. Should a simpler factoring method be developed, then the
security of encryption products utilizing public key cryptography technology could be reduced or eliminated. Even if no breakthroughs in factoring or other methods of attacking cryptographic systems are made, factoring problems can theoretically be
solved by computer systems significantly faster and more powerful than those presently available. Any significant advance in techniques for attacking cryptographic systems could render some or all of our existing products and services obsolete or
unmarketable.





Security systems based on public key cryptography assign users a public key and a private key, each
of which is required to encrypt and decrypt data. The security afforded by this technology depends on the users key remaining confidential. It is therefore critical that the private key be kept secure.





Our products are subject to export controls. If we are unable to obtain necessary approvals, our ability to make international sales could be limited.





Exports of software products utilizing encryption technology are generally restricted by the United States
and various foreign governments. Cryptographic products typically require export licenses from United States government agencies. We are currently exporting software products and services with requisite export approval under United States law.
However, the list of products and countries for which export approval is required, and the related regulatory policies, could be revised beyond their current scope, and we may not be able to obtain necessary approval for the export of our products.
Our inability to obtain required approvals under these regulations could limit our ability to make international sales. Furthermore, our competitors may also seek to obtain approvals to export products that could increase the amount of competition
we face.





Risks Related to the Stock Market in General





Our stock price may decline due to market and economic factors.





In recent years the stock market in general, and the market for shares of small capitalization and technology stocks in particular, have experienced extreme price fluctuations, which have often been unrelated to the operating
performance of affected companies. There can be no assurance that the market price of our common stock will not experience significant fluctuations in the future, including fluctuations unrelated to our performance. Such fluctuations could
materially adversely affect the market price of our common stock.





Securities we issue to fund our operations could dilute your
ownership.





We may decide to raise additional funds through public or private debt or equity financing to fund
our operations. If we raise funds by issuing equity securities, the percentage ownership of current stockholders will be reduced and the new equity securities may have right prior to those of our common stock. We may not obtain sufficient financing
on terms that are favorable to you or us.





Provisions in our charter documents and Delaware law could prevent or delay a change in
control, which could reduce the market price of our common stock.





We are controlled by our executive
officers, directors and major stockholders, whose interests may conflict with yours. Provisions in our charter documents and Delaware law could prevent or delay a change in control, which could reduce the market price of our common stock.





In addition, provisions of Delaware law may discourage, delay or prevent someone from acquiring or merging with
us. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock.




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ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.





FOREIGN CURRENCY
RISK





We develop products in the United States and market our products in North America, Europe and
Asia/Pacific regions. As a result, our financial results could be affected by changes in foreign currency exchange rates or weak economic conditions in foreign markets. Because substantially all of our revenues are currently denominated in U.S.
dollars, a strengthening of the dollar could make our products less competitive in foreign markets. Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are in
short-term instruments, including money market funds and commercial paper, and long-term investments mature between one and two years. Our interest expense is also sensitive to changes in the general level of U.S. interest rates because the interest
rate charged on a portion of our long-term debt varies with the prime rate. Due to the nature of our investments and borrowings, we believe that we are not subject to any material exposure to interest rate fluctuations. A hypothetical change in
interest rates of 100 basis points would have an immaterial effect on our operating results and cash flows.





As of
June 30, 2002, we have not entered into any derivative contracts, either for hedging or trading purposes.




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PART II.    OTHER INFORMATION





ITEM 1.    LEGAL PROCEEDINGS





A class action lawsuit was filed on
December 3, 2001 in the United States District Court for the Southern District of New York on behalf of purchasers of our common stock alleging violations of federal securities laws. Lachance v. Valicert, Inc. et al., No. 01-CV-10889 (SAS)
(S.D.N.Y.), related to In re Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS). The case is brought purportedly on behalf of all persons who purchased our common stock from July 27, 2000 through December 6, 2000. The complaint names
as defendants the Company and two of its officers, and an investment banking firm that served as an underwriter for our initial public offering in July 2000.





The complaint alleges violations of Section 11 and 15 of the Securities Act of 1933 against all defendants and Section 10(b) of the Securities Exchange Act of 1934 against the underwriter on the
grounds that the prospectus incorporated in the registration statement for the offering failed to disclose, among other things, that (i) the underwriter had solicited and received excessive and undisclosed commissions from certain investors in
exchange for which the underwriter allocated to those investors material portions of the shares of our stock sold in the initial public offering, and (ii) the underwriter had entered into agreements with customers whereby the underwriter agreed to
allocate shares of our stock sold in the initial public offering to those customers in exchange for which the customers agreed to purchase additional shares of our stock in the aftermarket at pre-determined prices. No specific damages are claimed.





We are aware that similar allegations have been made in lawsuits relating to more than 300 other initial public
offerings conducted in 1999 and 2000. Management believes that the allegations against us and our officers are without merit and intends to contest them vigorously. However, the litigation is in the preliminary stage, and its outcome cannot be
predicted. The litigation process is inherently uncertain. If the outcome of the litigation is adverse to the Company and if, in addition, we were required to pay significant monetary damages in excess of available insurance, our business would be
significantly harmed.





ITEM 2.    CHANGES IN SECURITIES AND USE OF PROCEEDS





None.





ITEM 3.    DEFAULTS UPON SENIOR SECURITIES





None.





ITEM 4.    SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS





Valicerts Annual Meeting of Stockholders was held on May 29, 2002 in Mountain View, California. Proxies representing 16,908,002 shares of common stock or 73.39% of the total outstanding shares were voted at the
Annual Meeting of Stockholders. The table below presents the voting results :





Election of Class II
Director





Votes For

Votes WithheldJohn Johnston

16,896,318

11,684





Appointment of Independent Auditors





The stockholders approved the appointment of Deloitte & Touche LLP as our independent public auditors for the fiscal year ending
December 31, 2002. The proposal received 16,789,300 affirmative votes, 117,957 negative votes, and 750 abstentions.





ITEM 5.    OTHER INFORMATION





None.




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ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K





(a)    Exhibits





3.1

Fourth Amended and Restated Certificate of Incorporation of the Company is incorporated by reference to the Companys Registration Statement on Form
S-8, as filed on January 22, 2001.3.2

Amended and Restated Bylaws of the Company is incorporated by reference to the Companys Registration Statement on Form S-8, as filed on January 22,
2001.4.1

Amended and Restated Rights Agreement dated as of July 21, 1999 is incorporated by reference to the Companys Registration Statement on Form S-1, as
filed on July 27, 2000.4.2

Registration Rights Agreement dated as of June 15, 2002 is incorporated by reference to the Companys Registration Statement on Form S-1, as filed on
July 25, 2001.4.3

Escrow Agreement dated as of June 15, 2001 is incorporated by reference to the Companys Registration Statement on Form S-1, as filed on July 25,
2001.4.4

Common Stock Purchase Agreement dated as of November 14, 2001 is incorporated by reference to the Companys Registration Statement on Form S-3, as
filed on December 6, 2001.4.5

Form of Common Stock Warrant dated as of November 14, 2001 is incorporated by reference to the Companys Registration Statement on Form S-3, as filed
on December 6, 2001.4.6

Registration Rights Agreement dated as of November 14, 2001 is incorporated by reference to the Companys Registration Statement on Form S-3, as filed
on December 6, 2001.4.7

Asset Purchase and Sale Agreement dated as of December 12, 2001 is incorporated by reference to the Companys Registration Statement on Form S-3/A, as
filed on January 18, 2002.4.8

Registration Rights Agreement dated as of December 21, 2001 is incorporated by reference to the Companys Registration Statement on Form S-3/A, as
filed on January 18, 2002.99.1

Certification by Chief Executive Officer.99.2

Certification by Chief Financial Officer.





None.





(b)    Reports on Form 8-K.





Current report on Form 8-K filed with the Securities and Exchange Commission on May 15, 2002.




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SIGNATURES





Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereto duly authorized.





VALICERT, INC.By:

/s/    TIMOTHY
CONLEYTimothy Conley Chief Financial
Officer





Dated: August 14, 2002




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