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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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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 March 31, 2003



| ̈ |  | 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)



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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 by check mark whether the Registrant is
an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes ̈No  þ



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



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|Class                          |  | Outstanding atApril 30, 2003
|------------------------------ |  | ----------------------------
|Common Stock, $0.001 par value |  | 25,183,565 shares           



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##### Table of Contents



VALICERT,
INC.



TABLE OF CONTENTS



|                                 |  |                                                                                                                           |  | Page
|-------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------- |  | ----
|PART I.    FINANCIAL INFORMATION |  |                                                                                                                          
|                                
|Item 1.                          |  | Financial Statements                                                                                                      |  | 3   
|                                
|                                 |  | Condensed Consolidated Balance Sheets as of March 31, 2003 and December 31, 2002                                          |  | 3   
|                                
|                                 |  | Condensed Consolidated Statements of Operations and Comprehensive Loss for the three months ended March 31, 2003 and 2002 |  | 4   
|                                
|                                 |  | Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and 2002                        |  | 5   
|                                
|                                 |  | Notes to Condensed Consolidated Financial Statements                                                                      |  | 6   
|                                
|Item 2.                          |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                     |  | 11  
|                                
|Item 3.                          |  | Quantitative and Qualitative Disclosures About Market Risk                                                                |  | 28  
|                                
|Item 4.                          |  | Controls and Procedures                                                                                                   |  | 29  
|                                
|PART II.    OTHER INFORMATION    |  |                                                                                                                          
|                                
|Item 1.                          |  | Legal Proceedings                                                                                                         |  | 29  
|                                
|Item 2.                          |  | Changes in Securities and Use of Proceeds                                                                                 |  | 30  
|                                
|Item 3.                          |  | Defaults upon Senior Securities                                                                                           |  | 30  
|                                
|Item 4.                          |  | Submission of Matters to Vote of Security Holders                                                                         |  | 30  
|                                
|Item 5.                          |  | Other Information                                                                                                         |  | 30  
|                                
|Item 6.                          |  | Exhibits and Reports on Form 8-K                                                                                          |  | 30  
|                                
|Signature                        |  | 32                                                                                                                       
|                                
|Certifications                   |  | 33                                                                                                                       
|                                
|Exhibit Index                    |  | 35                                                                                                                       



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PART I



ITEM 1.    FINANCIAL STATEMENTS



VALICERT, INC. AND SUBSIDIARIES



CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands)



|                                           |  | March 31, 2003 |         |   | December 31, 2002 |  
|------------------------------------------ |  | -------------- | ------- | - | ----------------- | -
|ASSETS                                     |  |                |         |   |                   |  
|Current assets:                            |  |                |         |   |                   |  
|Cash and cash equivalents                  |  | $              | 2,323   |   |                   | $
|Accounts receivable, net                   |  |                | 2,337   |   |                   |  
|Prepaid expenses and other current assets  |  |                | 268     |   |                   |  
|                                           |  |                |         |   |                   |  
|Total current assets                       |  |                | 4,928   |   |                   |  
|Property and equipment, net                |  |                | 1,206   |   |                   |  
|Goodwill, net                              |  |                | 7,496   |   |                   |  
|Other assets                               |  |                | 255     |   |                   |  
|                                           |  |                |         |   |                   |  
|Total assets                               |  | $              | 13,885  |   |                   | $
|                                           |  |                |         |   |                   |  
|                                          
|LIABILITIES AND STOCKHOLDERS EQUITY       |  |                |         |   |                   |  
|Current liabilities:                       |  |                |         |   |                   |  
|Accounts payable and accrued liabilities   |  | $              | 2,586   |   |                   | $
|Deferred revenue                           |  |                | 2,758   |   |                   |  
|Current portion of long-term debt          |  |                | 981     |   |                   |  
|                                           |  |                |         |   |                   |  
|Total current liabilities                  |  |                | 6,325   |   |                   |  
|Long-term debt                             |  |                | 210     |   |                   |  
|                                           |  |                |         |   |                   |  
|Total liabilities                          |  |                | 6,535   |   |                   |  
|                                           |  |                |         |   |                   |  
|Contingencies (Note 8)                     |  |                |         |   |                   |  
|                                          
|Stockholders equity:                      |  |                |         |   |                   |  
|Common stock                               |  |                | 106,317 |   |                   |  
|Deferred stock compensation                |  |                | (756    | ) |                   |  
|Accumulated deficit                        |  |                | (98,211 | ) |                   |  
|                                           |  |                |         |   |                   |  
|Total stockholders equity                 |  |                | 7,350   |   |                   |  
|                                           |  |                |         |   |                   |  
|Total liabilities and stockholders equity |  | $              | 13,885  |   |                   | $
|                                           |  |                |         |   |                   |  



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 March 31, |       
|------------------------------------------------------------------ |  | ---------------------------- | ------
|                                                                   |  | 2003                         |       
|Revenues:                                                          |  |                              |       
|Software license                                                   |  | $                            | 1,708 
|Subscription fees and other services                               |  |                              | 1,119 
|                                                                   |  |                              |       
|Total revenues                                                     |  |                              | 2,827 
|Cost of revenues:                                                  |  |                              |       
|Software license                                                   |  |                              |      
|Subscription fees and other services                               |  |                              | 196   
|                                                                   |  |                              |       
|Total cost of revenues                                             |  |                              | 196   
|                                                                   |  |                              |       
|Gross profit                                                       |  |                              | 2,631 
|                                                                   |  |                              |       
|Operating expenses:                                                |  |                              |       
|Research and development                                           |  |                              | 1,060 
|Sales and marketing                                                |  |                              | 1,948 
|General and administrative                                         |  |                              | 682   
|Merger related expenses                                            |  |                              | 562   
|Stock compensation *                                               |  |                              | 253   
|Amortization of intangible assets                                  |  |                              |      
|Restructuring and impairment charges                               |  |                              |      
|                                                                   |  |                              |       
|Total operating expenses                                           |  |                              | 4,505 
|                                                                   |  |                              |       
|Operating loss                                                     |  |                              | (1,874
|Interest and other expense, net                                    |  |                              | (51   
|                                                                   |  |                              |       
|Loss from continuing operations                                    |  |                              | (1,925
|Loss from discontinued operations (Note 2)                         |  |                              |      
|                                                                   |  |                              |       
|Net loss                                                           |  |                              | (1,925
|Other comprehensive loss:                                          |  |                              |       
|Unrealized loss on short-term investments                          |  |                              |      
|                                                                   |  |                              |       
|Comprehensive loss                                                 |  | $                            | (1,925
|                                                                   |  |                              |       
|Loss per share, basic and diluted:                                 |  |                              |       
|Loss from continuing operations                                    |  | $                            | (0.08 
|Loss from discontinued operations                                  |  |                              |      
|Net loss                                                           |  | $                            | (0.08 
|                                                                   |  |                              |       
|Shares used in computation of basic and diluted net loss per share |  |                              | 25,224
|                                                                   |  |                              |       
|*    Stock compensation:                                           |  |                              |       
|Cost of subscription fees and other services                       |  | $                            | 3     
|Research and development                                           |  |                              | 51    
|Sales and marketing                                                |  |                              | 136   
|General and administrative                                         |  |                              | 63    
|                                                                   |  |                              |       
|Total                                                              |  | $                            | 253   
|                                                                   |  |                              |       



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)



|                                                                                          |  | Three MonthsEnded March 31, |       
|----------------------------------------------------------------------------------------- |  | --------------------------- | ------
|                                                                                          |  | 2003                        |       
|Cash flows from operating activities:                                                     |  |                             |       
|Net loss                                                                                  |  | $                           | (1,925
|Adjustments to reconcile net loss to net cash used in operating
activities:               |  |                             |       
|Depreciation and amortization                                                             |  |                             | 255   
|Stock compensation                                                                        |  |                             | 253   
|Amortization of intangible assets                                                         |  |                             |      
|Interest on stockholder notes                                                             |  |                             |      
|Amortization of warrants issued in connection with debt financing                         |  |                             | 16    
|Non-cash restructuring and impairment charges                                             |  |                             |      
|Changes in assets and liabilities:                                                        |  |                             |       
|Accounts receivable                                                                       |  |                             | 818   
|Prepaid expenses and other current assets                                                 |  |                             | 110   
|Other assets                                                                              |  |                             | 235   
|Accounts payable and accrued liabilities                                                  |  |                             | (481  
|Deferred revenue                                                                          |  |                             | 275   
|Other liabilities                                                                         |  |                             |      
|                                                                                          |  |                             |       
|Net cash used in operating activities                                                     |  |                             | (444  
|Cash flows from investing activities:                                                     |  |                             |       
|Disposal (purchases) of property and equipment, net                                       |  |                             | 36    
|                                                                                          |  |                             |       
|Net cash provided by (used in) investing activities                                       |  |                             | 36    
|Cash flows from financing activities:                                                     |  |                             |       
|Proceeds from issuance of common stock, net of repurchases                                |  |                             | 13    
|Collection of notes receivable from stockholders                                          |  |                             |      
|Repayment of borrowings                                                                   |  |                             | (412  
|                                                                                          |  |                             |       
|Net cash used in financing activities                                                     |  |                             | (399  
|Net decrease in cash and equivalents                                                      |  |                             | (807  
|Cash and cash equivalentsbeginning of period                                             |  |                             | 3,130 
|                                                                                          |  |                             |       
|Cash and cash equivalentsend of period                                                   |  | $                           | 2,323 
|                                                                                          |  |                             |       
|Supplemental disclosure of cash flow informationcash paid during the period for
interest |  | $                           | 50    
|                                                                                          |  |                             |       



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-month period ended March 31, 2003 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, 2002 filed with the Securities and Exchange Commission on March 17, 2003.



The accompanying interim condensed consolidated financial statements have been prepared assuming that the
Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the accompanying financial statements and in the audited consolidated financial
statements included in the Companys Annual Report on Form 10-K for the year ended December 31, 2002, the Company had net losses of $1.9 million and $21.7 million and negative cash flows from operations of $449,000 and $19.0 million in the
three months ended March 31, 2003 and the year ended December 31, 2002, respectively, and an accumulated deficit of $98.2 million at March 31, 2003. These factors raise substantial doubt as to whether the Company will be able to continue as a going
concern for at least the next 12 months.



The
financial statements do not include any adjustments relating to the recoverability and reclassification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a
going concern. As discussed in Note 9, on February 18, 2003, the Company entered into a definitive merger agreement with Tumbleweed Communications Corp. In the event that the proposed merger is not consummated, the Company intends to seek additional
debt or equity financing to fund its operations. However, no assurances can be given that additional financing would be available.



Note 2.    Discontinued Operations



In January 2002, the Company announced its decision to exit its application service provider (hosting) business and ceased to offer the
service to new customers. The operations associated with this business consisted of a data center and related personnel. Under the terms of existing contracts, Valicert continued to operate the service through January 2003 and continued to recognize
previously deferred revenue related to these hosting arrangements. As Valicert was unable to dispose of the hosting business or classify the assets as held-for-sale until January 2003 the hosting business did not meet the requirements to be
classified as a discontinued operation until the March 31, 2003 consolidated financial statements were prepared.



In January 2003, the Company completed its final contract related to the hosting business. Accordingly, the results of the operations of
the hosting business have been classified as discontinued and prior periods have been reclassified on this basis. During the three months ended March 31, 2002, the Company recorded $130,000 of revenues and $231,000 of costs of revenues related to
the hosting business. The Company also recorded impairment charges of $1.0 million related to the hosting business in the quarter ended March 31, 2002 (see Note 7) which have been included in loss from discontinued operations. No revenues or
expenses were recognized for this business in the three months ended March 31, 2003.



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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.    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 March 31, |       
|----------------------------------------------------------------------- |  | ---------------------------- | ------
|                                                                        |  | 2003                         |       
|Net loss (numerator), basic and diluted                                 |  | $                            | (1,925
|                                                                        |  |                              |       
|Shares (denominator):                                                   |  |                              |       
|Weighted average common shares outstanding                              |  |                              | 25,263
|Weighted average common shares subject to repurchase and held in escrow |  |                              | (39   
|                                                                        |  |                              |       
|Shares used in computation, basic and diluted                           |  |                              | 25,224
|                                                                        |  |                              |       
|Net loss per share, basic and diluted                                   |  | $                            | (0.08 
|                                                                        |  |                              |       



At March
31, 2003 and 2002, options to purchase 4,769,491 and 3,713,924 shares of common stock, respectively, and warrants to purchase 1,036,063 and 1,244,396 shares of common stock, respectively, were excluded from the calculation of diluted net loss per
share, as their inclusion would be anti-dilutive.



Note
5.    Recent Accounting Pronouncements



In June 2002, the Financial Accounting Standards Board (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 (EITF) Issue No. 94-3. The Company adopted the provisions of SFAS No. 146 on January 1, 2003. SFAS No. 146 may affect the timing of recognizing
future restructuring costs as well as the amounts recognized.



In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45
requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. The Company adopted the provisions of FIN 45 for guarantees issued or modified after December
31, 2002. The adoption of this standard did not have a material effect on the Companys consolidated financial statements.



In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosurean
amendment of FASB Statement No. 123. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for
stock-based employee compensation. In addition, SFAS No. 148 amends the



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disclosure requirements of SFAS No. 123 to require prominent disclosures in financial statements about the
method of accounting for stock-based employee compensation and the effect of the method used on reported results. The disclosures required by SFAS No. 148 are included in these consolidated financial statements.



Note 6.    Stock Compensation



The Company accounts for stock-based awards to employees
using the intrinsic value method in accordance with Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, as amended. The following table illustrates the effect on net loss if the Company had
applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation (in thousands):



|                                                                                                                |  | Three Months Ended March 31, |       
|--------------------------------------------------------------------------------------------------------------- |  | ---------------------------- | ------
|                                                                                                                |  | 2003                         |       
|Net loss:                                                                                                       |  |                              |       
|As reported:                                                                                                    |  | $                            | (1,925
|Add: total stock compensation expense included in reported net loss                                             |  |                              | 253   
|Deduct: total stock-based employee compensation expense determined under fair value
based method for all awards |  |                              | (552  
|                                                                                                                |  |                              |       
|Pro forma net loss                                                                                              |  | $                            | (2,224
|                                                                                                                |  |                              |       
|Pro forma basic and diluted net loss per share                                                                  |  | $                            | (0.09 
|                                                                                                                |  |                              |       



The pro
forma stock compensation expense for the three months ended March 31, 2003 and 2002 has been calculated using the Black-Scholes option valuation model with the following weighted average assumptions:



|                        |  | Three Months Ended March 31,
|----------------------- |  | ----------------------------
|                        |  | 2003                        
|Expected life in years  |  | 5                           
|Expected volatility     |  | 100%                        
|Risk-free interest rate |  | 4.2%                        
|Expected dividends      |  |                            



Note
7.    Restructuring Charges



During January of 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 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
three months ended March 31, 2002, the Company recorded restructuring and impairment charges of approximately $4.7 million in accordance with EITF Issue No. 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 Staff Accounting Bulletin (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. As discussed in Note 2, in January 2002, the Company announced its decision to
exit its application service provider business. As a result of this action, management determined that the value of certain equipment was impaired and recorded an impairment charge of approximately $1.0 million, which is included in loss from
discontinued operations. In March 2002, the Company consolidated its corporate facilities and terminated the long-term facility lease contract for an unutilized facility located in Mountain View, California. As a result of this action, the Company
recorded additional restructuring and impairment charges of approximately $3.7 million, which is comprised of $3.6 million for settlement costs and forfeiture expenses associated with the building, $562,000 related to the impairment of associated
equipment and leasehold improvements and the write-off of security deposits, offset by the reversal of previously recorded deferred rent of $434,000.



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. In re Valicert, Inc. Initial Public Offering Securities Litigation, 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 former chief
executive officer, its chief financial officer, and an investment banking firm that served as an underwriter for the Companys initial public offering in July 2000.



The amended complaint alleges violations of Sections 11 and 15 of the Securities Act and Sections 10(b) and
20(a) of the Exchange Act, of 1934, as amended (the Exchange Act) on the grounds that the prospectus incorporated in the registration of 1933, as amended (the Securities Act) 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. The amended complaint also alleges that false analyst repots were issued. No specific damages
are claimed.



On February 19, 2003, Judge
Scheindlin issued a ruling on the motions. The Court denied the Companys motion to dismiss the claims under the Securities Act. The Court granted the Companys motion to dismiss the claims under the Securities Exchange Act. The Company
believes that the allegations are without merit and intends to contest them vigorously. If the outcome of the litigation is adverse to the Company and if, in addition, it is required to pay significant monetary damages in excess of available
insurance, our business would be significantly harmed. At March 31, 2003, management is unable to determine the amount of loss to the Company, if any, that would result from an unfavorable ruling in this matter.



On December 12, 2002, the Company granted options to purchase
a total of 1,029,209 shares of the Companys common stock at an exercise price of $0.28 per share, which was the fair market value on the date of grant. Such grants were not properly qualified under the California Corporate Securities Law of
1968, as amended. The Company submitted an application for a permit from the California Department of Corporations in order to effectuate a rescission offer and minimize any liability the Company may have. In May 2003, the rescission offer was
completed, and the liability to the Company was not material.



On April 23, 2003, Tumbleweed Communications Corp. (see Note 9) received a letter from CoreStreet, Ltd. in which CoreStreet, Ltd. indicated it had filed a patent infringement action against Valicert. The Company has not been served
with a complaint. Accordingly, management is unable to assess the likelihood of an unfavorable outcome with respect to this matter or the amount of potential loss, if any.



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.



Under the indemnification of the Companys standard reseller agreements and software license agreements, the Company agrees to defend
the reseller/licensee against third party claims asserting infringement by Companys products of certain intellectual property rights, which may include patents, copyrights, trademarks or trade secrets, and to pay any judgments entered on such
claims against the reseller/licensee.



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Note
9.    Merger Agreement



On February 18, 2003, the Company signed a definitive agreement to merge with Tumbleweed Communications Corp. (Tumbleweed) in a stock-for-stock transaction, where each share of the Companys common stock will be
exchanged for .385 shares of Tumbleweed common stock, or approximately 9.8 million shares, which represent approximately 24% of Tumbleweeds outstanding stock immediately following the closing of the merger. The merger remains subject to
certain closing conditions, which includes approval by the Companys stockholders. There can be no assurances that the merger will be consummated. In connection with the proposed merger, the Company incurred expenses of $562,000 during the
three months ended March 31, 2003.



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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



Valicert, Inc., (Valicert or the Company) develops and licenses secure Internet communications and identity
validation software for file transfer, financial messaging, and business process integration. Enterprises and government agencies primarily use our products to accelerate their financial and corporate supply chain processes and exchange sensitive
data inside and outside of their organizations. Using our products, our customers may migrate from private computer networks and paper processes to the Internet, thus reducing their expenses and gaining operating efficiencies.



Our products and services are complementary to the enterprise
application integration initiatives underway at many large companies today. These initiatives are intended to integrate the various computing systems at companies and connect them electronically to their customers and partners. This integration
creates more efficient end-to-end flows of information, such as orders and payments, resulting in potential cost savings for the companies due to more rapid business processing and reduced needs for paperwork and manual re-entry of data. Our
software enables companies to use extranets to securely exchange both structured, e.g., Electronic Data Interchange, or EDI, and eXtensible Markup Language, or XML, and unstructured information with business partners. Our products are available on a
range of computing platforms, from laptops to servers and mainframes.



On February 18, 2003, we signed a definitive agreement to merge with Tumbleweed Communications Corp. (Tumbleweed) in a stock-for-stock transaction, where each share of our common stock will be exchanged for .385
shares of Tumbleweed common stock, or approximately 9.8 million shares, which represent approximately 24% of Tumbleweeds outstanding stock immediately following the closing of the merger. The merger remains subject to certain closing
conditions, which includes approval by our stockholders. There can be no assurances that the merger will be consummated. In connection with the proposed merger, we incurred expenses of $562,000 during the three months ended March 31, 2003.



In January 2002, we announced our decision to
exit our application service provider (hosting) business and ceased to offer the service to new customers. The operations associated with this business consisted of a data center and related personnel. Under the terms of existing contracts, we
continued to operate the service through January 2003 and continued to recognize previously deferred revenue related to these hosting arrangements. As we were unable to dispose of the hosting business or classify the assets as held-for-sale until
January 2003 the hosting business did not meet the requirements to be classified as a discontinued operation until the March 31, 2003 consolidated financial statements were prepared.



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. Our preparation of the consolidated financial statements require 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. Our actual results may differ from these estimates.



Restructuring and impairment charges.    In January and March of 2002, we recorded
net restructuring and impairment charges of approximately $4.7 million in accordance with EITF Issue No. 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 Staff Accounting Bulletin (SAB) 100, Restructuring and Impairment Charges. Our restructuring initiatives involved
strategic decisions to cease providing certain services and consolidate corporate facilities. In January 2002, we announced our decision to exit our application service provider business. As a result of this action, our management determined that
the value of certain equipment was impaired and recorded an impairment charge of approximately $1.0 million, which is included in loss from discontinued operations. In March 2002, we consolidated our corporate facilities and terminated the long-term
facility lease contract for an unutilized facility located in Mountain View, California. As a result of this action, we recorded additional restructuring and impairment charges of approximately $3.7 million, which is comprised of $3.6 million for
settlement costs and forfeiture expenses associated with the building, $562,000 related to the impairment of associated equipment and leasehold improvements and the write-off of security deposits, offset by the reversal of previously recorded
deferred rent of $434,000. At March 31, 2003,



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accrued liabilities included $20,000 related to these restructuring initiatives, which is expected to be
paid in fiscal 2003.



Valuation of goodwill
and other intangible assets.    Our long-lived assets include goodwill and other intangible assets. At March 31, 2003, we had $7.5 million of goodwill and other intangible assets, accounting for 54.0% of our total assets. In
assessing the recoverability of our goodwill and other intangibles, we must make certain estimates and assumptions to determine the fair value of the respective assets. If these estimates or 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, or SFAS, 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 and annual impairment tests during the quarters ended June 30, 2002 and December 31, 2002, respectively, and determined that there was
no impairment.



Allowances for doubtful
accounts.    A significant portion of our receivables is concentrated with a small number of customers. At March 31, 2003, three customers accounted for 40% of our net accounts receivable, and at December 31, 2002, two
customers accounted for 28% of net accounts receivable. While we record allowances for doubtful accounts for estimated credit losses, future collections from our customers could differ significantly from these estimates, which could negatively
affect our future operating results.



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
| | - |  | -------------------------------------



| |  |  | collectibility is reasonably assured.
| | - |  | -------------------------------------



Revenue from shipments to resellers is generally recognized at the time of delivery of the software to the reseller, unless collectibility
is not reasonably assured, in which case revenue is deferred until the fee is collected. Should our estimates regarding the collectibility of amounts due from resellers change, our future results could be impacted.



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. 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 its normal business practice. In such cases, we recognize revenue when the
fee becomes due. If we do not consider collectibility reasonably assured, 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.



Stock compensation.    At March 31, 2003, 548,728 shares of common stock underlying notes receivable were
subject to variable accounting. As such, we will record additional stock compensation charges related to these shares should the market price of our common stock rise above certain levels. For 148,728 of these shares, these additional



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charges will begin when the market price of our common stock exceeds $0.72 per share. For the remaining
400,000 shares, such charges will commence at various market prices, starting at $3.00 per share.



Results of Operations



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



|                                         |  | Three Months Ended March 31, |   
|---------------------------------------- |  | ---------------------------- | --
|                                         |  | 2003                         |   
|Revenue:                                 |  |                              |   
|Software license                         |  | 60.4                         | % 
|Subscription fees and other services     |  | 39.6                         | % 
|Total revenues                           |  | 100.0                        | % 
|Cost of revenues:                        |  |                              |   
|Software license                         |  |                             | % 
|Subscription fees and other services     |  | 6.9                          | % 
|Total cost of revenues                   |  | 6.9                          | % 
|Gross profit                             |  | 93.1                         | % 
|                                        
|Operating expenses:                      |  |                              |   
|Research and development                 |  | 37.5                         | % 
|Sales and marketing                      |  | 68.9                         | % 
|General and administrative               |  | 24.1                         | % 
|Merger related expenses                  |  | 19.9                         | % 
|Stock compensation                       |  | 8.9                          | % 
|Amortization of intangible assets        |  |                             | % 
|Restructuring and impairment charges     |  |                             | % 
|Total operating expenses                 |  | 159.4                        | % 
|Operating loss                           |  | (66.3                        | )%
|Interest and other income (expense), net |  | (1.8                         | )%
|Loss from continuing operations          |  | (68.1                        | )%
|Loss from discontinued operations        |  |                             | % 
|Net loss                                 |  | (68.1                        | )%



Three Months Ended
March 31, 2003 and 2002



Net Loss



Our net loss decreased to $1.9 million
for the three months ended March 31, 2003 from $10.7 million for the three months ended March 31, 2002. The decrease was due to lower operating expenses and cost of revenues, primarily due to lower personnel-related costs resulting from a reduced
workforce. In addition, we recorded $4.7 million of restructuring and impairment charges during the quarter ended March 31, 2002. We have incurred cumulative losses of $98.2 million as of March 31, 2003.



Revenues



Total revenues decreased to $2.8 million for the three months
ended March 31, 2003 from $3.2 million for the three months ended March 31, 2002. We believe the decrease in revenues was primarily due to delayed information technology spending and a slowdown in PKI spending. In the three months ended March 31,
2003, we experienced a $660,000 decrease in professional services consulting revenue and a $187,000 decrease in subscription revenues, partially offset by a $470,000 increase in product license revenues. Revenues earned from customers outside of
North America accounted for 29.1% of total revenues in the three months ended March 31, 2003, compared to 57.8% in the same period in 2002.



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Software
license revenues accounted for 60.4% of our total revenues for the three months ended March 31, 2003 compared to 35.6% for the three months ended March 31, 2002. Subscription fees and other service revenues accounted for 39.6% of our total revenues
for quarter ended March 31, 2003 compared to 64.4% for the quarter ended March 31, 2002. The increase in license revenues, as a percentage of total revenues, was primarily due to the decrease in professional services consulting and application
service provider revenues.



The current economic
environment both in the United States of America and globally provides us with limited 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.    Costs of software license revenues consist primarily of royalty-bearing
technology licensed from third parties. In three months ended March 31, 2003, there were no royalty costs because the agreements related to these licenses ceased and we no longer utilized these technologies. In three months ended March 31, 2002,
cost of software license revenues was $253,000. These costs, as a percentage of total revenues, were 7.9% for the quarter ended March 31, 2002.



Cost of subscription fees and other services revenues.    Cost of subscription fees and other services revenues
relate to providing consulting and support services. These costs include salaries and other personnel-related costs, depreciation, telecommunications and other costs. Our cost of subscription fees and other services revenues decreased to $196,000
for the three months ended March 31, 2003 from $1.0 million for the three months ended March 31, 2002. Of this decrease, $747,000 related to salaries and other personnel-related costs. The decrease was due to the fact that during 2002, we completed
a number of reductions in our consulting and support services workforce.



As a percentage of total revenues, cost of subscription fees and other services revenues was 6.9% for the three months ended March 31, 2003, as compared to 32.6% for the three months ended March 31, 2002. This decrease can
was primarily due to a reduction in costs for subscription fees and other services that exceeded the associated revenues from the quarter ended March 31, 2002 to the quarter ended March 31, 2003.



We expect that the cost of subscription fees and other service
revenue will not vary significantly in absolute dollars throughout 2003, but will fluctuate as a percentage of total revenues.



Operating Expenses



Research and development.    Research and development expenses consist of salaries and other personnel-related
costs, third-party consulting services and the costs of facilities and computer equipment. Research and development costs decreased to $1.1 million for the three months ended March 31, 2003 from $2.3 million for the three months ended March 31,
2002, a decrease of 54.7%. Of this decrease, $371,000 related to facilities, $279,000 related to third-party consultants and contractors and $625,000 related to salaries and other personnel-related costs, due to a decrease in headcount in the
quarter ended March 31, 2003. Research and development expenses as a percentage of total revenues decreased to 37.5% in the quarter ended March 31, 2003 from 73.0% in the quarter ended March 31, 2002 due to costs decreasing at a faster rate than
revenues. During 2002, we established a development facility in Bangalore, India in order to continue our investment in product development and support but at a lower cost structure as compared to that in the United States. We employed approximately
40 employees in India at March 31, 2003. We expect that the research and development expenses will not vary significantly in absolute dollar amount, but will fluctuate as a percentage of total revenues .



Sales and marketing.    Sales and
marketing expenses consist of salaries and other personnel-related costs, sales commissions, marketing programs, travel and the costs of facilities and computer equipment. Sales and marketing expenses decreased to $1.9 million in the three months
ended March 31, 2003 from $3.4 million in the three months ended March 31, 2002, a decrease of 43.0%. Of this decrease, caused primarily by reductions in sales and marketing headcount, $791,000 related to reduced salaries and other personnel related
costs, $297,000 related to



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facilities costs and $290,000 related to reduced travel and entertainment. Sales and marketing costs as a
percentage of total revenues were 68.9% in the quarter ended March 31, 2003 compared to 106.6% in the quarter ended March 31, 2002. During 2002, we closed international sales offices in Argentina, Canada, France, Germany, Hong Kong, Singapore and
Spain. We expect that the sales and marketing expenses will not vary significantly in absolute dollar amount, but will fluctuate as a percentage of total revenues.



General and administrative.    General and administrative expenses consist of
salaries and other personnel-related costs for our finance and human resource employees, legal and accounting services and costs of computer equipment. General and administrative expenses decreased to $682,000 in the three months ended March 31,
2003 compared to $1.3 million in the three months ended March 31, 2002, a 45.7% decrease. Of this decrease, $320,000 related to reduced salaries and other personnel related costs and $262,000 related to a decrease in use of third-party consultants
and contractors. General and administrative costs as a percentage of total revenues were 24.1% in the quarter ended March 31, 2003 compared to 39.2% in the quarter ended March 31, 2002. This decrease in general and administrative expenses as a
percentage of total revenues resulted primarily because our expenses decreased at a greater rate than our revenues. We expect that the general and administrative expenses will not vary significantly in absolute dollar amount, but will fluctuate as a
percentage of total revenues.



Merger related
expenses.    On February 18, 2003, we signed a definitive agreement to merge with Tumbleweed Communications Corp. (Tumbleweed). The merger remains subject to certain closing conditions, which includes approval by
our stockholders. There can be no assurances that the merger will be consummated. In connection with the proposed merger, we incurred expenses of $562,000 during the three months ended March 31, 2003. These expenses include $254,000 related to
investment banking fees, $250,000 related to legal expenses and $58,000 related to accounting costs. We will incur additional costs through the close of the merger, which we expect to be complete in the second or third quarter of 2003.



Amortization of goodwill and
intangibles.    Amortization of intangibles, related to our December 1999 acquisition of Receipt.com was $153,000 in the three months ended March 31, 2002. Intangible assets associated with these expenses were fully amortized
at December 31, 2002 and, as such, we did not record an expense during the three months ended March 31, 2003.



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. 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 $253,000 in the three months ended March 31, 2003 and $429,000 in the three months ended March 31, 2002.



Restructuring and impairment charges.    During the three months ended March 31, 2002, we recorded net
restructuring and impairment charges of approximately $3.7 million in accordance with EITF Issue No. 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 Staff Accounting Bulletin (SAB) 100, Restructuring and Impairment Charges. Our restructuring initiatives involved
strategic decisions to cease providing certain services and consolidate corporate facilities. In January 2002, we announced our decision to exit our application service provider business. As a result of this action, our management determined that
the value of certain equipment was impaired and recorded an impairment charge of approximately $1.0 million. In March 2002, we consolidated our corporate facilities and terminated the long-term facility lease contract for an unutilized facility
located in Mountain View, California. As a result of this action, we recorded additional restructuring and impairment charges of approximately $3.7 million, which is comprised of $3.6 million for settlement costs and forfeiture expenses associated
with the building, $562,000 related to the impairment of associated equipment and leasehold improvements and the write-off of security deposits, offset by the reversal of previously recorded deferred rent of $434,000.



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Interest
and other income (expense).    Interest and other expense, net, decreased to $51,000 in the three months ended March 31, 2003 from $174,000 in the three months ended March 31, 2002. This decrease was primarily due to a
decrease in interest costs on our equipment loans and leases, partially offset by lower interest income due to decreased cash and investment balances and lower interest rates earned on our investments.



Loss from discontinued operationsIn January 2002,
we announced our decision to exit our application service provider (hosting) business and ceased to offer the service to new customers. The operations associated with this business consisted of a data center and related personnel. Under the terms of
existing contracts, we continued to operate the service through January 2003 and continued to recognize previously deferred revenue related to these hosting arrangements. As we were unable to dispose of the hosting business or classify the assets as
held-for-sale until January 2003 the hosting business did not meet the requirements to be classified as a discontinued operation until the March 31, 2003 consolidated financial statements were prepared.



In January 2003, we completed our final contract related to
the hosting business. Accordingly, the results of the operations of the hosting business have been classified as discontinued and prior periods have been reclassified on this basis. During the three months ended March 31, 2002, we recorded $130,000
of revenues and $231,000 of costs of revenues related to the hosting business. We also recorded impairment charges of $1.0 million related to the hosting business in the quarter ended March 31, 2002 (see Note 7) which have been included in loss from
discontinued operations. No revenues or expenses were recognized for this business in the three months ended March 31, 2003.



Liquidity and Capital Resources



Changes in financial condition



Net cash used in operating activities of $444,000 in the three months ended March 31, 2003 and $6.3 million in the three months ended
March 31, 2002 was primarily used to fund our net losses. Net cash used for operating activities in the quarter ended March 31, 2003 related primarily to a net loss of $1.9 million and payment of liabilities of $486,000, partially offset by non-cash
stock compensation and depreciation and amortization charges of $508,000, collections of accounts receivable of $818,000 and other changes in working capital.



Net cash provided by investing activities was $36,000 in the three months ended March 31, 2003 compared to net cash used by investing
activities of $105,000 in the three months ended March 31, 2002. Net cash provided by investing activities in the first quarter of 2003 primarily related to the disposal of computer equipment. Net cash used in investing activities in the first
quarter of 2002 primarily related to capital equipment expenditures. These expenditures primarily related 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 equipment lease commitments.



Net cash used in financing activities was $399,000 in the three months ended March 31, 2003 compared to net cash provided by financing
activities of $314,000 in the three months ended March 31, 2002. Net cash used in financing activities in the three months ended March 31, 2003 primarily related to repayment of borrowings of $412,000, partially offset by cash received for common
stock issuances. Net cash provided by financing activities in the three months ended March 31, 2002 primarily related to repayment of borrowings of $360,000, partially offset by cash received for common stock issuance and stockholder note
repayments.



Future funding requirements



On February 18, 2003, we entered into a
definitive agreement to merge with Tumbleweed Communications Corp. in a stock-for-stock transaction. We believe that, with the cash resources of Tumbleweed, we will have sufficient resources to meet our working capital needs for at least the next 12
months. In the event the merger is not



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completed, we believe we will need to raise additional working capital in the next 12 months. We used
$807,000 in the first quarter of 2003 and expect to reduce the amount of net cashed used to $100,000 by the fourth quarter of 2003. We expect we would need to raise additional by the fourth quarter of 2003. Due to recurring losses and negative cash
flows, there is substantial doubt about our ability to continue as a going concern if additional capital is not raised. We may not be able to obtain adequate or favorable financing at that time. Any additional financing may dilute your ownership
interest in our company. New equity securities could have rights senior to those of our common stockholders.



Recent Accounting Pronouncements



In June 2002, the Financial Accounting Standards Board (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 (EITF) Issue No. 94-3. We adopted the provisions of SFAS No. 146 on January 1, 2003. SFAS No. 146 may affect
the timing of recognizing future restructuring costs as well as the amounts recognized.



In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. We adopted the provisions of FIN 45 for guarantees issued
or modified after December 31, 2002. The adoption of this standard did not have a material effect on our consolidated financial statements.



In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosurean
amendment of FASB Statement No. 123. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in financial statements about the method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The disclosures required by SFAS No. 148 are included in our condensed consolidated financial statements.



Factors That May Impact Future Results



Risks Related to Our Business



Investors may lose their investment if we are unable to continue as a going concern, which may occur if we do not complete the merger
with Tumbleweed, achieve profitability or raise additional financing this year.



We reported a net losses of $1.9 million in the three months ended March 31, 2003 and of $21.7 million in the year ended December 31, 2002 and had cumulative losses of $98.2 million at March 31, 2003.
At March 31, 2003, we had a cash balance of $2.3 million and, at March 31, 2003, we had a cash balance of $2.3 million and had not reported a profitable quarter since inception in 1996. These factors raise substantial doubt as to whether we will be
able to continue in business. Our independent auditors have included a paragraph in their report stating that substantial doubt exists as to our ability to continue as a going concern.



To continue our operations, we must increase our revenues, complete the merger with Tumbleweed or raise
additional funds. If we are unable to increase revenues, our current level of operations is not sustainable. If the proposed merger with Tumbleweed is not completed, we will seek additional financing. Additional financing may not be available on
acceptable terms, if at all. If we do not increase revenues, complete the merger with Tumbleweed or raise additional financing, we may cease operations and initiate liquidation proceedings in which case investors would likely lose their entire
investment.



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The price
of our common stock has declined, and may continue to decline, as a result of the transfer of our securities from The Nasdaq National Market to The Nasdaq SmallCap Market.



On September 9, 2002, we transferred our securities to The Nasdaq SmallCap Market from The Nasdaq National
Market. This transfer may deter many potential investors from purchasing our common stock, further limiting the market for such securities. Because of this limited market, our stock price may decline, resulting in additional losses for investors.
Furthermore, the Nasdaq staff has advised us that our securities may be delisted from The Nasdaq SmallCap Market on June 6, 2003 if we have not complied with the minimum bid price of $1.00 per share prior to that date. If our stock is delisted from
the NASDAQ SmallCap Market, the price of our stock may decline even further.



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 SmallCap 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 June 6, 2003 or we otherwise fail to meet certain criteria for continued listing on The Nasdaq Small Cap Market, we have been notified by Nasdaq that our common stock may be
delisted. Should our common stock be delisted from The Nasdaq Small Cap Market, our common stock would trade on the Over-the-Counter (OTC) Market. If our common stock is traded on the 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, 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 which could result in delisting from the Nasdaq SmallCap Market.



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. The market price per share of our common stock
following the reverse stock split may not 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 Small Cap 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 affected 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, the reduced
number of shares that would be outstanding after the reverse stock split could adversely affect liquidity of our common stock. Moreover, our ability to repurchase fractional shares in connection with a reverse split may be limited or prohibited by
applicable state law regarding the redemption or repurchase of securities for cash. In any event, effecting such a split will entail substantial cost to comply with applicable federal and state securities laws,



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particularly in those states where a permit of special qualification is required. We may lack the cash
resources to satisfy these costs and therefore effect compliance.



The costs of operating as an independent public company may not be justified in light of our historical and projected operating results.



The costs of operating a small capitalization public company are considerable and have increased for us as a
result of compliance with the Nasdaq listing requirements, regulatory costs arising from the implementation of the Sarbanes-Oxley Act, compliance with the various blue sky and other state laws applicable to small capitalization companies, and
otherwise. These increased costs may place a significant and increasing burden on us and divert our managements attention from operating our business to raising capital and complying with application regulation. Moreover, like many other small
capitalization companies, our ability to attract and retain employees with equity compensation has diminished, which may necessitate the need to pay additional cash compensation to employees, management and directors to motivate and retain them. In
the event that the merger with Tumbleweed is not completed, we may be unable to operate efficiently as an independent public company in light of these additional costs or otherwise, and the inability to do so would materially and adversely affect
our prospects and ability to continue as an independent going concern.



Our recently announced merger with Tumbleweed may subject our stock price to downward adjustments as a result of adverse developments in Tumbleweeds business.



We announced on February 18, 2003 that we had entered into a
merger agreement with Tumbleweed, pursuant to which our stockholders will receive 0.385 shares of Tumbleweed common stock for each outstanding share of our common stock that they hold. Since we may terminate the agreement only in very limited
circumstances and the exchange ratio is not subject to adjustment, our stock price may be affected by changes in Tumbleweeds stock price. Accordingly, our stockholders are subject to the risk of downward adjustments in our stock price as a
result of adverse developments in Tumbleweeds business. Moreover, if for any reason we are unable to complete the merger with Tumbleweed, the price of our common stock may be adversely affected.



Our efforts to close the proposed merger with Tumbleweed
may harm our business as a result of delays in executing our separate business strategy and uncertainties caused by the proposed merger.



Our efforts to complete the proposed merger with Tumbleweed are complex and time consuming, and may disrupt our business. The attention
and effort devoted to the proposed merger may significantly divert managements attention from our other important business objectives.



Completion of the proposed merger is not certain, and this uncertainty may harm our business by disrupting relationships with employees,
customers, suppliers and other strategic relationships.



As a result of these uncertainties and the efforts related to the proposed merger with Tumbleweed, our business could be harmed as a result as a result of:



| |  |  | the inability to obtain alternative funding sources during the pendancy of the merger for purposes of ensuring liquidity and viability as an independent going
concern;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | potential loss of key management, development or other personnel;
| | - |  | -----------------------------------------------------------------



| |  |  | decline in employee morale;
| | - |  | ---------------------------



| |  |  | difficulties in hiring qualified development and other personnel to fill open positions;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | cancellations, reductions or delays in orders for our products or services;
| | - |  | ---------------------------------------------------------------------------



| |  |  | the reluctance of new or old customers and vendors to enter into or expand relationships or agreements with us; and
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | an inability to pursue or complete acquisitions of other companies that may be strategic to our business.
| | - |  | ---------------------------------------------------------------------------------------------------------



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If we are
unable to complete the proposed merger with Tumbleweed, our business will be harmed because of the costs and other matters that have arisen because of the proposed merger.



The proposed merger is subject to approval by our stockholders and other customary closing conditions. The
proposed merger may not be successfully completed. If so, our business may be harmed as a result of:



| |  |  | legal, accounting and other costs that we have has incurred in conjunction with the proposed merger;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | a potential loss of key management, development or other personnel;
| | - |  | -------------------------------------------------------------------



| |  |  | a decline in employee morale;
| | - |  | -----------------------------



| |  |  | damage to customer relationships, including cancellations, reductions or delays in orders for our products or services;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | a loss of key strategic relationships or key business partners; and
| | - |  | -------------------------------------------------------------------



| |  |  | delays in product development or development of new service capabilities.
| | - |  | -------------------------------------------------------------------------



Pursuant to terms of the merger agreement, we have not pursued other corporate opportunities, including
raising additional funds and continuing our operations as a standalone company. As a result, if we do not consummate the merger with Tumbleweed, our financial condition may be inadequate for us to continue to operate our business. In addition, our
inability to complete the merger with Tumbleweed may lower our value or reduce our ability to merge with other companies that may have been interested in acquiring us. In addition, we could be required to pay a termination fee to Tumbleweed upon the
occurrence of certain events.



If the merger
with Tumbleweed is not consummated, we will have to raise additional capital or we may not be able to develop or enhance our products, services and markets.



If the merger with Tumbleweed is not consummated, we will have to seek additional funding. If we cannot
quickly 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 to raise funds, stockholders may experience significant dilution and the new equity securities may have rights,
preferences or privileges senior to those of our common stock.



Because we have a limited operating history, it is difficult 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;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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.



Fluctuations in our quarterly
operating results may not be predictable and may result in significant volatility in our stock price.



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Our quarterly
results depend on a number of factors, many of which are beyond our control. Our quarterly results have in the past fluctuated, and may in the future fluctuate, 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.
| | - |  | ---------------------------------------------------------------------------



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.



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 $1.9 million in the three months ended March 31, 2003 and $10.7 million in the three months ended March 31, 2002. As of March 31, 2003, we had incurred cumulative losses of $98.2 million. Widespread acceptance of electronic commerce may be
adversely affected as a result of general or industry specific economic conditions. 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 be unable 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.



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 products may not achieve the necessary
level of market acceptance.



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;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | 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 customer 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 March 31, 2003, one customer, Unisys Corporation, accounted for 22% of total revenues. For the three months ended March 31, 2002, no one customer accounted for more than 10% 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.



We have a lengthy sales and implementation cycle, which
increases the cost of completing sales and renders completion of sales less predictable.



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.



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 that may result in future additional costs or limit the market for product
sales.



Products and services provided to
our international customers accounted for 29.1% of our revenues during the quarter ended March 31, 2003 and 57.8% of our revenues during the three months ended March 31, 2002. Conducting business outside of the United States subjects us to
additional risks, including:



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



| |  |  | 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 receivable; and
| | - |  | -----------------------------------------------



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



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Managing these
risks may subject us to additional costs that may not be justified in light of the market opportunity, and the inability to comply with or manage foreign laws and related risks may preclude or limit sales in foreign jurisdictions. In addition, the
recent outbreak of severe acute respiratory syndrome, or SARS, that began in China, Hong Kong, Singapore and Vietnam may have a negative impact on our operations. Our operations may be impacted by a number of SARS-related factors, including, but not
limited to, reduced sales in our international retail channels and increased supply chain costs. If the number of cases continues to rise or spread to other areas, our international sales and operations could be harmed.



We must maintain and enter into new collaborative
agreements in order to implement our business plan, and the inability to do so could adversely affect future operating results.



One of our objectives is 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. If we are unable to maintain our strategic alliances or enter into additional strategic
alliances, our business would be materially harmed.



We have entered into technology, marketing and distribution agreements with several companies. We may be unable to leverage the brand and distribution power of these agreements to increase the adoption rate of our technology. We have
been establishing agreements 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 agreements choose not to integrate our technology into their
offerings, the adoption of our software products and outsourced services would be inhibited. Furthermore, agreements our success will depend in part on the ultimate success of other parties to these agreements.



Our existing agreements do not, and any future agreements may
not, grant us exclusive marketing or distribution rights. In addition, the other parties may not view their agreements with us as significant for their own businesses. Therefore, these parties 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.



Our success depends on our ability
to grow and develop our direct sales and indirect distribution channels and the inability to do so could adversely affect future operating results.



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 have made recent changes to our management team and board of directors. The result of these changes is uncertain and may not be
effective.



John Vigouroux, our former
president of field operations, was named president and chief executive officer and appointed to the board of directors in October 2002. Joseph (Yosi) Amram resigned as our president and chief executive officer in October 2002. Mr. Amram
continues to act as our advisor and remains on our board of directors. Mr. Vigouroux has not previously served as President or Chief Executive Officer of an independent public company. If Mr. Vigouroux does not effectively integrate into his new
leadership role or if he does not work effectively with our existing management team, our business may suffer.



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 morale of our remaining employees is low, and we may be unable to retain them, particularly in
light of our limited cash resources. In addition, if our stock price decreases substantially, it may be more difficult to retain employees who consider



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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 would harm our business.



We may be
unable to adequately protect our intellectual property rights, and the inability to do so could render our products less desirable and adversely affect our operating results.



We rely on copyrights, trade secrets, know-how, patents, continuing technological innovations and licensing
opportunities to maintain and further develop our market position. In addition, 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. The inability to continue to procure or use this technology
could harm our business.



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. Others may independently develop substantially equivalent proprietary technology or gain
access to our trade secrets or disclose our technology and that we may be unable to 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.



Our pending or future patent applications may not be granted
and any patents that are issued may not be enforceable or valid. Additionally, the coverage claimed in a patent application can be significantly reduced before the patent is issued. We may not be 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.



We may be subject to
claims of patent infringement, which could result in substantial costs to us, and, if adversely determined, render our products less desirable or competitive or require us to obtain a license.



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 an 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 infringed their intellectual property rights based upon issued
patents, trade secrets or know-how that they believe cover our technology. For example, on April 23, 2003, Tumbleweed received a letter from CoreStreet, Ltd. in which CoreStreet, Ltd. indicated it had filed a patent infringement action against us.
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 may not 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
may be unable to obtain any such licenses at a reasonable cost, if at all. Defense of any lawsuit or failure to obtain such license could harm our business.



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



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



Our software products
and services are used in systems with other vendors products. These products and services 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.
| | - |  | -------------------------



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, we may be unable 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.



We could incur substantial costs resulting from product liability claims relating 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.



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 our common stock alleging violations of federal securities laws. In re Valicert, Inc. Initial Public Offering Securities Litigation, No. 01-CV-10889 (SAS) (S.D.N.Y.), related to In re Initial Public Offerings Securities Litigation,
No. 21 MC 92 (SAS).



For more information about
this case, including the allegations made by the plaintiffs, please Part II, Item 1 of this report entitled Legal Proceedings. We may be unable to prevail in this lawsuit. Failure to prevail could weaken our financial position. In
particular, if the outcome of the litigation requires us to pay significant monetary damages in excess of available insurance, our business would suffer. In addition, we may become subject to other



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types of litigation in the future. Litigation is often expensive and diverts managements attention
and resources, which could harm 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.



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



At March 31, 2003, we had recorded goodwill with a net book value of $7.5 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 have not recorded any impairment charges through March 31, 2003. However, if our 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 our expenses and adversely affect our operating results.



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.



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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.



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



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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. If a simpler factoring method is developed, the security of encryption products
using 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.



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.



ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET 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 expense is sensitive to changes in the general level of U.S. interest rates because the interest rate charged on a



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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 March 31, 2003, we had not entered into any derivative
contracts, either for hedging or trading purposes.



ITEM 4.    CONTROLS AND PROCEDURES



(a)    Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of
our disclosure controls and procedures, as such term is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended, within 90 days prior to the filing date of this report. Based on this evaluation, our chief
executive officer and chief financial officer concluded that our disclosure controls and procedures are effective at recording, processing, summarizing and reporting the information that we are required to disclose in this report.



(b)    There have been no significant
changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced in
paragraph (a) above.



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. In re Valicert, Inc. Initial Public Offering Securities Litigation, 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, its former chief executive officer, its chief financial officer and an investment banking firm that served as an
underwriter for our initial public offering in July 2000.



The amended complaint alleges violations of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 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. The amended complaint also alleges that false analyst reports were issued. 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. On July 15, 2002, we (and the other issuers named in the lawsuit) moved to dismiss all complaints. On February 19, 2003, Judge Scheindlin issued a ruling on the
motions. The Court denied our motion to dismiss the claims under the Securities Act of 1933. The Court granted our motion to dismiss the claims under the Securities Exchange Act of 1934.



On April 23, 2003, Tumbleweed received a letter from CoreStreet, Ltd. in which CoreStreet, Ltd. indicated it
had filed a patent infringement action against us. We have not been served with a complaint. Accordingly, we are unable to assess the likelihood of an unfavorable outcome with respect to this matter or the amount of potential loss, if any.



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.



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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



None.



ITEM 5.    OTHER INFORMATION



None.



ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K



(a)    Exhibits



|     
|-----
|3.1  
|     
|3.2  
|     
|4.1  
|     
|4.2  
|     
|4.3  
|     
|4.4  
|     
|4.5  
|     
|4.6  
|     
|4.7  
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|4.8  
|     
|10.8 
|     
|10.9 
|     
|10.10



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|     
|-----
|10.11
|     
|10.12
|     
|10.13
|     
|10.14
|     
|10.15
|     
|10.16
|     
|10.17
|     
|10.18
|     
|10.19
|     
|99.1 
|     
|99.2 



(b)    Reports on Form 8-K.



Current report on Form 8-K filed with the Securities and Exchange Commission on March 5, 2003.



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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:    May 13, 2003



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CERTIFICATIONS



I, John Vigouroux,
Chief Executive Officer of the registrant, certify that:



1.    I have reviewed this quarterly report on Form 10-Q of Valicert, Inc.;



2.    Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to
state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;



3.    Based on my knowledge, the financial
statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this
quarterly report;



4.    The
registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:



(a)    designed such
disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly
report is being prepared;



(b)    evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and



(c)    presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;



5.    The registrants other
certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of the registrants board of directors (or persons performing the equivalent function):



(a)    all significant
deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material
weaknesses in internal controls; and



(b)    any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and



6.    The registrants other
certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect the internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.



|Date:    May 13, 2003 |  | /s/    JOHN VIGOUROUXJohn Vigouroux President and Chief Executive Officer
|--------------------- |  | -------------------------------------------------------------------------



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I, Timothy Conley, Chief
Financial Officer of the registrant, certify that:



1.    I have reviewed this quarterly report on Form 10-Q of Valicert, Inc.;



2.    Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to
state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;



3.    Based on my knowledge, the financial
statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this
quarterly report;



4.    The
registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:



(a)    designed such
disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly
report is being prepared;



(b)    evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and



(c)    presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;



5.    The registrants other
certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of the registrants board of directors (or persons performing the equivalent function):



(a)    all significant
deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material
weaknesses in internal controls; and



(b)    any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and



6.    The registrants other
certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect the internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.



|Date:    May 13, 2003 |  | /s/    TIMOTHY CONLEYTimothy Conley Chief Financial Officer
|--------------------- |  | -----------------------------------------------------------



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EXHIBIT INDEX



|     
|-----
|3.1  
|     
|3.2  
|     
|4.1  
|     
|4.2  
|     
|4.3  
|     
|4.4  
|     
|4.5  
|     
|4.6  
|     
|4.7  
|     
|4.8  
|     
|10.8 
|     
|10.9 
|     
|10.10
|     
|10.11
|     
|10.12
|     
|10.13
|     
|10.14
|     
|10.15
|     
|10.16



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|     
|-----
|10.17
|     
|10.18
|     
|10.19
|     
|99.1 
|     
|99.2 



36