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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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(Mark one)

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

For the quarterly period ended September 30, 2006

OR



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

For the transition period from  to

Commission File Number 000-24733



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ENTRUST, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|MARYLAND                                                       |  | 62-1670648                       
|(State or other jurisdiction of incorporation or organization) |  | (IRS employer identification no.)

ONE HANOVER PARK, SUITE 800

16633 DALLAS PARKWAY

ADDISON, TX 75001

(Address of principal executive offices & zip code)

Registrants telephone number, including area code: (972) 713-5800



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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  x    No ̈

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act.

Large accelerated filer ̈Accelerated filer  x    Non-accelerated filer ̈

Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act.):    Yes ̈No  x

There were 59,965,011 shares of the registrants Common stock, par value $0.01 per share, outstanding as of
November 1, 2006.



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##### Table of Contents

ENTRUST, INC.

TABLE OF CONTENTS



|                                                                                              |  |   
|--------------------------------------------------------------------------------------------- |  | --
|PART I. FINANCIAL INFORMATION                                                                 |  | 1 
|                                                                                              | 
|ITEM 1. FINANCIAL STATEMENTS                                                                  |  | 1 
|CONDENSED CONSOLIDATED BALANCE SHEETS                                                         |  | 1 
|CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                                               |  | 2 
|CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                                               |  | 3 
|NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                          |  | 4 
|ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |  | 19
|ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            |  | 46
|ITEM 4. CONTROLS AND PROCEDURES                                                               |  | 48
|                                                                                              | 
|PART II. OTHER INFORMATION                                                                    |  | 48
|                                                                                              | 
|ITEM 1. LEGAL PROCEEDINGS                                                                     |  | 48
|ITEM 1A. RISK FACTORS                                                                         |  | 48
|ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                           |  | 56
|ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                       |  | 57
|ITEM 5. OTHER INFORMATION                                                                     |  | 57
|ITEM 6. EXHIBITS                                                                              |  | 57
|                                                                                              | 
|SIGNATURES                                                                                    |  | 58

Entrust, Entrust-Ready, and getAccess are registered trademarks of Entrust, Inc. or a subsidiary of Entrust, Inc.
in certain countries. Entrust Authority, Entrust TruePass, Entrust GetAccess, Entrust Entelligence, Entrust Cygnacom, are trademarks or service marks of Entrust, Inc. or a subsidiary of Entrust, Inc. in certain countries. All other trademarks and
service marks used in this quarterly report are the property of their respective owners.



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##### Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ENTRUST, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                                          |  |                   |          |   |                  |   |          |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | -------- | - | ---------------- | - | -------- | -
|(In thousands, except share and per share data)                                                                                                                                           |  | September 30,2006 |          |   | December 31,2005 |  
|Assets                                                                                                                                                                                    |  |                   |          |   |                  |   |          |  
|Current assets:                                                                                                                                                                           |  |                   |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                                                                                 |  | $                 | 25,780   |   |                  | $ | 59,929   |  
|Short-term marketable investments                                                                                                                                                         |  |                   | 2,659    |   |                  |   | 22,524   |  
|Accounts receivable (net of allowance for doubtful accounts of $1,272 at September 30, 2006 and $467 at December 31,
2005)                                                                |  |                   | 15,582   |   |                  |   | 20,341   |  
|Prepaid expenses and other receivables                                                                                                                                                    |  |                   | 3,535    |   |                  |   | 4,782    |  
|                                                                                                                                                                                          |  |                   |          |   |                  |   |          |  
|Total current assets                                                                                                                                                                      |  |                   | 47,556   |   |                  |   | 107,576  |  
|Property and equipment, net                                                                                                                                                               |  |                   | 2,996    |   |                  |   | 2,677    |  
|Purchased product rights and other purchased intangible assets, net                                                                                                                       |  |                   | 14,502   |   |                  |   | 2,086    |  
|Goodwill, net                                                                                                                                                                             |  |                   | 60,214   |   |                  |   | 12,713   |  
|Long-term strategic and equity investments                                                                                                                                                |  |                   | 270      |   |                  |   | 3,630    |  
|Other long-term assets, net                                                                                                                                                               |  |                   | 1,387    |   |                  |   | 1,767    |  
|                                                                                                                                                                                          |  |                   |          |   |                  |   |          |  
|Total assets                                                                                                                                                                              |  | $                 | 126,925  |   |                  | $ | 130,449  |  
|                                                                                                                                                                                          |  |                   |          |   |                  |   |          |  
|Liabilities                                                                                                                                                                               |  |                   |          |   |                  |   |          |  
|Current liabilities:                                                                                                                                                                      |  |                   |          |   |                  |   |          |  
|Accounts payable                                                                                                                                                                          |  | $                 | 8,947    |   |                  | $ | 7,223    |  
|Accrued liabilities                                                                                                                                                                       |  |                   | 8,272    |   |                  |   | 6,411    |  
|Accrued restructuring charges, current portion                                                                                                                                            |  |                   | 5,093    |   |                  |   | 3,552    |  
|Deferred revenue                                                                                                                                                                          |  |                   | 24,974   |   |                  |   | 20,895   |  
|                                                                                                                                                                                          |  |                   |          |   |                  |   |          |  
|Total current liabilities                                                                                                                                                                 |  |                   | 47,286   |   |                  |   | 38,081   |  
|Accrued restructuring charges, long-term portion                                                                                                                                          |  |                   | 20,624   |   |                  |   | 22,397   |  
|Other long-term liabilities                                                                                                                                                               |  |                   | 236      |   |                  |   | 859      |  
|                                                                                                                                                                                          |  |                   |          |   |                  |   |          |  
|Total liabilities                                                                                                                                                                         |  |                   | 68,146   |   |                  |   | 61,337   |  
|                                                                                                                                                                                          |  |                   |          |   |                  |   |          |  
|Minority interest in subsidiary                                                                                                                                                           |  |                   | 4        |   |                  |   | 4        |  
|                                                                                                                                                                                          |  |                   |          |   |                  |   |          |  
|Shareholders equity                                                                                                                                                                      |  |                   |          |   |                  |   |          |  
|Common stock, par value $0.01 per share: 250,000,000 authorized shares: 59,967,051 and 59,954,551 issued and outstanding shares at
September 30, 2006 and December 31, 2005, respectively |  |                   | 600      |   |                  |   | 600      |  
|Additional paid-in-capital                                                                                                                                                                |  |                   | 763,113  |   |                  |   | 762,279  |  
|Unearned compensation                                                                                                                                                                     |  |                   |         |   |                  |   | (1,814   | )
|Accumulated deficit                                                                                                                                                                       |  |                   | (705,587 | ) |                  |   | (691,916 | )
|Accumulated other comprehensive income (loss)                                                                                                                                             |  |                   | 649      |   |                  |   | (41      | )
|                                                                                                                                                                                          |  |                   |          |   |                  |   |          |  
|Total shareholders equity                                                                                                                                                                |  |                   | 58,775   |   |                  |   | 69,108   |  
|                                                                                                                                                                                          |  |                   |          |   |                  |   |          |  
|Total liabilities and shareholders equity                                                                                                                                                |  | $                 | 126,925  |   |                  | $ | 130,449  |  
|                                                                                                                                                                                          |  |                   |          |   |                  |   |          |  

The accompanying notes are an integral part of these financial statements.



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##### Table of Contents

ENTRUST, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS



|                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|-------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                               |  | Three months endedSeptember 30, |        |   | Nine months endedSeptember 30, |  
|(In thousands, except share and per share data)                |  | 2006                            |        |   | 2005                           |   |        | 2006 |  |   | 2005    |  
|Revenues:                                                      |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Product                                                        |  | $                               | 8,788  |   |                                | $ | 7,668  |      |  | $ | 22,754  |   |  | $ | 25,135 |  
|Services and maintenance                                       |  |                                 | 15,243 |   |                                |   | 15,983 |      |  |   | 44,430  |   |  |   | 48,232 |  
|                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Total revenues                                                 |  |                                 | 24,031 |   |                                |   | 23,651 |      |  |   | 67,184  |   |  |   | 73,367 |  
|                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Cost of revenues:                                              |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Product                                                        |  |                                 | 1,246  |   |                                |   | 1,420  |      |  |   | 4,420   |   |  |   | 3,400  |  
|Services and maintenance                                       |  |                                 | 7,252  |   |                                |   | 7,291  |      |  |   | 21,700  |   |  |   | 23,505 |  
|Amortization of purchased product rights                       |  |                                 | 319    |   |                                |   | 215    |      |  |   | 738     |   |  |   | 600    |  
|                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Total cost of revenues                                         |  |                                 | 8,817  |   |                                |   | 8,926  |      |  |   | 26,858  |   |  |   | 27,505 |  
|                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Gross profit                                                   |  |                                 | 15,214 |   |                                |   | 14,725 |      |  |   | 40,326  |   |  |   | 45,862 |  
|                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Operating expenses:                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Sales and marketing                                            |  |                                 | 9,710  |   |                                |   | 6,709  |      |  |   | 24,431  |   |  |   | 21,480 |  
|Research and development                                       |  |                                 | 5,505  |   |                                |   | 3,979  |      |  |   | 14,148  |   |  |   | 12,617 |  
|General and administrative                                     |  |                                 | 3,426  |   |                                |   | 3,130  |      |  |   | 10,654  |   |  |   | 8,986  |  
|Restructuring charges and adjustments                          |  |                                 |       |   |                                |   |       |      |  |   | 2,765   |   |  |   |       |  
|                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Total operating expenses                                       |  |                                 | 18,641 |   |                                |   | 13,818 |      |  |   | 51,998  |   |  |   | 43,083 |  
|                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Income (loss) from operations                                  |  |                                 | (3,427 | ) |                                |   | 907    |      |  |   | (11,672 | ) |  |   | 2,779  |  
|                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Other income (expense):                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Interest income                                                |  |                                 | 363    |   |                                |   | 600    |      |  |   | 1,945   |   |  |   | 1,705  |  
|Gain on sale of asset                                          |  |                                 |       |   |                                |   |       |      |  |   |        |   |  |   | 200    |  
|Foreign exchange gain (loss)                                   |  |                                 | (4     | ) |                                |   | (55    | )    |  |   | (275    | ) |  |   | (24    | )
|Write-down of long-term strategic and equity investments       |  |                                 |       |   |                                |   |       |      |  |   | (3,016  | ) |  |   |       |  
|Loss from equity investments                                   |  |                                 | (51    | ) |                                |   | (210   | )    |  |   | (344    | ) |  |   | (661   | )
|                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Total other income (expense)                                   |  |                                 | 308    |   |                                |   | 335    |      |  |   | (1,690  | ) |  |   | 1,220  |  
|                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Income (loss) before income taxes                              |  |                                 | (3,119 | ) |                                |   | 1,242  |      |  |   | (13,362 | ) |  |   | 3,999  |  
|Provision for income taxes                                     |  |                                 | 120    |   |                                |   | 286    |      |  |   | 309     |   |  |   | 981    |  
|                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Net income (loss)                                              |  | $                               | (3,239 | ) |                                | $ | 956    |      |  | $ | (13,671 | ) |  | $ | 3,018  |  
|                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Net income (loss) per share:                                   |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Basic                                                          |  | $                               | (0.05  | ) |                                | $ | 0.02   |      |  | $ | (0.23   | ) |  | $ | 0.05   |  
|Diluted                                                        |  | $                               | (0.05  | ) |                                | $ | 0.02   |      |  | $ | (0.23   | ) |  | $ | 0.05   |  
|Weighted average common shares used in per share computations: |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Basic                                                          |  |                                 | 59,807 |   |                                |   | 59,974 |      |  |   | 59,814  |   |  |   | 61,129 |  
|Diluted                                                        |  |                                 | 59,807 |   |                                |   | 62,753 |      |  |   | 59,814  |   |  |   | 62,875 |  

The accompanying notes are an integral part of these financial statements.



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ENTRUST, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                              |  |                                |         |   |      |   |         |  
|------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                              |  | Nine months endedSeptember 30, |        
|                                                              |  | 2006                           |         |   | 2005 |  
|                                                              |  | (In thousands)                 |        
|OPERATING ACTIVITIES:                                         |  |                                |         |   |      |   |         |  
|Net income (loss)                                             |  | $                              | (13,671 | ) |      | $ | 3,018   |  
|Non-cash items in net income (loss):                          |  |                                |         |   |      |   |         |  
|Depreciation and amortization                                 |  |                                | 2,396   |   |      |   | 4,426   |  
|Non-cash compensation expense related to stock plans          |  |                                | 2,725   |   |      |   | 208     |  
|Loss from equity investments                                  |  |                                | 344     |   |      |   | 661     |  
|Intercompany profit elimination                               |  |                                |        |   |      |   | 96      |  
|Provision for (reduction in) allowance for doubtful accounts  |  |                                | 795     |   |      |   | (339    | )
|Write-down of strategic and equity investments                |  |                                | 3,016   |   |      |   |        |  
|Gain on sale of asset                                         |  |                                |        |   |      |   | (200    | )
|Changes in operating assets and liabilities:                  |  |                                |         |   |      |   |         |  
|(Increase) decrease in accounts receivable                    |  |                                | 5,900   |   |      |   | (3,111  | )
|(Increase) decrease in prepaid expenses and other receivables |  |                                | 1,437   |   |      |   | (669    | )
|Increase (decrease) in accounts payable                       |  |                                | 793     |   |      |   | 2,005   |  
|Increase (decrease) in accrued liabilities                    |  |                                | 1,571   |   |      |   | (2,257  | )
|Decrease in accrued restructuring charges                     |  |                                | (232    | ) |      |   | (3,093  | )
|Increase (decrease) in deferred revenue                       |  |                                | 1,818   |   |      |   | (1,594  | )
|                                                              |  |                                |         |   |      |   |         |  
|Net cash provided by (used in) operating activities           |  |                                | 6,892   |   |      |   | (849    | )
|                                                              |  |                                |         |   |      |   |         |  
|INVESTING ACTIVITIES:                                         |  |                                |         |   |      |   |         |  
|Purchases of marketable investments                           |  |                                | (12,735 | ) |      |   | (59,035 | )
|Maturities of marketable investments                          |  |                                | 32,600  |   |      |   | 78,214  |  
|Purchases of property and equipment                           |  |                                | (1,038  | ) |      |   | (1,098  | )
|Proceeds on sale of asset                                     |  |                                |        |   |      |   | 200     |  
|Increase in long-term equity investments                      |  |                                |        |   |      |   | (458    | )
|Increase in other long-term assets                            |  |                                | (87     | ) |      |   | (684    | )
|Purchase of businesses, net of cash acquired                  |  |                                | (58,997 | ) |      |   |        |  
|                                                              |  |                                |         |   |      |   |         |  
|Net cash provided by (used in) investing activities           |  |                                | (40,257 | ) |      |   | 17,139  |  
|                                                              |  |                                |         |   |      |   |         |  
|FINANCING ACTIVITIES:                                         |  |                                |         |   |      |   |         |  
|Repayment of long-term liabilities                            |  |                                | (570    | ) |      |   | (180    | )
|Repurchase of common stock                                    |  |                                | (2,519  | ) |      |   | (16,902 | )
|Proceeds from issuance of common stock                        |  |                                | 675     |   |      |   |        |  
|Proceeds from exercise of stock options                       |  |                                | 1,045   |   |      |   | 4,219   |  
|                                                              |  |                                |         |   |      |   |         |  
|Net cash used in financing activities                         |  |                                | (1,369  | ) |      |   | (12,863 | )
|                                                              |  |                                |         |   |      |   |         |  
|EFFECT OF EXCHANGE RATE CHANGES ON CASH                       |  |                                | 585     |   |      |   | 400     |  
|                                                              |  |                                |         |   |      |   |         |  
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS          |  |                                | (34,149 | ) |      |   | 3,827   |  
|CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD              |  |                                | 59,929  |   |      |   | 36,325  |  
|                                                              |  |                                |         |   |      |   |         |  
|CASH AND CASH EQUIVALENTS AT END OF PERIOD                    |  | $                              | 25,780  |   |      | $ | 40,152  |  
|                                                              |  |                                |         |   |      |   |         |  

The accompanying notes are an integral part of these financial statements.



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ENTRUST, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share data, unless indicated otherwise)

NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been
prepared on the same basis as the audited annual consolidated financial statements and, in the opinion of management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial
position, results of operations and cash flows of Entrust, Inc., a Maryland corporation, and its consolidated subsidiaries (collectively, the Company). The results of operations for the three and nine months ended September 30, 2006
are not necessarily indicative of the results to be expected for the full year. Certain information and footnote disclosures normally contained in financial statements prepared in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the Consolidated Financial Statements and related Notes contained in the Companys Annual Report on
Form 10-K for the year ended December 31, 2005.

NOTE 2. ACQUISITIONS

Orion Security Solutions, Inc. (Orion)

On June 15, 2006, the Company completed the
acquisition of all of the issued and outstanding shares of common stock of Orion, a Virginia corporation, pursuant to a stock purchase agreement dated as of June 15, 2006 (Stock Purchase Agreement) among the Company, Orion, and the
shareholders of Orion. The Company acquired all of the common stock of Orion, a privately-held provider of public key infrastructure services to defense-related governmental agencies and other customers, such as the Department of Defense, the United
States Marine Corps and the National Security Agency and commercial companies in the healthcare industry, in exchange for $9,000 in cash and $135 in acquisition-related costs. The acquisition was made in order to extend the Companys overall
leadership in the United States government vertical, by further strengthening the Companys ability to provide identity and information security to the United States civilian government agencies, adding key defense agencies to the
Companys customer base. Although, the Company intends to continue Orions business substantially in the manner conducted by Orion immediately prior to the acquisition, it plans to integrate the business into Entrust Cygnacom, a wholly
owned subsidiary of the Company, located in McLean, Virginia.

The acquisition was accounted for under the purchase method of accounting, and, accordingly,
the purchase price of approximately $9,135 was allocated to the fair value of the tangible and intangible assets and liabilities acquired, with the remainder allocated to goodwill. In addition, the results of operations of Orion have been included
in the Companys consolidated financial statements commencing from June 1, 2006, the effective date of the acquisition for accounting purposes. In the three months ended September 30, 2006, the Company recorded amortization of $115,
related to customer relationships and non-competition agreement assets arising from this acquisition. In connection with the purchase price allocation, the Company undertook an appraisal of the intangible assets, which resulted in the purchase price
of these assets being allocated, on a preliminary basis, as follows:



|                           |  |                    |  |               |      
|-------------------------- |  | ------------------ |  | ------------- | -----
|                           |  | AmortizationPeriod |  | PurchasePrice
|Net tangible assets        |  |                   |  | $             | 526  
|Customer relationships     |  | 5 years            |  |               | 960  
|Non-competition agreements |  | 5 years            |  |               | 769  
|Goodwill                   |  |                   |  |               | 6,880
|                           |  |                    |  |               |      
|Total                      |  |                    |  | $             | 9,135
|                           |  |                    |  |               |      



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Business Signatures Corporation (Business Signatures)

On July 19, 2006, the Company completed the acquisition of all of the issued and outstanding shares of capital stock and options of Business Signatures, a
privately-held supplier of Zero Touch Fraud Detection solutions that provide non-invasive real time online fraud detection capability that require no change to business applications, based in Redwood City, California, in exchange for approximately
$48,024 in cash and vested options to purchase shares of the Companys Common stock with an aggregate fair value of approximately $722. The Company also expects that it will incur approximately $2,465 in acquisition-related expenses and will
assume net liabilities of Business Signatures of approximately $1,060. The acquisition enables the Company to combine Business Signatures zero touch capability with the Companys IdentityGuard authentication platform in order to offer
customers strong consumer authentication solutions, that are easy to implement, user-friendly and cost effective with the ability to evolve over time, to help meet the Federal Financial Institutions Examination Council (FFIEC)
requirement to implement stronger security measures for online customers, as well as other requirements for online transaction security and integrity.

The
acquisition was accounted for under the purchase method of accounting, and, accordingly, the purchase price of approximately $51,211 was allocated to the fair value of the tangible and intangible assets and liabilities acquired, with the remainder
allocated to goodwill. In addition, the results of operations of Business Signatures have been included in the Companys consolidated financial statements commencing from July 19, 2006, the effective date of the acquisition for accounting
purposes. In the three months ended September 30, 2006, the Company recorded amortization of $243, related to customer/partner relationships and purchased product rights arising from this acquisition. In connection with the purchase price
allocation, the Company undertook an appraisal of the intangible assets, which resulted in the purchase price of these assets being allocated, on a preliminary basis, as follows:



|                         |  |                    |  |               |        |  
|------------------------ |  | ------------------ |  | ------------- | ------ | -
|                         |  | AmortizationPeriod |  | PurchasePrice |       
|Net tangible liabilities |  |                   |  | $             | (1,060 | )
|Customer relationships   |  | 10 years           |  |               | 2,870  |  
|Partner relationships    |  | 10 years           |  |               | 3,660  |  
|Purchased product rights |  | 10 years           |  |               | 5,120  |  
|Goodwill                 |  |                   |  |               | 40,621 |  
|                         |  |                    |  |               |        |  
|Total                    |  |                    |  | $             | 51,211 |  
|                         |  |                    |  |               |        |  

The allocation of the purchase price is preliminary and subject to further analysis. Any modification will result
in a reallocation of the amounts attributable to the intangible assets, which could result in a change in the amortization period and/or amount subject to amortization.

The following unaudited pro forma data summarize the combined results of operations of the Company, Orion and Business Signatures for the three and nine months ended September 30, 2006 and 2005, respectively, as
if the acquisitions had taken place as of the beginning of the respective periods, and, accordingly, include a full periods amortization of the assets related to customer relationships, purchased product rights and non-competition agreements
in each period shown.



|                                     |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|------------------------------------ |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                     |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                     |  | 2006                            |        |   | 2005                           |   |        | 2006 |  |   | 2005    |  
|Revenues                             |  | $                               | 24,087 |   |                                | $ | 24,663 |      |  | $ | 69,114  |   |  | $ | 75,727 |  
|Net loss                             |  |                                 | (3,745 | ) |                                |   | (1,604 | )    |  |   | (20,613 | ) |  |   | (4,633 | )
|Basic and diluted net loss per share |  |                                 | (0.06  | ) |                                |   | (0.03  | )    |  |   | (0.34   | ) |  |   | (0.08  | )

These pro forma amounts are not necessarily indicative of future results of
operations.



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##### Table of Contents

NOTE 3. INVESTMENT IN OHANA WIRELESS, INC.

Ohana was incorporated on July 10, 2003. It was formed to design, assemble and install high frequency wireless communications systems. On September 30, 2003, the Company loaned Ohana $650 in the form of a
convertible loan pursuant to the terms of a convertible loan agreement (the Loan Agreement). The Company believed that its security solutions could be integrated with Ohanas products and anticipated that an investment in Ohana
would assist the Company in furthering the development of its distribution capability in Asia through technology and distribution partnerships. This convertible loan was structured to automatically convert into Ohanas stock if Ohana was
successful in closing a round of equity financing by July 31, 2004, based on minimum terms set out in the Loan Agreement.

In the second and third
quarters of 2004, the Company made additional advances of $300 and $275, respectively, resulting in a total outstanding convertible loan of $1,225 which by July 2004 was secured with certain exclusive rights to Ohanas intellectual property.

In the third quarter of 2004, the Company determined that the loan was unlikely to be repaid. Also in the third quarter of 2004 we concluded a term sheet
with Ohana and certain of its shareholders and creditors which anticipated that Ohana would become a wholly owned subsidiary of ADML Holdings, Ltd. (ADML Holdco) and all loans, together with accrued interest, would convert into stock of
ADML Holdco (Ohana Restructuring). In view of these factors we classified the loans as long-term in nature.

If the Ohana Restructuring had
materialized on September 30, 2004, we would have held the equivalent of approximately 12% ownership interest in ADML Holdco (exclusive of the anticipated final disbursement in the fourth quarter of 2004). Also, we had concluded that because of
the additional investment in July 2004, and additional rights obtained through the security granted in connection with the loans, we gained the potential ability to exercise significant influence over the operations of Ohana. Therefore, beginning
the third quarter of 2004, the Company accounted for its investment in Ohana under the equity method. Accordingly, the Company included its share of losses of Ohana for the period from July 1, 2004 to December 17, 2004, in the amount of
$193, in its consolidated statement of operations for 2004.

The Ohana Restructuring closed on November 16, 2004 and the Company received
approximately 14.3% of the issued common shares of ADML Holdco and a warrant exercisable for additional shares of ADML Holdco at one tenth of one penny ($0.001) per share if, and to the extent, that the valuation of Asia Digital Media, as determined
by an arms length investor contributing a minimum amount of cash for equity in Asia Digital Media is less than the total consideration contributed by ADML Holdco, the Company, and another investor for equity in Asia Digital Media.

In December 2004 ADML Holdco directly subscribed for 60.6% of the share capital of Asia Digital Media in exchange for a contribution of the entire issued share
capital of Ohana. However, this transaction was subsequently rescinded on December 27, 2005, when the Company entered into the Rescission Agreement with Asia Digital Media and ADML Holdco to rescind such subscription, resulting in the return of
the shares of Asia Digital Media issued to ADML Holdco for cancellation and the corresponding return of the entire issued capital of Ohana to ADML Holdco.

Upon conclusion of the Rescission Agreement, the Company owned approximately 14.3% of the issued share capital of Ohana. The carrying value of this investment was $750 at December 31, 2005; and, the Company had recorded cumulative
losses from its investment in Ohana of $750 since the fourth quarter of 2004, including $96, $461 and $193 in 2006, 2005 and 2004, respectively. As a consequence of the Rescission Agreement, there are no additional terms associated with the
Companys investment in ADML Holdco that would impact its accounting for this investment under FIN 46 (R), the Company has no further commitments or other arrangements to provide funding for any shortfalls ADML Holdco may incur, and there are
no variable interests with respect to ADML Holdco, other than its common stock interest of 14.3%.



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Dr. Anthony E. Hwang, a director of the Company from August 4, 2003 to December 27, 2005, was interim
Chief Executive Officer of Ohana at the time of the September 2003 Loan Agreement through to March 1, 2004. Dr. Hwang was also a director of Ohana from August 4, 2003 through March 31, 2004.

Dr. Hwang and his family members own a controlling interest in Fil-Fibers Manufacturing Inc., Ltd. (Fil-Fibers).

Fil-Fibers was both a creditor and shareholder in Ohana immediately prior to the Ohana Restructuring. After the Ohana Restructuring, Fil-Fibers was a minority
shareholder in ADML Holdco.

During the first quarter of 2006, the Company was informed of an Ohana re-financing, which coupled with the changes in the
business outlook, led the Company to conclude that the expectations for Ohana had not materialized and an impairment charge was required to adjust the net carrying value of the Companys equity ownership. As a result, the Company recorded in
the first quarter of fiscal 2006 an impairment of its investment in Ohana of $659. No amount of the charge will result in future cash expenditures. The carrying value of the Companys investment in Ohana at September 30, 2006 was $91.

NOTE 4. ASIA DIGITAL MEDIA JOINT VENTURE

On
September 16, 2004, the Company and certain other investors agreed to subscribe for shares in a newly formed joint venture called Asia Digital Media pursuant to a subscription agreement (as amended, the Subscription Agreement). The
investment closed on December 17, 2004.

The parties agreed that: (i) the Company would directly subscribe for approximately 16.7% of the share
capital of Asia Digital Media in exchange for a cash contribution of $2,000 and in-kind contribution of $1,300, both of which, after intercompany profit eliminations, aggregated to $3,088; (ii) ADML Holdco, in which the Company held a 14.3%
ownership interest, would directly subscribe for 60.6% of the share capital of Asia Digital Media in exchange for a contribution of the entire issued share capital of Ohana; and (iii) the remaining capital stock of Asia Digital Media would be
owned by two investors and China Aerospace New World Technology Limited (CANW), a company incorporated in Hong Kong, in exchange for cash and/or in-kind contributions.

After the closing, the Companys total direct and indirect equity holdings in Asia Digital Media were approximately 25.3%. During the first quarter of 2005, the Company received additional shares of common stock
of Asia Digital Media as reimbursement for legal costs incurred by the Company on behalf of Asia Digital Media during its formation and for administrative services provided by the Company. These additional shares were valued at $458 and resulted in
an increase of the Companys total direct and indirect equity holdings in Asia Digital Media to 27.4% at June 30, 2005.

Dr. Anthony E.
Hwang, a former director of the Company, and Mr. F. William Conner, Chairman, President and Chief Executive Officer of the Company, became directors of Asia Digital Media on December 17, 2004. Dr. Hwang subsequently resigned from the
Board of Directors of Entrust, Inc. effective November 17, 2005. Concurrently with this resignation, Mr. Conner resigned as a director of Asia Digital Media effective November 18, 2005.

On December 27, 2005, the Company entered into the Rescission Agreement with Asia Digital Media and ADML Holdco to rescind the Subscription Agreement in part,
resulting in the return of the shares of Asia Digital Media issued to ADML Holdco for cancellation and the corresponding return of the entire issued capital of Ohana to ADML Holdco. In addition, Dr. Hwang resigned as a director of Asia Digital
Media. Upon conclusion of the Rescission Agreement, the Company owned approximately 44% of the issued share capital of Asia Digital Media. Entrust appointed Mr. James D. Kendry, Vice President and Chief Governance Officer, as a director of
Asia Digital Media. After the Rescission Agreement was executed, the Companys conclusion that Asia Digital Media did not meet the definition of a variable interest entity remained unchanged.

The Company accounts for its investment in Asia Digital Media under the equity method. Accordingly, the Company has included its share of losses of Asia Digital Media,
in the amount of $51 and $344, in its condensed consolidated statement of operations for the three and nine months ended September 30, 2006,



7



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##### Table of Contents

respectively, and $134 and $407 for the three and nine months ended September 30, 2005, respectively. The Company
has recorded cumulative losses through September 30, 2006 from its investment in Asia Digital Media of $1,010 since its investment in the fourth quarter of 2004.

During the first quarter of 2006, the Company was informed of changes in its Chinese partners ability to invest in the second funding round of Asia Digital Media. This factor, among others, had significant
negative implications for Asia Digital Media. The Company had concluded that expectations for Asia Digital Media had not materialized and an impairment charge was required to adjust the net carrying value of the Companys equity ownership. As a
result, the Company recorded in the first quarter of fiscal 2006 an impairment of its investment in Asia Digital Media in the amount of $2,357. No amount of the charge will result in future cash expenditures. After this impairment and inclusion of
the Companys share of Asia Digital Medias losses, the remaining carrying value of the Companys investment in Asia Digital Media at September 30, 2006 was $179.

NOTE 5. STOCK-BASED COMPENSATION AND STOCK OPTION PLANS

SFAS No. 123(R) Adoption

In December 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004), Share-Based Payment
(SFAS No. 123(R)), which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation (SFAS No. 123). SFAS No. 123(R) supersedes APB Opinion No. 25, Accounting
for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R)
requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement, over the service period, based on their grant-date fair values. Pro forma disclosure is no longer an alternative.

SFAS No. 123(R) is effective for the first annual period beginning after June 15, 2005 and, therefore, the Company adopted SFAS No. 123(R)
in the first quarter of 2006, recognizing compensation expense for employee stock awards. The Company adopted SFAS No. 123(R) using the modified-prospective transition method, in which compensation cost is recognized beginning with the
effective date (a) based on the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the
effective date of SFAS No. 123(R) that remain unvested on the effective date.

As previously permitted by SFAS No. 123, the Company formerly
accounted for share-based payments to employees using APB Opinion No. 25s intrinsic value method and, as such, generally did not recognize compensation cost for employee stock options. For all options granted to employees in the periods
disclosed prior to 2006, the exercise price of each option granted was equal to the fair value of the underlying stock at the date of grant and therefore, no stock-based compensation costs were reflected in earnings for these options.

Accordingly, the adoption of SFAS No. 123(R)s fair value method has had, and will continue to have, a significant impact on the Companys result of
operations. The continued impact of adoption of SFAS No. 123(R) will depend on levels of share-based awards granted in the future. In general, the annual stock-based compensation expense is expected to decline in future years when compared to
the expense reported in prior years in the Companys pro forma stock-based compensation disclosures. This decline is primarily the result of a change in stock-based compensation strategy as determined by management.

For the three and nine months ended September 30, 2006 compensation cost of $1,146 and $2,725 respectively, was recognized for employee stock compensation. This
compensation cost included estimation of expected forfeitures. Forfeiture estimations are based on analysis of historical forfeiture rates.

As a result of
adopting SFAS No. 123(R) on January 1, 2006, the Companys net loss for the three and nine months ending September 30, 2006 is approximately $924 and $2,199 higher, respectively, than if it had continued to account for share
based compensation under APB Opinion 25. Also, the Companys net loss per share was higher by $0.02 and $0.04 for the three and nine months ended September 30, 2006, respectively, than under its previous accounting method for share based
compensation.



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In addition to ongoing recognition of stock-based compensation expense, the Company recognized a one-time cumulative
transition adjustment in the first quarter of 2006. A net reduction of $32 to compensation expense was recorded in the first quarter, related to the effect of estimated forfeitures on outstanding awards. This net reduction is with respect to the
compensation cost that would not have been recognized in prior periods had forfeitures been estimated during those periods. This adjustment applies only to compensation cost recognized in fiscal 2005 related to RSU and SAR awards that are unvested
at adoption date.

In accordance with the provisions of SFAS No. 123(R), no unearned deferred compensation expense was recorded for stock-based awards
to employees. Compensation costs related to stock based awards are treated as a credit to Additional Paid in Capital in Shareholders Equity when the expense is recognized over the requisite service period. Unearned deferred compensation
recorded in 2005 of $1,814 related to SARs and RSUs granted in that year had been subsequently reversed in the first quarter of 2006 to comply with the SFAS No. 123(R) provisions which prohibit such practice.

In addition, had the Company adopted SFAS No. 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123, as
described in the disclosure of pro forma net income (loss) and earnings per share in the following table.



|                                                                                                        |  |                                      |        |   |                                     |   |        |  
|------------------------------------------------------------------------------------------------------- |  | ------------------------------------ | ------ | - | ----------------------------------- | - | ------ | -
|                                                                                                        |  | Three months endedSeptember 30, 2005 |        |   | Nine months endedSeptember 30, 2005 |  
|Net income, as reported:                                                                                |  | $                                    | 956    |   |                                     | $ | 3,018  |  
|Total stock-based employee compensation expense determined under fair value-based method for all awards |  |                                      | (1,447 | ) |                                     |   | (3,437 | )
|                                                                                                        |  |                                      |        |   |                                     |   |        |  
|Pro forma net loss                                                                                      |  | $                                    | (491   | ) |                                     | $ | (419   | )
|                                                                                                        |  |                                      |        |   |                                     |   |        |  
|Net income (loss) per share:                                                                            |  |                                      |        |   |                                     |   |        |  
|Basicas reported                                                                                       |  | $                                    | 0.02   |   |                                     | $ | 0.05   |  
|Basicpro forma                                                                                         |  |                                      | (0.01  | ) |                                     |   | (0.01  | )
|Dilutedas reported                                                                                     |  |                                      | 0.02   |   |                                     |   | 0.05   |  
|Dilutedpro forma                                                                                       |  | $                                    | (0.01  | ) |                                     | $ | (0.01  | )

Impact on the Statement of Cash Flows

Share based awards are settled by issuance of common shares and are recorded as non-cash items in net loss on the statement of cash flows. No tax benefits related to share based awards for the three and nine months
ended September 30, 2006 was recognized.

Valuation of Stock Options Granted Prior to the Adoption of SFAS No. 123(R)

Under the previous provisions of SFAS No. 123, the fair value of options was estimated, as of the date of grant, using the Black-Scholes option pricing model. The
Company believes the inputs and method used to value these options under SFAS No. 123 pro-forma disclosures were reasonable, and hence, no correction to the original fair value estimation has been made to outstanding, unvested, stock options as
at January 1, 2006. Under the Black-Scholes option pricing model, input assumptions are determined at the time of option grant and are not adjusted for the life of that grant. The following weighted average assumptions were used in the option
fair value calculations.



|                                      |  |               |   |  |      |   |  |      |   |  |      |  
|------------------------------------- |  | ------------- | - |  | ---- | - |  | ---- | - |  | ---- | -
|                                      |  | Year of Grant |  
|                                      |  | 2002          |   |  | 2003 |   |  | 2004 |   |  | 2005 |  
|Expected Term (years)                 |  | 5             |   |  | 5    |   |  | 5    |   |  | 5    |  
|Expected Volatility                   |  | 116           | % |  | 108  | % |  | 102  | % |  | 55   | %
|Expected Dividend Yield               |  |              |   |  |     |   |  |     |   |  |     |  
|Discount Rate - Bond Equivalent Yield |  | 4.13          | % |  | 3.30 | % |  | 3.20 | % |  | 4.07 | %



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##### Table of Contents

Compensation cost of stock options is recognized in accordance with the accelerated method with the cost to be recognized
over the remaining requisite service period.

Restricted Stock Units (RSUs)

During the three months ended September 30, 2006, the Company issued 278,457 restricted stock units to employees with an average grant date value of $3.27 per unit.
Restricted stock units are valued at fair value of the underlying stock on the date of grant. Compensation cost related to RSUs is recognized over the requisite service period, which is generally between two to four years.

Of the restricted stock units granted, 145,957 carrying specific performance vesting conditions were awarded to certain employees. The vesting of such awards is subject
to certain performance targets in future periods. If such performance conditions are not met, the awards forfeit. As of September 30, 2006, no compensation cost has been accrued or recognized with respect to these awards, as it was concluded
that the attainment of the performance conditions was not probable at that date.

The total compensation cost related to non-vested RSUs awards not yet
recognized, and the related weighted-average requisite service period remaining is as follows:



|              |  |                                                |       |                                                |      |                                        |   |     
|------------- |  | ---------------------------------------------- | ----- | ---------------------------------------------- | ---- | -------------------------------------- | - | ----
|Year of Grant |  | UnearnedCompensation Cost atSeptember 30, 2006 |       | WeightedAverage ServicePeriodRemaining inYears |      | Average Grant Date Fair Value per Unit
|2005          |  | $                                              | 1,148 |                                                | 2.71 |                                        | $ | 4.01
|2006          |  |                                                | 1,053 |                                                | 1.53 |                                        | $ | 3.69
|              |  |                                                |       |                                                |      |                                        |   |     
|              |  | $                                              | 2,201 |                                                |      |                                        |   |     
|              |  |                                                |       |                                                |      |                                        |   |     

The following tables summarize information concerning outstanding RSUs for the three month period ended
September 30, 2006.



|                                        |  |                                      |   |  |                                      |       |  
|--------------------------------------- |  | ------------------------------------ | - |  | ------------------------------------ | ----- | -
|                                        |  | Three MonthsEnded September 30, 2006 |   |  | Weighted AverageGrant Date FairValue |      
|Balance outstanding, June 30, 2006      |  | 672,576                              |   |  | $                                    | 2,740 |  
|Granted                                 |  | 278,457                              |   |  |                                      | 877   |  
|Matured                                 |  | (343                                 | ) |  |                                      | (1    | )
|Cancelled                               |  | (22,773                              | ) |  |                                      | (27   | )
|                                        |  |                                      |   |  |                                      |       |  
|Balance outstanding, September 30, 2006 |  | 927,917                              |   |  | $                                    | 3,589 |  
|                                        |  |                                      |   |  |                                      |       |  

The aggregate fair value of RSUs outstanding at September 30, 2006 is
$3,164.

Stock Appreciation Rights (SARs)

SARs give the issuer a right to participate in the appreciation of the underlying stock up to a capped value of four times the stock price on date of grant. SARs are settled by issuance of common stock.

A total of 75,000 SARs were granted to employees in the nine months ended September 30, 2006, which had a strike price of $3.32 per right, equivalent to the
underlying share price on the date of grant. These instruments vest over four years and have a contractual life of seven years.



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##### Table of Contents

A total of 132,668 SARs were granted to the members of our Board of Directors in 2005 and have a vesting period of three
years and a contractual life of seven years.

The total compensation cost related to these SARs awards not yet recognized
is displayed in the following table.



|              |  |                                                |     |                                                  |     
|------------- |  | ---------------------------------------------- | --- | ------------------------------------------------ | ----
|Year of Grant |  | Unearned CompensationCost at September 30,2006 |     | Weighted AverageService PeriodRemaining in Years
|2005          |  | $                                              | 42  |                                                  | 1.64
|2006          |  | $                                              | 749 |                                                  | 3.45
|              |  |                                                |     |                                                  |     
|              |  | $                                              | 791 |                                                  |     
|              |  |                                                |     |                                                  |     

SFAS No. 123(R) requires stock-based compensation to be determined based upon the fair value of the award on
the date of grant. If the fair value is not readily determinable, a valuation technique that reflects all substantive characteristics of the instrument is required. Management has selected the Black-Scholes option valuation model to determine the
fair value of issued SARs. All substantive characteristics of the instrument have been incorporated into the formula, including the capped value portion.

Significant input assumptions required to estimate the fair value of SARs include the following:



| |  |  | Expected Term: The SEC Staff Accounting Bulletin No. 107 simplified method has been used to determine a weighted average expected term of the instruments granted.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Expected Volatility: The Company has estimated expected volatility based on its actual stock price history over a reasonable period of time.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------

The following weighted average assumptions were used in estimating the fair value of issued SARs.



|                                 |  |               |   |  |      |  
|-------------------------------- |  | ------------- | - |  | ---- | -
|                                 |  | Year of Grant |  
|                                 |  | 2006          |   |  | 2005 |  
|Expected award life, in years    |  | 4.75          |   |  | 4.5  |  
|Expected risk free interest rate |  | 4.11          | % |  | 3.36 | %
|Dividend yield                   |  |              |   |  |     |  
|Expected volatility              |  | 55            | % |  | 60   | %

Stock Options

Acquisition Assumption of Business Signatures 2002 Stock Plan

As fully described in Note 2, on July 19, 2006, the Company completed
the acquisition of all of the outstanding stock of Business Signatures. As part of this acquisition, the Company assumed the obligations of Business Signatures under its 2002 Stock Plan. Under this plan, the Company assumed options to purchase
1,792,092 shares of Business Signature Common stock in exchange for options to purchase 1,150,590 shares of the Companys Common stock. The assumed options have a fair value estimated at $2,709 at the date of assumption, utilizing the following
Black-Scholes input assumptions:



|                                       |  |   |      |  
|-------------------------------------- |  | - | ---- | -
|Weighted Average Expected Term (years) |  |   | 6.05 |  
|Expected Volatility                    |  |   | 55   | %
|Expected Dividend Yield                |  |   |     |  
|Discount Rate  Bond Equivalent Yield  |  |   | 4.11 | %
|Weighted Average Exercise Price        |  | $ | 1.48 |  



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##### Table of Contents

On the date of acquisition, 269,250 options to purchase the Companys Common stock were vested with an estimated
value of $722. The fair value of assumed, vested options was accounted for as part of the purchase price. The remaining fair value of $1,987 of unvested options constitutes future compensation cost to be recognized over the remaining service
periods, including $162 in the three months ended September 30, 2006.

All stock compensation disclosures, on a go forward basis, includes the assumed
Business Signatures 2002 stock plan options.

The total compensation cost related to non-vested stock option awards not yet recognized and the related
weighted average period remaining for stock options is as follows:



|           |  |                                                |       |                                                   |     
|---------- |  | ---------------------------------------------- | ----- | ------------------------------------------------- | ----
|           |  | UnearnedCompensation Cost atSeptember 30, 2006 |       | WeightedAverage Service Period Remaining in Years
|Grant Year |  |                                                |       |                                                   |     
|2002       |  | $                                              | 47    |                                                   | 0.01
|2003       |  |                                                | 312   |                                                   | 0.83
|2004       |  |                                                | 476   |                                                   | 1.69
|2005       |  |                                                | 353   |                                                   | 1.99
|2006       |  |                                                | 3,706 |                                                   | 3.08
|           |  |                                                |       |                                                   |     
|           |  | $                                              | 4,894 |                                                   |     
|           |  |                                                |       |                                                   |     

Summary Stock Options and SARs

The following tables summarize information concerning outstanding stock options and SARs as at September 30, 2006:



|                         |  |                             |  |                                         |  |                              |       |                         |   |                             |  |                              |  |                         |       |  |   |      
|------------------------ |  | --------------------------- |  | --------------------------------------- |  | ---------------------------- | ----- | ----------------------- | - | --------------------------- |  | ---------------------------- |  | ----------------------- | ----- |  | - | -----
|                         |  | Options Outstanding         |  | Options Exercisable                    
|Range of Exercise Prices |  | Number ofOptionsOutstanding |  | WeightedAverageRemainingContractualLife |  | WeightedAverageExercisePrice |       | AggregateIntrinsicValue |   | Number ofOptionsExercisable |  | WeightedAverageExercisePrice |  | AggregateIntrinsicValue
|$0.12 to $2.44           |  | 819,708                     |  | 6.93                                    |  | $                            | 0.72  |                         | $ | 2,245                       |  | 507,311                      |  | $                       | 0.90  |  | $ | 1,299
|$2.45 to $5.00           |  | 7,571,014                   |  | 7.96                                    |  |                              | 3.66  |                         |   | 1,448                       |  | 4,374,430                    |  |                         | 3.74  |  |   | 996  
|$5.01 to $6.72           |  | 165,486                     |  | 2.90                                    |  |                              | 6.15  |                         |   |                            |  | 165,486                      |  |                         | 6.15  |  |   |     
|$6.73 to $6.86           |  | 1,849,621                   |  | 5.17                                    |  |                              | 6.75  |                         |   |                            |  | 1,849,621                    |  |                         | 6.75  |  |   |     
|$6.87 to $10.00          |  | 4,035,800                   |  | 4.56                                    |  |                              | 6.88  |                         |   |                            |  | 4,035,800                    |  |                         | 6.88  |  |   |     
|$10.01 to $50.00         |  | 410,551                     |  | 3.38                                    |  |                              | 22.72 |                         |   |                            |  | 410,551                      |  |                         | 22.72 |  |   |     
|$50.01 to $130.25        |  | 8,800                       |  | 3.49                                    |  |                              | 79.62 |                         |   |                            |  | 8,800                        |  |                         | 79.62 |  |   |     
|                         |  |                             |  |                                         |  |                              |       |                         |   |                             |  |                              |  |                         |       |  |   |      
|Total                    |  | 14,860,980                  |  |                                         |  |                              |       |                         | $ | 3,693                       |  | 11,351,999                   |  |                         |       |  | $ | 2,295
|                         |  |                             |  |                                         |  |                              |       |                         |   |                             |  |                              |  |                         |       |  |   |      



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Stock Option and SARs In-the-Money and Out-of-the-Money Information as of September 30, 2006(1)



|                                 |  |             |  |                |  |            |  |                                         |  
|-------------------------------- |  | ----------- |  | -------------- |  | ---------- |  | --------------------------------------- | -
|                                 |  | Exercisable |  | Un-exercisable |  | Total      |  | Percentage of Total Options Outstanding |  
|In-the-Money                     |  | 1,192,757   |  | 892,688        |  | 2,085,445  |  | 14                                      | %
|Out-the-Money                    |  | 10,159,242  |  | 2,616,293      |  | 12,775,535 |  | 86                                      | %
|                                 |  |             |  |                |  |            |  |                                         |  
|Total Options & SARs Outstanding |  | 11,351,999  |  | 3,508,981      |  | 14,860,980 |  | 100                                     | %
|                                 |  |             |  |                |  |            |  |                                         |  

---

|(1) | The closing price of the Companys Common stock was $3.46 on September 29, 2006, as reported by The NASDAQ National Market. The average closing price over
the three month period ended September 30, 2006 was $3.17
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Stock Award Plans Summary of Activity

On March 15, 2006, the Board of Directors adopted resolutions, subject to shareholder approval, to approve entry into the 2006 Stock Incentive Plan (the 2006
Plan). The plan was approved at the annual shareholders meeting held May 5, 2006. The Board adopted the 2006 Plan because it believes that continued grants of stock options, as well as grants of restricted stock and other stock-based
awards, are an important element in attracting, retaining and motivating persons who are expected to make important contributions to the Company.

The
Amended and Restated 1996 Stock Incentive Plan, the enCommerce, Inc. 1997 Stock Option Plan, as amended and restated, and the 1999 Non-Officer Employee Stock Incentive Plan, as amended (together, the Prior Plans), were terminated and no
further grants will be permitted under the Prior Plans, provided that, this termination of the Prior Plans will not affect awards that are outstanding under the Prior Plans.

Summary of activity for stock options and SARs under the 2006 Plan, the Business Signatures 2002 plan, as assumed, and the Prior Plans is set forth below:



|                                        |  |            |   |  |                               |      |                          |   |                           |  |                                          |      |  |     
|--------------------------------------- |  | ---------- | - |  | ----------------------------- | ---- | ------------------------ | - | ------------------------- |  | ---------------------------------------- | ---- |  | ----
|                                        |  | Shares     |   |  | WeightedAverageExercise Price |      | AggregateIntrinsic Value |   | WeightedAverageFair Value |  | WeightedAverageRemainingContractual Life
|Outstanding as of June 30, 2006         |  | 13,064,764 |   |  | $                             | 5.59 |                          | $ |                          |  | $                                        | 5.46 |  | 5.53
|Vested                                  |  | 10,412,176 |   |  | $                             | 6.46 |                          | $ |                          |  | $                                        | 6.91 |  | 5.14
|Unvested                                |  | 2,652,588  |   |  | $                             | 2.85 |                          | $ | 1,860                     |  | $                                        | 0.94 |  | 6.74
|                                        |  |            |   |  |                               |      |                          |   |                           |  |                                          |      |  |     
|Exercisable as of June 30, 2006         |  | 10,412,176 |   |  | $                             | 6.46 |                          | $ |                          |  | $                                        | 6.91 |  | 5.14
|                                        |  |            |   |  |                              
|Assumed (Business Signatures 2002 Plan) |  | 1,150,590  |   |  | $                             | 1.48 |                          | $ | 2,282                     |  | $                                        | 2.35 |  | 8.99
|Granted                                 |  | 1,024,000  |   |  | $                             | 3.36 |                          | $ |                          |  | $                                        | 1.77 |  | 6.90
|Exercised                               |  | (93,650    | ) |  | $                             | 3.19 |                          | $ | 99                        |  | $                                        | 1.61 |  | 3.88
|Canceled                                |  | (284,724   | ) |  | $                             | 6.76 |                          | $ |                          |  | $                                        | 5.51 |  | 6.76
|Vested (Expired)                        |  | (183,312   | ) |  | $                             | 9.70 |                          | $ |                          |  | $                                        | 7.60 |  | 5.51
|Unvested (Forfeited)                    |  | (101,412   | ) |  | $                             | 3.04 |                          | $ |                          |  | $                                        | 1.73 |  | 7.12
|                                        |  |            |   |  |                               |      |                          |   |                           |  |                                          |      |  |     
|Outstanding as of September 30, 2006    |  | 14,860,980 |   |  | $                             | 5.35 |                          | $ |                          |  | $                                        | 4.77 |  | 6.45
|Vested                                  |  | 11,351,999 |   |  | $                             | 6.00 |                          | $ |                          |  | $                                        | 5.68 |  | 5.64
|Unvested                                |  | 3,508,981  |   |  | $                             | 2.55 |                          | $ |                          |  | $                                        | 1.86 |  | 6.55
|Exercisable as of September 30, 2006    |  | 11,351,999 |   |  | $                             | 6.00 |                          | $ |                          |  | $                                        | 5.68 |  | 5.64



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NOTE 6. STOCK REPURCHASE PROGRAM

On July 29, 2002, the Company announced that its Board of Directors had authorized the Company to repurchase up to an aggregate of 7,000,000 shares of its Common stock. The program has subsequently been extended
three times, most recently on July 22, 2005 when the Board of Directors authorized a further extension of this stock repurchase program to permit the purchase of up to 10,000,000 shares of the Companys Common stock through
December 15, 2006. This quantity of shares of Common stock is in addition to the 6,928,640 shares of the Companys Common stock already purchased under the Companys stock repurchase program through June 30, 2005. The Company did
not repurchase any shares of its Common stock during the three months ended September 30, 2006. During the nine months ended September 30, 2006, the Company repurchased 703,000 shares of its Common stock for a total cash outlay of $2,519,
at an average price of $3.58 per share, including commissions paid to brokers. As of September 30, 2006, the Company has repurchased 8,530,124 of the authorized 16,928,640 shares of its Common stock under this program, for a total cash outlay
of $33,610, at an average price of $3.94 per share, including commissions paid to brokers.

Repurchases under the stock repurchase program may take place
from time to time until December 15, 2006, or an earlier date determined by the Companys board of directors, in open market, negotiated or block transactions, and may be suspended or discontinued at any time. The Companys management
will determine the timing and amount of shares repurchased based on its evaluation of market and business conditions. The repurchased shares will be considered authorized but unissued shares of the Company and will be available for issuance under
the Companys stock incentive, employee stock purchase and other stock benefit plans, and for general corporate purposes, including possible acquisitions. The stock repurchase program will be funded using the Companys working capital.

NOTE 7. ALLOWANCE FOR DOUBTFUL ACCOUNTS

The Company
performs ongoing credit evaluations of its customers and, generally, does not require collateral from its customers to support accounts receivable. The Company maintains an allowance for doubtful accounts due to credit risk; to provide adequate
protection against estimated losses resulting from the inability of customers to make required payments. The Company bases its ongoing estimate of allowance for doubtful accounts primarily on the aging of balances in its accounts receivable,
historical collection patterns and changes in the creditworthiness of its customers. Based upon this analysis, the Company records an increase in the allowance for doubtful accounts when the prospect of collecting a specific account receivable
becomes doubtful. The allowance for doubtful accounts is established based on the best information available to the Company and is re-evaluated and adjusted as additional information is received. The following table summarizes the changes in the
allowance for doubtful accounts for the nine months ended September 30, 2006:



|                                                                  |  |                                 |       |      |   |      |  
|----------------------------------------------------------------- |  | ------------------------------- | ----- | ---- | - | ---- | -
|                                                                  |  | Nine Months Ended September 30, |      
|                                                                  |  | 2006                            |       | 2005 |  
|Allowance for doubtful accounts, beginning of period              |  | $                               | 467   |      | $ | 988  |  
|Provision for (reduction in) allowance for doubtful accounts, net |  |                                 | 795   |      |   | (339 | )
|Amounts written-off, net of recoveries                            |  |                                 | 10    |      |   | (170 | )
|                                                                  |  |                                 |       |      |   |      |  
|Allowance for doubtful accounts, end of period                    |  | $                               | 1,272 |      | $ | 479  |  
|                                                                  |  |                                 |       |      |   |      |  

NOTE 8. ACCRUED RESTRUCTURING CHARGES

May 2003 Restructuring Plan

Following the first quarter of 2003, when the Companys revenues fell short
of its expectations and guidance, management began a re-assessment of the Companys operations to ensure that expenses were optimally aligned to its customers and markets, and structured such that costs would not exceed revenues by the fourth
quarter of 2003.

On May 27, 2003, the Company announced a restructuring plan aimed at lowering costs and better aligning its resources to customer
needs. The plan allows the Company to have tighter integration between customer



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touch functions, which better positions the Company to take advantage of the market opportunities for its new products,
and solutions. The restructuring plan included eliminating positions to lower operating costs, closing under-utilized office capacity, and re-assessing the useful life of related excess long-lived assets. The Company also announced non-cash charges
related to the impairment of a long-term strategic investment and the impairment of purchased product rights acquired through the enCommerce acquisition of June 2000.

The workforce portion of the restructuring plan included severance and related costs of $4,813 in 2003 for 151 positions from all functional areas of the Company and had been significantly completed by
December 31, 2003. The consolidation of under-utilized facilities included costs relating to lease obligations through the first quarter of 2009, primarily from the excess space in the Companys Santa Clara, California and Addison, Texas
facilities, and accelerated amortization of related leaseholds and equipment. The facilities plan was executed by September 30, 2003 and, as a result, the Company recorded $4,116 of charges during 2003 relating to these facilities, including
$1,310 for accelerated amortization on leaseholds and equipment whose estimated useful lives had been impacted by the plan to cease using the related excess capacity in the Companys facilities and $2,806 for lease obligations related to excess
capacity at Company locations for which the cease-use date occurred during 2003. The total amount of the workforce and facilities charges was $8,929.

The
Company has evaluated and pursued all reasonable possibilities to settle the lease obligations associated with the May 2003 restructuring, but has been unable to find an acceptable outcome. Therefore, the Company has concluded that it is appropriate
to classify the portion of the outstanding liabilities that is not payable within the next 12 months as long-term liabilities. However, in terms of long-term liquidity requirements, the current obligations would require the Company to fund its
remaining accrued restructuring charges for the May 2003 restructuring as follows: $150 in fiscal 2007 and $150 in fiscal 2008.

Summary of Accrued
Restructuring Charges for May 2003 Restructuring

The following table is a summary of the accrued restructuring charges related to the May 2003 plan at
September 30, 2006:



|                                   |  |                                         |     |              |   |                                                 |  |   |    
|---------------------------------- |  | --------------------------------------- | --- | ------------ | - | ----------------------------------------------- |  | - | ---
|(in millions)                      |  | Total ChargesAccrued atBeginning ofYear |     | CashPayments |   | AccruedRestructuringCharges atSeptember 30,2006
|Consolidation of excess facilities |  | $                                       | 0.4 |              | $ | 0.1                                             |  | $ | 0.3
|                                   |  |                                         |     |              |   |                                                 |  |   |    

June 2001 Restructuring Plan

On June 4, 2001, the Company announced a Board-approved restructuring plan to refocus on the Companys most significant market opportunities and to reduce operating costs due to the macroeconomic factors
that were negatively affecting technology investment in the market. The restructuring plan included a workforce reduction, consolidation of excess facilities, and discontinuance of non-core products and programs.

The workforce portion of the restructuring plan was largely completed by the end of the fourth quarter of 2001 and primarily related to severance costs, fringe benefits
due to severed employees and outplacement services.

The consolidation of excess facilities included the closure of eight offices throughout the world, but
the majority of the costs related to the Companys facility in Santa Clara, California. These costs are payable contractually over the remaining term of the Santa Clara facility lease, which runs through 2011, reduced by estimated sublease
recoveries. The discontinuance of non-core products and programs was primarily related to the discontinuance of certain of the Companys business program initiatives and certain applications that had not achieved their growth and profitability
objectives. In addition, the Company



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withdrew from certain committed marketing events and programs. The cash outflow related to the majority of these
discontinued products and programs was substantially completed by the end of the second quarter of 2002, while remaining marketing and distribution agreement obligations related to certain discontinued products were settled in the third quarter of
2003. The Company had initiated all actions required by the restructuring plan by the end of the second quarter of 2002.

During the first and second
quarters of 2006, the Company made further adjustments to the restructuring charges that had previously been recorded related to the June 2001 restructuring plan with respect to our Santa Clara, California facility. The building is currently
subleased, but the current sublease was scheduled to end in December 2006. Although the Company had been monitoring the sublet market on an on-going basis, the extension offer it received during the first quarter of 2006, coupled with the
preparations the Company had begun for placing the facility on the market, caused the Company to revisit its estimated sublease recoveries at that time. The Company had concluded that it would need to increase the restructuring charges that it had
previously recorded related to its June 2001 restructuring plan by a further $2,895 in the first quarter of fiscal 2006 to reflect a change in the Companys projected sublet lease recoveries as evidenced by the market for leased facilities in
that region. This charge represented a reduction in the cash that the Company expected to recover from future subtenants. During the second quarter of 2006, the Company concluded an extension agreement with the current sublessee to sublease the
California facility through to March 31, 2011, which represents substantially all of the remaining lease period on the building. As a result of the conclusion of the final sublease arrangement during the second quarter of 2006, the Company
adjusted its accrual related to the June 2001 restructuring downward by $130 to reflect the known sublet lease recoveries under the extension agreement. These adjustments have been charged to the restructuring charges line in the consolidated
statement of operations.

The Company has evaluated and pursued all reasonable possibilities to settle the lease obligations associated with the June 2001
restructuring, but has been unable to find an acceptable outcome. Therefore, the Company has concluded that it is appropriate to classify the portion of the outstanding liabilities that is not payable within the next 12 months to long-term
liabilities. However, the current obligations would require the Company to fund $1,000 of its accrued restructuring charges for the June 2001 restructuring before the end of fiscal 2006, with the remaining accrued restructuring charges for the June
2001 restructuring to be paid as follows: $5,300 in fiscal 2007, $5,300 in fiscal 2008, $5,500 in fiscal 2009 and $8,300 in fiscal 2010 and beyond.

Summary of Accrued Restructuring Charges for June 2001 Restructuring

The following table is a summary of the accrued restructuring charges
related to the June 2001 plan at September 30, 2006:



|                                   |  |                                           |      |               |   |             |  |                                                   |     |  |   |     
|---------------------------------- |  | ----------------------------------------- | ---- | ------------- | - | ----------- |  | ------------------------------------------------- | --- |  | - | ----
|(in millions)                      |  | Total Charges Accrued atBeginning of Year |      | Cash Payments |   | Adjustments |  | Accrued RestructuringCharges atSeptember 30, 2006
|Consolidation of excess facilities |  | $                                         | 25.5 |               | $ | 2.9         |  | $                                                 | 2.8 |  | $ | 25.4
|                                   |  |                                           |      |               |   |             |  |                                                   |     |  |   |     

As of September 30, 2006, the Company had estimated a total of $12,500 of sublease recoveries in its
restructuring accrual. Of this amount, $12,400 is related to the Santa Clara facility. In addition, $12,400 of the $12,500 is recoverable under existing sublease agreements, with only approximately $100 of rent recoveries being based on estimates
that may be subject to adjustments based upon changes in the real estate sublet markets.

NOTE 9. NET INCOME (LOSS) PER SHARE AND SHARES OUTSTANDING

Basic net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of shares of Common stock of all classes
outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) by the weighted average number of shares of Common stock and potential Common stock outstanding, and when dilutive, options to purchase
Common stock using the treasury stock method. The options to purchase Common stock are excluded from the



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computation of diluted net income (loss) per share if their effect is antidilutive. The antidilutive effect excluded from
the diluted net loss per share computation related to options to purchase Common stock under the treasury stock method for the three and nine months ended September 30, 2006 was 1,160,005 and 549,547 shares, respectively, compared to a dilutive
effect of 2,610,760 and 1,642,900 shares for the three and nine months ended September 30, 2005, respectively, which increased the weighted average common shares outstanding used in the computation of diluted net income (loss) per share. In
addition, 10,159,242 and 7,068,123 out-of-the-money exercisable options that had exercise prices in excess of the average market price for the three months ended September 30, 2006 and 2005, respectively, were excluded from the computation of
diluted net income (loss) per share in accordance with the treasury stock method.

In the three and nine months ended September 30, 2006, the Company
issued 94,243 and 488,846 shares of Common stock, respectively, related to the exercise of employee stock options. In addition, the Company issued 226,654 shares of its Common stock to an employee of the Company, in exchange for $675 in cash.

NOTE 10. MARKETABLE AND OTHER INVESTMENTS

The Company
maintains marketable investments mainly in a strategic cash management account. This account is invested primarily in highly rated corporate securities, in securities guaranteed by the U.S. government or its agencies and highly rated municipal
bonds, primarily with a remaining maturity of not more than 24 months.

The Company holds equity securities stated at cost, which represent long-term
investments in private companies made in 2000 and 2001 for business and strategic alliance purposes. The Companys ownership share in these companies ranges from 1% to 10% of the outstanding voting share capital. The Company monitors and
assesses the ongoing operating performance of the underlying companies for evidence of impairment. Since 2001, the Company has recorded impairments totaling $14,818 with respect to these investments as a result of other than temporary declines in
fair value. The strategic investments made in 2000 and 2001 had no remaining net carrying value at September 30, 2006. In addition, the Company holds an investment recorded at cost in ADML Holdings, Ltd., and its affiliate, Ohana Wireless, Inc.
(collectively, Ohana), which at September 30, 2006 represented approximately 14% of the voting share capital of Ohana. See Note 3 for additional discussion.

The Company also holds an equity interest in Asia Digital Media, which at September 30, 2006 represented approximately 44% of the voting share capital of this company. This investment is accounted for by the
Company using the equity method of accounting for investments in common stock. See Note 4 for additional discussion.

The Company recorded no revenues from
Asia Digital Media for the three and nine months ended September 30, 2006. Revenues recorded by the Company from Asia Digital Media represented less than 1% of total revenues for the three and nine months ended September 30, 2005.

The Company did not generate any sales with any other companies in which it has made strategic equity investments recorded at cost in the three and nine
months ended September 30, 2006 and 2005.

NOTE 11. SEGMENT AND GEOGRAPHIC INFORMATION

Segment information

The Company conducts business in one
operating segment: namely, the design, production and sale of software products and related services for securing digital identities and information. The nature of the Companys different products and services is similar and, in general, the
type of customers for those products and services is not distinguishable. The Company does, however, prepare information for internal use by the Chairman, President and Chief Executive Officer on a geographic basis. Accordingly, the Company has
included a summary of the financial information, on a geographic basis, as reported to the Chairman, President and Chief Executive Officer.



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Geographic information

Revenues are attributed to specific geographical areas based on where the sales orders originated. Company assets are identified with operations in the respective geographic areas.

The Company operates in three main geographic areas as follows:



|                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|--------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                        |  | Three months endedSeptember 30, |        |   | Nine months endedSeptember 30, |  
|                                        |  | 2006                            |        |   | 2005                           |   |        | 2006 |  |   | 2005    |  
|Revenues:                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|United States                           |  | $                               | 12,934 |   |                                | $ | 11,510 |      |  | $ | 33,553  |   |  | $ | 34,670 |  
|Canada                                  |  |                                 | 3,872  |   |                                |   | 5,205  |      |  |   | 13,886  |   |  |   | 15,381 |  
|Europe, Asia and Other                  |  |                                 | 7,225  |   |                                |   | 6,936  |      |  |   | 19,745  |   |  |   | 23,316 |  
|                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Total revenues                          |  | $                               | 24,031 |   |                                | $ | 23,651 |      |  | $ | 67,184  |   |  | $ | 73,367 |  
|                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Income (loss) before income taxes:      |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|United States                           |  | $                               | (441   | ) |                                | $ | 825    |      |  | $ | (5,860  | ) |  | $ | 1,745  |  
|Canada                                  |  |                                 | (2,344 | ) |                                |   | 572    |      |  |   | (6,459  | ) |  |   | 2,803  |  
|Europe, Asia and Other                  |  |                                 | (334   | ) |                                |   | (155   | )    |  |   | (1,043  | ) |  |   | (549   | )
|                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Total income (loss) before income taxes |  | $                               | (3,119 | ) |                                | $ | 1,242  |      |  | $ | (13,362 | ) |  | $ | 3,999  |  
|                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |        |  



|                       |  |                   |         |                  |   |        
|---------------------- |  | ----------------- | ------- | ---------------- | - | -------
|                       |  | September 30,2006 |         | December 31,2005
|Total assets:          |  |                   |         |                  |   |        
|United States          |  | $                 | 105,083 |                  | $ | 95,057 
|Canada                 |  |                   | 17,540  |                  |   | 30,771 
|Europe, Asia and Other |  |                   | 4,302   |                  |   | 4,621  
|                       |  |                   |         |                  |   |        
|Total                  |  |                   | 126,925 |                  |   | 130,449
|                       |  |                   |         |                  |   |        

NOTE 12. COMPREHENSIVE INCOME

The components of comprehensive income are as follows:



|                                         |  |                                 |        |                                |      |   |       |  |   |         |   |  |   |       |  
|---------------------------------------- |  | ------------------------------- | ------ | ------------------------------ | ---- | - | ----- |  | - | ------- | - |  | - | ----- | -
|                                         |  | Three months endedSeptember 30, |        | Nine months endedSeptember 30, |     
|                                         |  | 2006                            |        |                                | 2005 |   | 2006  |  |   | 2005    |  
|Net income (loss)                        |  | $                               | (3,239 | )                              |      | $ | 956   |  | $ | (13,671 | ) |  | $ | 3,018 |  
|Foreign currency translation adjustments |  |                                 | (166   | )                              |      |   | 203   |  |   | 690     |   |  |   | (476  | )
|                                         |  |                                 |        |                                |      |   |       |  |   |         |   |  |   |       |  
|Comprehensive income (loss)              |  | $                               | (3,405 | )                              |      | $ | 1,159 |  | $ | (12,981 | ) |  | $ | 2,542 |  
|                                         |  |                                 |        |                                |      |   |       |  |   |         |   |  |   |       |  

NOTE 13. LEGAL PROCEEDINGS

The Company is subject, from time to time, to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted
with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Companys consolidated results of operations or consolidated financial position. Certain legal proceedings in
which we are involved are discussed in Part 1. Item 3. of our Annual Report on Form 10-K for the year ended December 31, 2005. Unless otherwise indicated, all proceedings in that earlier Report remain outstanding.



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NOTE 14. CONTINGENCIES

Entrust entered into a contract with the General Services Administration (GSA) on March 31, 2000. It had come to the Companys attention that it might have a potential liability to the GSA under this contract, and the
Company has advised the GSA of this matter. The Company conducted a self-assessment of its compliance and internal processes with respect to the agreement, as well as the pricing requirements of the agreement, which was completed in September 2004.
The Company estimated its probable minimum liability at $352 and accrued this estimated amount in 2003. The results of the Companys self-assessment indicate that the liability is not significantly different from its estimate in 2003. Payment
of the amount of this liability has now been made to the GSA, but is subject to audit.

NOTE 15. RECENTLY ISSUED ACCOUNTING STANDARDS

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement
No. 109,(FIN No. 48), which clarifies the accounting for uncertainty in tax positions. FIN No. 48 requires that the Company recognize in its financial statements, the impact of a tax position, if that position
is more likely than not of not being sustained on audit, based on the technical merits of the position. FIN No. 48 seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to
accounting for income taxes. The provisions of FIN No. 48 will be effective for the Company as of the beginning of its 2007 fiscal year, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening
retained earnings. The Company is currently evaluating the impact of adopting FIN No. 48 on its consolidated financial position and results of operations.

In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements, which establishes a framework for measuring fair value under other accounting pronouncements that require fair value measurements and expands
disclosures about such measurements. SFAS No. 157 does not require any new fair value measurements, but rather it creates a consistent method for calculating fair value measurements to address non-comparability of financial statements
containing fair value measurements utilizing different definitions of fair value. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company does not anticipated that the
adoption of SFAS No. 157 will have a significant impact on its consolidated financial position, results of operations or cash flows.

In September
2006, the SEC staff issued Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB No. 108
was issued to provide consistency between how registrants quantify financial statement misstatements. Historically, there have been two widely-used methods for quantifying the effects of financial statement misstatements, the roll-over
method and the iron curtain method. While the roll-over method primarily quantifies the amount by which the current year income statement is misstated, the iron curtain method primarily quantifies the error as the cumulative amount
by which the current year balance sheet is misstated. The Company currently uses the roll-over method for quantifying identified financial statement misstatements. SAB No. 108 establishes an approach that requires quantification of
financial statement misstatements based on the effects of the misstatement on each of the companys financial statements and the related financial statement disclosures. This approach is commonly referred to as the dual
approach because it requires quantification of errors under both the roll-over and iron curtain methods. The Company will not be required to record an adjustment as a result of its adoption of SAB No. 108.

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

This report contains
forward-looking statements that involve risks and uncertainties. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934,



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including without limitation statements regarding our expectations, beliefs, intentions or strategies regarding the
future. All forward-looking statements included in this report are based on information available to us, up to and including, the date of this document, and we assume no obligation to update any such forward-looking statements. Our actual results
could differ significantly from those anticipated in these forward-looking statements as a result of certain factors, including those set forth below under Overview and Risk Factors and elsewhere in this report. The following
discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and notes thereto appearing elsewhere in this report.

EXECUTIVE OVERVIEW

Entrust is a global provider of
software that secures digital identities and information. Over 1,500 enterprises and government agencies in more than 50 countries use our solutions to help secure the digital lives of their citizens, customers, employees and partners. Our proven
software and services can help customers achieve regulatory and corporate compliance, while helping to turn security challenges, such as identity theft and loss of intellectual property, into business opportunities.

We conduct business in one operating segment. We develop, market and sell software solutions that secure digital identities and information. We also perform professional
services to install, support, and integrate our software solutions with other applications. All of these activities may be fulfilled in conjunction with partners and are managed through our global organization.

As an innovator and pioneer in the Internet security field, Entrusts market leadership and expertise in delivering award-winning identity and data protection
management software solutions is demonstrated by the diversity of its products, geographic representation, and customer segments. We continue to drive revenue in our key products.

On July 19, 2006 we acquired Business Signatures. Business Signatures is a leading provider of zero touch fraud detection solutions. Unlike other fraud detection solutions, the Business Signatures eFraud
product provides a real time fraud detection capability that requires no changes to the business application. Organizations can rapidly deploy the solution and begin passively monitoring user activity - quickly identifying and responding to
suspicious behavior. This also allows for sophisticated fraud analytics to be performed to identify and respond to evolving threats. The zero touch nature of the eFraud product helps allow organizations to take advantage of these capabilities in a
fraction of the time compared to other approaches.

With the addition of Business Signatures, Entrust now has three key platforms, Authentication,
Transaction Monitoring and Information Protection. We now have a unique end-to-end platform for securing digital identities and information. This end-to-end software platform is easy to implement, user friendly and cost effective with the ability to
evolve over time to grow with our customers needs.

Two of Entrusts platforms, Authentication and Transaction Monitoring, come together to provide a
new level of assurance for both internal and external parties, through Risk-Based Authentication.

As we all know, every transaction is not created
equally. An online banking customer that only views their account balances is performing at a very different level of transaction than someone that is transferring $10,000 out of their account, or adding new bill payees. In every transaction, the
level of risk grows as the dollar value of the transaction grows. Risk-Based Authentication allows for the proper level of security to be implemented based on the sensitivity of any given transaction. Entrust offers a range of authentication
capabilities with its authentication platform so that specific methods can be used with specific users and applications. First steps can be as simple as deploying SSL certificates or user name and password. Entrust has long played a key role in this
space through our SSL and single sign-on products.

Risk-Based Authentication, however, goes much deeper than SSL and single sign-on. Risk-Based
Authentication is having the ability to judge each individual transaction on its own merits driven by policy



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level decisions on the level of risk associated with certain transactions. With Entrusts Risk-Based Authentication
solution, transactions can be monitored in real time and then a determination can be made on the level of security required for that transaction. This is done through the combination of Entrust IdentityGuard and Entrust TransactionGuard. This
combined offering is a modern architecture for consumer authentication which has a layered approach of non-invasive anomaly detection and selective intervention with minimal impact on the user experience.

By the end of the year, financial institutions in the United States must offer stronger security measures for online customers according to the Federal Financial
Institutions Examination Councils (FFIEC) guidance. The financial institutions want the easiest and most cost effective solution. We are well positioned with a wide portfolio that allows the financial institutions to start with an easy, cost
effective solution to meet the initial requirements and then utilize our full Risk-Based Authentication platform to provide additional layers of security in the coming years.

Product Category Financial Metrics:



| |  |  | Emerging products (IdentityGuard, Boundary Messaging, and Fraud Detection) accounted for $3.4 million, or 38% of product revenue, up 171% from $1.2 million in Q2, 2006 and up 125%
from $1.5 million in Q3, 2005.
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| |  |  | PKI products accounted for $4.1 million, or 47% of product revenue, down 29% from $5.8 million in Q2, 2006 and down 14% from $4.8 million in Q3, 2005.
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| |  |  | Single sign-on products accounted for $1.3 million, or 15% of product revenue, up 263% from $0.4 million in Q2, 2006 and down 7% from $1.4 million in Q3, 2005.
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We also provide support services and professional services, including architecture, installation, and integration services related to the
products that we sell. These services represent a significant portion of our revenues, but are closely related to the demand for our products. In addition, the margins on our products are significantly higher than margins on our services. As a
result, we are primarily focused on growing our product revenues.

Entrust sells its solutions globally, with an emphasis on North America, Europe and
Asia. These primary areas have demonstrated the most potential for early adoption of the broadest set of Entrust solutions. Entrust extends to other non-core geographies through strategic partner relationships, which increases the leverage of our
direct sales channel worldwide. In North America, Entrust is targeting a return to revenue growth in its software business by leveraging Entrusts historical strength in selling to key verticals such as government (Federal, State, Provincial),
financial services and healthcare organizations. Europe is a region where Entrusts products and solutions continue to experience strong demand and we believe that the European market will provide growth, with increased momentum from
governments and enterprises leveraging Entrusts solutions to transform their business processes and to leverage the internet and networking applications.

We market and sell our products and services in both the enterprise and government market space. In the third quarter of 2006, 32% of our product sales were in our extended government vertical market, which includes healthcare. This revenue
has been driven by key global projects that have started to increase product purchases. In the extended government vertical market, we have a strong penetration in the U.S. Federal government, the governments of Canada, Singapore, Denmark, the
United Kingdom and across continental Europe. In fact, Entrust now counts 10 of the top 11 e-governments, as outlined by this years Accenture report, as customers.

A key change in the government space has been the movement from purely internal security solutions that our customers require to more external citizen facing applications. These projects include ePassports, National
ID programs, physical and logical access programs for government employees, and a growing number of citizen facing applications. Security is at the core of all these projects and our wide product set positions Entrust well in this space. We have
already announced three ePassport projects that Entrust has won, we have been selected as the infrastructure for a number of national ID and Ministry of Defense programs, and we are well positioned in a number of employee credentialing projects like
the US HSPD-12 program.



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We also won an IdentityGuard strong authentication solution for a key citizen facing application for the U.S. Federal
government.

Large government projects involve government bureaucracies, large system integrators and differing technical requirements. In order to help us
better navigate through these opportunities, we are bolstering our government team with addition of Andrew Pinder, the former e-Envoy for the government of the United Kingdom. During Andrews tenure as e-Envoy, the UK received acclaim for
becoming a leading e-government and e-business leader. Andrew brings a wealth of additional experience as he served as the head of European Operations and Technology at Citibank. He also held positions as the Director of Operations and Technology at
Prudential Corporation and as Director of Information Technology at the Office of Inland Revenue in the UK. Andrew will help lead our global government efforts on projects such as the move to e-passports, national ID cards and securing citizen
identities and information. Andrew is joining Entrust as Sr. Vice President, Government Solutions, reporting to the CEO.

In the third quarter of 2006, 68%
of our product sales were in our extended enterprise vertical market. We continue to see demand from global enterprises as they continue to respond to regulatory and governance compliance demands and extend their internal and external networks to
more and more individuals inside and outside their domain. We have experienced a change in the shape of many enterprise deals. Specifically, Enterprises are buying for their immediate need and then adding to their purchases as the projects begin
roll out.

Our largest vertical within the enterprise market is the financial services vertical. In this quarter, financial services revenue increased 111%
from last quarter and 89% from a year ago. Financial institutions are focused on FFIEC and other global compliance regulations, which drove demand for our Risk-Based Authentication and messaging solutions. Year-to-date product revenue from the
financial services vertical is up 92% over last year.

A key driver of our product growth has been the recent spotlight on identity theft due to breaches
at companies like Choicepoint and LexisNexis. These breaches have proven that self-regulation over the past few years has been insufficient at addressing the underlying issues. Recent legislation has addressed these concerns. California S.B. 1386
has cast more visibility on the issue for citizens, corporations, and the government. This law requires both corporations and the government to notify California residents if their sensitive data has been breached unless encryption technology is
deployed. Additionally, 34 other states have now passed breach notification requirements. On a national level, bills are being written to protect citizens from identity theft and alert them if their information has been stolen.

Entrust has been a leader in securing digital identities and information for many years. In the fourth quarter of 2004, we introduced IdentityGuard, which is our
easy-to-use second factor of authentication solution. We now have 226 pilots under way for IdentityGuard. In Q3 2006, IdentityGuard accounted for $1.8 million of product revenue. IdentityGuards low cost relative to hardware, its simplicity for
the mass market, and its effectiveness in countering online theft and phishing, are the key drivers for the increased revenue growth we are experiencing. Along with the revenue growth for second factor authentication, we are also seeing customers
increasingly interested in data protection and encryption. With a combination of Entrust IdentityGuard, GetAccess and TruePass, customers can accomplish authentication and role based access control, digital signature, and encryption from one
solution provider.

Entrust has a goal to develop new channels to market, in addition to our direct sales force. In the second quarter of 2005, our largest
deal was through our partnership with SIA, with whom we won the Spanish national ID card. In Q3, 2006, 13 of our 86 transactions were fulfilled through partners, helping us achieve our revenue increase. This success was driven by North American
channel partners, which now totals 51 in the TrustedPartner Program.

In March 2006, Entrust introduced a Managed PKI service. This service was launched in
May 2006 in response to customer requests for Entrust to offer a hosted service to give them a choice between a service offering for PKI certificates and our traditional PKI software purchase option. Our service offering is



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designed to help enterprises and government agencies grow and accelerate their core business security, without having to
develop PKI expertise internally. Our managed service offering will allow our customers the flexibility to now have our market leading technology delivered in an outsourced service model. This is not our first entrance into the services arena. We
have been helping our customers for years design, deploy and manage our solutions. We have also been successful in growing our SSL certificate, which is up over 20% year-to-date. Our new Managed PKI Service offering will give us access to a new
market of customers that can help us drive both additional license revenue, as well as new ratable services revenues.

Entrust relies significantly on
large deals in each quarter. Our software revenue from our top five customers in Q3, 2006 was approximately 12% of our total revenue in that quarter and we did not have a product deal over $1 million. This was within our historical range, which is
generally between 10% and 25% of revenue from the top five customers and zero to four transactions over $1 million. We continue to be impacted from time to time on our software revenue by the timing of our customers buying process, which may
include proof of concepts, senior management reviews, and budget delays that sometimes results in longer than anticipated sales cycles. We are also impacted by our customers recent buying behavior, which is to buy only for immediate need as
opposed to making a larger purchase in order to get a better discount. Any of these factors may impact our revenue on a quarterly basis.

Our management uses the following metrics to measure performance:



| |  |  | Number and average size of product revenue transactions;
| | - |  | --------------------------------------------------------



| |  |  | Number of deals over $1 million;
| | - |  | --------------------------------



| |  |  | Top-five product revenue transactions as a percentage of total revenues;
| | - |  | ------------------------------------------------------------------------



| |  |  | Product revenue split between extended enterprise and extended government verticals;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | Product revenue split between three key product areas: Emerging Growth Products, Public Key Infrastructure and Single Sign-on;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | Geographic revenue split;
| | - |  | -------------------------



| |  |  | Product and services revenues as a percentage of total revenues;
| | - |  | ----------------------------------------------------------------



| |  |  | Gross profit as a percentage of services and maintenance revenues; and
| | - |  | ----------------------------------------------------------------------



| |  |  | Deferred revenue, cash and marketable investment balances.
| | - |  | ----------------------------------------------------------

BUSINESS OVERVIEW

During the third quarter of 2006, we continued our strategy of focusing on core vertical and geographic markets.
Revenues of $24.0 million represented a 2% increase from the third quarter of 2005, and consisted of 37% product sales and 63% services and maintenance. Services and maintenance revenues decreased 5% from the third quarter of 2005, due to decreased
demand for both consulting services and support and maintenance services, while product revenues increased 15% from the third quarter of 2005, driven by an improved product transaction closure rate, despite a lower average purchase value, compared
to the same quarter of 2005. Net loss for the third quarter of 2006 was $3.2 million, or $0.05 per share, compared to net income of $1.0 million, or $0.02 per share for the same period of 2005, with total expenses increasing 21% to $27.5 million. We
generated $3.5 million in cash flow from operations in the third quarter of 2006, compared to net cash used in operations of $0.7 million in the same quarter of 2005. Entrust Emerging Growth Products (Entrust IdentityGuard, Boundary Messaging and
Fraud Detection) accounted for 38% of product revenue, which is an increase of 125% from Q3, 2005 and an increase of 171% from Q2, 2006. Entrust PKI Products accounted for 47% of product revenue, which is a decrease of 14% from Q3, 2005 and a
decrease of 29% from Q2, 2006. Entrust Certificate Services revenues, a component of our PKI Product solutions suite, increased 16% over Q3, 2005 and was flat with Q2, 2006. Entrust Single Sign-On Products accounted for 15% of product revenue, which
is a decrease of 7% from Q3, 2005 and an increase of 263% from Q2, 2006. Extended Government accounted for 32% and Extended Enterprise accounted for 68% of the product revenue in the quarter. The financial vertical accounted for approximately 46% of
third quarter 2006 product revenues, an increase of 111% over Q2, 2006 and 89% over Q3, 2005, driven by increased demand for multi-factor authentication, zero touch fraud detection and boundary messaging.



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Other highlights from the third quarter of 2006 included:



| |  |  | The top five product transactions accounted for 12% of Q3, 2006 revenues. We had no product deals over $1 million, which is consistent with the same quarter of 2005. The average
purchase size this quarter was $83,000, down from $93,000 in Q3, 2005 and up from $81,000 in Q2, 2006. Total transactions in Q3, 2006 were 86, which is up from 67 in Q3, 2005, and 71 in Q2, 2006. Twenty-two (or 26%) of the transactions were from new
customers, an increase of 47% from Q3, 2005.
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| |  |  | Entrust IdentityGuard revenue (included in the Emerging Growth Products revenue) achieved its highest quarter ever with $1.8 million of product revenue. Entrust IdentityGuard
transactions also reached their highest level at 23 this quarter, up from 16 in Q2, 2006 and 9 in Q3, 2005. Entrust IdentityGuard pilots and trials reached 226, up from 189 in Q2, 2006 and up from 33 in Q3, 2005. In the quarter, follow on orders
from Bank of New Zealand, CommerceBank and Shufa coupled with a new U.S. Federal Government agency drove the increased IdentityGuard product revenue in the quarter.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Entrusts Boundary Messaging product revenue was $0.8 million (included in the Emerging Growth Products revenue), which is its highest quarterly attainment in the products
history. Year-to-date, our Boundary Messaging solutions have increased 30% over last year. The quarterly revenue included a follow on purchase from a large financial services company that standardized and deployed Entrust Messaging Server in the
quarter.
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| |  |  | Zero Touch Fraud Detection, which is the technology obtained from our acquisition of Business Signatures earlier in the quarter, achieved total revenues of $1.0 million. Product
revenue of $0.8 million (included in the Emerging Growth Products revenue) for fraud detection was the highest quarterly attainment in the history of the company and exceeded last years total revenue. The company continues to see increased
demand for Risk-based Authentication solutions.
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| |  |  | Deferred revenue was $25.0 million, which is an increase of 15% from Q3, 2005 and an increase of 9% from Q2, 2006.
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| |  |  | We made no repurchases of Common stock under our share purchase program in the third quarter of 2006.
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| |  |  | We ended Q3, 2006 with $28.4 million in cash and marketable securities, which is down from $74.7 million at the end of Q2, 2006 due to the acquisition of Business Signatures, and no
debt.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We acquired Business Signatures, a leading supplier of Zero Touch Fraud Detection solutions that provide non-invasive real time online fraud detection capability and that require no
change to business applications, based in Redwood City, California.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Entrust and Vericept Corporation announced a strategic partnership to deliver fully embedded email encryption functionality in a content monitoring and control solution. Under the
terms of the agreement, Vericept will integrate the Entrust Entelligence Messaging Server encryption capability into Vericepts Control 360° product providing automatic encryption, compliance and content control to both Vericept and Entrust
customers. In addition, we will become a reseller partner of Vericepts content control solutions.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | US Bank selected Entrusts Zero Touch Fraud Detection solution to help assist with its FFIEC compliance activities. The deal was secured through Entrusts
partnership with IBM Global Business Services. The platform was also deployed real-time for online fraud prevention for Citibank North America in the quarter.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

CRITICAL ACCOUNTING POLICIES

In the third quarter of 2006, our most complex accounting
judgments were made in the areas of software revenue recognition, allowance for doubtful accounts, restructuring charges and related adjustments, accounting for long-term strategic and equity investments, purchase accounting, the provision for
income



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taxes and stock-based compensation. The restructuring and related charges are not anticipated to be recurring in nature.
However, the financial reporting of restructuring and related charges will continue to require judgments until such time as the corresponding accruals are fully paid out and/or no longer required. Software revenue recognition, allowance for doubtful
accounts, accounting for long-term strategic and equity investments, purchase accounting, provision for income taxes and stock-based compensation are expected to continue to be ongoing elements of our critical accounting processes and judgments.

Software Revenue Recognition

With respect to
software revenue recognition, we recognize revenues in accordance with the provisions of the American Institute of Certified Public Accountants Statement of Position No. 97-2, Software Revenue Recognition, Statement of
Position No. 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions and related accounting guidance and pronouncements. Due to the complexity of some software license agreements, we
routinely apply judgments to the application of software revenue recognition accounting principles to specific agreements and transactions. We analyze various factors, including a review of the specifics of each transaction, historical experience,
credit worthiness of customers and current market and economic conditions. Changes in judgments based upon these factors could impact the timing and amount of revenues and cost recognized. Different judgments and/or different contract structures
could lead to different accounting conclusions, which could have a material effect on our reported earnings.

Revenues from perpetual software license
agreements are recognized when we have received an executed license agreement or an unconditional order under an existing license agreement, the software has been shipped (if there are no significant remaining vendor obligations), collection of the
receivable is reasonably assured, the fees are fixed and determinable and payment is due within twelve months. Revenues from license agreements requiring the delivery of significant unspecified software products in the future are accounted for as
subscriptions and, accordingly, are recognized ratably over the term of the agreement from the first instance of product delivery. License revenues are generated both through direct sales to end users as well as through various partners, including
system integrators, value-added resellers and distributors. License revenue is recognized when the sale has occurred for an identified end user, provided all other revenue recognition criteria are met. We are notified of a sale by a reseller to the
end user customer in the same period that the product is actually sold through to the end user customer. We do not offer a right of return on sales of our software products.

For all sales, we use a binding contract, purchase order or another form of documented agreement as evidence of an arrangement with the customer. Sales to our distributors are evidenced by a master agreement governing
the relationship, together with binding purchase orders on a transaction-by-transaction basis. We consider delivery to occur when we ship the product, so long as title and risk of loss have passed to the customer. If an arrangement includes
undelivered products or services that are essential to the functionality of the delivered product, delivery is not considered to have occurred until these products or services are delivered.

At the time of a transaction, we assess whether the sale amount is fixed or determinable based upon the terms of the documented agreement. If we determine the fee is not
fixed or determinable at the outset, we recognize revenue when the fee becomes fixed and determinable. We assess if collection is reasonably assured based on a number of factors, including past transaction history with the customer and the
creditworthiness of the customer. If we determine that collection is not reasonably assured, we do not record revenue until such time as collection becomes probable, which is generally upon the receipt of cash.

We do not generally include acceptance provisions in arrangements with customers. However, if an arrangement includes an acceptance provision, we recognize revenue upon
the customers acceptance of the product, which occurs upon the earlier of receipt of a written customer acceptance or expiration of the acceptance period.

We are sometimes subject to fiscal funding clauses in our software licensing transactions with the United States government and its agencies. Such clauses generally provide that the license is cancelable if the legislature or funding
authority does not appropriate the funds necessary for the governmental unit to fulfill



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its obligations under the licensing arrangement. In these circumstances, software licensing arrangements with
governmental organizations containing a fiscal funding clause are evaluated to determine whether the uncertainty of a possible license arrangement cancellation is remote. If the likelihood of cancellation is assessed as remote, then the software
licensing arrangement is considered non-cancelable and the related software licensing revenue is recognized when all other revenue recognition criteria have been met.

For arrangements involving multiple elements, we allocate revenue to each component based on the vendor-specific objective evidence of the fair value of the various elements. These elements may include two or more of
the following: software licenses, maintenance and support, consulting services and training. We first allocate the arrangement fee, in a multiple-element transaction, to the undelivered elements based on the total fair value of those undelivered
elements, as indicated by vendor-specific objective evidence. This portion of the arrangement fee is deferred. Then the difference (residual) between the total arrangement fee and the amount deferred for the undelivered elements is recognized as
revenue related to the delivered elements. We attribute the discount offered in a multiple-element arrangement entirely to the delivered elements of the transaction, which are typically software licenses. Fair values for the future maintenance and
support services are based upon substantially similar sales of renewals of maintenance and support contracts to other customers. Fair value of future services, training or consulting services is based upon substantially similar sales of these
services to other customers. In some instances, a group of contracts or agreements with the same customer may be so closely related that they are, in effect, part of a single multiple-element arrangement, and therefore, we would undertake to
allocate the corresponding revenues amongst the various components, as described above.

We generally do not engage in
non-monetary transactions.

We also eliminate intercompany profits on revenue transactions with unconsolidated subsidiaries that are accounted for under
the equity method to the extent of our ownership interest in that related party, if the product and/or services have not been sold through to an unrelated third party end-user customer.

Our consulting services generally are not essential to the functionality of the software. Our software products are fully functional upon delivery and do not require any significant modification or alteration.
Customers purchase these consulting services to facilitate the adoption of our technology and dedicate personnel to participate in the services being performed, but they may also decide to use their own resources or appoint other consulting service
organizations to provide these services. When the customization is essential to the functionality of the licensed software, then both the software license and consulting services revenues are recognized under the percentage of completion method,
which requires revenue to be recognized based upon the percentage of work effort completed on the project.

Allowance for Doubtful Accounts

We maintain doubtful accounts allowances for estimated losses resulting from the inability of our customers to make required payments. We assess
collection based on a number of factors, including previous transactions with the customer and the creditworthiness of the customer. We do not request collateral from our customers.

We base our ongoing estimate of allowance for doubtful accounts primarily on the aging of the balances in the accounts receivable, our historical collection patterns and changes in the creditworthiness of our
customers. Based upon the analysis and estimates of the uncollectibility of our accounts receivable, we record an increase in the allowance for doubtful accounts when the prospect of not collecting a specific account receivable becomes probable. The
allowance for doubtful accounts is established based on the best information available to us and is re-evaluated and adjusted as additional information is received. We exhaust all avenues and methods of collection, including the use of third party
collection agencies, before writing-off a customer balance as uncollectible. While credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit
loss rates that we have in the past. Each circumstance in which we conclude that a provision for non-payment by a customer may be required must be carefully considered in order to determine the true factors leading to that potential non-payment to
ensure that it is proper for it to be categorized as an allowance for bad debts. We have focused on improving our accounts receivable aging and, as a result, had



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been able to reduce our corresponding allowance for doubtful accounts in 2004 and 2005 in the process. However, a
significant change in the financial condition of a major customer, such as the European distributor discussed below, could have a material impact on our estimates regarding the sufficiency of our allowance. Our accounts receivable include material
balances from a limited number of customers, with five customers accounting for 23% of gross accounts receivable at September 30, 2006, compared to 39% of gross accounts receivable at September 30, 2005. No customer accounted for 10% or
more of net accounts receivable at September 30, 2006. For more information on our customer concentration, see our related discussion in Risk Factors. Therefore, changes in the assumptions underlying this assessment or changes in
the financial condition of our customers, resulting in an impairment of their ability to make payments, and the timing of information related to the change in financial condition could result in a different assessment of the existing credit risk of
our accounts receivable and thus, a different required allowance, which could have a material impact on our reported earnings.

During the first nine
months of 2006, we became aware of financial concerns regarding one of our European distributors and, as a result, we concluded that it was necessary to record an increase to our provision for doubtful accounts in the aggregate amount of $795
thousand, of which $300 thousand was recorded in the third quarter, as a charge against sales and marketing expenses.

Restructuring Charges and
Adjustments

June 2001 Restructuring Plan

On
June 4, 2001, we announced that our Board of Directors had approved a restructuring plan to refocus on the most significant market opportunities and to reduce operating costs due to the macroeconomic factors that were negatively affecting
technology investment in the market. The restructuring plan included a workforce reduction, consolidation of excess facilities, and discontinuance of non-core products and programs.

As a result of the restructuring plan and the impact of macroeconomic conditions on us and our global base of customers, we recorded restructuring charges of $65.5 million in the second quarter of 2001, with a
subsequent reduction of $1.1 million in the first half of 2002. In the second quarter of 2003, we made a further adjustment to increase the restructuring charges that we had previously recorded related to the June 2001 restructuring plan by $6.7
million to reflect a change in our projected sublet lease recoveries for our Santa Clara, California facility. We concluded that this was required as a result of our realization that the market for leased facilities in that region will not recover
in the timeframe that we had estimated, as evidenced by significantly lower projected sublease rates for our facility as supplied to us by our external real estate advisors. We also recorded a $2.1 million reduction to our June 2001 restructuring
accrual in the third quarter of 2003, as a result of the July 2003 settlement of an existing contractual obligation under a marketing and distribution agreement, at a value significantly less than the full accrued obligation.

During the first and second quarters of 2006, we made further adjustments to the restructuring charges that had previously been recorded related to the June 2001
restructuring plan with respect to our Santa Clara, California facility. The building is currently subleased, but the current sublease was scheduled to end in December 2006.

Although we had been monitoring the sublet market on an on-going basis, the extension offer we received during the first quarter of 2006, coupled with the preparations we had begun for placing the facility on the
market, caused us to revisit our estimated sublease recoveries at that time. We had concluded that we would need to increase the restructuring charges that we had previously recorded related to our June 2001 restructuring plan by a further $2.9
million in the first quarter of fiscal 2006 to reflect a change in our projected sublet lease recoveries as evidenced by the market for leased facilities in that region. This charge represented a reduction in the cash that we expected to recover
from future subtenants. During the second quarter of 2006, we concluded an extension agreement with the current sublessee to sublease the California facility through to March 31, 2011, which represents substantially all of the remaining lease
period on the building. As a result of the conclusion of the final sublease arrangement during the second quarter of 2006, we adjusted our accrual related to the June 2001 restructuring downward by $130 thousand to reflect the known sublet lease
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Our assessment required assumptions in estimating the original accrued restructuring charges of $65.5 million at
June 30, 2001, including estimating future recoveries of sublet income from excess facilities, liabilities from employee severances, and costs to exit business activities. Changes in these assessments with respect to the accrued restructuring
charges for the June 2001 restructuring program, particularly related to restructured facilities, of $25.4 million at September 30, 2006, could have a material effect on our reported results, as actual results could vary from these assumptions
and estimates. As at September 30, 2006, due to the conclusion of the extension agreement with the subtenant in connection with our California facility, the remaining estimated sublease recoveries included in our restructuring accrual, that are
not currently contracted under existing sublease agreements, amounted to only approximately $100 thousand.

The restructuring plan announced on
June 4, 2001 was completed by June 2002. No further charges are anticipated. However, actual results could vary from the currently recorded estimates.

May 2003 Restructuring Plan

On May 27, 2003, we announced a restructuring plan aimed at lowering costs and better aligning our
resources to customer needs. The plan allows us to have tighter integration between the groups in our organization that interact with customers, which better positions us to take advantage of the market opportunities for our new products. The
restructuring plan included the elimination of employee positions to lower operating costs, closing of under-utilized office space, and re-assessing the value of related excess long-lived assets.

Our assessment required assumptions in estimating the restructuring charges of $8.9 million, including estimating liabilities related to employee severance, future
recoveries of sublet income from excess facilities, and other costs to exit activities. Changes in these assessments with respect to the accrued restructuring charges for the May 2003 restructuring plan of $0.3 million at September 30, 2006
could have a material effect on our reported results. In addition, actual results could vary from these assumptions and estimates, in particular with regard to the sublet of excess facilities, resulting in an adjustment that could have a material
effect on our future financial results. Our accrual related to the May 2003 restructuring at September 30, 2006 includes a total of $0.2 million of estimated sublease recoveries, which may be subject to adjustment based upon changes in the real
estate sublet markets.

The restructuring plan announced on May 27, 2003 was completed by December 31, 2003. No further changes are anticipated.
However, actual results could vary from the currently recorded estimates.

Accounting for Long-term Strategic Investments

We assess the recoverability of the carrying value of strategic investments on an on-going basis, but at least annually. Factors that we consider important in determining
whether an assessment is warranted and could trigger impairment include, but are not limited to, the likelihood that the company in which we invested would have insufficient cash flows to operate for the next twelve months, significant changes in
the companys operating performance or business model and changes in overall market conditions. These investments are in private companies, of which we typically own less than 10% of the outstanding stock. We account for these investments under
the cost method. Because there is not a liquid market for these securities, we often must make estimates of the value of our investments.

As a result of
the Rescission Agreement discussed in the next section, as of December 31, 2005, we held an investment in Ohana, in the amount of $750 thousand, representing approximately 14.3% of the issued common shares of Ohana. This investment is now
accounted for under the cost method. By December 31, 2005, we had recorded cumulative losses related to our $1.5 million investment in Ohana of $750 thousand since the fourth quarter of 2004.

During the first quarter of 2006, we were informed of an Ohana re-financing, which coupled with the changes in the business outlook, led us to conclude that the
expectations for Ohana had not materialized and an impairment charge was required to adjust the net carrying value of our equity ownership. As a result, we recorded in the first quarter of fiscal 2006 an impairment of our investment in Ohana of $659
thousand. No amount of the charge will result in future cash expenditures. After this impairment, the remaining carrying value of our investment in Ohana was $91 thousand at September 30, 2006.



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Accounting for Long-term Equity Investments

We held $2.9 million of investments as of December 31, 2005 that we account for under the equity basis of accounting, which represent our equity ownership in Asia Digital Media. Asia Digital Media is a joint
venture, involving us and several other investors, formed for the purpose of delivering secure technology solutions enabling HDTV satellite broadcasting, high-speed internet and on-line transaction services to the Chinese market.

Our investment in Asia Digital Media began as a loan to Ohana of $650 thousand in 2003, which was convertible into equity of Ohana. In the second quarter of 2004 this
was increased to $950 thousand. In July 2004, this loan was further increased to $1.225 million. This amount was further increased to $1.5 million in the fourth quarter of 2004. We determined that the loan was unlikely to be repaid but rather
expected it to be converted into equity in ADML Holdings, Ltd. (ADML Holdco), once Ohana became a wholly owned subsidiary of ADML Holdco in connection with the Ohana Restructuring. On an as-converted basis at September 30, 2004, we
would have owned approximately 12% of ADML Holdco (exclusive of the anticipated final disbursement in the fourth quarter of 2004). Beginning the third quarter of 2004, we had accounted for our investment in Ohana under the equity method, in
accordance with the provisions of APB No. 18, The Equity Method of Accounting for Investments in Common Stock and ARB No. 51, Consolidated Financial Statements. Accordingly, we included our share of post-acquisition
losses of Ohana, prior to the Ohana Restructuring, in the amount of $193 thousand in our consolidated net income for the 2004 fiscal year. The Ohana Restructuring closed on November 16, 2004 and we received approximately 14.3% of the issued
common shares of ADML Holdco, together with a warrant that may become exercisable for additional shares of ADML Holdco upon the happening of certain events.

On September 16, 2004, the Company and certain other investors agreed to subscribe for shares in a newly formed joint venture called Asia Digital Media pursuant to a subscription agreement (as amended, the Subscription
Agreement). The investment closed on December 17, 2004. We directly subscribed for approximately 16.7% of the share capital of Asia Digital Media in exchange for a cash contribution of $2.0 million and in-kind contributions of software
products and professional services totaling $1.3 million. Of this amount, $1.1 million was recorded on account of the in-kind contributions as revenue in the fourth quarter of 2004, net of intercompany profit eliminations. Also, ADML Holdco, in
which we held an approximate 14.3% ownership interest for our $1.5 million investment, directly subscribed for 60.6% of the share capital of Asia Digital Media in exchange for a contribution of the entire issued share capital of Ohana. The remaining
capital stock of Asia Digital Media is owned by two investors and China Aerospace New World Technology Limited, a company incorporated in Hong Kong. During the first quarter of 2005, we received additional shares of common stock of Asia Digital
Media in reimbursement for legal costs incurred by us on behalf of Asia Digital Media during its formation and for administrative services that we provided. These additional shares were valued at $458 thousand and resulted in an increase of our
total direct and indirect equity holdings in Asia Digital Media to 27.4% as of September 30, 2005.

On December 27, 2005, we entered into the
Rescission Agreement with Asia Digital Media and ADML Holdco to rescind the Subscription Agreement in part, resulting in the return of the shares of Asia Digital Media issued to ADML Holdco for cancellation and the corresponding return of the entire
issued capital of Ohana to ADML Holdco. Upon conclusion of the procedures required to give effect to the Rescission Agreement, we owned approximately 44% of the issued share capital of Asia Digital Media and approximately 14.3% of the issued share
capital of Ohana.

Beginning with the fourth quarter of 2004, we have accounted for our investment in Asia Digital Media under the equity method.
Accordingly, we have included our share of post-acquisition losses of Asia Digital Media, in the amount of $51 and $344 thousand in the three and nine months ended September 30, 2006, respectively, and a cumulative $1.1 million in our
consolidated net income since the fourth quarter of 2004. See notes 3 and 4 to our condensed consolidated financial statements for additional information.



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Upon execution of the Rescission Agreement, we have no commitments or other arrangements to provide funding for any
shortfalls ADML Holdco may incur, and there are no variable interests with respect to ADML Holdco, other than its common stock interest of 14.3%. Therefore, FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities
(FIN No. 46(R)) is not applicable to this investment.

We have concluded that Asia Digital Media does not meet the definition of a
variable interest entity, as described in FIN No. 46(R). As the company began initial operations in December 2004, engaging primarily in research and development, and having no revenue, we determined that Asia Digital Media is a development
stage enterprise. Furthermore, the capitalization of Asia Digital Media anticipates raising additional equity to fund the scaled production pilot and commercial roll-out. However, the cash invested in Asia Digital Media by investors of $4.5 million,
is expected to be sufficient equity to fund the initial development stage, which is defined as implementation of a pilot system with all specified functions in a limited commercial environment. In addition, we determined that each shareholder of
Asia Digital Media shares in the risk of loss and that the shareholders, as a group, share the returns. Finally, we concluded that Asia Digital Media does not operate substantively on behalf of one entity that receives a disproportionately fewer
voting rights to avoid consolidation.

During the first quarter of 2006, we were informed of changes in our Chinese partners ability to invest in the
second funding round of Asia Digital Media. This factor, among others, had significant negative implications for Asia Digital Media. We concluded that expectations for Asia Digital Media had not materialized and an impairment charge was required to
adjust the net carrying value of our equity ownership. As a result, we recorded in the first quarter of fiscal 2006 an impairment of our investment in Asia Digital Media in the amount of $2.4 million. No amount of the charge will result in future
cash expenditures. After this impairment, the remaining carrying value of our investment in Asia Digital Media was $179 thousand at September 30, 2006.

Purchase Accounting

In June 2006, we completed the acquisition of all of the issued and outstanding shares of the common stock of
Orion, based in McLean, Virginia, while on July 19, 2006, we completed the acquisition of all of the issued and outstanding shares of capital stock and options of Business Signatures, based in Redwood City, California.

These acquisitions were accounted for under the purchase method of accounting, and, accordingly, the purchase prices were allocated to the fair value of the tangible and
intangible assets and liabilities acquired, with the remainder allocated to goodwill. In determining the fair value of the intangible assets acquired, we are required to make significant assumptions and judgments regarding such things as the
estimated future cash flows that we believe will be generated as a result of the acquisition of customer/partner relationships, purchased product rights and workforce, and the estimated useful life of these acquired intangible assets. We believe
that our assumptions and resulting conclusions are the most appropriate based on existing information and market expectations. However, different assumptions and judgments as to future events could have resulted in different fair values being
allocated to the intangible assets acquired. We will review these assets for impairment in future, in accordance with the guidance in SFAS No. 142, Goodwill and Intangible Assets, which require goodwill to be reviewed for impairment
at least annually or whenever events indicate that their carrying amount may not be recoverable, and SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.

Provision for Income Taxes

The preparation of our
consolidated financial statements requires us to estimate our income taxes in each of the jurisdictions in which we operate, including those outside the United States. In addition, we have based the calculation of our income taxes in each
jurisdiction upon inter-company agreements, which could be challenged by tax authorities in these jurisdictions. The income tax accounting process involves our estimating our actual current exposure in each jurisdiction together with assessing
temporary differences resulting from differing treatment of items, such as deferred revenue and accrued restructuring charges, for tax and accounting purposes. These differences result in the recognition of deferred tax assets and liabilities. We
then record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized.



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Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and
liabilities and any valuation allowance recorded against deferred tax assets. We recorded a valuation allowance of $138.6 million as of September 30, 2006, which offsets deferred income tax assets relating to United States and foreign net
operating loss (NOL) and tax credit carry-forwards in the amount of $112.6 million and $26.0 million of deferred tax assets resulting from temporary differences. This valuation allowance represents the full value of our deferred tax assets, due to
uncertainties related to our ability to utilize our deferred tax assets as a result of our recent history of financial losses. Therefore, our balance sheet includes no net deferred tax benefits related to these deferred tax assets. Valuation
allowances are provided against net deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent
upon the generation of future taxable income and the timing of the temporary differences becoming deductible. We consider, among other available information, historical earnings, scheduled reversals of deferred tax liabilities, projected future
taxable income, prudent and feasible tax planning strategies and other matters in making this assessment. Until an appropriate level of profitability is sustained, we expect to continue to record a full valuation allowance and will not record any
benefit from the deferred tax assets.

Stock-Based Compensation

Our stock award program is a broad-based, long-term retention program that is intended to contribute to our success by attracting, retaining and motivating talented employees and to align employee interests with the
interests of our existing shareholders. Stock based awards may be granted to employees when they first join us, when there is a significant change in an employees responsibilities and, occasionally, to achieve equity within a peer group. Stock
based awards may also be granted in specific circumstances for retention or reward purposes. The Compensation Committee of the Board of Directors may, however, grant additional awards to executive officers and key employees for other reasons. Under
the stock based award plans, the participants may be granted options to purchase shares of Common stock and substantially all of our employees and directors participate in at least one of our plans. Options issued under these plans generally are
granted at fair market value at the date of grant, become exercisable at varying rates, generally over three or four years. Options issued before April 29, 2005, generally expire ten years from the date of grant; awards issued on or after
April 29, 2005, generally expire seven years from the date of grant.

We recognize that stock options and other stock-based incentive awards dilute
existing shareholders and have attempted to control the number granted while remaining competitive with our compensation packages. The Compensation Committee of the Board of Directors oversees the granting of all stock-based incentive awards.

On March 15, 2006, the Board of Directors adopted resolutions, subject to shareholder approval, to approve entry into the 2006 Stock Incentive Plan
(the 2006 Plan). The plan was approved at the annual shareholders meeting held May 5, 2006. The Board adopted the 2006 Plan because it believes that continued grants of stock options, as well as grants of restricted stock and other
stock-based awards, are an important element in attracting, retaining and motivating persons who are expected to make important contributions.

The Amended
and Restated 1996 Stock Incentive Plan, the enCommerce, Inc. 1997 Stock Option Plan, as amended and restated, and the 1999 Non-Officer Employee Stock Incentive Plan, as amended (together, the Prior Plans), will terminate and no further
grants will be permitted under the Prior Plans, provided that, this termination of the Prior Plans will not affect awards that are outstanding under the Prior Plans.

In January 2005, our Board of Directors approved accelerating the vesting of all of the outstanding unvested stock options granted to our directors, officers and employees under applicable stock incentive plans, with
an exercise price greater than $4.79. As a result of the acceleration, options to acquire approximately 2.8 million shares of our Common stock, which otherwise would have vested from time to time over the next four years, became immediately
exercisable. All other terms and conditions applicable to outstanding stock option grants remain in effect.



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The decision to accelerate the vesting of affected stock options was primarily based upon the issuance of SFAS No.123(R),
Accounting for Stock-Based Compensation (SFAS No. 123(R)). In addition, because these options had exercise prices in excess of current market values and are not fully achieving their original objectives of incentive
compensation and employee retention, the acceleration may have a positive effect on employee morale and retention. By accelerating the vesting of the affected stock options, we are not required to record any amount of compensation expense for such
accelerated stock options in current or future periods.

In addition, we decided to use restricted stock units (RSUs) and stock appreciation
rights (SARs) in future incentive compensation plans for employees and members of the Board of Directors, in place of or in combination with stock options to purchase shares of our stock.

RSUs allow the employees to receive Common stock of the Company once the units vest. The RSUs generally vest over two to four years. In accordance with the
provisions of SFAS No. 123(R), (discussed below), no unearned deferred compensation expense was recorded for stock-based awards to employees. Compensation costs related to stock based awards are treated as a credit to Additional Paid in Capital
when the expense is recognized over the requisite service period.

Adoption of SFAS No. 123(R)

In December 2004, the Financial Accounting Standards Board issued SFAS No. 123(R) which supersedes APB Opinion No. 25 and requires an entity to measure the cost
of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award, and recognize that cost over the service period. SFAS No. 123(R) is effective for the first annual period beginning
after June 15, 2005 and, therefore, we began recognizing compensation expense related to employee stock awards from and after January 1, 2006.

SFAS 123(R) requires us to measure compensation cost for stock awards at fair value and recognize compensation over the service period for awards expected to vest. The estimation of stock awards that will ultimately vest requires judgment,
and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. We consider many factors when estimating awards expected to vest
including type of awards, employee class, and our historical experience. Actual results, and future changes in estimates, may differ substantially from our current estimates.

We use the Black-Scholes option pricing model to determine the fair value of our stock options. The determination of the fair value of stock-based awards using an option pricing model is affected by our stock price as
well as assumptions regarding a number of complex and subjective variables. Changes in the input assumptions can materially affect the fair value estimate of our stock options. Those assumptions include estimating; the expected volatility of the
market price of our common stock over the expected term, the expected term of the award, the risk free interest rate expected during the option term and the expected dividends to be paid.

We have reviewed each of these assumptions carefully and determined our best estimate for these variables. Of these assumptions, the expected volatility of our common
stock is the most difficult to estimate since it is based on expected performance of our common stock. We use the implied volatility of historical market prices for our common stock on the public stock market to estimate expected volatility. An
increase in the expected volatility, expected term, and risk free interest rate, all will cause an increase in compensation expense. The dividend yield on our common stock is assumed to be zero since we do not pay dividends and have no current plans
to do so in the future.

For the three and nine months ended September 30, 2006 compensation expense of $1.1 million and $2.7 million, respectively,
was recognized for stock options, RSUs and SARs as a result of the adoption of SFAS No. 123(R). Total remaining compensation estimated to be recognized over the remaining service periods for these awards is $7.9 million.



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In addition to ongoing recognition of stock-based compensation expense, we recognized a one-time cumulative transition
adjustment in the first quarter of 2006. A reduction of $32 thousand in compensation expense was made related to the effect of estimated forfeitures on outstanding awards. This adjustment was to record the cumulative effect of a change in accounting
principle, to reflect the compensation cost that would not have been recognized in prior periods had forfeitures been estimated during those periods. This adjustment applies only to compensation cost previously recognized in fiscal 2005 related to
RSUs and SARs awards granted in that year.

Prior to 2006, under the fair value recognition provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, stock-based compensation expense was disclosed in notes to the financial statements. The effect of this expense in fiscal 2005 would have been to create a pro forma net loss for 2005 of $2.1 million, compared to
reported net income of $6.4 million.

RECENTLY ISSUED ACCOUNTING STANDARDS

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109,
(FIN No. 48), which clarifies the accounting for uncertainty in tax positions. FIN No. 48 requires that we recognize in our financial statements, the impact of a tax position, if that position is more likely than not of not
being sustained on audit, based on the technical merits of the position. FIN No. 48 seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to accounting for income taxes. The
provisions of FIN No. 48 will be effective for us as of the beginning of our 2007 fiscal year, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. We are currently evaluating
the impact of adopting FIN No. 48 on our consolidated financial position and results of operations.

In September 2006, the FASB issued SFAS
No. 157,Fair Value Measurements, which establishes a framework for measuring fair value under other accounting pronouncements that require fair value measurements and expands disclosures about such measurements. SFAS
No. 157 does not require any new fair value measurements, but rather it creates a consistent method for calculating fair value measurements to address non-comparability of financial statements containing fair value measurements utilizing
different definitions of fair value. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We do not anticipated that the adoption of SFAS No. 157 will have a significant impact
on our consolidated financial position, results of operations or cash flows.

In September 2006, the SEC staff issued Staff Accounting Bulletin
(SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB No. 108 was issued to provide consistency between how
registrants quantify financial statement misstatements. Historically, there have been two widely-used methods for quantifying the effects of financial statement misstatements, the roll-over method and the iron curtain
method. While the roll-over method primarily quantifies the amount by which the current year income statement is misstated, the iron curtain method primarily quantifies the error as the cumulative amount by which the current year balance sheet
is misstated. We currently use the roll-over method for quantifying identified financial statement misstatements. SAB No. 108 establishes an approach that requires quantification of financial statement misstatements based on the effects of
the misstatement on each of the companys financial statements and the related financial statement disclosures. This approach is commonly referred to as the dual approach because it requires quantification of errors under both
the roll-over and iron curtain methods. We will not be required to record an adjustment as a result of our adoption of SAB No. 108.



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RESULTS OF OPERATIONS

The following table sets forth certain condensed consolidated statement of operations data expressed as a percentage of total revenues for the periods indicated:



|                                                         |  |                                 |    |  |                                |   |  |       |    |  |       |  
|-------------------------------------------------------- |  | ------------------------------- | -- |  | ------------------------------ | - |  | ----- | -- |  | ----- | -
|                                                         |  | Three months endedSeptember 30, |    |  | Nine months endedSeptember 30, |  
|                                                         |  | 2006                            |    |  | 2005                           |   |  | 2006  |    |  | 2005  |  
|Revenues:                                                |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Product                                                  |  | 36.6                            | %  |  | 32.4                           | % |  | 33.9  | %  |  | 34.3  | %
|Services and maintenance                                 |  | 63.4                            |    |  | 67.6                           |   |  | 66.1  |    |  | 65.7  |  
|                                                         |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Total revenues                                           |  | 100.0                           |    |  | 100.0                          |   |  | 100.0 |    |  | 100.0 |  
|                                                         |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Cost of revenues:                                        |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Product                                                  |  | 5.2                             |    |  | 6.0                            |   |  | 6.6   |    |  | 4.6   |  
|Amortization of purchased product rights                 |  | 1.3                             |    |  | 0.9                            |   |  | 1.1   |    |  | 0.8   |  
|Services and maintenance                                 |  | 30.2                            |    |  | 30.8                           |   |  | 32.3  |    |  | 32.1  |  
|                                                         |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Total cost of revenues                                   |  | 36.7                            |    |  | 37.7                           |   |  | 40.0  |    |  | 37.5  |  
|                                                         |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Gross profit                                             |  | 63.3                            |    |  | 62.3                           |   |  | 60.0  |    |  | 62.5  |  
|                                                         |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Operating expenses:                                      |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Sales and marketing                                      |  | 40.4                            |    |  | 28.4                           |   |  | 36.4  |    |  | 29.3  |  
|Research and development                                 |  | 22.9                            |    |  | 16.8                           |   |  | 21.1  |    |  | 17.2  |  
|General and administrative                               |  | 14.3                            |    |  | 13.2                           |   |  | 15.8  |    |  | 12.2  |  
|Restructuring charges and adjustments                    |  |                                |    |  |                               |   |  | 4.1   |    |  |      |  
|                                                         |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Total operating expenses                                 |  | 77.6                            |    |  | 58.4                           |   |  | 77.4  |    |  | 58.7  |  
|                                                         |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Income (loss) from operations                            |  | (14.3                           | )  |  | 3.9                            |   |  | (17.4 | )  |  | 3.8   |  
|                                                         |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Other income (expense):                                  |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Interest income                                          |  | 1.5                             |    |  | 2.5                            |   |  | 2.9   |    |  | 2.3   |  
|Foreign exchange gain (loss)                             |  |                                |    |  | (0.2                           | ) |  | (0.4  | )  |  |      |  
|Loss from equity investments                             |  | (0.2                            | )  |  | (0.9                           | ) |  | (0.5  | )  |  | (0.9  | )
|Gain on sale of asset                                    |  |                                |    |  |                               |   |  |      |    |  | 0.2   |  
|Write-down of long-term strategic and equity investments |  |                                |    |  |                               |   |  | (4.5  | )  |  |      |  
|                                                         |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Total other income (expense)                             |  | 1.3                             |    |  | 1.4                            |   |  | (2.5  | )  |  | 1.6   |  
|                                                         |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Income (loss) before income taxes                        |  | (13.0                           | )  |  | 5.3                            |   |  | (19.9 | )  |  | 5.4   |  
|Provision for income taxes                               |  | 0.5                             |    |  | 1.3                            |   |  | 0.5   |    |  | 1.3   |  
|                                                         |  |                                 |    |  |                                |   |  |       |    |  |       |  
|Net income (loss)                                        |  | (13.5                           | )% |  | 4.0                            | % |  | (20.4 | )% |  | 4.1   | %
|                                                         |  |                                 |    |  |                                |   |  |       |    |  |       |  

REVENUES

Total Revenues



|                      |  |                                  |      |                                 |   |                   |  |      |      |                                |   |      |                               |   |   |  |     |   
|--------------------- |  | -------------------------------- | ---- | ------------------------------- | - | ----------------- |  | ---- | ---- | ------------------------------ | - | ---- | ----------------------------- | - | - |  | --- | --
|                      |  | Three months ended September 30, |      | Nine months ended September 30, |   | Percentage change | 
|(millions)            |  | 2006                             |      | 2005                            |   | 2006              |  | 2005 |      | Three Months EndedSeptember 30 |   |      | Nine Months EndedSeptember 30 |  
|North America         |  | $                                | 16.8 |                                 | $ | 16.7              |  | $    | 47.5 |                                | $ | 50.1 |                               | 1 | % |  | (5  | )%
|Outside North America |  |                                  | 7.2  |                                 |   | 7.0               |  |      | 19.7 |                                |   | 23.3 |                               | 3 | % |  | (15 | )%
|                      |  |                                  |      |                                 |   |                   |  |      |      |                                |   |      |                               |   |   |  |     |   
|Total                 |  | $                                | 24.0 |                                 | $ | 23.7              |  | $    | 67.2 |                                | $ | 73.4 |                               | 2 | % |  | (8  | )%
|                      |  |                                  |      |                                 |   |                   |  |      |      |                                |   |      |                               |   |   |  |     |   

Our total revenues were $24.0 million for the three months ended September 30, 2006, which represented an
increase of 2% from the $23.7 million of total revenues for the three months ended September 30, 2005. Total revenues were $67.2 million for the nine months ended September 30, 2006, which represented a decrease of 8% from the $73.4
million of total revenues for the nine months ended September 30, 2005. The increase in total revenues during the three months ended September 30, 2006, when compared to the same period of 2005, was driven primarily by our emerging growth
products, which includes



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IdentityGuard, Boundary Messaging and Fraud Detection, particularly in the financial services sector as financial
institutions focus on global compliance regulations. The decrease in total revenues during the nine months ended September 30, 2006, when compared to the same period of 2005, was driven primarily by decreased average deal size for product
transactions, primarily outside of North America, and a shift in our product mix toward our emerging growth products, which tend to be smaller up front deals that carry less professional services requirements. Improvements, both in North America and
internationally, for the third quarter, but overall decline for the first nine months of 2006 were in part due to the extended government market. For the three and nine months ended September 30, 2006, extended government revenues in the United
States were $4.5 million and $12.9 million, respectively, compared to $4.6 million and $15.7 million for the same periods in 2005, representing a 2% decrease and a 18% decrease, respectively. The level of non-North American revenues has fluctuated
from period to period and this trend is expected to continue for the foreseeable future. The United States and Canadian governments represented 16% and 8% of total revenues in the third quarter of 2006, respectively, when including revenues sold
through resellers to the government end users. However, direct sales to the United States and Canadian governments represented only 9% and 7% of total revenues in the third quarter of 2006, respectively. Overall, the United States and Canadian
governments represented 17% and 12% of total revenues for the first nine months 2006, when including revenues sold through resellers to the government end users. However, direct sales to the United States and Canadian governments each represented
only 11% of total revenues in the first nine months of 2006. No other individual customer accounted for 10% or more of total revenues in the three and nine months ended September 30, 2006.

We eliminate intercompany profits on revenue transactions with unconsolidated subsidiaries that are accounted for under the equity method to the extent of our ownership
interest in that related party, if the product and/or services have not been sold through to an unrelated third party end-user customer. During the three and nine months ended September 30, 2005, we sold product and consulting services to Asia
Digital Media with a fair value of $116 thousand and $713 thousand, respectively, which after intercompany profit eliminations related to our direct and indirect ownership at September 30, 2005 of approximately 27%, was recognized as $92
thousand and $617 thousand of net revenues, respectively. We had no revenues from Asia Digital Media during the first nine months of 2006.

Product
Revenues



|                             |  |                                  |     |   |                                 |   |     |                   |  |   |      |   |  |                                |      |   |                               |    |   |  |     |   
|---------------------------- |  | -------------------------------- | --- | - | ------------------------------- | - | --- | ----------------- |  | - | ---- | - |  | ------------------------------ | ---- | - | ----------------------------- | -- | - |  | --- | --
|                             |  | Three months ended September 30, |     |   | Nine months ended September 30, |   |     | Percentage change | 
|(millions)                   |  | 2006                             |     |   | 2005                            |   |     | 2006              |  |   | 2005 |   |  | Three Months EndedSeptember 30 |      |   | Nine Months EndedSeptember 30 |   
|North America                |  | $                                | 5.7 |   |                                 | $ | 5.2 |                   |  | $ | 15.8 |   |  | $                              | 15.3 |   |                               | 10 | % |  | 3   | % 
|Outside North America        |  |                                  | 3.1 |   |                                 |   | 2.5 |                   |  |   | 7.0  |   |  |                                | 9.8  |   |                               | 24 | % |  | (29 | )%
|                             |  |                                  |     |   |                                 |   |     |                   |  |   |      |   |  |                                |      |   |                               |    |   |  |     |   
|Total                        |  | $                                | 8.8 |   |                                 | $ | 7.7 |                   |  | $ | 22.8 |   |  | $                              | 25.1 |   |                               | 14 | % |  | (9  | )%
|                             |  |                                  |     |   |                                 |   |     |                   |  |   |      |   |  |                                |      |   |                               |    |   |  |     |   
|Percentage of total revenues |  |                                  | 37  | % |                                 |   | 32  | %                 |  |   | 34   | % |  |                                | 34   | % |                               |    |   |  |     |   

Product revenues of $8.8 million for the three months ended September 30, 2006 represented an increase of 14%
from the $7.7 million for the three months ended September 30, 2005, representing 37% and 32% of total revenues in the respective periods. Product revenues of $22.8 million for the nine months ended September 30, 2006 represented a
decrease of 9% from the $25.1 million for the nine months ended September 30, 2005, representing 34% of total revenues in each of their respective periods. The increase in the three months ended September 30, 2006 when compared to the same
period in 2005 is primarily due to our emerging growth products; namely IdentityGuard, Boundary Messaging and Fraud Detection, which benefited from the addition of Business Signatures in the third quarter. As a result, we experienced a higher
product transaction closure rate. Highlighting this trend, we had 86 product revenue transactions (a product revenue transaction is defined as a product sale in excess of $10 thousand) in the third quarter of 2006, up from 67 in the same quarter of
2005, or a 28% increase. This was the result of an improvement in the



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closure rate for deals under $500 thousand. Overall, we had 216 product revenue transactions in the first nine months of
2006, up from 208 in the first nine months of 2005, or a 4% increase. The decrease in the first three quarters of 2006 when compared to the same period in 2005 is primarily due to our difficulty in closing deals over a million dollars, closing just
two product deals in excess of one million dollars in the first nine months of 2006, compared to four in the same period of 2005. In addition, the revenues generated from government customers were down in the first nine months of 2006, representing
43% of product revenues compared to 55% for the same period in 2005, mainly due to a reduction in large government PKI deals in 2006. New project purchases remain subject to governmental budgetary constraints, particularly in the United States, so
that these revenues will fluctuate from period to period. More importantly, the impact on revenues was amplified by the fact that the average product revenue transaction size decreased from $93 thousand for the third quarter 2005 to $83 thousand for
the same period of 2006, or a decrease of 11%. The average product transaction size decreased 18% to $83 thousand for the first nine months of 2006 from $101 thousand for the first nine months of 2005. This downward trend in transaction size is due
to a shift in our product mix toward our lower cost emerging growth products. In general, the top-five average quarterly product revenue transactions as a percentage of total revenues decreased from 15% for the first nine months of 2005 to 13% for
the same period in 2006. Product revenues as a percentage of total revenues increased for the three months ended September 30, 2006, compared to the same period in 2005, due to improved demand for products, relative to the demand for services.

Services and Maintenance Revenues



|                             |  |                                  |      |   |                                 |   |      |                   |  |   |      |   |  |                                |      |   |                              |    |    |  |    |   
|---------------------------- |  | -------------------------------- | ---- | - | ------------------------------- | - | ---- | ----------------- |  | - | ---- | - |  | ------------------------------ | ---- | - | ---------------------------- | -- | -- |  | -- | --
|                             |  | Three months ended September 30, |      |   | Nine months ended September 30, |   |      | Percentage change | 
|(millions)                   |  | 2006                             |      |   | 2005                            |   |      | 2006              |  |   | 2005 |   |  | Three Months EndedSeptember 30 |      |   | Nine MonthsEndedSeptember 30 |   
|North America                |  | $                                | 11.1 |   |                                 | $ | 11.5 |                   |  | $ | 31.7 |   |  | $                              | 34.8 |   |                              | (3 | )% |  | (9 | )%
|Outside North America        |  |                                  | 4.1  |   |                                 |   | 4.5  |                   |  |   | 12.7 |   |  |                                | 13.5 |   |                              | (9 | )% |  | (6 | )%
|                             |  |                                  |      |   |                                 |   |      |                   |  |   |      |   |  |                                |      |   |                              |    |    |  |    |   
|Total                        |  | $                                | 15.2 |   |                                 | $ | 16.0 |                   |  | $ | 44.4 |   |  | $                              | 48.3 |   |                              | (5 | )% |  | (8 | )%
|                             |  |                                  |      |   |                                 |   |      |                   |  |   |      |   |  |                                |      |   |                              |    |    |  |    |   
|Percentage of total revenues |  |                                  | 63   | % |                                 |   | 68   | %                 |  |   | 66   | % |  |                                | 66   | % |                              |    |    |  |    |   

Services and maintenance revenues of $15.2 million for the three months ended September 30, 2006 represented
a decrease of 5% from the $16.0 million for the three months ended September 30, 2005, representing 63% and 68% of total revenues in the respective periods. Services and maintenance revenues of $44.4 million for the nine months ended
September 30, 2006 represented a decrease of 8% from the $48.3 million for the nine months ended September 30, 2005, representing 66% of total revenues in each the respective periods. The decrease in services and maintenance revenues for
the three and nine months ended September 30, 2006 compared to the same periods in 2005 is due to a shift in demand to our emerging growth products, which require less professional services to implement, deploy and integrate, than our PKI and
single sign-on solutions. Also, third party hardware revenues are lower for the first nine months of 2006 by $1.1 million when compared to the same period last year, because of a significant hardware order which bolstered services revenues in the
first nine months of 2005. We have also experienced lower Canadian government professional services revenues in 2006 and a shift in services that has accompanied our growth in U.S. channel partners revenues. Services and maintenance revenues as a
percentage of total revenues for the three months ended September 30, 2006 decreased compared to the same period in 2005 due to improvement in product revenues combined with a decrease in services and maintenance revenues.



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EXPENSES

Total
Expenses



|                             |  |                                  |      |   |                                 |   |      |                   |  |   |      |   |  |                                |      |   |                               |    |   |  |    |  
|---------------------------- |  | -------------------------------- | ---- | - | ------------------------------- | - | ---- | ----------------- |  | - | ---- | - |  | ------------------------------ | ---- | - | ----------------------------- | -- | - |  | -- | -
|                             |  | Three months ended September 30, |      |   | Nine months ended September 30, |   |      | Percentage change | 
|(millions)                   |  | 2006                             |      |   | 2005                            |   |      | 2006              |  |   | 2005 |   |  | Three Months EndedSeptember 30 |      |   | Nine Months EndedSeptember 30 |   
|Total expenses               |  | $                                | 27.5 |   |                                 | $ | 22.7 |                   |  | $ | 78.9 |   |  | $                              | 70.6 |   |                               | 21 | % |  | 12 | %
|                             |  |                                  |      |   |                                 |   |      |                   |  |   |      |   |  |                                |      |   |                               |    |   |  |    |  
|Percentage of total revenues |  |                                  | 115  | % |                                 |   | 96   | %                 |  |   | 117  | % |  |                                | 96   | % |                               |    |   |  |    |  

Total expenses consist of costs of revenues associated with products and services and maintenance, amortization of
purchased products rights and operating expenses associated with sales and marketing, research and development, general and administrative and restructuring charges and adjustments. Total expenses of $27.5 million and $78.9 million for the three and
nine months ended September 30, 2006, respectively, represented an increase of 21% and 12% in each of the respective periods. The increase in the three months and nine months ended September 30, 2006, when compared to the same periods in
2005, were due primarily to the impact of additional costs associated with stock option compensation, increased headcount primarily due to acquisitions, marketing programs, outside professional services, amortization of purchased intangible assets,
a provision recorded against accounts receivable balances with one of our European distributors, and a net first half adjustment to our restructuring accruals of $2.8 million related to our excess Santa Clara facility, offset by lower facility
depreciation costs for leasehold improvements at our Ottawa facility and lower third party hardware expenses. As of September 30, 2006 we had 515 full-time employees globally, compared to 484 full-time employees at September 30, 2005 and
475 full-time employees at December 31, 2005. No employees are covered by a collective bargaining agreement.

COST OF REVENUES

Cost of Product Revenues



|                               |  |                                  |     |   |                                 |   |     |                   |  |   |      |   |  |                                |     |   |                              |     |    |  |    |  
|------------------------------ |  | -------------------------------- | --- | - | ------------------------------- | - | --- | ----------------- |  | - | ---- | - |  | ------------------------------ | --- | - | ---------------------------- | --- | -- |  | -- | -
|                               |  | Three months ended September 30, |     |   | Nine months ended September 30, |   |     | Percentage change | 
|(millions)                     |  | 2006                             |     |   | 2005                            |   |     | 2006              |  |   | 2005 |   |  | Three Months EndedSeptember 30 |     |   | Nine MonthsEndedSeptember 30 |    
|Cost of product revenues       |  | $                                | 1.2 |   |                                 | $ | 1.4 |                   |  | $ | 4.4  |   |  | $                              | 3.4 |   |                              | (14 | )% |  | 29 | %
|                               |  |                                  |     |   |                                 |   |     |                   |  |   |      |   |  |                                |     |   |                              |     |    |  |    |  
|Percentage of product revenues |  |                                  | 14  | % |                                 |   | 18  | %                 |  |   | 19   | % |  |                                | 14  | % |                              |     |    |  |    |  

Cost of product revenues consists primarily of costs associated with product media, documentation, packaging and
royalties to third-party software vendors. Cost of product revenues was $1.2 million for the three months ended September 30, 2006, which represented a 14% decrease from $1.4 million for the three months ended September 30, 2005,
representing 14% and 18% of product revenues in each of the respective periods. Cost of product revenues of $4.4 million for the nine months ended September 30, 2006 represented a 29% increase from $3.4 million for the nine months ended
September 30, 2005, which represented 19% and 14% of product revenues in their respective periods. The decrease in the cost of product revenues in absolute dollars and as a percentage of total product revenues from the third quarter of 2005
compared to the same quarter of 2006 is due to a shift towards products, such as our Emerging Growth Products, that do not incorporate third party technologies relative to the prior year. The increase in the cost of product revenues in absolute
dollars and as a percentage of total product revenues from the nine months ended September 30, 2005 to the same period of 2006 is primarily attributable to one large product revenue transaction that carried a third-party software royalty in the
first quarter of 2006. The mix of



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third-party products and the relative gross margins achieved with respect to these products may vary from period to
period and from transaction to transaction and, consequently, our gross margins and results of operations could be adversely affected.

Cost of
Services and Maintenance Revenues



|                                                |  |                                  |     |   |                                 |   |     |                   |  |   |      |   |  |                                |      |                              |  |    |  |    |   
|----------------------------------------------- |  | -------------------------------- | --- | - | ------------------------------- | - | --- | ----------------- |  | - | ---- | - |  | ------------------------------ | ---- | ---------------------------- |  | -- |  | -- | --
|                                                |  | Three months ended September 30, |     |   | Nine months ended September 30, |   |     | Percentage change | 
|(millions)                                      |  | 2006                             |     |   | 2005                            |   |     | 2006              |  |   | 2005 |   |  | Three Months EndedSeptember 30 |      | Nine MonthsEndedSeptember 30 | 
|Cost of services and maintenance revenues       |  | $                                | 7.3 |   |                                 | $ | 7.3 |                   |  | $ | 21.7 |   |  | $                              | 23.5 |                              |  | -- |  | (8 | )%
|                                                |  |                                  |     |   |                                 |   |     |                   |  |   |      |   |  |                                |      |                              |  |    |  |    |   
|Percentage of services and maintenance revenues |  |                                  | 48  | % |                                 |   | 46  | %                 |  |   | 49   | % |  |                                | 49   | %                            |  |    |  |    |   

Cost of services and maintenance revenues consists primarily of personnel costs associated with customer support,
training and consulting services, as well as amounts paid to third-party consulting firms for those services. Cost of services and maintenance revenues was $7.3 million for the three months ended September 30, 2006, which was consistent with
the same period of 2005, representing 30% and 31% of total revenues for the respective periods. Cost of services and maintenance revenues was $21.7 million for the nine months ended September 30, 2006, which represented an 8% decrease from
$23.5 million for the nine months ended September 30, 2005, representing 32% of total revenues for each of the respective periods.



|                              |  |                                   |      |   |                              |   |      |  
|----------------------------- |  | --------------------------------- | ---- | - | ---------------------------- | - | ---- | -
|                              |  | Year over year change 2005to 2006 |     
|(millions)                    |  | Three months endedSeptember 30    |      |   | Nine monthsendedSeptember 30 |  
|Facilities related costs      |  | $                                 | (0.3 | ) |                              | $ | (0.8 | )
|Third party hardware          |  |                                   | (0.1 | ) |                              |   | (0.8 | )
|Outside professional services |  |                                   | (0.1 | ) |                              |   | (0.2 | )
|Staff related costs           |  |                                   | 0.5  |   |                              |   |     |  
|                              |  |                                   |      |   |                              |   |      |  
|                              |  | $                                 |     |   |                              | $ | (1.8 | )
|                              |  |                                   |      |   |                              |   |      |  

Cost of services and maintenance revenues was flat between the third quarter of 2006 and the same quarter of 2005,
mainly the result of the net effect of decreased facilities costs, third party hardware and outside professional services, offset by an increase in staff related costs. The increased staff related costs are primarily related to stock option
compensation expenses and increased compensation costs associated with existing resources. The $1.8 million decrease for the first nine months of 2006, when compared to the same period in 2005, can be attributed primarily to the reduced facilities
related costs due to lower depreciation on our Ottawa facility, reduced third party hardware expenses and reduced other outside service costs. The third party hardware costs were much higher in the first nine months of 2005 because of a significant
hardware order from a customer during that period. The number of employees on our services and maintenance teams decreased by 1% overall, from September 30, 2005 to September 30, 2006 in response to the decline in demand for consulting and
integration services, despite the increased resources added as a result of the acquisition of Orion in June 2006 and Business Signatures in July 2006. The increase in the services and maintenance expenses as a percentage of total revenues in the
third quarter of 2006 was due to the lower total revenues compared to the third quarter of 2005. Services and maintenance expenses as a percentage of total revenues were consistent between the first nine months of



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2006 and the same period of 2005, which was the net result of lower overall services and maintenance expenses accounting
for a two-percentage point decrease in the services and maintenance expenses as a percentage of total revenues, while the lower total revenues in the first nine months of 2006 resulted in a two-percentage point increase, compared to the first nine
months of 2005.

Services and maintenance gross profit as a percentage of services and maintenance revenues was 52% for the three months ended
September 30, 2006 and 54% for the three months ended September 30, 2005. Services and maintenance gross profit as a percentage of services and maintenance revenues was 51% for each of the nine months ended September 30, 2006 and
2005, respectively. The decrease in services and maintenance gross profit as a percentage of services and maintenance revenues in the third quarter of 2006, compared to the same quarter of 2005, was primarily attributable to lower professional
services revenues, particularly in Canada, which accounted for the three-percentage point decrease, partly offset by a one-percentage point increase due to improved support and maintenance margins in the third quarter of 2006. Services and
maintenance gross profit as a percentage of services and maintenance revenues overall for the first nine months of 2006 was consistent with the same period of 2005, which was the net effect of a two-percentage point improvement due to support and
maintenance, offset completely by the lower professional services margins experienced in the first three quarters of 2006. We plan to continue to optimize the utilization of existing professional services resources, while addressing incremental
customer opportunities that may arise with the help of partners and other sub-contractors, until an investment in additional full-time resources is justifiable. This may have an adverse impact on the gross profit for services and maintenance, as the
gross profit realized by using partners and sub-contractors is generally lower. The mix and volume of services and maintenance revenues may vary from period to period and from transaction to transaction, which will also affect our gross margins and
results of operations.

OPERATING EXPENSES

Operating ExpensesSales and Marketing



|                             |  |                                  |     |   |                                 |   |     |                   |  |   |      |   |  |                                |      |   |                              |    |   |  |    |  
|---------------------------- |  | -------------------------------- | --- | - | ------------------------------- | - | --- | ----------------- |  | - | ---- | - |  | ------------------------------ | ---- | - | ---------------------------- | -- | - |  | -- | -
|                             |  | Three months ended September 30, |     |   | Nine months ended September 30, |   |     | Percentage change | 
|(millions)                   |  | 2006                             |     |   | 2005                            |   |     | 2006              |  |   | 2005 |   |  | Three Months EndedSeptember 30 |      |   | Nine MonthsEndedSeptember 30 |   
|Sales and marketing          |  | $                                | 9.7 |   |                                 | $ | 6.7 |                   |  | $ | 24.4 |   |  | $                              | 21.5 |   |                              | 45 | % |  | 13 | %
|                             |  |                                  |     |   |                                 |   |     |                   |  |   |      |   |  |                                |      |   |                              |    |   |  |    |  
|Percentage of total revenues |  |                                  | 40  | % |                                 |   | 28  | %                 |  |   | 36   | % |  |                                | 29   | % |                              |    |   |  |    |  

Sales and marketing expenses increased to $9.7 million for the three months ended September 30, 2006 from
$6.7 million for the comparable period in 2005. For the nine months ended September 30, 2006, sales and marketing expenses increased to $24.4 million from $21.5 million for the comparable period in 2005. Sales and marketing expenses represented
40% and 36% of total revenues for the three and nine months ended September 30, 2006, compared to 28% and 29% for the three and nine months ended September 30, 2005.



|                                      |  |                                   |      |   |                              |   |      |  
|------------------------------------- |  | --------------------------------- | ---- | - | ---------------------------- | - | ---- | -
|                                      |  | Year over year change 2005to 2006 |     
|(millions)                            |  | Three months endedSeptember 30    |      |   | Nine monthsendedSeptember 30 |  
|Facilities related costs              |  | $                                 | (0.2 | ) |                              | $ | (0.8 | )
|Marketing programs                    |  |                                   | 0.7  |   |                              |   | 0.9  |  
|Outside professional services         |  |                                   | 0.2  |   |                              |   | 0.1  |  
|Staff related costs                   |  |                                   | 1.2  |   |                              |   | 1.3  |  
|Allowance for doubtful accounts       |  |                                   | 0.9  |   |                              |   | 1.2  |  
|Amortization of purchased intangibles |  |                                   | 0.2  |   |                              |   | 0.2  |  
|                                      |  |                                   |      |   |                              |   |      |  
|                                      |  | $                                 | 3.0  |   |                              | $ | 2.9  |  
|                                      |  |                                   |      |   |                              |   |      |  



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The increase in sales and marketing expenses for the three and nine months ended September 30, 2006, when compared
to the same periods in 2005, was primarily due to higher staff related costs and purchased intangibles amortization associated with the Business Signatures acquisition, increased spending on marketing programs due to higher advertising expenses in
the quarter, focused on generating awareness of our brand and FFIEC solutions. In addition, we recorded increases in our bad debt provision of $0.3 million and $0.8 million in the three and nine months ended September 30, 2006, respectively,
recorded against accounts receivable balances with one of our European distributors, compared to a net bad debt provision reversal of $0.6 million and $0.4 million, respectively, in the comparable periods of the prior year. Sales and marketing
headcount increased 29% when compared to one year ago. These increases were partially offset by lower facility related costs because the leasehold improvements associated with our Ottawa facility reached the point of being fully depreciated late in
2005. The increase in sales and marketing expenses as a percentage of total revenues for the three and nine months ended September 30, 2006, compared to the same periods of 2005, reflects the higher expenses in 2006, which resulted in a
twelve-percentage point increase in three months ended September 30, 2006 and a four-percentage point increase in nine months ended September 30, 2006. This effect was magnified for the nine months ended September 30, 2006, by a
three-percentage point increase in sales and marketing expenses as a percentage of total revenues due to lower total revenues when compared to the same period of 2005. We intend to continue to focus on improving the productivity of the sales and
marketing teams. As planned we added additional sales coverage, which should allow us to better execute on the opportunities we are seeing in both in the United States and abroad. We will continue to focus on our channels, with a view to providing
the executive team time to focus on strategically growing the business. However, we believe it is necessary for us to continue to make significant investments in sales and marketing to support the launch of new products, services and marketing
programs by maintaining our strategy of (a) investing in hiring and training our sales force in anticipation of future market growth, and (b) investing in marketing efforts in support of new product launches. We believe it is necessary to
invest in marketing programs that will improve the awareness and understanding of information security governance, and we will continue to invest in marketing toward that goal. Failure to make such investments could have a significant adverse effect
on our operations. While we are focused on marketing programs and revenue-generating opportunities to increase software revenues, there can be no assurances that these initiatives will be successful.

During the first nine months of 2006, the provision for doubtful accounts increased by $0.8 million due primarily to a provision recorded related to accounts receivable
balances with one of our European distributors.

Operating ExpensesResearch and Development



|                             |  |                                  |     |   |                                 |   |     |                   |  |   |      |   |  |                                |      |   |                              |    |   |  |    |  
|---------------------------- |  | -------------------------------- | --- | - | ------------------------------- | - | --- | ----------------- |  | - | ---- | - |  | ------------------------------ | ---- | - | ---------------------------- | -- | - |  | -- | -
|                             |  | Three months ended September 30, |     |   | Nine months ended September 30, |   |     | Percentage change | 
|(millions)                   |  | 2006                             |     |   | 2005                            |   |     | 2006              |  |   | 2005 |   |  | Three Months EndedSeptember 30 |      |   | Nine MonthsEndedSeptember 30 |   
|Research and development     |  | $                                | 5.5 |   |                                 | $ | 4.0 |                   |  | $ | 14.1 |   |  | $                              | 12.6 |   |                              | 38 | % |  | 12 | %
|                             |  |                                  |     |   |                                 |   |     |                   |  |   |      |   |  |                                |      |   |                              |    |   |  |    |  
|Percentage of total revenues |  |                                  | 23  | % |                                 |   | 17  | %                 |  |   | 21   | % |  |                                | 17   | % |                              |    |   |  |    |  



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Research and development expenses increased to $5.5 million for the third quarter of 2006 from $4.0 million for the same
period in 2005, while research and development expenses increased to $14.1 million from $12.6 million for the nine months ended September 30, 2006 and 2005, respectively. Research and development expenses represented 23% and 21% of total
revenues for the three and nine months ended September 30, 2006, respectively, compared to 17% in each of the comparable periods of 2005.



|                              |  |                                   |      |   |                              |   |      |  
|----------------------------- |  | --------------------------------- | ---- | - | ---------------------------- | - | ---- | -
|                              |  | Year over year change 2005to 2006 |     
|(millions)                    |  | Three months endedSeptember 30    |      |   | Nine monthsendedSeptember 30 |  
|Facilities related costs      |  | $                                 | (0.2 | ) |                              | $ | (0.7 | )
|Outside professional services |  |                                   | 0.5  |   |                              |   | 0.6  |  
|Staff related costs           |  |                                   | 1.2  |   |                              |   | 1.6  |  
|                              |  |                                   |      |   |                              |   |      |  
|                              |  | $                                 | 1.5  |   |                              | $ | 1.5  |  
|                              |  |                                   |      |   |                              |   |      |  

The increase in research and development expenses for the three and nine months ended September 30, 2006,
when compared to the same periods in 2005, was primarily due to higher staff related costs ($0.7 million) and increased spending on outside professional contractors ($0.4 million), as a result of the Business Signatures acquisition. The increase in
staff-related and contractor costs was also the result of an unfavorable shift in the exchange rates between Canada and the U.S., resulting in increased costs of $0.3 million and $0.9 million for the three and nine months ended September 30,
2006 when compared to the same periods in 2005, since the majority of these research and development expenses are denominated in Canadian dollars. In addition, staff-related costs were higher due to the recognition of stock option expenses in the
first three quarters of 2006. These increases were partially offset by lower depreciation costs associated with our Ottawa facility. The increase in research and development expenses as a percentage of total revenues for the three and nine months
ended September 30, 2006, compared to the same periods of 2005, reflects the higher expenses in 2006, which resulted in a six-percentage point increase in three months ended September 30, 2006 and a two-percentage point increase in nine
months ended September 30, 2006. This effect was magnified by a two-percentage point increase in research and development expenses as a percentage of total revenues due to lower total revenues for the nine months ended September 30, 2006
when compared to the same period in 2005. We believe that we must continue to maintain our investment in research and development in order to protect our technological leadership position, software quality and security assurance leadership. We
therefore expect that research and development expenses may have to increase in the future.

Operating ExpensesGeneral and Administrative



|                             |  |                                  |     |   |                                 |   |     |                   |  |   |      |   |  |                               |     |   |                              |    |   |  |    |  
|---------------------------- |  | -------------------------------- | --- | - | ------------------------------- | - | --- | ----------------- |  | - | ---- | - |  | ----------------------------- | --- | - | ---------------------------- | -- | - |  | -- | -
|                             |  | Three months ended September 30, |     |   | Nine months ended September 30, |   |     | Percentage change | 
|(millions)                   |  | 2006                             |     |   | 2005                            |   |     | 2006              |  |   | 2005 |   |  | Three MonthsEndedSeptember 30 |     |   | Nine MonthsEndedSeptember 30 |   
|General and administrative   |  | $                                | 3.4 |   |                                 | $ | 3.1 |                   |  | $ | 10.7 |   |  | $                             | 9.0 |   |                              | 10 | % |  | 19 | %
|                             |  |                                  |     |   |                                 |   |     |                   |  |   |      |   |  |                               |     |   |                              |    |   |  |    |  
|Percentage of total revenues |  |                                  | 14  | % |                                 |   | 13  | %                 |  |   | 16   | % |  |                               | 12  | % |                              |    |   |  |    |  



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General and administrative expenses increased to $3.4 million and $10.7 million for the three and nine months ended
September 30, 2006, respectively, from $3.1 million and $9.0 million for the comparable periods in 2005. General and administrative expenses represented 14% and 16% of total revenues for the three and nine months ended September 30, 2006,
compared to 13% and 12% for the comparable periods in 2005.



|                              |  |                                   |      |   |                              |   |      |  
|----------------------------- |  | --------------------------------- | ---- | - | ---------------------------- | - | ---- | -
|                              |  | Year over year change 2005 to2006 |     
|(millions)                    |  | Three monthsendedSeptember 30     |      |   | Nine monthsendedSeptember 30 |  
|Facilities related costs      |  | $                                 | (0.2 | ) |                              | $ | (0.2 | )
|Outside professional services |  |                                   | 0.1  |   |                              |   | 0.6  |  
|Staff related costs           |  |                                   | 0.4  |   |                              |   | 1.3  |  
|                              |  |                                   |      |   |                              |   |      |  
|                              |  | $                                 | 0.3  |   |                              | $ | 1.7  |  
|                              |  |                                   |      |   |                              |   |      |  

The increase in staff-related costs in absolute dollars in the first three and nine months of 2006 compared to the
same periods of 2005 was primarily due to deferred compensation plan costs and stock-based compensation expenses recognized under SFAS No. 123(R), as well as incremental reported costs resulting from the unfavorable shift in the exchange rates
between Canada and the U.S. Also, additional legal expenses were incurred in connection with a patent infringement claim initiated by us earlier in 2006, which was the primary cause of the increase in outside professional services in the nine months
ended September 30, 2006. General and administrative expenses as a percentage of total revenues increased for the three and nine months ended September 30, 2006 compared to the same periods of 2005, due mainly to the increase in recorded
expenses, which accounted for one-percentage point and three-percentage points of the increase, respectively, This effect was magnified by a one-percentage point increase in general and administrative expenses as a percentage of total revenues due
to lower total revenues for the nine months ended September 30, 2006 when compared to the same period in 2005. We continue to explore opportunities to gain additional efficiencies in our administrative processes and to contain expenses in these
functional areas.

Amortization of Purchased Product Rights and Other Purchased Intangibles

Amortization of purchased product rights was $319 thousand and $738 thousand for the three and nine months ended September 30, 2006, respectively, compared to $215
thousand and $600 thousand for the same periods in 2005. These costs are related to the developed technology purchased in connection with the acquisitions of Business Signatures in 2006, as well as the acquisition of certain business assets from
AmikaNow! during 2004. This expense was recorded as a component of cost of revenues.

Amortization of other purchased intangibles totaled $268 thousand and
$302 thousand for the three and nine months ended September 30, 2006, respectively, compared to $19 thousand and $56 thousand for the same periods in 2005. These costs are related to the customer/partner relationships and non-competition
agreement assets purchased in connection with the acquisitions of Orion and Business Signatures in 2006, as well as the acquisition of certain business assets from AmikaNow! during 2004. Of this expense, $217 thousand and $251 thousand, was recorded
as a component of sales and marketing expenses for the three and nine months ended September 30, 2006, while $51 thousand was recorded as a component of cost of services and maintenance revenues for the three months ended September 30,
2006.



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Restructuring Charges and Adjustments

During the first nine months of 2006, we made adjustments to increase the restructuring charges that we had previously recorded related to the June 2001 restructuring plan with respect to our Santa Clara, California
facility. The current sublease was scheduled to end in December 2006. Although we had been monitoring the sublet market on an on-going basis, we had received an extension offer and had begun preparations for placing the facility on the market. These
events caused us to revisit our estimated sublease recoveries at that time. We concluded that we needed to increase the restructuring charges that we had previously recorded related to our June 2001 restructuring plan by a further $2.9 million in
the first quarter of fiscal 2006 to reflect a change in our projected sublet lease recoveries as evidenced by the market for leased facilities in that region. Subsequently, in the second quarter of 2006, we made a further adjustment to decrease the
restructuring charges that we had previously recorded related to the June 2001 restructuring plan with respect to our Santa Clara, California facility by $130 thousand, to reflect the fact that the building sublease was extended with the current
subtenant to March 31, 2011 and the corresponding expected sublet lease recoveries. These adjustments were charged to the restructuring charges line in the condensed consolidated statement of operations.

Interest Income

Interest income was $363 thousand and $1.9
million for three and nine months ended September 30, 2006, respectively, compared to $600 thousand and $1.7 million for the same periods of 2005, representing 2% and 3% of total revenues for the three and nine months ended September 30,
2006, respectively, compared to 3% and 2% of total revenues for the same periods in 2005. The decrease in investment income for the third quarter of 2006 compared to the same period of 2005 was due to the funds invested in the acquisition of Orion
and Business Signatures. The increase in investment income from the first nine months of 2005 to the same period of 2006 reflected improved interest rates experienced over the first nine months on funds invested, despite the reduced balance of funds
invested as a result of amounts drawn down to fund cash flow from operations, stock repurchases, to acquire long-lived assets during the last year and the acquisitions of Orion in the second quarter and Business Signatures in the third quarter. The
funds invested decreased to $28.4 million at September 30, 2006 from $84.0 million at September 30, 2005. However, the rate of return on our marketable investments improved to approximately 5% in the first nine months of 2006 compared to a
rate of return of approximately 3% in the same period of 2005.

Loss from Equity Investments

We recorded $51 thousand and $344 thousand of losses, net of intercompany profit eliminations, related to our investments in Asia Digital Media for the three and nine
months ended September 30, 2006, respectively, compared to $210 thousand and $661 thousand for the three and nine months ended September 30, 2005, respectively. We began accounting for this investment under the equity method of accounting
in the fourth quarter of 2004, since we had the potential to significantly influence its operations and management.

Write-down of Long-term
Strategic and Equity Investments

We recorded non-cash charges in the first quarter of 2006 related to the impairment of long-term investments in
Asia Digital Media and Ohana of $2.4 million and $659 thousand, respectively, as it was concluded that these investments had suffered an other than temporary decline in fair value.

Provision for Income Taxes

We recorded an income tax provision of $120 thousand and $309 thousand for the
three and nine months ended September 30, 2006, respectively, compared to $286 thousand and $981 thousand for the same periods of 2005. These provisions represent primarily the taxes payable in certain foreign jurisdictions. The effective
income tax rates differed from statutory rates primarily due to the impairment of long-term strategic investments and purchased product rights, foreign research and development tax credits, as well as an adjustment of the valuation allowance that
has offset the tax benefits from the significant net operating loss and tax credit carry-forwards available.



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LIQUIDITY AND CAPITAL RESOURCES

We generated cash of $6.9 million in operating activities during the nine months ended September 30, 2006. This cash inflow was primarily a result of a decrease in accounts receivable of $5.9 million, an increase
in deferred revenue of $1.8 million, an increase in accounts payable and accrued liabilities of $2.4 million, and a decrease in prepaid expenses and other receivables of $1.4 million, partially offset by cash outflows resulting from a net loss after
adjusting for non-cash charges of $4.4 million, and a decrease in accrued restructuring charges of $0.2 million. Our average days sales outstanding at September 30, 2006 was 58 days, which represents a decrease from the 70 days that we reported
at June 30, 2006. The overall decrease in days sales outstanding from June 30, 2006 was mainly due to increased in-quarter collections due to improved sales linearity compared to the second quarter of 2006, combined with an increase in the
allowance for doubtful accounts from the previous period. For purposes of calculating average days sales outstanding, we divide ending accounts receivable by the applicable quarters revenues and multiply this amount by 90 days. The level of
accounts receivable at each quarter end is affected by the concentration of revenues in the final weeks of each quarter and may be negatively affected by expanded international revenues in relation to total revenues as licenses to international
customers often have longer payment terms.

Any increase or decrease in our accounts receivable balance and days sales outstanding will affect our cash
flow from operations and liquidity. Our accounts receivable and days sales outstanding may increase due to changes in factors such as the timing of when sales are invoiced and the length of customers payment cycle. Generally, international and
indirect customers pay at a slower rate than domestic and direct customers, so that an increase in revenue generated from international and indirect customers may increase our days sales outstanding and accounts receivable balance. We have observed
an increase in the length of our customers payment cycles, which may result in higher accounts receivable balances, and could expose us to greater general credit risks with our customers and increased bad debt expense.

During the first nine months of 2006, we used $40.3 million of our cash related to investing activities. Cash provided by net reductions in our marketable investments in
the amount of $19.9 million was offset by the investment of $8.8 million in the acquisition of Orion, $50.2 million in the acquisition of Business Signatures, $1.0 million in property and equipment, primarily for computer hardware upgrades
throughout our organization and $0.1 million in other long-term assets related to capitalized software development costs.

We used cash of $1.4 million in
financing activities during the nine months ended September 30, 2006 primarily for the repurchase of our Common stock in the amount of $2.5 million and $0.6 million to repay long term liabilities, offset by $1.7 million of cash provided by the
issuance of Common stock, of which $1.0 million related to the exercise of employee stock options.

As of September 30, 2006, our cash, cash
equivalents and marketable investments in the amount of $28.4 million provided our principal sources of liquidity. Overall, we used $46.3 million and $54.0 million in cash, cash equivalents and marketable investments in the three and nine months
ended September 30, 2006, respectively. Although we continue to target operating profitability, based on sustainable revenue and operating expense structures, we estimate that we may continue to use cash in fiscal 2006 to satisfy the
obligations provided for under our restructuring program. However, if operating losses continue to occur, then cash, cash equivalents and marketable investments will be negatively affected.

On July 29, 2002, we announced that our Board of Directors had authorized us to repurchase up to an aggregate of 7,000,000 shares of our Common stock. The program
has subsequently been extended three times, most recently on July 22, 2005 when the Board of Directors authorized a further extension of this stock repurchase program to permit the purchase of up to 10,000,000 shares of our Common stock through
December 15, 2006. This quantity of Common shares is in addition to the 6,928,640 shares of our Common stock already purchased under the stock repurchase program through June 30, 2005.



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We did not repurchase any shares of our Common stock under this share purchase program during the third quarter of 2006.
During the first nine months of 2006, we repurchased 703,000 shares of our Common stock for a total cash outlay of $2.5 million at an average price of $3.58, including commissions paid to brokers. As of September 30, 2006, we had repurchased
8,530,124 of the authorized 16,928,640 shares of our common stock under this program, for a total cash outlay of $33,610,000, at an average price of $3.94 per share, including commissions paid to brokers.

While there can be no assurance as to the extent of usage of liquid resources in future periods, we believe that our cash flows from operations and existing cash, cash
equivalents and marketable investments will be sufficient to meet our needs for at least the next twelve months.

In terms of long-term liquidity
requirements, we will need to fund the $25.7 million of accrued restructuring charges at September 30, 2006 through fiscal 2011, as detailed below. This amount is net of estimated sublet recoveries on restructured facilities of $12.7 million.
The lease obligations included in these accrued restructuring charges are disclosed in the table of contractual commitments below. In addition, we expect to spend approximately $2.0 million per year on capital expenditures, primarily for computer
equipment needed to replace existing equipment that is coming to the end of its useful life.

We believe that our existing cash, cash equivalents and
marketable investments, as well as future operating cash flows, will be sufficient to fund these long-term requirements.

We have commitments that will
expire at various times through 2015. We lease administrative and sales offices and certain property and equipment under non-cancelable operating leases that will expire in 2015. A summary of our contractual commitments at September 30, 2006 is
as follows:



|                                                                          |  |                       |        |                 |   |          |  |          |        |                  |   |       |  |   |      
|------------------------------------------------------------------------- |  | --------------------- | ------ | --------------- | - | -------- |  | -------- | ------ | ---------------- | - | ----- |  | - | -----
|                                                                          |  | Payment Due by Period
|                                                                          |  | Total                 |        | Less than1 Year |   | 1-3Years |  | 3-5Years |        | More than5 Years
|                                                                          |  | (in thousands)       
|Operating lease obligations - currently utilized equipment and facilities |  | $                     | 22,128 |                 | $ | 3,662    |  | $        | 7,791  |                  | $ | 3,834 |  | $ | 6,841
|Operating lease obligations - restructured facilities                     |  |                       | 31,665 |                 |   | 6,628    |  |          | 20,301 |                  |   | 4,736 |  |   |     
|Guaranteed payments to AmikaNow!                                          |  |                       | 649    |                 |   | 649      |  |          |       |                  |   |      |  |   |     
|2005 Entrust Deferred Incentive and Retention Bonus Plan                  |  |                       | 1,176  |                 |   | 784      |  |          | 392    |                  |   |      |  |   |     
|                                                                          |  |                       |        |                 |   |          |  |          |        |                  |   |       |  |   |      
|Total                                                                     |  | $                     | 55,618 |                 | $ | 11,723   |  | $        | 28,484 |                  | $ | 8,570 |  | $ | 6,841
|                                                                          |  |                       |        |                 |   |          |  |          |        |                  |   |       |  |   |      

In addition to the lease commitments included above, we have provided letters of credit totaling $3.3 million as
security deposits in connection with certain office leases.

The 2005 Entrust Deferred Incentive and Retention Bonus Plan (the Deferred Plan)
was adopted by the Compensation Committee of the Board of Directors on November 7, 2005. The primary objective of the Deferred Plan is to attract and retain valued employees by remunerating selected executives and other key employees with cash
awards based on the contribution of the individual employee. The Deferred Plan became effective on January 1, 2006. The Compensation Committee, in its sole discretion, shall determine which employees are eligible to receive awards under the
plan and shall grant awards in such amounts and on such terms as it shall determine provided that the aggregate amount of all such awards do not exceed $2.4 million. Subject to limited exceptions, an employees award under the plan shall vest
in one-eighth of the amount of the award at the end of each calendar quarter following the original grant date, provided that the employee continues to be employed by us on each of such dates. During the first quarter of 2006, we granted awards to
employees under the plan that potentially could result in payments of $1.6 million over the next two years, assuming that all employees receiving the awards remain employed with us for the entire two year vesting period of the awards.

In the ordinary course of business, we enter into standard indemnification agreements with our business partners and customers. Pursuant to these agreements, we agree to
modify, repair or replace the product, pay royalties for a right to use, defend and reimburse the indemnified party for actual damages awarded by



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a court against the indemnified party for an intellectual property infringement claim by a third party with respect to
our products and services, and indemnify for property damage that may be caused in connection with consulting services performed at a customer site by our employees or our subcontractors. The term of these indemnification agreements is generally
perpetual. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. We have general and umbrella insurance policies that generally enable us to recover a portion of any amounts
paid. We have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe the estimated fair value of these agreements is minimal. Accordingly, we have no liabilities recorded for
these agreements as of September 30, 2006.

We generally warrant for ninety days from delivery to a customer that our software products will perform
free from material errors that prevent performance in accordance with user documentation. Additionally, we warrant that our consulting services will be performed consistent with generally accepted industry standards including other warranties. We
have only incurred nominal expense under our product or service warranties. As a result, we believe the estimated fair value of our obligations under these agreements is minimal. Accordingly, we have no liabilities recorded for these agreements as
of September 30, 2006.

We have entered into employment and executive retention agreements with certain employees and executive officers, which, among
other things, include certain severance and change of control provisions. We have also entered into agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is, or was, serving at our
request in such capacity.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Risk Associated with Interest Rates

Our investment policy states that we will invest our cash reserves, including cash, cash equivalents and marketable investments, in investments that are designed to
preserve principal, maintain liquidity and maximize return. We actively manage our investments in accordance with these objectives. Some of these investments are subject to interest rate risk, whereby a change in market interest rates will cause the
principal amount of the underlying investment to fluctuate. Therefore, depreciation in principal value of an investment is possible in situations where the investment is made at a fixed interest rate and the market interest rate then subsequently
increases.

The following table presents the cash, cash equivalents and marketable investments that we held at September 30, 2006, that would have
been subject to interest rate risk, and the related ranges of maturities as of those dates:



|                                                            |  |                         |       |              |   |            |  |             |   |  |   |  
|----------------------------------------------------------- |  | ----------------------- | ----- | ------------ | - | ---------- |  | ----------- | - |  | - | -
|                                                            |  | MATURITY (in thousands)
|                                                            |  | Within3 months          |       | 3 to 6months |   | > 6 months |  | > 12 months
|Investments classified as cash and cash equivalents         |  | $                       | 3,396 |              | $ |           |  | $           |  |  | $ | 
|Investments classified as short-term marketable investments |  |                         |      |              |   | 2,659      |  |             |  |  |   |  
|                                                            |  |                         |       |              |   |            |  |             |   |  |   |  
|Total amortized cost                                        |  | $                       | 3,396 |              | $ | 2,659      |  | $           |  |  | $ | 
|                                                            |  |                         |       |              |   |            |  |             |   |  |   |  
|Fair value                                                  |  | $                       | 3,396 |              | $ | 2,655      |  | $           |  |  | $ | 
|                                                            |  |                         |       |              |   |            |  |             |   |  |   |  

We try to manage this risk by maintaining our cash, cash equivalents and marketable investments with high quality
financial institutions and investment managers. As a result, we believe that our exposure to market risk related to interest rates is minimal. Our financial instrument holdings at quarter-end were analyzed to determine their sensitivity to interest
rate changes. The fair values of these instruments were determined by net present values. In this sensitivity analysis, we used the same change in interest rate for all maturities. All other factors were held constant. If there were an adverse
change in interest rates of 10%, the expected effect on net income related to our financial instruments would be immaterial.



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Risk Associated with Exchange Rates

We are subject to foreign exchange risk as a result of exposures to changes in currency exchange rates, specifically between the United States and Canada, the United Kingdom, the European Union and Japan. This
exposure is not considered to be material with respect to the United Kingdom, European and Japanese operations due to the fact that these operations are not significant. However, because a disproportionate amount of our expenses are denominated in
Canadian dollars, through our Canadian operations, while our Canadian denominated revenue streams are cyclical, we are exposed to exchange rate fluctuations in the Canadian dollar, and in particular, fluctuations between the U.S. and Canadian
dollar. Therefore, a favorable change in the exchange rate for the Canadian subsidiary would result in higher revenues when translated into U.S. dollars, but would also mean expenses would be higher in a corresponding fashion and to a greater
degree.

Historically, we have not engaged in formal hedging activities, but we do periodically review the potential impact of this foreign exchange risk
to ensure that the risk of significant potential losses is minimized. However, as a significant portion of our expenses are incurred in Canadian dollars, our expense base increased by $1.5 million in the first nine months of 2006, when compared to
the same period in 2005, due to fluctuations in the exchange rate between the United States and Canadian dollars.

In the past, when advantageous, we have
engaged in forward contracts to purchase Canadian dollars, to cover exposures on Canadian subsidiarys expenses that are denominated in Canadian dollars, in an attempt to reduce earnings volatility that might result from fluctuations in the
exchange rate between the Canadian and U.S. dollar. We did not engage in any forward contracts to purchase Canadian dollars during the third quarter of 2006, and no previously purchased foreign exchange contracts had extended past June 30,
2006. We currently have not engaged in any forward contracts to purchase Canadian dollars to cover exposures on expenses denominated in Canadian dollars for the fourth quarter of 2006 or future periods.

Risk Associated with Long-term Strategic Investments

We invested in
several privately held companies in 2000 and 2001 for business and strategic alliance purposes, most of which are technology companies in the start-up or development stage, or are companies with technologies and products that are targeted at
geographically distant markets. As a result of other than temporary declines in the net realizable value, these investments were fully impaired over the period from 2001 to 2003. Accordingly, there is no net book value remaining for these strategic
investments as of September 30, 2006.

As a result of the Rescission Agreement discussed elsewhere in this Quarterly Report, as of December 31,
2005, we held an investment in Ohana, in the amount of $750 thousand, representing approximately 14.3% of the issued common shares of Ohana. This investment is now accounted for under the cost method. Ohana is in the start-up or development stage,
and may lack the financial resources, licenses, technology and governmental approvals necessary to import, develop or offer for sale any commercial product or service. If the demand for Ohanas products and services materializes slowly, to a
minimum extent, or not at all in the relevant market, we could lose all or substantially all of our investment. We have recorded cumulative losses from our investment in Ohana of $750 thousand since the fourth quarter of 2004.

During the first quarter of 2006, we were informed of an Ohana re-financing, which coupled with the changes in the business outlook, led us to conclude that the
expectations for Ohana had not materialized and an impairment charge was required to adjust the net carrying value of our equity ownership. As a result, we recorded in the first quarter of fiscal 2006 an impairment of our investment in Ohana of $659
thousand. After this impairment, the remaining carrying value of our investment in Ohana at September 30, 2006 was $91 thousand.

Risk Associated
with Equity Investments

In total we have invested $3.7 million in Asia Digital Media, representing an equity interest of approximately 44% in the
issued common shares of Asia Digital Media at December 31, 2005. Asia Digital Media is a joint venture in the start-up or development stage, and may lack the financial resources, licenses, technology and governmental approvals necessary to
import, develop or offer for sale in China any



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commercial product or service. Asia Digital Media has built, integrated, tested, and demonstrated the end-to-end solution
within a lab environment and has put its first real subscribers into a live network as part of alpha trials. Asia Digital Media is currently working directly with cable operators and end users to refine its products for the market. If no such
offerings are developed due to insufficient financial resources, inability to license required third party intellectual property, technical problems, or a lack of necessary governmental approvals, we could lose all or substantially all of our
investment. In addition, if the demand for Asia Digital Medias products and services materializes slowly, to a minimum extent, or not at all in the relevant market, we could lose all or substantially all of our investment.

We have recorded cumulative losses from our investment in Asia Digital Media of $1.0 million since the investment in the fourth quarter of 2004. During the first quarter
of 2006, we were informed of changes in our Chinese partners ability to invest in the second funding round of Asia Digital Media. This factor, among others, had significant negative implications for Asia Digital Media. We concluded that
expectations for Asia Digital Media had not materialized and an impairment charge was required to adjust the net carrying value of our equity ownership. As a result, we recorded in the first quarter of fiscal 2006 an impairment of our investment in
Asia Digital Media in the amount of $2.4 million. After this impairment, the remaining carrying value of our investment in Asia Digital Media at September 30, 2006 was $179 thousand.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and
procedures (as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934), as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or
submit under the Securities Exchange Act of 1934 and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure.

Changes in Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during the most recent fiscal quarter that
have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company is subject, from time to time, to various legal proceedings and claims, either
asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse
effect on the Companys consolidated results of operations or consolidated financial position. Certain legal proceedings in which we are involved are discussed in Part 1. Item 3. of our Annual Report on Form 10-K for the year ended
December 31, 2005. Unless otherwise indicated, all proceedings in that earlier Report remain outstanding.

ITEM 1A. RISK FACTORS

Our revenues and operating results are subject to significant fluctuations and such
fluctuations may lead to a reduced market price for our stock.

Our revenues and operating results have varied in the past and may
continue to fluctuate in the future. We believe that period-to-period comparisons of our operating results are not necessarily meaningful, but



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securities analysts and investors often rely upon these comparisons as indicators of future performance. If our operating
results in any future period fall below the expectations of securities analysts and investors, or the guidance that we provide, the market price of our securities would likely decline. Factors that have caused our results to fluctuate in the past
and which are likely to affect us in the future include the following:



| |  |  | reduced capital expenditures for software;
| | - |  | ------------------------------------------



| |  |  | length of sales cycles associated with our product offerings;
| | - |  | -------------------------------------------------------------



| |  |  | the timing, size and nature of our licensing transactions;
| | - |  | ----------------------------------------------------------



| |  |  | the increased dependency on partners for end user fulfillment;
| | - |  | --------------------------------------------------------------



| |  |  | market acceptance of new products or product enhancements by us;
| | - |  | ----------------------------------------------------------------



| |  |  | market acceptance of new products or product enhancements by our competitors;
| | - |  | -----------------------------------------------------------------------------



| |  |  | the relative proportions of revenues derived from licenses and services and maintenance;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | the timing of new personnel hires and the rate at which new personnel become productive;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | changes in pricing policies by our competitors;
| | - |  | -----------------------------------------------



| |  |  | changes in our operating expenses;
| | - |  | ----------------------------------



| |  |  | fluctuations in foreign currency exchange rates; and
| | - |  | ----------------------------------------------------



| |  |  | reduced spending by critical vertical markets.
| | - |  | ----------------------------------------------

Estimating future
revenues is difficult, and our failure to do so accurately may lead to a reduced market price for our stock and reduced profitability.

Estimating future revenues is difficult because we ship our products soon after an order is received and, as such, we do not have a significant order backlog. Thus, quarterly license revenues depend heavily upon orders received and shipped
within the same quarter. Moreover, we historically have recorded 50% to 60% of our total quarterly revenues in the third month of the quarter, with a concentration of revenues in the second half of that month. We expect that this concentration of
revenues, which is attributable in part to the tendency of some customers to make significant capital expenditures at the end of a fiscal quarter and to sales patterns within the software industry, will continue.

Our expense levels are based, in significant part, upon our expectations as to future revenues and are largely fixed in the short term. We may be unable
to adjust spending in a timely manner to compensate for any unexpected shortfall in revenues. Any significant shortfall in revenues in relation to our expectations could have an immediate and significant effect on our profitability for that quarter
and may lead to a reduced market price for our stock.

Because of the lengthy and unpredictable sales cycle associated with our large software
transactions, we may not succeed in closing transactions on a timely basis or at all, which would adversely affect our revenues and operating results.

Transactions for our solutions often involve large expenditures, and the sales cycles for these transactions are often lengthy and unpredictable. Factors affecting the sales cycle include:



| |  |  | customers budgetary constraints, particularly in a soft economic environment where technology spending is often deferred;
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | the timing of customers budget cycles; and
| | - |  | -------------------------------------------



| |  |  | customers internal approval processes.
| | - |  | ---------------------------------------

We may not
succeed in closing such large transactions on a timely basis or at all, which could cause significant variability in our revenues and results of operations for any particular period. If our results of operations and cash flows fall below the
expectations of securities analysts, or below the targeted guidance range that we have provided, our stock price may decline.



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A limited number of customers has accounted for a significant percentage of our revenues, which may decline if we
cannot maintain or replace these customer relationships, and for a significant percentage of our accounts receivable.

Historically, a
limited number of customers have accounted for a significant percentage of our revenues. In the third quarter of 2006, our three largest customers accounted for 28% of revenues. In 2005, 2004 and 2003, our three largest customers accounted in the
aggregate for 31%, 32% and 29% of revenues, respectively. We anticipate that our results of operations in any given period will continue to depend to a significant extent upon revenues from a small number of large customers. In addition, we
anticipate that such customers will continue to vary over time, so that the achievement of our long-term goals will require us to obtain additional significant customers on an ongoing basis. Our failure to enter into a sufficient number of large
licensing agreements during a particular period could have a material adverse effect on our revenues.

In addition, our accounts receivable
include material balances from a limited number of customers, with five customers accounting for 23% of gross accounts receivable at September 30, 2006, compared to 39% of gross accounts receivable at September 30, 2005. No customer
accounted for 10% or more of net accounts receivable at September 30, 2006. As of September 30, 2006, the total accounts receivable is $15.6 million, net of an allowance for doubtful accounts of $1.3 million. Changes in the financial
condition of these customers could result in a different assessment of the existing credit risk of our accounts receivable and thus, a different required allowance, which could have a material impact on our reported earnings.

The U.S. and Canadian Federal Governments account for a significant percentage of our revenues, which may decline or be subject to delays, which would adversely
affect our operating results.

The extended government vertical (Governments, including Healthcare) accounted for 43% of our product
revenue in the first nine months of 2006 and 55% of product revenue in fiscal 2005. The U.S. and Canadian governments represented 17% and 12% of total revenues, respectively, in the first nine months of 2006, which includes revenues sold through
resellers to these government end users. Sustaining and growing revenues in the government market will depend, in large part, on the following:



| |  |  | the adoption rate of our products within government departments and agencies;
| | - |  | -----------------------------------------------------------------------------



| |  |  | the timing and amount of budget appropriations for information technology and specifically information security;
| | - |  | ----------------------------------------------------------------------------------------------------------------



| |  |  | the timing of adoption of information security policies and regulations, including, but not limited to the Health Insurance Portability and Accountability Act of 1996 (HIPAA), the
Gramm-Leach-Bliley Act and the California Breach Disclosure Law (SB1386); and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to develop and maintain the appropriate business relationships with partners with whom the government contracts for information security projects.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------

A decline, or delay in the growth of this market could reduce demand for our products, adversely affecting our revenues and
results of operations. In addition, changes in Government officials as a result of elections could have an impact on our prospects in the Government market. Our ability to sell to the Government may also be impacted by changes to, or termination of,
the supply agreement(s) we have in place with the Government, which from time to time come up for renewal and renegotiation. Finally, failure to properly monitor pricing on government contracts could result in liability for penalties to the
government for non-compliance.

We sometimes enter into complex contracts, which require ongoing monitoring and administration. Failure to monitor and
administer these contracts properly could result in liability or damages.

We sometimes enter into complex contracts with our Government
customers that contain clauses that provide that if a customer who falls within a specific category (known as a Relevant Customer) is offered better terms on the Companys software products and related services that had been offered to the
Government customer, then the Government customer will be able to buy additional quantities of those software products and services for the same length of time, from the same effective date and on the better



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terms that were offered to the Relevant Customer. The Company monitors compliance with these contracts on a continuous
basis. The Company also conducts periodic self-assessments to ensure that the contracts are being properly administered and that there are no accruing liabilities for non-compliance. If these contracts are not properly monitored and administered,
they may be breached and could result in damages payable by us which, depending on their magnitude, could have a material adverse effect on our business, financial condition and results of operations.

War, the significant threat of war, or a terrorist act could adversely affect our business.

Historically, the economy has been adversely affected by war, the significant threat of war and terrorist acts. Any of these factors could cause one or
more of the following to occur:



| |  |  | government spending could be reprioritized to wartime activities;
| | - |  | -----------------------------------------------------------------



| |  |  | global enterprise spending budgets could be cut or delayed resulting in lower demand for our products; or
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | widespread and unprecedented acts of cyber-terrorism could cause disruption of communications and technology infrastructures, which could impact our customers or products and could
have unforeseen economic impacts.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

A decline or delay in economic spending due to war, the significant threat of war or a
terrorist act could reduce demand for our products, materially adversely affecting our revenues and results of operations.

A widespread outbreak of an
illness or other health issue could negatively affect our business, making it more difficult and expensive to meet our obligations to our customers, and could result in reduced demand from our customers.

A number of countries in the Asia/Pacific region have experienced outbreaks of SARS and/or bird flu in recent years. As a result of such an outbreak,
businesses can be shut down temporarily and individuals can become ill or quarantined. Outbreaks of infectious diseases such as these, particularly in North America, Europe or other locations significant to our operations, could adversely affect
general commercial activity, which could have a material adverse effect on our financial condition, results of operations, business or prospects. If our operations are curtailed because of health issues, we may need to seek alternate sources of
supply for services and staff and these alternate sources may be more expensive. Alternate sources may not be available or may result in delays in shipments to our customers, each of which would affect our results of operations. In addition, a
curtailment of our product design operations could result in delays in the development of new products. Further, if our customers businesses are affected by health issues, they might delay or reduce purchases from us, which could adversely
affect our results of operations.

If the enterprise information technology budgets and the digital identity security market do not continue to grow,
demand for our products and services will be adversely affected.

The market for digital identity and information security solutions is
at an early stage of development. Continued growth of the digital identity security market will depend, in large part, on the following:



| |  |  | the continued increase in the number of organizations adopting or expanding intranets and extranets;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | the rate of adoption of Internet-based business applications such as Web Services;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | the ability of network infrastructures to support an increasing number of users and services;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | the public recognition of the potential threat posed by computer hackers and other unauthorized users; and
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | the continued development of new and improved services for implementation across the Internet, intranets and extranets.
| | - |  | -----------------------------------------------------------------------------------------------------------------------



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A decline in the growth of this market could reduce demand for our products, adversely affecting our
revenues and results of operations.

A breach of security at one of our customers, whether or not due to our products, could harm our reputation and
reduce the demand for our products.

The processes used by computer hackers to access or sabotage networks and intranets are rapidly
evolving. A well-publicized actual or perceived breach of network or computer security at one of our customers, regardless of whether such breach is attributable to our products, third-party technology used within our products or any significant
advance in techniques for decoding or cracking encrypted information, could adversely affect the markets perception of us and our products, and could have an adverse effect on our reputation and the demand for our products.

In addition, the security level of our products is dependent upon the processes and procedures used to install and operate our products.
Failure on the part of our customers to properly install and operate our products, could cause a security breach, which could adversely affect the markets perception of us and our products, and could have an adverse effect on our reputation
and the demand for our products.

Sales of our products may decline if some of our products are found to contain bugs or errors.

Our existing testing procedures may not detect errors, failures or bugs in our software products. Such errors may become evident at any time during the
life of our products. The discovery of any errors, failures or bugs in any products, including third-party technology incorporated into our products, may result in:



| |  |  | adverse publicity;
| | - |  | ------------------



| |  |  | product returns;
| | - |  | ----------------



| |  |  | the loss or delay of market acceptance of our products; and
| | - |  | -----------------------------------------------------------



| |  |  | third-party claims against us.
| | - |  | ------------------------------

Accordingly, the
discovery of any errors, failures or bugs may have a significant adverse effect on the sales of our products and our results of operations.

We have
invested in technology companies in the start-up or development stage, particularly our investments in Asia, whose products and technology may not succeed, which may result in a loss of all or substantially all of our investment.

We have invested in several privately held companies, including Asia Digital Media and ADML Holdings, Ltd, including its affiliate, Ohana Wireless, Inc.
(collectively, Ohana). Most of these companies are technology companies in the start-up or development stage, or are companies with technologies and products that are targeted at geographically distant markets. These investments carry
risks as a result of potentially conflicting objectives between the owners including, but not limited to, agreement on business plans, budgets, and key staffing decisions. In addition, these companies are subject to many other risks including
technological risk, competitive risk, risks pertaining to governmental approvals, political risks, currency risks, funding risks and risks of end-user acceptance. If the demand for the technologies and products offered by these privately held
companies materializes slowly, to a minimum extent, or not at all in relevant markets, we could lose all or substantially all of our investment in these companies, which would have an adverse effect on our business, financial condition and results
of operations. In the first quarter of fiscal 2006, we concluded that expectations for Asia Digital Media and Ohana had not materialized and an impairment of the net carrying value of our investments in Asia Digital Media and Ohana was recorded in
the amount of $2.4 million and $659 thousand, respectively. No further impairment of these investments has been recorded since that time.

Our revenues
may decline if we cannot compete successfully in an intensely competitive market.

We target our products at the rapidly evolving market
for digital identity and information security solutions. Many of our current and potential competitors have longer operating histories, greater name recognition, larger installed bases and significantly greater financial, technical, marketing and
sales



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resources than we do. As a result, they may be able to react more quickly to emerging technologies and changes in
customer requirements, or to devote greater resources to the promotion and sale of their products. In addition, certain of our current competitors in particular segments of the security marketplace may in the future broaden or enhance their
offerings to provide a more comprehensive solution competing more fully with our functionality.

Increased competition and increased market
volatility in our industry could result in lower prices, reduced margins or the failure of our products and services to achieve or maintain market acceptance, any of which could have a serious adverse effect on our business, financial condition and
results of operations.

Our business will not be successful if we do not keep up with the rapid changes in our industry.

The emerging market for digital identity and information security products and related services is characterized by rapid technological developments,
frequent new product introductions and evolving industry standards. To be competitive, we have to continually improve the performance, features and reliability of our products and services, particularly in response to competitive offerings, and be
first to market with new products and services or enhancements to existing products and services. Our failure to develop and introduce new products and services successfully on a timely basis and to achieve market acceptance for such products and
services could have a significant adverse effect on our business, financial condition and results of operations.

We may have difficulty managing our
operations, which could adversely affect our ability to successfully grow our business.



| |  |  | Our ability to manage future growth, if any, will depend upon our ability to:
| | - |  | -----------------------------------------------------------------------------



| |  |  | continue to implement and improve operational, financial and management information systems on a timely basis; and
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | expand, train, motivate and manage our work force.
| | - |  | --------------------------------------------------

Our
personnel, systems, procedures and controls may not be adequate to support our operations. The geographic dispersal of our operations may make it more difficult to manage our growth.

We depend on our key personnel for the success of our business and the loss of one or more of our key personnel could have an adverse effect on our ability to manage our business or could be negatively perceived in
the capital markets.

Our success and our ability to manage our business depend, in large part, upon the efforts and continued service
of our senior management team. The loss of one or more of our key personnel could have a material adverse effect on our business and operations. It could be difficult for us to find replacements for our key personnel, as competition for such
personnel is intense. Further, such a loss could be negatively perceived in the capital markets, which could reduce the market value of our securities.

If we fail to continue to attract and retain qualified personnel, our business may be harmed.

Our future success depends
upon our ability to continue to attract and retain highly qualified scientific, technical, sales and managerial personnel, including key personnel at acquired companies. Competition for such personnel is intense, particularly in the field of
information security, and there can be no assurance that we can retain our key scientific, technical, sales and managerial employees or that we can attract, motivate or retain other highly qualified personnel in the future. These challenges are made
more severe by our history of operating losses, the employment reductions from our restructurings, and the fact that the exercise price of a majority of outstanding stock options is below the current market price of our stock. If we cannot retain or
are unable to hire such key personnel, our business, financial condition and results of operations could be significantly adversely affected.



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We may not be able to protect our intellectual property rights, which could make us less competitive and cause us to
lose market share.

Our future success will depend, in part, upon our intellectual property rights and our ability to protect these
rights. We rely on a combination of patent, copyright, trademark and trade secret laws, nondisclosure agreements, shrink-wrap licenses and other contractual provisions to establish, maintain and protect our proprietary rights. Despite our efforts to
protect our proprietary rights, unauthorized third parties may:



| |  |  | copy aspects of our products;
| | - |  | -----------------------------



| |  |  | obtain and use information that we regard as proprietary; or
| | - |  | ------------------------------------------------------------



| |  |  | infringe upon our patents.
| | - |  | --------------------------

Policing piracy and other
unauthorized use of our products is difficult, particularly in international markets and as a result of the growing use of the Internet. In addition, third parties might successfully design around our patents or obtain patents that we would need to
license or design around. Finally, the protections we have obtained may not be sufficient because:



| |  |  | some courts have held that shrink-wrap licenses, because they are not signed by the licensee, are not enforceable;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | our trade secrets, confidentiality agreements and patents may not provide meaningful protection of our proprietary information; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | we may not seek additional patents on our technology or products, and such patents, even if obtained, may not be broad enough to protect our technology or products.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our inability or failure to protect our proprietary rights could have a significant adverse effect on our business,
financial condition or results of operations, while actions taken to enforce our intellectual property rights could substantially increase our quarterly expenses.

We have been subject to, and may in the future become subject to, intellectual property infringement claims that could be costly and could result in a diversion of managements attention.

As the number of security products in the industry and the functionality of these products further overlaps, software developers and publishers may
increasingly become subject to claims of infringement or misappropriation of the intellectual property or proprietary rights of others. From time to time, we have received notices from third parties either soliciting our interest in obtaining a
license under one or more patents owned or licensed by these third parties or suggesting that our products may be infringing one or more patents owned or licensed by these third parties.

From time to time, we have received notices from various customers stating that we may be responsible for indemnifying such customers pursuant to
indemnification obligations in product license agreements with such customers for alleged infringement of patents assigned to third parties. To date, we are not aware that any customer has filed an action against us for indemnification. In addition,
third parties may assert infringement or misappropriation claims against us in the future. Defending or enforcing our intellectual property could be costly and could result in a diversion of managements attention, which could have a
significant adverse effect on our business, financial condition or results of operations. A successful claim against us could also have a significant adverse effect on our results of operations for the period in which damages are paid. Additionally,
as a result of a successful claim, we could potentially be enjoined from using technology that is required for our products to remain competitive, which could in turn have an adverse effect on our results of operations for subsequent periods.

We may lose access to technology that we license from outside vendors, which loss could adversely affect our ability to sell our products.

We rely on outside licensors for patent and/or software license rights in technology that is incorporated into and is necessary for the
operation of our products. Our success will depend in part on our continued ability to have access to such technologies that are or may become important to the functionality of our products. Any inability to continue to procure or use such
technology could have a significant adverse effect on our ability to sell some of our products.



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We rely on partners to integrate our products with their products and to resell our products. Changes in these
relationships could adversely affect our ability to sell our products.

We rely on partners to integrate our products with their
products or to maintain adherence to industry standards so that our products will be able to work with them to provide enhanced security attributes. For example, our ability to provide digital signatures on Adobe forms is dependent upon Adobe
continuing to allow Entrust to have access to their private Application Programming Interfaces in future releases. In addition, we have resale relationships with companies such as Critical Path, Safenet, Pointsec, Vericept and Sun
Microsystems/Waveset. Inability to maintain these relationships could have a material adverse effect on our results of operations.

Current and future
acquisitions or investments could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our results of operations.

It is possible, as part of our current and future growth strategies that we will from time-to-time acquire or make investments in companies, technologies,
product solutions or professional services offerings. With respect to these acquisitions, we would face the difficulties of assimilating personnel and operations from the acquired businesses and the problems of retaining and motivating key personnel
from such businesses. In addition, these acquisitions may disrupt our ongoing operations, divert senior management from day-to-day business, increase our expenses and adversely impact our results of operations. Any future acquisitions would involve
certain other risks, including the assumption of additional liabilities, potentially dilutive issuances of equity securities and incurrence of debt. In addition, these types of transactions often result in charges to earnings for such items as
amortization of purchased intangibles or in-process research and development expenses.

For example, in June 2006, we completed the
acquisition of all of the issued and outstanding shares of the common stock of Orion, based in McLean, Virginia, and in July 2006, we completed the acquisition of all of the issued and outstanding shares of the capital stock and options of Business
Signatures, based in Redwood City, California. While management expects to successfully integrate the newly acquired technology and operations, each of the above risks applies to these acquisitions.

We face risks associated with our international operations, which, if not managed properly, could have a significant adverse effect on our business, financial
condition or results of operations.

In the future, we may establish additional foreign operations, hire additional personnel and
establish relationships with additional partners internationally. This expansion would require significant management attention and financial resources and could have an adverse effect on our business, financial condition and results of operations.
Although our international sales currently are primarily denominated in U.S. dollars, we may increasingly denominate sales in foreign currencies in the future. In addition, our international business may be subject to the following risks:



| |  |  | difficulties in collecting international accounts receivable;
| | - |  | -------------------------------------------------------------



| |  |  | difficulties in obtaining U.S. export licenses, especially for products containing encryption technology;
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | potentially longer payment cycles for customer payments;
| | - |  | --------------------------------------------------------



| |  |  | increased costs associated with maintaining international marketing efforts;
| | - |  | ----------------------------------------------------------------------------



| |  |  | introduction of non-tariff barriers and higher duty rates;
| | - |  | ----------------------------------------------------------



| |  |  | difficulties in enforcement of contractual obligations and intellectual property rights;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | difficulties managing personnel, partners and operations in remote locations; and
| | - |  | ---------------------------------------------------------------------------------



| |  |  | increased complexity in global corporate tax structure.
| | - |  | -------------------------------------------------------

Any one of these risks could significantly and adversely affect our business, financial condition or results of operations.



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If the laws regarding exports of our products further limit or otherwise restrict our business, we could be prohibited
from shipping our products to restricted countries, which would result in a loss of revenues.

Some of our products are subject to
export controls under the laws of the United States, Canada and other countries. The list of products and countries for which exports are restricted, and the relevant regulatory policies, are likely to be revised from time to time. If we cannot
obtain required government approvals under these regulations, we may not be able to sell products abroad or make products available for sale internationally via computer networks such as the Internet. Furthermore, United States governmental controls
on the export of encryption products and technology may in the future restrict our ability to export some of our products.

Our stock price is volatile
and may continue to be volatile in the future.

The trading price of our Common stock has been, and is expected to continue to be,
highly volatile and may be significantly and adversely affected by factors such as:



| |  |  | actual or anticipated fluctuations in our operating results;
| | - |  | ------------------------------------------------------------



| |  |  | announcements of technological innovations;
| | - |  | -------------------------------------------



| |  |  | new products introduced by, or new contracts entered into by, us or our competitors;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | developments with respect to patents, copyrights or propriety rights;
| | - |  | ---------------------------------------------------------------------



| |  |  | conditions and trends in the security industry;
| | - |  | -----------------------------------------------



| |  |  | changes in financial estimates by securities analysts; and
| | - |  | ----------------------------------------------------------



| |  |  | general market conditions and other factors.
| | - |  | --------------------------------------------

Provisions of our
charter and bylaws may delay or prevent transactions that are in our shareholders best interests.

Our charter and bylaws contain provisions,
including a staggered board of directors that may make it more difficult for a third party to acquire us, or may discourage bids to do so. We think these measures enable us to review offers for our shares of Common stock to determine if they are in
the best interests of our shareholders. These provisions could limit the price that investors might be willing to pay for shares of our Common stock and could make it more difficult for a third party to acquire, or could discourage a third party
from acquiring, a majority of our outstanding voting stock. Our Board of Directors also has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including
voting rights, of those shares without any further vote or action by the shareholders. The rights of the holders of Common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be
issued in the future. The issuance of preferred stock could make it more difficult for a third party to acquire, or may discourage a third party from acquiring, a majority of our outstanding voting stock.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The table below sets forth the information with
respect to purchases made by or on behalf of Entrust, Inc. or any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of our common stock during the three months ended September 30,
2006.



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|                                                   |  |                                |  |                            |   |                                                                                   |   |                                                                                |          
|-------------------------------------------------- |  | ------------------------------ |  | -------------------------- | - | --------------------------------------------------------------------------------- | - | ------------------------------------------------------------------------------ | ---------
|Period                                             |  | Total Number ofSharesPurchased |  | AveragePrice Paidper Share |   | Total Number of Shares Purchasedas Part of PubliclyAnnounced Plansor Programs (1) |   | Maximum Number ofShares That May Yet BePurchased Under thePlans or
Programs(1)
|Month #1 (July 1, 2006 to July 31, 2006)           |  |                               |  | $                          |  |                                                                                   |  |                                                                                | 8,398,516
|Month #2 (August 1, 2006 to August 31, 2006)       |  |                               |  |                            |  |                                                                                   |  |                                                                                | 8,398,516
|Month #3 (September 1, 2006 to September 30, 2006) |  |                               |  |                            |  |                                                                                   |  |                                                                                | 8,398,516
|Total                                              |  |                               |  | $                          |  |                                                                                   |  |                                                                                | 8,398,516

---

|(1) | On July 29, 2002, the Company announced that its Board of Directors had authorized the Company to repurchase up to an aggregate of 7,000,000 shares of its Common stock. The
program has subsequently been extended three times, most recently on July 22, 2005 when the Board of Directors authorized a further extension of this stock repurchase program to permit the purchase of up to 10,000,000 shares of the
Companys Common stock through December 15, 2006. This quantity of Common shares is in addition to the 6,928,640 shares of the Companys Common stock already purchased under the Companys stock repurchase program through
June 30, 2005. As of September 30, 2006, the Company had repurchased 8,530,124 of the authorized 16,928,640 shares of its common stock under this program, for a total cash outlay of $33,610,000, at an average price of $3.94 per share,
including commissions paid to brokers.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

During the third quarter of 2006, the Company completed the sale of 226,654 unregistered restricted
shares of Common stock to an employee of the Company at a price of $2.98 per share.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS



|               |  |                                                                                                                                                                                                
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                                    
|10.1           |  | Contract of Employment between Entrust (Europe) Ltd and Andrew Pinder, dated October 29, 2006 (incorporated
by reference to Exhibit 10.1 to Form 8-K filed by the Company on November 2, 2006)*
|               | 
|10.2           |  | Offer Letter of Entrust (Europe) Ltd to Andrew Pinder, dated October 29, 2006 (incorporated by reference to
Exhibit 10.2 to Form 8-K filed by the Company on November 2, 2006)*                
|               | 
|31.1           |  | Rule 13a-14(a) Certification of Chief Executive Officer.                                                                                                                                       
|               | 
|31.2           |  | Rule 13a-14(a) Certification of Chief Financial Officer.                                                                                                                                       
|               | 
|32.1           |  | Section 1350 Certification of Chief Executive Officer.                                                                                                                                         
|               | 
|32.2           |  | Section 1350 Certification of Chief Financial Officer.                                                                                                                                         

---

|* | Management contract or compensatory agreement.
|- | ----------------------------------------------



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.



|                        |  |                                                  
|----------------------- |  | -------------------------------------------------
|                        |  | ENTRUST, INC.                                    
|                        |  | (Registrant)                                     
|                        | 
|Dated: November 6, 2006 |  | /s/ David J. Wagner                              
|                        |  | David J. Wagner                                  
|                        |  | Chief Financial Officer and Senior Vice President
|                        |  | (Principal Financial and Accounting Officer)     

EXHIBIT INDEX



|               |  |                                                                                                                                                                                                
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                                    
|10.1           |  | Contract of Employment between Entrust (Europe) Ltd and Andrew Pinder, dated October 29, 2006 (incorporated
by reference to Exhibit 10.1 to Form 8-K filed by the Company on November 2, 2006)*
|               | 
|10.2           |  | Offer Letter of Entrust (Europe) Ltd to Andrew Pinder, dated October 29, 2006 (incorporated by reference to
Exhibit 10.2 to Form 8-K filed by the Company on November 2, 2006)*                
|               | 
|31.1           |  | Rule 13a-14(a) Certification of Chief Executive Officer.                                                                                                                                       
|               | 
|31.2           |  | Rule 13a-14(a) Certification of Chief Financial Officer.                                                                                                                                       
|               | 
|32.1           |  | Section 1350 Certification of Chief Executive Officer.                                                                                                                                         
|               | 
|32.2           |  | Section 1350 Certification of Chief Financial Officer.                                                                                                                                         

---

|* | Management contract or compensatory agreement.
|- | ----------------------------------------------



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