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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 UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------



For the quarterly period ended September 30, 2004



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 an accelerated filer (as defined in Rule 12b-2 of the Exchange
Act).    Yes  x    No ̈



There were 62,651,255 shares of the registrants $.01 par value Common stock outstanding
as of November 2, 2004.



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##### Table of Contents

ENTRUST, INC.



TABLE OF CONTENTS



|                              |  |                                                                                       |  |     
|----------------------------- |  | ------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                       |  | Page
|PART I.
FINANCIAL INFORMATION |  |                                                                                      
|                              |  |                                                                                      
|Item 1.                       |  | Financial Statements                                                                  |  |     
|                              |  |                                                                                      
|                              |  | Condensed Consolidated Balance Sheets                                                 |  | 3   
|                              |  |                                                                                      
|                              |  | Condensed Consolidated Statements of Operations                                       |  | 4   
|                              |  |                                                                                      
|                              |  | Condensed Consolidated Statements of Cash Flows                                       |  | 5   
|                              |  |                                                                                      
|                              |  | Notes to Condensed Consolidated Financial Statements                                  |  | 6   
|                              |  |                                                                                      
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 18  
|                              |  |                                                                                      
|Item 3.                       |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 44  
|                              |  |                                                                                      
|Item 4.                       |  | Controls and Procedures                                                               |  | 45  
|                              | 
|PART II.
OTHER INFORMATION    |  |                                                                                      
|                              |  |                                                                                      
|Item 2.                       |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 46  
|                              |  |                                                                                      
|Item 6.                       |  | Exhibits                                                                              |  | 46  
|                              | 
|SIGNATURES                    |  | 48                                                                                   



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.



2



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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)                                                                                                                                           |  | (Unaudited)SEPTEMBER 302004 |          |   | DECEMBER 312003 |  
|                                                                                                                                                                                          |  |                            
|ASSETS                                                                                                                                                                                    |  |                             |          |   |                 |   |          |  
|Current assets:                                                                                                                                                                           |  |                             |          |   |                 |   |          |  
|Cash and cash equivalents                                                                                                                                                                 |  | $                           | 41,767   |   |                 | $ | 37,903   |  
|Short-term marketable investments                                                                                                                                                         |  |                             | 53,472   |   |                 |   | 54,386   |  
|Accounts receivable (net of allowance for doubtful accounts of $1,068 at September 30, 2004 and $4,032 at December 31, 2003)                                                              |  |                             | 15,946   |   |                 |   | 18,771   |  
|Prepaid expenses and other receivables                                                                                                                                                    |  |                             | 3,877    |   |                 |   | 3,980    |  
|                                                                                                                                                                                          |  |                             |          |   |                 |   |          |  
|                                                                                                                                                                                          |  |                            
|Total current assets                                                                                                                                                                      |  |                             | 115,062  |   |                 |   | 115,040  |  
|Long-term marketable investments                                                                                                                                                          |  |                             | 5,384    |   |                 |   | 12,379   |  
|Property and equipment, net                                                                                                                                                               |  |                             | 5,679    |   |                 |   | 7,678    |  
|Purchased product rights and purchased non-contractual customer relationships, net                                                                                                        |  |                             | 2,971    |   |                 |   |         |  
|Goodwill, net                                                                                                                                                                             |  |                             | 13,036   |   |                 |   | 11,186   |  
|Long-term equity investment                                                                                                                                                               |  |                             | 1,103    |   |                 |   | 660      |  
|Other long-term assets, net                                                                                                                                                               |  |                             | 1,780    |   |                 |   | 1,809    |  
|                                                                                                                                                                                          |  |                             |          |   |                 |   |          |  
|                                                                                                                                                                                          |  |                            
|Total assets                                                                                                                                                                              |  | $                           | 145,015  |   |                 | $ | 148,752  |  
|                                                                                                                                                                                          |  |                             |          |   |                 |   |          |  
|                                                                                                                                                                                          |  |                            
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                      |  |                             |          |   |                 |   |          |  
|Current liabilities:                                                                                                                                                                      |  |                             |          |   |                 |   |          |  
|Accounts payable                                                                                                                                                                          |  | $                           | 7,052    |   |                 | $ | 6,192    |  
|Accrued liabilities                                                                                                                                                                       |  |                             | 7,617    |   |                 |   | 9,619    |  
|Accrued restructuring charges, current portion                                                                                                                                            |  |                             | 4,300    |   |                 |   | 35,426   |  
|Deferred revenue                                                                                                                                                                          |  |                             | 23,220   |   |                 |   | 16,615   |  
|                                                                                                                                                                                          |  |                             |          |   |                 |   |          |  
|                                                                                                                                                                                          |  |                            
|Total current liabilities                                                                                                                                                                 |  |                             | 42,189   |   |                 |   | 67,852   |  
|Accrued restructuring charges, long term portion                                                                                                                                          |  |                             | 27,125   |   |                 |   |         |  
|Other long-term liabilities                                                                                                                                                               |  |                             | 1,399    |   |                 |   | 228      |  
|                                                                                                                                                                                          |  |                             |          |   |                 |   |          |  
|                                                                                                                                                                                          |  |                            
|Total liabilities                                                                                                                                                                         |  |                             | 70,713   |   |                 |   | 68,080   |  
|                                                                                                                                                                                          |  |                             |          |   |                 |   |          |  
|                                                                                                                                                                                          |  |                            
|Minority interest in subsidiary                                                                                                                                                           |  |                             | 10       |   |                 |   |         |  
|                                                                                                                                                                                          |  |                             |          |   |                 |   |          |  
|Shareholders equity:                                                                                                                                                                     |  |                             |          |   |                 |   |          |  
|Common stock, par value $0.01 per share; 250,000,000 authorized shares; 62,645,015 and 63,593,188 issued and outstanding shares at September
30, 2004 and December 31, 2003, respectively |  |                             | 626      |   |                 |   | 636      |  
|Additional paid-in capital                                                                                                                                                                |  |                             | 774,272  |   |                 |   | 779,339  |  
|Unearned compensation                                                                                                                                                                     |  |                             | (23      | ) |                 |   | (51      | )
|Accumulated deficit                                                                                                                                                                       |  |                             | (700,909 | ) |                 |   | (699,368 | )
|Accumulated other comprehensive income                                                                                                                                                    |  |                             | 326      |   |                 |   | 116      |  
|                                                                                                                                                                                          |  |                             |          |   |                 |   |          |  
|                                                                                                                                                                                          |  |                            
|Total shareholders equity                                                                                                                                                                |  |                             | 74,292   |   |                 |   | 80,672   |  
|                                                                                                                                                                                          |  |                             |          |   |                 |   |          |  
|                                                                                                                                                                                          |  |                            
|Total liabilities and shareholders equity                                                                                                                                                |  | $                           | 145,015  |   |                 | $ | 148,752  |  
|                                                                                                                                                                                          |  |                             |          |   |                 |   |          |  



See notes to condensed
consolidated financial statements



3



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##### Table of Contents

ENTRUST, INC.



CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS



|                                                               |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|-------------------------------------------------------------- |  | ------------------------------------------ | ------ | - | ----------------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                               |  | (Unaudited) Three Months EndedSeptember 30 |        |   | (Unaudited) Nine months EndedSeptember 30 |  
|                                                               |  | 2004                                       |        |   | 2003                                      |   |        | 2004 |  |   | 2003   |  
|                                                               |  | (In thousands, except per share data)      |       
|Revenues:                                                      |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|Product                                                        |  | $                                          | 6,495  |   |                                           | $ | 5,159  |      |  | $ | 18,384 |   |  | $ | 20,736  |  
|Services and maintenance                                       |  |                                            | 14,843 |   |                                           |   | 14,879 |      |  |   | 45,482 |   |  |   | 43,446  |  
|                                                               |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|                                                               |  |                                            |        |  
|Total revenues                                                 |  |                                            | 21,338 |   |                                           |   | 20,038 |      |  |   | 63,866 |   |  |   | 64,182  |  
|                                                               |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|                                                               |  |                                            |        |  
|Cost of revenues:                                              |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|Product                                                        |  |                                            | 827    |   |                                           |   | 881    |      |  |   | 2,954  |   |  |   | 2,561   |  
|Services and maintenance                                       |  |                                            | 6,637  |   |                                           |   | 7,926  |      |  |   | 21,473 |   |  |   | 23,624  |  
|Amortization of purchased product rights                       |  |                                            | 175    |   |                                           |   |       |      |  |   | 198    |   |  |   | 568     |  
|                                                               |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|                                                               |  |                                            |        |  
|Total cost of revenues                                         |  |                                            | 7,639  |   |                                           |   | 8,807  |      |  |   | 24,625 |   |  |   | 26,753  |  
|                                                               |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|                                                               |  |                                            |        |  
|Gross profit                                                   |  |                                            | 13,699 |   |                                           |   | 11,231 |      |  |   | 39,241 |   |  |   | 37,429  |  
|                                                               |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|Operating expenses:                                            |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|Sales and marketing                                            |  |                                            | 5,757  |   |                                           |   | 8,758  |      |  |   | 18,592 |   |  |   | 27,739  |  
|Research and development                                       |  |                                            | 3,944  |   |                                           |   | 5,953  |      |  |   | 12,860 |   |  |   | 18,182  |  
|General and administrative                                     |  |                                            | 3,305  |   |                                           |   | 3,223  |      |  |   | 9,793  |   |  |   | 10,073  |  
|Impairment of purchased product rights                         |  |                                            |       |   |                                           |   |       |      |  |   |       |   |  |   | 1,134   |  
|Restructuring charges and adjustments                          |  |                                            |       |   |                                           |   | 2,233  |      |  |   |       |   |  |   | 13,623  |  
|                                                               |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|                                                               |  |                                            |        |  
|Total operating expenses                                       |  |                                            | 13,006 |   |                                           |   | 20,167 |      |  |   | 41,245 |   |  |   | 70,751  |  
|                                                               |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|                                                               |  |                                            |        |  
|Income (loss) from operations                                  |  |                                            | 693    |   |                                           |   | (8,936 | )    |  |   | (2,004 | ) |  |   | (33,322 | )
|                                                               |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|                                                               |  |                                            |        |  
|Other income (expense):                                        |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|Interest income                                                |  |                                            | 359    |   |                                           |   | 377    |      |  |   | 904    |   |  |   | 1,409   |  
|Foreign exchange gain (loss)                                   |  |                                            | (118   | ) |                                           |   | (92    | )    |  |   | 442    |   |  |   | (372    | )
|Loss from equity investment                                    |  |                                            | (296   | ) |                                           |   | (212   | )    |  |   | (675   | ) |  |   | (450    | )
|Write-down of long-term strategic investments                  |  |                                            |       |   |                                           |   |       |      |  |   |       |   |  |   | (2,780  | )
|                                                               |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|                                                               |  |                                            |        |  
|Total other income (expense)                                   |  |                                            | (55    | ) |                                           |   | 73     |      |  |   | 671    |   |  |   | (2,193  | )
|                                                               |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|                                                               |  |                                            |        |  
|Income (loss) before income taxes and minority interest        |  |                                            | 638    |   |                                           |   | (8,863 | )    |  |   | (1,333 | ) |  |   | (35,515 | )
|Minority interest in subsidiary                                |  |                                            | (2     | ) |                                           |   |       |      |  |   | (2     | ) |  |   |        |  
|                                                               |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|Income (loss) before income taxes                              |  |                                            | 636    |   |                                           |   | (8,863 | )    |  |   | (1,335 | ) |  |   | (35,515 | )
|Provision for income taxes                                     |  |                                            | 143    |   |                                           |   | 91     |      |  |   | 206    |   |  |   | 411     |  
|                                                               |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|                                                               |  |                                            |        |  
|Net income (loss )                                             |  | $                                          | 493    |   |                                           | $ | (8,954 | )    |  | $ | (1,541 | ) |  | $ | (35,926 | )
|                                                               |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|                                                               |  |                                            |        |  
|Net income (loss) per share:                                   |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|Basic                                                          |  | $                                          | 0.01   |   |                                           | $ | (0.14  | )    |  | $ | (0.02  | ) |  | $ | (0.56   | )
|Diluted                                                        |  | $                                          | 0.01   |   |                                           | $ | (0.14  | )    |  | $ | (0.02  | ) |  | $ | (0.56   | )
|Weighted average common shares used in per share computations: |  |                                            |        |   |                                           |   |        |      |  |   |        |   |  |   |         |  
|Basic                                                          |  |                                            | 62,684 |   |                                           |   | 63,407 |      |  |   | 63,138 |   |  |   | 63,601  |  
|Diluted                                                        |  |                                            | 62,932 |   |                                           |   | 63,407 |      |  |   | 63,138 |   |  |   | 63,601  |  



See notes to condensed
consolidated financial statements



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##### Table of Contents

ENTRUST, INC.



CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                              |  |                                           |         |   |      |   |          |  
|--------------------------------------------------------------------------------------------- |  | ----------------------------------------- | ------- | - | ---- | - | -------- | -
|                                                                                              |  | (Unaudited) NINE MONTHS ENDEDSEPTEMBER 30 |        
|                                                                                              |  | 2004                                      |         |   | 2003 |  
|                                                                                              |  | (In thousands)                            |        
|OPERATING ACTIVITIES:                                                                         |  |                                           |         |   |      |   |          |  
|Net loss                                                                                      |  | $                                         | (1,541  | ) |      | $ | (35,926  | )
|Non-cash items in net loss:                                                                   |  |                                           |         |   |      |   |          |  
|Depreciation and amortization                                                                 |  |                                           | 4,042   |   |      |   | 6,620    |  
|Impairment of purchased product rights                                                        |  |                                           |        |   |      |   | 1,134    |  
|Write-down of long-term strategic investments                                                 |  |                                           |        |   |      |   | 2,780    |  
|Unearned compensation amortized                                                               |  |                                           | 45      |   |      |   | 60       |  
|Loss from equity investments                                                                  |  |                                           | 673     |   |      |   | 450      |  
|Reduction in allowance for doubtful accounts                                                  |  |                                           | (1,981  | ) |      |   |         |  
|Non-monetary revenue transaction                                                              |  |                                           | (186    | ) |      |   |         |  
|Minority interest in subsidiary                                                               |  |                                           | 2       |   |      |   |         |  
|Changes in operating assets and liabilities:                                                  |  |                                           |         |   |      |   |          |  
|Decrease in accounts receivable                                                               |  |                                           | 5,808   |   |      |   | 6,378    |  
|(Increase) decrease in prepaid expenses and other receivables                                 |  |                                           | (39     | ) |      |   | 428      |  
|Increase (decrease) in accounts payable                                                       |  |                                           | 174     |   |      |   | (2,711   | )
|Decrease in accrued liabilities                                                               |  |                                           | (2,372  | ) |      |   | (2,833   | )
|Increase (decrease) in accrued restructuring charges                                          |  |                                           | (4,001  | ) |      |   | 5,175    |  
|Increase in deferred revenue                                                                  |  |                                           | 5,669   |   |      |   | 2,179    |  
|                                                                                              |  |                                           |         |   |      |   |          |  
|                                                                                              |  |                                          
|Net cash provided by (used in) operating activities                                           |  |                                           | 6,293   |   |      |   | (16,266  | )
|                                                                                              |  |                                           |         |   |      |   |          |  
|                                                                                              |  |                                          
|INVESTING ACTIVITIES:                                                                         |  |                                           |         |   |      |   |          |  
|Purchases of marketable investments                                                           |  |                                           | (61,394 | ) |      |   | (186,961 | )
|Dispositions of marketable investments                                                        |  |                                           | 69,303  |   |      |   | 213,344  |  
|Purchases of property and equipment                                                           |  |                                           | (1,067  | ) |      |   | (1,348   | )
|Increase in other long-term assets                                                            |  |                                           | (924    | ) |      |   | (367     | )
|Purchase of businesses                                                                        |  |                                           | (3,480  | ) |      |   |         |  
|                                                                                              |  |                                           |         |   |      |   |          |  
|                                                                                              |  |                                          
|Net cash provided by investing activities                                                     |  |                                           | 2,438   |   |      |   | 24,668   |  
|                                                                                              |  |                                           |         |   |      |   |          |  
|                                                                                              |  |                                          
|FINANCING ACTIVITIES:                                                                         |  |                                           |         |   |      |   |          |  
|Repayment of long-term liabilities                                                            |  |                                           |        |   |      |   | (44      | )
|Repurchase of common stock                                                                    |  |                                           | (5,752  | ) |      |   | (3,677   | )
|Decrease in long-term deposits                                                                |  |                                           |        |   |      |   | (2       | )
|Proceeds from exercise of stock options and sale of shares under employee stock purchase plan |  |                                           | 658     |   |      |   | 921      |  
|                                                                                              |  |                                           |         |   |      |   |          |  
|                                                                                              |  |                                          
|Net cash used in financing activities                                                         |  |                                           | (5,094  | ) |      |   | (2,802   | )
|                                                                                              |  |                                           |         |   |      |   |          |  
|                                                                                              |  |                                          
|EFFECT OF EXCHANGE RATE CHANGES ON CASH                                                       |  |                                           | 227     |   |      |   | (271     | )
|                                                                                              |  |                                           |         |   |      |   |          |  
|                                                                                              |  |                                          
|NET INCREASE IN CASH AND CASH EQUIVALENTS                                                     |  |                                           | 3,864   |   |      |   | 5,329    |  
|CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                                              |  |                                           | 37,903  |   |      |   | 32,043   |  
|                                                                                              |  |                                           |         |   |      |   |          |  
|CASH AND CASH EQUIVALENTS AT END OF PERIOD                                                    |  | $                                         | 41,767  |   |      | $ | 37,372   |  
|                                                                                              |  |                                           |         |   |      |   |          |  
|                                                                                              |  |                                          
|NON-CASH INVESTING AND FINANCING ACTIVITIES:                                                  |  |                                           |         |   |      |   |          |  
|Minimum future payment obligations relating to purchase transaction                           |  | $                                         | 1,202   |   |      | $ |         |  
|                                                                                              |  |                                           |         |   |      |   |          |  



See notes to condensed
consolidated financial statements



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##### Table of Contents

ENTRUST, INC.



NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS



(Unaudited)



(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, 2004 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 Notes to Consolidated Financial Statements for the year ended December 31, 2003 contained in the Companys Annual Report on
Form 10-K. Certain reclassifications have been made to prior years balances in order to conform to fiscal 2004 presentation, namely, the classification of amortization of purchased product rights and the reclassification of revenues from the
sale of web server certificates from services and maintenance revenues to product revenues on the condensed consolidated statements of operations.



NOTE 2. ACQUISITION OF BUSINESSES



On June 18, 2004, the Company completed the acquisition of intellectual property and certain other assets of AmikaNow! Corporation (AmikaNow), a
privately-held provider of advanced e-mail content scanning and analysis technology, which is a development stage company with negligible revenue, in exchange for $2,676 in cash and $1,293 in guaranteed future payments payable over three years and
other acquisition-related costs. In addition, the Company offered employment to certain employees of AmikaNow. The Company may be required to make additional payments of up to a maximum of $2,400, in the form of royalties calculated based on the
sale of products that incorporate the technology acquired from AmikaNow for a period of three years following the date of acquisition, if and only if sufficient sale of products take place in this time frame.



The acquisition was accounted for under the purchase method of accounting and, accordingly,
the purchase price of approximately $3,969 was allocated to the fair value of the tangible and intangible assets and liabilities acquired, with the remainder allocated to goodwill. Amortization of $178 and $201 has been recorded in the three months
and nine months ended September 30, 2004, related to purchased product rights and non-contractual customer relationship assets arising from this acquisition. In connection with the purchase price allocation, the Company valued the tangible and
intangible assets acquired, which resulted in the purchase price of these assets being allocated, on a preliminary basis, as follows:



|                                       |  |                     |  |                          |      
|-------------------------------------- |  | ------------------- |  | ------------------------ | -----
|                                       |  | Amortization Period |  | Purchase PriceAllocation
|Purchased product rights               |  | 4 years             |  | $                        | 2,608
|Non-contractual customer relationships |  | 3 years             |  |                          | 174  
|Property and equipment                 |  | 3 years             |  |                          | 9    
|Goodwill                               |  |                    |  |                          | 1,178
|                                       |  |                     |  |                          |      
|                                       |  |                    
|Total                                  |  |                     |  | $                        | 3,969
|                                       |  |                     |  |                          |      



On September 13, 2004, the Company
completed the acquisition, in exchange for $1,560 in cash, of 1,700,000 shares of voting common stock of Entrust Japan Co., Ltd. (Entrust Japan), a privately-held company engaged in selling, servicing and supporting solutions that enable
organizations to secure digital identities and information in the Japanese market, with an exclusive license to market and sell Entrust products in Japan. This acquisition of shares increased the Companys ownership interest in Entrust from 37%
to 99% of the outstanding voting stock. Entrust made an original investment of $393 for approximately 10% of the common stock in 1998. In April 2002, the Company increased its investment to approximately



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37%, through the contribution of $1,481 of cash and cash deposits and $385 of Entrust products and exclusivity rights, at
which time the Company began accounting for its investment in Entrust Japan in accordance with equity method. The Company has included its share of post-acquisition losses of Entrust Japan, in the amount of $174 and $551 for the three and nine
months ended September 30, 2004, respectively, in its consolidated losses for the current fiscal year. The Company has recorded cumulative losses from its investment in Entrust Japan of $1,756 since its increased investment in the second quarter of
2002.



The acquisition was accounted for under the purchase method of
accounting and, accordingly, the purchase price of approximately $1,669, which included the remaining balance of the Companys equity investment in Entrust Japan immediately prior to the September 2004 purchase, 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 Entrust Japan have been included in the Companys consolidated financial statements commencing
from September 13, 2004, the effective date of the acquisition for accounting purposes. No amortization related to this purchase has been recorded in the three and nine months ended September 30, 2004.



The condensed balance sheet of Entrust Japan at the effective date of the acquisition is as
follows:



|                                         |  |                     |      
|---------------------------------------- |  | ------------------- | -----
|                                         |  | AtSeptember 30,2004
|Assets:                                  |  |                     |      
|Cash                                     |  | $                   | 756  
|Accounts receivable                      |  |                     | 669  
|Other current assets                     |  |                     | 682  
|Property and equipment                   |  |                     | 205  
|Other long term assets                   |  |                     | 196  
|                                         |  |                     |      
|Total assets                             |  | $                   | 2,508
|                                         |  |                     |      
|Liabilities:                             |  |                     |      
|Accounts payable and accrued liabilities |  | $                   | 775  
|Deferred revenues                        |  |                     | 909  
|Long term liabilities                    |  |                     | 69   
|                                         |  |                     |      
|Total liabilities                        |  | $                   | 1,753
|                                         |  |                     |      
|Net assets                               |  | $                   | 755  
|                                         |  |                     |      



In connection with the purchase price
allocation, the Company valued the tangible and intangible assets acquired, which resulted in the purchase price of these assets being allocated, on a preliminary basis, as follows:



|                                       |  |                    |  |                          |      
|-------------------------------------- |  | ------------------ |  | ------------------------ | -----
|                                       |  | AmortizationPeriod |  | Purchase PriceAllocation
|Non-contractual customer relationships |  | 3.25 years         |  | $                        | 242  
|Net assets, as above                   |  |                   |  |                          | 755  
|Goodwill                               |  |                   |  |                          | 672  
|                                       |  |                    |  |                          |      
|Total                                  |  |                    |  | $                        | 1,669
|                                       |  |                    |  |                          |      



The following unaudited pro forma data
summarize the combined results of operations of Entrust, Inc., including the acquired business assets of AmikaNow and operations of Entrust Japan for the three and nine months ended September 30, 2004 and 2003, respectively, as if the acquisition
had taken place as of the beginning of the respective periods and, accordingly, include a full periods amortization of the assets related to purchased product rights and non-contractual customer relationships in each period shown.



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|                                              |  |                                             |        |      |                                            |        |      |  |   |        |   |  |   |         |  
|--------------------------------------------- |  | ------------------------------------------- | ------ | ---- | ------------------------------------------ | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                              |  | (Unaudited) Three Months EndedSeptember 30, |        |      | (Unaudited) Nine Months EndedSeptember 30, |       
|                                              |  | 2004                                        |        | 2003 |                                            |        | 2004 |  |   | 2003   |  
|Revenues                                      |  | $                                           | 21,723 |      | $                                          | 20,457 |      |  | $ | 65,109 |   |  | $ | 66,021  |  
|                                              |  |                                             |        |      |                                            |        |      |  |   |        |   |  |   |         |  
|Net income (loss)                             |  |                                             | 145    |      |                                            | (9,612 | )    |  |   | (3,394 | ) |  |   | (38,071 | )
|                                              |  |                                             |        |      |                                            |        |      |  |   |        |   |  |   |         |  
|Basic and diluted net income (loss) per share |  |                                             |       |      |                                            | (0.15  | )    |  |   | (0.05  | ) |  |   | (0.60   | )
|                                              |  |                                             |        |      |                                            |        |      |  |   |        |   |  |   |         |  



These pro forma amounts are not
necessarily indicative of the Companys future results of operations.



NOTE 3. STOCK-BASED COMPENSATION AND STOCK OPTION PLANS



Stock-Based Compensation



Stock-based compensation
arising from stock option grants is accounted for by the intrinsic value method under Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123, Accounting for Stock-Based
Compensation encourages, but does not require, the cost of stock-based compensation arrangements with employees to be measured based on the fair value of the equity instrument awarded. As permitted by SFAS No. 123, the Company applies APB
Opinion No. 25 and related interpretations in accounting for stock-based compensation awards to employees under its stock option plans. For all options granted to employees in the periods disclosed, 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 are reflected in earnings for these options. Had compensation costs for the Companys 1996 Plan, 1999 Plan, Special Plan and
enCommerce 1997 Plan been determined based on the fair value of the options at the grant date for awards to employees under these plans, consistent with the methodology prescribed under SFAS No. 123, the Companys net loss and net loss per
share would have been as follows, on a pro forma basis:



|                                                                                                        |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |         |  
|------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------- | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                                                        |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                                                        |  | 2004                            |        |   | 2003                           |   |         | 2004 |  |   | 2003   |  
|Net income (loss), as reported:                                                                         |  | $                               | 493    |   |                                | $ | (8,954  | )    |  | $ | (1,541 | ) |  | $ | (35,926 | )
|Total stock-based employee compensation expense determined under fair value-based method for all awards |  |                                 | (2,221 | ) |                                |   | (3,651  | )    |  |   | (7,842 | ) |  |   | (10,104 | )
|                                                                                                        |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |         |  
|Pro forma net income (loss)                                                                             |  | $                               | (1,728 | ) |                                | $ | (12,605 | )    |  | $ | (9,383 | ) |  | $ | (46,030 | )
|                                                                                                        |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |         |  
|Net income (loss) per share:                                                                            |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |         |  
|Basicas reported                                                                                       |  | $                               | 0.01   |   |                                | $ | (0.14   | )    |  | $ | (0.02  | ) |  | $ | (0.56   | )
|                                                                                                        |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |         |  
|Basicpro forma                                                                                         |  | $                               | (0.03  | ) |                                | $ | (0.20   | )    |  | $ | (0.15  | ) |  | $ | (0.72   | )
|                                                                                                        |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |         |  
|Dilutedas reported                                                                                     |  | $                               | 0.01   |   |                                | $ | (0.14   | )    |  | $ | (0.02  | ) |  | $ | (0.56   | )
|                                                                                                        |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |         |  
|Dilutedpro forma                                                                                       |  | $                               | (0.03  | ) |                                | $ | (0.20   | )    |  | $ | (0.15  | ) |  | $ | (0.72   | )
|                                                                                                        |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |         |  



In the pro forma calculations above,
the weighted average fair value for stock options granted during the three and nine months ended September 30, 2004 was estimated at $2.20 and $3.68, respectively, compared to $2.61 and $2.56 per option for the three and nine months ended September
30, 2003, respectively. The fair values of options were estimated as of the date of grant using the Black-Scholes option pricing model. The following weighted average assumptions were used in the calculations:



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|                               |  |                                 |   |  |                                |   |  |      |   |  |      |  
|------------------------------ |  | ------------------------------- | - |  | ------------------------------ | - |  | ---- | - |  | ---- | -
|                               |  | Three Months EndedSeptember 30, |   |  | Nine Months EndedSeptember 30, |  
|                               |  | 2004                            |   |  | 2003                           |   |  | 2004 |   |  | 2003 |  
|Expected option life, in years |  | 5                               |   |  | 5                              |   |  | 5    |   |  | 5    |  
|Risk free interest rate        |  | 3.41                            | % |  | 3.36                           | % |  | 3.16 | % |  | 3.29 | %
|Dividend yield                 |  |                                |   |  |                               |   |  |     |   |  |     |  
|Volatility                     |  | 106                             | % |  | 120                            | % |  | 104  | % |  | 120  | %



The Company recorded amortization of
unearned compensation of $9 and $45 into compensation expense for the three and nine months ended September 30, 2004, respectively, related to options granted to non-employees and restricted stock issued to members of the board of directors in a
prior period, compared to $46 and $60 for the three and nine months ended September 30, 2003, respectively.



Please see Critical Accounting Policies in Managements Discussion and Analysis of Financial Condition and Results of Operations, included in this quarterly report, for additional
information regarding application of SFAS No. 123 to the Companys stock-based compensation.



Stock Option Plans



The
following tables summarize information concerning outstanding options as of September 30, 2004:



|                         |  |                             |  |                                         |  |                              |       |                               |           |                               |   |      
|------------------------ |  | --------------------------- |  | --------------------------------------- |  | ---------------------------- | ----- | ----------------------------- | --------- | ----------------------------- | - | -----
|                         |  | Options Outstanding         |  | Options Exercisable                    
|Range of Exercise Prices |  | Number ofOptionsOutstanding |  | WeightedAverageRemainingContractualLife |  | WeightedAverageExercisePrice |       | Number of Options Exercisable |           | WeightedAverageExercise Price
|                         |  |                             |  |                                         | 
|$0.12 to $2.44           |  | 571,994                     |  | 2.8 years                               |  | $                            | 2.14  |                               | 545,095   |                               | $ | 2.13 
|$2.45 to $5.00           |  | 6,530,527                   |  | 8.5 years                               |  |                              | 3.61  |                               | 1,984,146 |                               |   | 3.17 
|$5.01 to $6.72           |  | 642,670                     |  | 6.0 years                               |  |                              | 5.47  |                               | 547,917   |                               |   | 5.51 
|$6.75 to $6.86           |  | 2,667,419                   |  | 5.5 years                               |  |                              | 6.75  |                               | 2,543,902 |                               |   | 6.75 
|$6.87 to $10.00          |  | 4,065,150                   |  | 6.6 years                               |  |                              | 6.89  |                               | 2,663,636 |                               |   | 6.89 
|$10.01 to $50.00         |  | 582,315                     |  | 5.3 years                               |  |                              | 21.44 |                               | 554,267   |                               |   | 21.82
|$50.01 to $130.25        |  | 15,800                      |  | 5.5 years                               |  |                              | 74.72 |                               | 15,800    |                               |   | 74.72
|                         |  |                             |  |                                         |  |                              |       |                               |           |                               |   |      
|                         |  |                             |  |                                         | 
|Total:                   |  | 15,075,875                  |  |                                         |  |                              | 5.84  |                               | 8,854,763 |                               |   | 6.70 
|                         |  |                             |  |                                         |  |                              |       |                               |           |                               |   |      



The following table sets forth a
comparison, as of September 30, 2004, of the number of shares subject to options with exercise prices at or below the closing price per share of the Companys Common stock on September 30, 2004 (In-the-Money options) to the number
of shares of the Companys Common stock subject to options with exercise prices greater than the closing price per share of the Companys Common stock on such date (Out-of-the-Money options) (in actual shares):



In-the-Money and Out-of-the-Money Option Information as of September 30, 2004 (1)



|                          |  |             |  |               |  |            |  |                                       |  
|------------------------- |  | ----------- |  | ------------- |  | ---------- |  | ------------------------------------- | -
|                          |  | Exercisable |  | Unexercisable |  | Total      |  | Percentage ofTotal OptionsOutstanding |  
|In-the-Money              |  | 1,211,573   |  | 530,373       |  | 1,741,946  |  | 12                                    | %
|Out-of-the-Money          |  | 7,643,190   |  | 5,690,739     |  | 13,333,929 |  | 88                                    | %
|                          |  |             |  |               |  |            |  |                                       |  
|                          |  |             |  |              
|Total Options Outstanding |  | 8,854,763   |  | 6,221,112     |  | 15,075,875 |  | 100                                   | %
|                          |  |             |  |               |  |            |  |                                       |  

---

|(1) | The closing price of the Companys Common stock was $2.53 on September 30, 2004, as reported by the NASDAQ National Market.
|--- | ---------------------------------------------------------------------------------------------------------------------------



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NOTE 4. EQUITY INVESTMENT IN ENTRUST JAPAN



On September 13, 2004, the Company increased its ownership of Entrust Japan to 99 percent. Prior to that date, the Company had included its
share of post-acquisition losses of Entrust Japan, in the amount of $174 and $551 for the three and nine months ended September 30, 2004, respectively, in its consolidated losses for the current fiscal year. The Company has recorded cumulative
losses from its investment in Entrust Japan of $1,756, since its increased investment in the second quarter of 2002 up to the date of acquiring majority ownership of Entrust Japan on September 13, 2004.



Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable
Interest Entities (FIN No. 46), issued in January 2003 and revised in December 2003, requires a company to consolidate a variable interest entity (VIE) if the company has variable interests that give it a majority of
the expected losses or a majority of the expected residual returns of the entity. The Company has evaluated the applicability of FIN No. 46 to its investment in Entrust Japan and the possible impact on its consolidated results of operations and
consolidated balance sheet. Entrust Japan is a private Japanese corporation founded in June 1998. Entrust Japan is engaged in selling, servicing and supporting solutions that enable organizations to secure digital identities and information in the
Japanese market. Entrust Japan has an exclusive license to market and sell Entrust products in Japan. They also provide professional services and support for the software solutions that they sell. Entrust Japan generates annual revenues of
approximately $4,000, with total assets of approximately $3,400 at June 30, 2004. Entrust made an original investment of $393 for approximately 10% of the common stock. In April 2002, the Company increased its investment to the current approximately
37% through the contribution of $1,481 of cash and cash deposits and $385 of Entrust products and exclusivity rights. The cash equity investment that the Company has made totals $1,881 plus $385 of in-kind investment. The Company has concluded that
the $1,881 amount represents its total equity at risk and would be the maximum exposure to loss as a result of its involvement with Entrust Japan. In addition, we do not have any obligation to provide additional cash funding to them. The Company has
concluded that Entrust Japan meets the definition of a VIE, as described in FIN No. 46, as it does not have an equity investment at risk that is sufficient to permit Entrust Japan to finance its activities without additional subordinated financial
support from other parties. Although the Company holds a significant variable interest, it has determined that it is not the primary beneficiary of Entrust Japan because the Companys interests do not give it a majority of the expected losses
and residual returns of the entity. Accordingly, there was no impact on the Companys consolidated results of operations and consolidated balance sheet, as a result of the adoption of FIN No. 46.



As a result of the acquisition of 1,700,000 shares of voting common stock of Entrust Japan on
September 13, 2004, which increased the Companys ownership of Entrust Japan to 99%, the Company changed to the full consolidation method of accounting for Entrust Japan effective on that date.



NOTE 5. EQUITY INVESTMENT IN OHANA WIRELESS, INCORPORATED.



On September 30, 2003, the Company loaned OHANA Wireless, Incorporated, a California
corporation (Ohana), $650 in the form of a convertible loan pursuant to the terms of a convertible loan agreement (the Loan Agreement). Ohana was incorporated on July 10, 2003. It was formed to design, assemble and install
high frequency wireless communication systems. The Company believes that its security solutions can 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 series A preferred 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 quarter of 2004 and July 2004, the Company made additional advances of $300 and $275, respectively, resulting in a total outstanding convertible loan of $1,225. In July 2004, the Loan Agreement was amended to provide for automatic conversion
of the convertible loan if the contemplated round of equity financing closed by October 1, 2004 and to secure the loan with certain rights to Ohanas intellectual property.



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In the third quarter of 2004, the Company determined that the loan was unlikely to be repaid in the near term and
therefore, classified the amount as long-term in nature. Further, on an as-if converted basis, assuming that the loan converted as expected by the Company, at September 30, 2004 the Company would have held the equivalent of an approximate 12%
ownership share of Ohana. The Company has concluded that because of the additional investment and additional rights obtained in July 2004, it gained the potential ability to exercise significant influence over the operations of Ohana. Therefore,
beginning the third quarter of 2004, the Company has accounted for its 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, the Company has included its share of post-acquisition losses of Ohana, in the amount of $122, in its consolidated losses for the current fiscal year.



Between October 27, 2004 and October 29, 2004, the Company and the shareholders of Ohana
entered into a series of agreements providing for the restructuring of Ohana (the Ohana Restructuring). These agreements anticipate that Ohana will become a wholly owned subsidiary of a new company, ADML Holdings, Ltd. (Ohana
Holdco), and all loans by the Company to Ohana would convert into stock of Ohana Holdco. On October 27, 2004, an additional loan of $275 was made by the Company to Ohana, which would also convert into stock of Ohana Holdco pursuant to such
agreements. Such agreements are expected to close on or about November 5, 2004 but are subject to certain customary closing conditions. If the Ohana Restructuring is closed in accordance with the terms of such agreements, the Company will own
approximately 14% of Ohana Holdcos issued and outstanding common stock, as a result of the conversion of the Companys loan of $1,500.



Anthony E. Hwang, a director of the Company since August 4, 2003, was interim CEO of Ohana at the time of the Loan Agreement through March 1, 2004. Mr. Hwang was also a
director of Ohana from August 4, 2003 through March 31, 2004.



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NOTE 6. SUBSEQUENT EVENT  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. The parties agreed that: (i) the Company would directly subscribe for 16.7% of the share capital of Asia Digital Media in exchange for a cash and in-kind contribution valued in the
aggregate at US$3,300; (ii) subject to completion of the Ohana Restructuring (see note 5), Ohana Holdco 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; (iii) the remaining capital stock of Asia Digital Media would be owned by RockRidge Asia Digital Media, LLC, a company formed in the State of Delaware (Rockridge), and China Aerospace New World Technology Limited, a company
incorporated in Hong Kong (CANW), in exchange for cash and/or in-kind contributions.



The parties agreed that the purpose of Asia Digital Media would be:



|(1) | the distribution of Company software in China,
|--- | ----------------------------------------------



|(2) | the distribution of secure digital television and media delivery systems and platforms in China based on Company and CANW software and hardware that incorporates Ohana technology,
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | the supply of media programming to and from the Chinese market, and
|--- | -------------------------------------------------------------------



|(4) | the provision of vendor financing for the sale of Asia Digital Medias secure digital delivery system products.
|--- | ---------------------------------------------------------------------------------------------------------------



Until the closing of this transaction, Asia Digital Media will remain a wholly owned
subsidiary of the Company. Upon the closing of this transaction, the Companys total direct and indirect equity holdings in Asia Digital Media will equal approximately 25%.



Closing of this transaction is anticipated to occur on November 30, 2004 subject to satisfaction of a number of conditions.



It is presently anticipated that Mr. Hwang, director of the Company, and Mr. F. William
Conner, Chairman, President and Chief Executive Officer of the Company, will be directors of Asia Digital Media.



NOTE 7. 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.
On July 22, 2003, the Company announced that its board of directors had authorized an extension to this stock repurchase program. Entrusts original stock repurchase program would have expired on July 28, 2003. The extended plan permits the
purchase of up to 7,000,000 shares of the Companys Common stock through September 1, 2004, in addition to the 2,229,200 shares already purchased prior to the extension. On August 2, 2004, the Company announced that its board of directors had
authorized an extension of this stock repurchase program to permit the purchase of up to 10,000,000 shares of the Companys Common Stock through September 15, 2005 in addition to the 3,412,940 shares already purchased prior to this extension.
During the three and nine months ended September 30, 2004, the Company repurchased 77,700 and 1,261,440 shares, respectively, of its Common stock for a total cash outlay of $194 and $5,752, respectively, at an average price of $2.50 and $4.56 per
share, respectively, including commissions paid to brokers. As of September 30, 2004, the Company has repurchased 3,490,640 shares of its Common stock under this program, for a total cash outlay of $11,689, at an average price of $3.35 per share,
including commissions paid to brokers.



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Repurchases under the stock repurchase program may take place from time to time until September 15, 2005, 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 8. RECOVERY OF ACCOUNT RECEIVABLE UNDER SETTLEMENT AGREEMENT



During the first quarter of 2004, the Company reached a settlement agreement on a significant and long outstanding receivable related to a
license agreement executed in June 2000. This receivable had been completely provided for in fiscal 2001, because it had been determined that the likelihood of full payment was less than probable, despite the fact that the Company had undertaken all
avenues of collection available to it, including litigation. As part of the process of pursuing collection through the court system, the Company entered into settlement discussions with the customer. As a result of these discussions, a settlement
was reached under which full payment of the original invoiced amount of approximately $2,000 was assured upon execution of a new agreement, half of which was received prior to March 31, 2004, while the other half remained in accounts receivable at
that date and was collected in April 2004. In total, the Company reduced its allowance for doubtful accounts by approximately $2,000 due to the settlement. As part of this settlement agreement, we also agreed to provide this customer with additional
software products and professional services, the related costs of which were provided for from the allowance for bad debts that had previously been set up against this receivable. These costs were estimated to be approximately $700 and were accrued
upon the execution of the settlement agreement. The remaining allowance in the amount of $1,300 was reversed against sales and marketing expenses as a recovery of this bad debt.



NOTE 9. 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, 2004:



|                                                                                              |  |                                   |        |  
|--------------------------------------------------------------------------------------------- |  | --------------------------------- | ------ | -
|                                                                                              |  | Nine MonthsEndedSeptember 30,2004 |       
|Allowance for doubtful accounts, beginning of period                                          |  | $                                 | 4,032  |  
|Reduction in provision for doubtful accounts, net                                             |  |                                   | (1,981 | )
|Reallocation to accrued liabilities to provide for costs associated with settlement agreement |  |                                   | (698   | )
|Amounts written-off, net of recoveries                                                        |  |                                   | (285   | )
|                                                                                              |  |                                   |        |  
|                                                                                              | 
|Allowance for doubtful accounts, end of period                                                |  | $                                 | 1,068  |  
|                                                                                              |  |                                   |        |  



During the third quarter of 2004, the
Company collected $550 that had been outstanding over 365 days and had previously been fully reserved. The balance of $550 was reversed against sales and marketing expense as a recovery of bad debt during the third quarter. Although the Company has
recently benefited from recovery of old receivables, at this time, we do not anticipate any significant recoveries from the allowance for doubtful accounts in the near future.



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NOTE 10. ACCRUED RESTRUCTURING CHARGES



May 2003 Restructuring Plan



Following the first quarter of 2003, when the Companys revenue attainment fell short of its expectations and guidance, management began a re-assessment of the
Companys operations to ensure that its expenses were optimally aligned to its customers and markets, and structured such that it could achieve its financial break even target for 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 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 Company conducted its assessment of the accounting effects of the May 2003 restructuring plan in accordance with SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal Activities, SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, APB Opinion No. 9, Reporting the Results of Operations, and the
relevant provisions of the SECs SAB No. 100, Restructuring and Impairment Charges.



The workforce portion of the restructuring plan included severance and related costs of $4,813 for 151 positions from all functional areas of the Company and had been significantly completed by December 31, 2003, of
which $4,289 was incurred in the second quarter of 2003, with the remaining costs of $524 incurred in the third quarter of 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 $3,759 of charges during the third quarter of 2003 relating to these facilities, including $953 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 the third quarter of 2003. However, the Company recorded
$357 in the second quarter of 2003 related to accelerated amortization on the impacted leaseholds and equipment. The total amount of the workforce and facilities charges was $8,929. Of this amount, $4,646 had been incurred by June 30, 2003 and
charged to the restructuring charges line in the condensed consolidated statement of operations for the second quarter of 2003, while the remaining $4,283 was recorded in the third quarter of 2003.



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, at this time, 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, in terms of long-term liquidity requirements, the current obligations would require the Company to fund $300 of its accrued restructuring charges for the May 2003 restructuring
before the end of fiscal 2004, with the remaining accrued restructuring charges for the May 2003 restructuring to be paid as follows: $900 in fiscal 2005, $100 in fiscal 2006, $100 in fiscal 2007 and $300 in fiscal 2008 and beyond.



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 restructuring plan at September 30, 2004:



|                                              |  |                                         |     |              |   |                                                   |  |   |    
|--------------------------------------------- |  | --------------------------------------- | --- | ------------ | - | ------------------------------------------------- |  | - | ---
|                                              |  | Total ChargesAccrued atBeginning ofYear |     | CashPayments |   | AccruedRestructuringCharges at September 30, 2004
|                                              |  | (in millions)                          
|Workforce reduction and other personnel costs |  | $                                       | 0.9 |              | $ | 0.6                                               |  | $ | 0.3
|Consolidation of excess facilities            |  |                                         | 2.2 |              |   | 0.8                                               |  |   | 1.4
|                                              |  |                                         |     |              |   |                                                   |  |   |    
|                                              |  |                                         |    
|Total                                         |  | $                                       | 3.1 |              | $ | 1.4                                               |  | $ | 1.7
|                                              |  |                                         |     |              |   |                                                   |  |   |    



In July 2003, the Company signed a
settlement and general release agreement with Zix Corporation, which resulted in the remaining contractual obligation under the Companys marketing and distribution agreement with Zix Corporation being



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settled at a value significantly less than the accrued $2,800 obligation at June 30, 2003. Under the settlement
agreement, the Company paid Zix Corporation $700 in July 2003 in fulfillment of all remaining obligations. This settlement resulted in the reversal of an accrual by the Company of $2,100, which was recorded through the restructuring charges line in
the condensed consolidated statement of operations for the third quarter of 2003.



In connection with the May 2003 restructuring plan, which included a further reduction in space utilized at the Companys Santa Clara, California facility, the Company reviewed market sublease rates in that region. Based on information
supplied to the Company, it was concluded that the sublease market would not recover in the timeframe that had originally been estimated due to the continued softening of sublease rates in that market, requiring an adjustment to increase the
facility related accrual recorded in June 2001, by $6,743. This adjustment was charged to the restructuring charges line in the condensed consolidated statement of operations for the second quarter of 2003.



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 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.



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, at this time, 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 $1,100 of its accrued restructuring charges
for the June 2001 restructuring before the end of fiscal 2004, with the remaining accrued restructuring charges for the June 2001 restructuring to be paid as follows: $3,000 in fiscal 2005, $3,400 in fiscal 2006, $5,000 in fiscal 2007 and $17,200 in
fiscal 2008 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 2001 restructuring plan at September 30, 2004:



|                                                 |  |                                         |      |              |   |                                                  |  |   |     
|------------------------------------------------ |  | --------------------------------------- | ---- | ------------ | - | ------------------------------------------------ |  | - | ----
|                                                 |  | Total ChargesAccrued atBeginning ofYear |      | CashPayments |   | AccruedRestructuringCharges atSeptember 30, 2004
|                                                 |  | (in millions)                          
|Consolidation of excess facilities               |  | $                                       | 32.1 |              | $ | 2.5                                              |  | $ | 29.6
|Discontinuance of non-core products and programs |  |                                         | 0.2  |              |   | 0.1                                              |  |   | 0.1 
|                                                 |  |                                         |      |              |   |                                                  |  |   |     
|                                                 |  |                                         |     
|Total                                            |  | $                                       | 32.3 |              | $ | 2.6                                              |  | $ | 29.7
|                                                 |  |                                         |      |              |   |                                                  |  |   |     



As of September 30, 2004, the Company
had estimated a total of $22,600 of sublease recoveries in our restructuring accrual. Of this amount, $22,100 is related to the Santa Clara facility. In addition, $7,900 of the $22,600 is recoverable under existing sublease agreements and the
remaining $14,700 of rent recoveries is based on estimates that may be subject to adjustments based upon changes in the real estate sublet markets.



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NOTE 11. 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 dilutive effect of the options to purchase Common stock are excluded from the computation of diluted net income (loss) per share if
the effect is antidilutive. For the three and nine months ended September 30, 2004, the antidilutive effect excluded from the diluted net loss per share computation due to options to purchase Common stock under the treasury stock method was 248,175
and 1,377,639 shares, respectively, compared to an antidilutive effect of 1,485,553 and 853,519 shares for the three and nine months ended September 30, 2003, respectively. In addition, 7,643,190 options which had exercise prices in excess of the
average market price during those periods were also excluded from the computation of diluted net loss per share.



In the three and nine months ended September 30, 2004, the Company issued nil and 314,017 shares, respectively, of Common stock related to the exercise of employee stock
options.



NOTE 12. 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
has the intent and ability to hold all of these investments until maturity. Therefore, all such investments are classified as held to maturity investments, and are stated at amortized cost. At September 30, 2004, the amortized cost of the
Companys held to maturity investments approximated fair value. Based on contractual maturities, these marketable investments were classified in either current assets or long-term assets.



Realized gains and losses on disposition of available for sale marketable investments are
included in other investment income in the results of operations. Unrealized gains and losses are included in other comprehensive income, except that the portion designated as being hedged in a fair value hedge is recognized in other investment
income during the period of the hedge. As at September 30, 2004, the Company does not hold any available for sale marketable investments.



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 in these companies ranges from 1% to 10% of the outstanding voting share capital at September 30, 2004. Consistent with the Companys policies for other long-lived assets, the carrying value of these
long-term strategic investments is periodically reviewed for impairment based upon such quantitative measures as expected undiscounted cash flows, as well as qualitative factors. In addition, the Audit Committee of the Board of Directors 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. These strategic investments had no net remaining carrying value at September 30, 2004.



The Company recorded revenues representing less than 1% of total revenues in each of the three and nine months ended September 30, 2004 and 2003, with respect to arms-length transactions with companies in which
it has made strategic equity investments recorded at cost.



NOTE 13. 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 segment 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:



|                                        |  |                                             |        |   |                                            |   |        |      |  |   |        |   |  |   |         |  
|--------------------------------------- |  | ------------------------------------------- | ------ | - | ------------------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                        |  | (Unaudited) Three Months EndedSeptember 30, |        |   | (Unaudited) Nine Months EndedSeptember 30, |  
|                                        |  | 2004                                        |        |   | 2003                                       |   |        | 2004 |  |   | 2003   |  
|Revenues:                               |  |                                             |        |   |                                            |   |        |      |  |   |        |   |  |   |         |  
|United States                           |  | $                                           | 12,534 |   |                                            | $ | 10,694 |      |  | $ | 35,973 |   |  | $ | 32,498  |  
|Canada                                  |  |                                             | 3,503  |   |                                            |   | 3,614  |      |  |   | 11,474 |   |  |   | 11,515  |  
|Europe, Asia and Other                  |  |                                             | 5,301  |   |                                            |   | 5,730  |      |  |   | 16,419 |   |  |   | 20,169  |  
|                                        |  |                                             |        |   |                                            |   |        |      |  |   |        |   |  |   |         |  
|                                        |  |                                             |        |  
|Total revenues                          |  | $                                           | 21,338 |   |                                            | $ | 20,038 |      |  | $ | 63,866 |   |  | $ | 64,182  |  
|                                        |  |                                             |        |   |                                            |   |        |      |  |   |        |   |  |   |         |  
|Income (loss) before income taxes:      |  |                                             |        |   |                                            |   |        |      |  |   |        |   |  |   |         |  
|United States                           |  | $                                           | 320    |   |                                            | $ | (5,007 | )    |  | $ | 216    |   |  | $ | (24,985 | )
|Canada                                  |  |                                             | 855    |   |                                            |   | (4,052 | )    |  |   | (1,312 | ) |  |   | (10,691 | )
|Europe, Asia and Other                  |  |                                             | (539   | ) |                                            |   | 196    |      |  |   | (239   | ) |  |   | 161     |  
|                                        |  |                                             |        |   |                                            |   |        |      |  |   |        |   |  |   |         |  
|                                        |  |                                             |        |  
|Total income (loss) before income taxes |  | $                                           | 636    |   |                                            | $ | (8,863 | )    |  | $ | (1,335 | ) |  | $ | (35,515 | )
|                                        |  |                                             |        |   |                                            |   |        |      |  |   |        |   |  |   |         |  





|                       |  |                   |         |                  |   |        
|---------------------- |  | ----------------- | ------- | ---------------- | - | -------
|                       |  | (Unaudited)      
|                       |  | September 30,2004 |         | December 31,2003
|Total assets:          |  |                   |         |                  |   |        
|United States          |  | $                 | 111,490 |                  | $ | 121,348
|Canada                 |  |                   | 28,887  |                  |   | 25,194 
|Europe, Asia and Other |  |                   | 4,638   |                  |   | 2,210  
|                       |  |                   |         |                  |   |        
|                       |  |                  
|Total                  |  | $                 | 145,015 |                  | $ | 148,752
|                       |  |                   |         |                  |   |        



NOTE 14. COMPREHENSIVE INCOME
(LOSS)



The components of comprehensive income (loss) are as follows:



|                                         |  |                                            |       |      |                                            |        |      |  |   |        |   |  |   |         |  
|---------------------------------------- |  | ------------------------------------------ | ----- | ---- | ------------------------------------------ | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                         |  | (Unaudited) Three MonthsEnded September30, |       |      | (Unaudited) Nine Months EndedSeptember 30, |       
|                                         |  | 2004                                       |       | 2003 |                                            |        | 2004 |  |   | 2003   |  
|Net income (loss)                        |  | $                                          | 493   |      | $                                          | (8,954 | )    |  | $ | (1,541 | ) |  | $ | (35,926 | )
|Foreign currency translation adjustments |  |                                            | 542   |      |                                            | 35     |      |  |   | 210    |   |  |   | 970     |  
|                                         |  |                                            |       |      |                                            |        |      |  |   |        |   |  |   |         |  
|                                         |  |                                            |       |     
|Comprehensive income (loss)              |  | $                                          | 1,035 |      | $                                          | (8,919 | )    |  | $ | (1,331 | ) |  | $ | (34,956 | )
|                                         |  |                                            |       |      |                                            |        |      |  |   |        |   |  |   |         |  



NOTE 15. LEGAL PROCEEDINGS



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, 2003; Note 11 to the condensed financial statements included in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2004; and Note 14 to the condensed
financial statements included in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2004. Unless otherwise indicated, all proceedings in those earlier Reports remain outstanding.



Other Legal Matters



The Company is subject, from time to time, to various other 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 other legal matters will have a material adverse effect on the Companys
consolidated results of operations or consolidated financial position.



NOTE
16. 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 has
been conducting 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 had estimated its probable minimum
liability 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.



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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, 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 Certain Factors that May Affect Our
Business 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.



OVERVIEW



Background



We are a global provider of Identity and Access Management solutions. Our software enables enterprises and governments to extend their
business reach to customers, partners and employees. Our solutions for secure identity management, secure messaging and secure data increase productivity and improve extended relationships by transforming the way transactions are done online. Over
1,400 organizations in more than 50 countries use our proven software and services to turn business and security challenges into secure business opportunities.



We conduct business in one operating segment. We develop, market and sell software solutions that secures 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 a global functional organization.



EXECUTIVE OVERVIEW



We are a global provider of software that helps our customers achieve their goals of securely
managing their wide range of identities across different platforms, architectures and devices. Our customer value is achieved when we serve as a trusted advisor to our customer and our products are successfully deployed. We accomplish this by
delivering software and services for our customers Identity and Access Management needs.



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The Identity and Access Management market, commonly called the I&AM market, is the overall segment of the information
technology market place that we participate in.



Our products and services
provide customers with I&AM solutions, which help to meet their specific needs for Secure Messaging, Secure Identity Management and Secure Data. Our broad set of capabilities in these three areas gives Entrust a strong portfolio in the I&AM
market. Customers benefit from their ability to purchase one set of capabilities from Entrust to meet their I&AM needs and have, at the same time, the option to extend their investment in our products and services across the requirements of
their business. We believe this is a competitive advantage for us. Our approach of blending best-in-class products and services, whether developed by Entrust or one of its partners, to deliver a comprehensive suite to the market space also goes
along well with the trusted advisor role that we have taken with our customers. We have the capabilities to assist our customers across their wide range of needs for I&AM, where many of our competitors can only assist them with respect to a
narrow range of needs. We look to continue to grow our market share in the I&AM space through the development of new products, partnerships and acquisitions.



We sell our products and services in both the enterprise and government market space. In Q3, 2004, 74% of our product sales were in our
extended enterprise vertical market. This is up from 55% a year ago and represented an increase of over $1.7 million from Q3, 2003 and nearly $2 million from Q2, 2004. The increase in product revenues in the enterprise market over the last year have
been driven by increased deployment by both our installed base as well as new customers. Enterprises are being driven by legislation and regulation to increase the security of their data and the identity of their employees as well as their
suppliers, partners and customers. In the fourth quarter we continue to see demand from global enterprises as they continue to extend their internal and external networks to more and more individuals inside and outside their domain.



In Q3, 2004, 26% of our product sales were in our extended government vertical market, which
includes healthcare. This is down from 36% in Q2, 2004 but was an increase in dollars over the previous quarter. The increase in revenue in the quarter was driven by key global projects, which have started to increase product purchases. In many of
these projects we have been providing services for several quarters and are now realizing the product revenues that are associated with those projects. We are well positioned in both markets, and we see growth opportunities in each area. In the
extended government vertical market, we have a strong penetration in the U.S. Federal government market space, the government of Canada, Singapore, Denmark, United Kingdom and across continental Europe. As governments continue to increase spending
on e-government initiatives and security projects, we are well positioned to help them in their I&AM needs. In the enterprise market, the need for a deeper integration with partners, suppliers and customers, coupled with the need for security
and lower costs, continues to be key drivers for our customers to purchase our offerings. Budgets, timing and allocation of budget dollars continue to keep us guarded on our growth expectations in the remainder of the year. We feel the spending
environment is better than it has been in the last two years, but this market could still cause quarterly fluctuations in our product revenue attainment.



We rely significantly on large deals in each quarter. Our software revenue from our top five customers in Q3, 2004 was approximately 14% of our total software revenue in
that quarter. This was at the low end of our historical range, which is generally between 10% and 25%. We had one deal over $1 million in Q3, 2004, as opposed to none in the last quarter. Although our revenue in the quarter allowed us to return to
profitability, we continue to be impacted on our software revenue by the process that our customers are going through to complete a proof of concept, which sometimes has proven to produce a longer sales cycle. 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.



In order to support our market opportunities, we have a marketing organization focused on
creating brand awareness and new business opportunities for the Company. Key branding initiatives include Web advertising, search engine optimization for keyword searches, public relations initiatives and sponsorships of key security and government
events and forums. One of these key initiatives that has carried over from 2003 to 2004 is our focus on positioning ourselves as a thought leader in information security governance (ISG). In 2003 we co-chaired a task force for the
Business Software Alliance to focus on this issue. The task force launched an in-depth framework for enterprise ISG. Also in 2003, we were selected to co-chair the Department of Homeland Securities Task Force on Cybersecurity. This task force is
also looking at the ISG issue, but from a homeland security standpoint. In April of this year, the task force released its findings and is currently working to gain industry and government support for the recommendations. We are hopeful that our
work on ISG will position us to be a key component of the quality process that companies adopt to secure their most critical digital resources.



Assisting us in our growth strategy in this market will be our ability to serve as the trusted advisor to our clients. In this capacity we will continue to expand our
offerings by building new products and solutions, partnering with technology providers and bringing it all together for the customer with our services offerings. Our services group gives us the capabilities to help our customers deploy a total
solution that meets their demands for securing digital identities and information. In Q3, 2004, our US professional services team achieved their highest quarterly professional services revenue in over three years and our



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Entrust Cygnacom division achieved their highest professional services quarterly revenue ever. Our services revenues
increased 4% from Q3, 2003, and were essentially flat from Q2, 2004. We believe that the investment in services is paying off. We remain positive on our outlook for services in 2004. However, budgets, adoption of our software and our leveraging of
our services partners could all impact our ability to create services revenue.



We earn revenue by providing both software and services to our customers. We earn software revenue mainly on a per user basis under a perpetual licensing agreement. We earn services revenue by providing support and maintenance to our
customers along with professional services for the planning, architecture and deployment of our products and services. In Q3, 2004, 30% of our revenue was from product sales and 70% was from services and maintenance, compared to 24% from product and
76% from services and maintenance in Q2, 2004, and 29% from product and 71% from services and maintenance in Q3, 2003. Over the last three years, we have become a more services-led company as we have been focused on helping our customers deploy our
products. In 2004, we will continue to focus on providing services to our customers, but we will also look to increase the percentage of software sales in relation to services, primarily through the introduction of new software products.



Over the past three years, we have focused on keeping our cost structure in line with our
current revenue opportunity. In the second quarter of 2003, we restructured the Company and established a goal of reaching breakeven by the end of 2003. In the fourth quarter of 2003 we met this goal and produced a $60 thousand net profit. We
followed that accomplishment up with net profits of $519 thousand and $493 thousand in Q1 and Q3, 2004, respectively. This achievement was an important step in our strategy of returning the Company to a growth and leadership position in the I&AM
market space. In the second quarter of 2004, our product revenues declined $2.6 million from the first quarter, falling short of expectations. However, product revenues recovered in Q3, 2004, posting a $1.8 million increase over Q2, 2004, and a $700
thousand increase over the same quarter of 2003.



We have a history of
providing valued security solutions to our customers. In 2003, we released a number of new products that are beginning to be deployed in the market. Evidence of new product deployment came in the second quarter of 2004 as all five of our top five
deals in the quarter contained at least one component of our newly released product offerings. Key in the third quarter of 2004 was the commercial release of Entrust Compliance Server. Entrust Compliance Server is a Linux-based appliance that helps
enterprise and government customers enable real-time e-mail compliance. This highly accurate and efficient content scanning technology, based on the technology we acquired in our asset purchase from AmikaNow!, automatically enforces e-mail policy
pertaining to individual privacy, intellectual property protection, anti-spam, vulgarity, and regulatory mandates such as HIPAA, Sarbanes-Oxley and Gramm-Leach Bliley.



To assist customers in protecting e-mail messages identified as private or sensitive, Entrust also announced enhancements to its boundary
and desktop e-mail security products, vastly increasing its secure messaging portfolio.



We also announced a new strategic technology, sales and marketing relationship with Pointsec Mobile Technologies in Q3, 2004. The relationship with Pointsec enables Entrust to address the growing need for protecting data on mobile devices.
Bringing together their award-winning security capabilities, the two companies developed and are now jointly marketing data security products designed to protect information in laptop, desktop, PDA, server and other mobile and wireless environments.
Further, in the third quarter of 2004, we increased our investments in Entrust Japan to a majority ownership and in Ohana Wireless.



Subsequent to the end of the quarter we released a new solution, Entrust IdentityGuard, a new strong authentication product designed to reduce the impact of identity
theft that has damaged confidence in on-line transactions. With the dramatic rise of attacks such as phishing, enterprises and their customers are seeking more cost-effective and flexible ways to protect users identities. Entrust IdentityGuard
provides an affordable, easy-to-implement and deployable second-factor of authentication solution that makes users less vulnerable to fraud, while helping organizations reduce the financial losses associated with identity theft.



Our management uses the following metrics to measure performance:



| | Number of product revenue transactions;
|- | ---------------------------------------



| | Average product revenue transaction size;
|- | -----------------------------------------



| | 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 solutions areas: Secure Messaging, Secure Identity Management, and Secure Data;
|- | -----------------------------------------------------------------------------------------------------------------------



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



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



| | Deferred revenue and Cash marketable investment balances
|- | --------------------------------------------------------



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BUSINESS OVERVIEW



During the third quarter of 2004, we continued our strategy of focusing on core vertical and geographic markets. Revenues of $21.3 million
consisted of 30% product sales and 70% services and maintenance. There was one deal over $1 million. Product revenue increased 12% over Q3, 2003, and 40% over Q2, 2004, driven by our higher software transaction closure rate and improved average
purchase value in the third quarter of 2004. Services and maintenance revenues were consistent with both the second quarter of 2004 and the third quarter of 2003. Q3, 2004 net income was $0.5 million, or $0.01 per share, compared to a $9.0 million
net loss, or $0.14 per share in Q3, 2003, and a net loss of $2.6 million, or $0.04 per share, in Q2, 2004. Entrust Secure Messaging Solutions accounted for 29% of software revenue, which is an increase of 247% from Q2, 2004 and an increase of 29%
from Q3, 2003. In the third quarter, we also achieved our first sale of Entrust Compliance Server. Entrust Secure Identity Management Solutions accounted for 57% of software revenue, which is an increase of 5% from Q2, 2004 and an increase of 8%
from Q3, 2003. Entrust Secure Data Solutions accounted for 13% of software revenue, which is an increase of 56% from Q2, 2004 and roughly equal to the software revenue in Q3, 2003. Entrust Certificate Services revenue increased 12% over Q2, 2004 and
45% over Q3, 2003. This is Entrust Certificate Services 4th consecutive record revenue quarter. Extended Enterprise accounted for 74% and Extended Government accounted for 26% of the product revenue in the quarter. The finance vertical accounted for
approximately 54% of third quarter product revenue.



Other highlights from the
third quarter of 2004 included:



| | Deferred revenue was $23.2 million, which is a year-over-year increase of approximately 25%.
|- | --------------------------------------------------------------------------------------------



| | Services and Maintenance comprised $14.8 million of total revenue. Services revenues were driven by Entrust Cygnacom, a business unit focused on providing security services to the
U.S. Federal government, and U.S. professional services, which achieved its highest revenue level in over three years.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Entrust Certificate Services achieved its 4thconsecutive quarter of revenue growth.
|- | -----------------------------------------------------------------------------------



| | We have produced cash from operations of approximately $6.3 million for the first nine months of 2004.
|- | ------------------------------------------------------------------------------------------------------



| | The top five transactions accounted for 14% of Q3, 2004 revenues. The average purchase size this quarter was $93 thousand, up from $90 thousand in Q2, 2004 and $79 thousand in Q3,
2003. Total transactions reached 56, which is up from 39 in Q2, 2004 and is consistent with historical levels.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our key technology-related accomplishments during the third quarter of 2004 included the following:



| | We announced Entrust IdentityGuard, a new strong-authentication product designed to reduce the impact of identity theft that has damaged confidence in on-line transactions. With the
dramatic rise of attacks such as phishing, enterprises and their customers are seeking more cost effective and flexible ways to protect users identities. Entrust IdentityGuard provides an affordable, easy-to-implement and deployable second
factor of authentication solution that makes users less vulnerable to fraud, while helping organizations reduce the financial losses associated with identity theft.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | We announced the commercial availability of the Entrust Entelligence Compliance Server, a Linux-based appliance that helps enterprise and government customers enable real-time e-mail compliance. This highly accurate and
efficient content scanning technology automatically enforces e-mail policy pertaining to individual privacy, intellectual property protection, anti-spam, vulgarity, and regulatory mandates such as HIPAA, Sarbanes-Oxley and Gramm-Leach Bliley. To
assist customers in protecting e-mail messages identified as private or sensitive, Entrust also announced enhancements to its boundary and desktop e-mail security products, vastly increasing our secure messaging portfolio.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | We announced that the recently-acquired AmikaNow! artificial intelligence-based compliance technology received the 2004 Frost & Sullivan Award for Technology Innovation. This
award was presented to AmikaNow! and Entrust in recognition of their efforts in developing a set of first-class compliance and anti-spam solutions. The Entrust-owned technology delivers a highly sophisticated content analysis tool that can
automatically analyze and categorize e-mail messages and documents based on the context and meaning of their contents, not simply pre-defined word lists.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Entrust and Pointsec Mobile Technologies announced a new strategic technology, sales and marketing relationship to address the growing need for protecting data on mobile devices.
Bringing together their award-winning security capabilities, the two companies developed and are now jointly marketing data security products designed to protect information in laptop, desktop, PDA, server and other mobile and wireless environments.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Entrust Ready Partners including ActivCard, AET Europe, Aladdin Knowledge Systems, Axalto, Datakey, Monet+, SafeNet and Siemens, recently outlined the continued availability of comprehensive security solutions for the
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Microsoft® Windows® platform and associated applications. These solutions enable organizations to strongly authenticate their users with the confidence of a hardware form factor. However, unlike most
proprietary token technology, they allow customers to add security capabilities beyond authentication for applications such as secure e-mail or file encryption. These solutions provide customers with a broad set of application security capabilities,
all from a single solution.



| | We announced that the U.S. Department of Agricultures National Finance Center (NFC), which uses our products, has been officially named a certified provider of Public Key
Infrastructure (PKI) services for the federal government after meeting the requirements of the Federal Identity Credentialing Committee (FICC). The NFC`s Entrust software-based offering is the only public-private collaboration to be certified by the
FICC.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



CRITICAL ACCOUNTING POLICIES



In the third quarter of 2004, 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 and purchase accounting, the provision for income 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, 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 probable 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. This policy is applicable to all sales
transactions, including sales to resellers and end user customers. 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 actual sale
took place. 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 onset, we recognize revenue when the fee becomes fixed and determinable. We assess if collection is probable 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 probable, 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.



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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 cancellable if the legislature or funding authority does not appropriate the funds necessary for the governmental unit to fulfill 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 a remote
contingency. If the likelihood of cancellation is assessed as remote, then the software licensing arrangement is considered non-cancellable 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 of the arrangement using the residual value method, based on the vendor-specific objective evidence of the fair value of the various elements. These elements may include one 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 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 separate sales of renewals of
maintenance and support contracts. Fair value of future services, training or consulting services is based upon separate 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. However, for arrangements involving
non-monetary exchanges the Company accounts for them in accordance with APB 29, Accounting for Nonmonetary Transactions. In the third quarter of 2004, we were involved in a non-monetary transaction with a customer; however, we
established that a clear business purpose for the transaction existed and we were reasonably able to assign fair value to the consideration given by both parties to the transaction. Therefore, we concluded that it was appropriate to recognize
revenue for the value of the product and services provided and record the associated expense for the products and services received. This non-monetary transaction accounted for less than 1% of total revenue for the third quarter of 2004.



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. At the time of a transaction, we assess whether the fee associated with the revenue transaction is fixed and determinable based on the payment terms associated with the transaction and the creditworthiness
of the customer. We also assess whether collection is reasonably assured. If any portion of a fee is due after 365 days from the invoice date, we account for the fee as not being fixed and determinable. In these cases, we recognize revenue as the
fees become due.



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. If we determine that collection of a fee is not reasonably assured, we defer the fee and recognize revenue at the time
collection becomes reasonably assured, which is generally upon receipt of cash.



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 collecting a specific account receivable becomes doubtful. 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



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it to be categorized as an allowance for bad debts. We have focused on improving our accounts receivable aging and, as a
result, have been able to reduce our corresponding allowance for doubtful accounts in the nine months of 2004 in the process. Our accounts receivable include material balances from a limited number of customers, with five customers accounting for
29% of gross accounts receivable at September 30, 2004, compared to 39% of gross accounts receivable at September 30, 2003. No customers accounted for 10% or more of net accounts receivable at September 30, 2004. For more information on our customer
concentration, see our related discussion in Certain Factors That May Affect Our Business. 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.



As of
September 30, 2004, the total accounts receivable is $15.9 million, net of an allowance for doubtful accounts of $1.1 million compared to $18.8 million, net of an allowance for doubtful accounts of $4.0 million as of December 31, 2003.



During the first quarter of 2004, we reached a settlement agreement on a significant and
long outstanding receivable related to a license agreement executed in June 2000. This receivable had been completely provided for in fiscal 2001, because it was our determination then that the likelihood of full payment was less than probable,
despite the fact that we had undertaken all avenues of collection available to us, including litigation. As part of the process of pursuing collection through the court system, we entered into settlement discussions with the customer. As a result of
these discussions, a settlement was reached under which full payment of the original invoiced amount of $2.0 million was assured upon execution of a new agreement, half of which was received prior to March 31, 2004, while the other half remained in
accounts receivable at that date and was collected in April 2004. In total, we reduced our allowance for doubtful accounts by approximately $2.0 million due to the settlement. As part of this settlement agreement, we also agreed to provide this
customer with additional software products and professional services, the related costs of which were provided for from the allowance that had previously been set up against the receivable. The remaining allowance in the amount of $1.3 million was
reversed against sales and marketing expenses as a recovery of this bad debt.



In a separate matter, during the third quarter of 2004, the Company collected $550 thousand that had been outstanding over 365 days and had previously been fully reserved. The balance of $550 thousand was reversed against sales and
marketing expense as a recovery of bad debt during the third quarter.



Restructuring 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. 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.



We conducted our assessment of the accounting effects of the June 2001 restructuring plan in
accordance with EITF No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity, SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed of, APB Opinion No. 9, Reporting the Results of Operations and the relevant provisions of the SECs SAB No. 100, Restructuring and Impairment Charges.



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 the estimation of sub lease income for restructured facilities, of $29.7 million at September 30, 2004, could have a material effect on our reported results, as actual
results could vary from these assumptions and estimates. As of September 30, 2004, we estimated a total of $22.6 million of sublease recoveries in our restructuring



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accrual. Of this amount, $22.1 million is related to the Santa Clara facility. In addition, $7.9 million of the $22.6
million is recoverable under existing sublease agreements, and the remaining $14.7 million of rent recoveries is based on estimates which may be subject to adjustment based upon changes in the real estate sublet markets.



The restructuring plan announced on June 4, 2001 was completed by June 2002. No further
changes 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.



The workforce portion of the restructuring
plan included severance and related costs of $4.8 million for 151 positions from all functional areas of the company and had been 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 excess space in the Companys Santa Clara, California and Addison, Texas facilities) and accelerated amortization on related leaseholds and equipment. The facilities plan was
executed by September 30, 2003 and, as a result, the Company recorded $4.1 million of charges during 2003 related to these facilities, including $1.3 million for accelerated amortization on leaseholds and equipment whose estimated useful lives had
been impacted by the plan to cease using the related excess space in the Companys facilities. The total amount of the workforce and facilities charges was $8.9 million. Of this amount, $4.6 million had been incurred by June 30, 2003 and
charged to the restructuring charges line in the consolidated statement of operations for the second quarter of 2003, while the remaining $4.3 million was recorded in the third quarter of 2003.



We conducted our assessment of the accounting effects of the May 2003 restructuring plan in
accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, APB Opinion No. 9, Reporting the Results of
Operations, and the relevant provisions of the SECs SAB No. 100, Restructuring and Impairment Charges.



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 $1.7 million at September 30, 2004 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, 2004 includes a total of $0.7 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 and Equity Investments and Purchase Accounting



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, made in 2000 and 2001, 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.



Since 2001, we have recorded a total of $14.8 million of impairment charges with respect to
our long-term strategic investments due to other than temporary declines in the value of these strategic investments. These impairments were related to our investments in several different companies. We have no other strategic investments recorded
as of June 30, 2004.



In April 2002, we began accounting for our investment in
Entrust Japan 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, under the
step acquisition method, during the second quarter of 2002, we recorded a retroactive adjustment to consolidated accumulated deficit to record our share of the post-acquisition losses of Entrust Japan for prior years in the amount of $393 thousand,
as required by this accounting guidance. This retroactive



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adjustment is attributable to our pro rata share of losses recorded by Entrust Japan during the period in which we owned
less than 10% of its voting stock, to the extent of our previous investment and affected the results of periods prior to those shown here.



In addition, we recorded our share of post-acquisition losses of Entrust Japan, in the amount of $174 thousand and $551 thousand in our consolidated losses for the three
and nine months ended September 30, 2004, respectively, compared to $212 thousand and $450 thousand for the three and nine months ended September 30, 2003, respectively. These losses are attributable to our pro rata share of Entrust Japans
losses, prior to our acquisition of a majority ownership interest in Entrust Japan on September 13, 2004, while we have had an equity ownership in Entrust Japan of approximately 37% of its voting stock and totaled $1.8 million since the second
quarter of 2002.



In addition, we had concluded, based on our understanding of
the facts, that prior to acquisition of 1,700,000 additional shares, Entrust Japan met the definition of a variable interest entity, as described in FIN No. 46, as it did not have an equity investment at risk that was sufficient to permit Entrust
Japan to finance its activities without additional subordinated financial support from other parties. Although we held a significant variable interest, we believe that we were not the primary beneficiary of Entrust Japan because our interests did
not give us a majority of the expected losses and residual returns of the entity. Accordingly, prior to September 13, 2004, we accounted for Entrust Japan under the equity method. We did not consolidate the results and financial position of Entrust
Japan with our consolidated results of operations and consolidated balance sheet for financial reporting purposes until September 13, 2004 when our ownership increased to 99%.



In July 2004, we increased our investment in Ohana to $1.225 million, which is held in the form of a convertible loan. This amount was
increased by $275 thousand in the fourth quarter of 2004 (see Note 5 to our Condensed Consolidated Financial Statements). We determined that the loan was unlikely to be repaid but rather expect it to be converted into equity in Ohana Holdco, once
Ohana becomes a wholly owned subsidiary of Ohana Holdco in connection with the Ohana Restructuring (see Note 5 to our Condensed Consolidated Financial Statements), which is expected to close on or about November 5, 2004 subject to customary closing
conditions. On an as-converted basis at September 30, 2004, we would have held the equivalent of approximately 12% ownership share of Ohana Holdco. We have concluded that because of the additional investment and additional rights obtained, in July
2004 we gained the potential ability to exercise significant influence over the operations of Ohana. Therefore, beginning the third quarter of 2004, we have 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 have included our share of post-acquisition losses of Ohana, in the
amount of $122 thousand in our consolidated losses for the current fiscal year.



If the demand for the technologies and products offered by Ohana materializes slowly, to a minimum extent, or not at all in the relevant market, we could lose all or substantially all of our investment in this company. To date, we have not
recorded any impairment in connection with this investment.



Ohana is an entity
in the development stage with limited equity. As a result, we have concluded that Ohana is a variable interest entity. Ohanas assets consist primarily of cash and intellectual property. We have also concluded that we are not the primary
beneficiary of Ohana and, accordingly, the convertible loan is recorded in other long-term assets in our consolidated balance sheet. Our maximum exposure to Ohana is the $1.5 million existing convertible loan.



On June 18, 2004, we completed the acquisition of intellectual property and certain other
assets of AmikaNow, a privately-held provider of advanced anti-spam, e-mail content scanning and analysis technology, which is a development stage company with negligible revenue, in exchange for $2.7 million in cash and $1.3 million in guaranteed
future payments payable over three years and other acquisition-related costs. In addition, we offered employment to certain employees of AmikaNow. Also, we may be required to make additional payments of up to a maximum of $2.4 million, in the form
of royalties calculated based on the sale of products that incorporate the technology acquired from AmikaNow for a period of three years following the date of acquisition, if and only if sufficient sale of products take place in this time frame.



On September 10, 2004, we completed the acquisition 1,700,000 shares of voting
common stock of Entrust Japan, a privately-held company engaged in selling, servicing and supporting solutions that enable organizations to secure digital identities and information in the Japanese market, with an exclusive license to market and
sell Entrust products in Japan., in exchange for $1.6 million in cash. This acquisition of shares increased our ownership interest in Entrust from 37% to 99% of the outstanding voting stock.



These acquisitions were accounted for under the purchase method of accounting, and,
accordingly, the purchase price in each case was 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 were 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 developed technology and non-contractual customer
relationships, 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 and SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, which require goodwill and intangible assets to be reviewed for impairment at
least annually or whenever events indicate that their carrying amount may not be recoverable. In such reviews, the related undiscounted cash flows expected are compared with their carrying values to determine if a write-down to fair value is
required.



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.



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 have a valuation allowance of $129.6 million as of September 30, 2004,
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 $104.5 million and $25.1 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. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to adjust our valuation allowance, which could materially impact
our financial position and results of operations.



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Stock-Based Compensation



Our stock option 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 stockholders. Stock options are typically granted to employees when they first join us but can also be granted when there is a significant
change in an employees responsibilities and, occasionally, to achieve equity within a peer group. The Compensation Committee of the Board of Directors may, however, grant additional options to executive officers and key employees for other
reasons. Under the stock option 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 and generally expire ten years from the date of grant.



We recognize that stock options dilute existing shareholders and have attempted to control
the number of options granted while remaining competitive with our compensation packages. At September 30, 2004, approximately 88% of our outstanding stock options carried exercise prices in excess of the closing market price of our Common stock on
that day. The Compensation Committee of the Board of Directors oversees the granting of all stock-based incentive awards.



We account for our stock option plans under the recognition and intrinsic value measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related accounting guidance. Accordingly, no stock-based compensation expense is reflected in net earnings for grants to employees under these plans, when the exercise price for options granted under these plans is equal to the
market value of the underlying Common stock on the date of grant. All of the options granted to employees in the periods after 1998 had exercise prices equal to the fair value of the underlying stock on the date of grant and therefore, no
stock-based compensation costs are reflected in earnings for these options in these periods. Compensation expense was recognized for our stock based compensation plans in 1998 because the exercise price of some options granted in that period were
determined, for accounting purposes, to be below the fair value of the underlying stock as of the grant date for such stock options.



If we had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based compensation, the effect
would have been to create a net loss in the three months ended September 30, 2004 of $1.7 million and to increase our net loss to $9.4 million for the nine months ended September 30, 2004, compared to a net loss of $12.6 million and $46.0 million
for the three and nine months ended September 30, 2003, respectively, and consequently, we would have reported a net loss per share of $0.03 and $0.20 for the three and nine months ended September 30, 2004, respectively, compared to a net loss per
share of $0.20 and $0.72 for the three and nine months ended September 30, 2003, respectively. However, we believe, that due to the volatility of our stock and the inherent limitations of option valuation models, the expenses that would be recorded
under SFAS No. 123 are not as meaningful as a careful consideration of the outstanding option data, which is disclosed in note 3 to our condensed consolidated financial statements, included in this report. As an illustration, because of significant
movement in the market value of our stock price, the percentage of total options outstanding that were considered to be In the Money (options with exercise prices at or below the closing market price per share) went from 35% at June 30,
2004 to 12% at September 30, 2004.



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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:



|                                                        |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|------------------------------------------------------- |  | ------------------------------------------ | - |  | ----------------------------------------- | -- |  | ----- | -- |  | ----- | --
|                                                        |  | (Unaudited)THREE MONTHS ENDEDSEPTEMBER 30, |   |  | (Unaudited)NINE MONTHS ENDEDSEPTEMBER 30, |   
|                                                        |  | 2004                                       |   |  | 2003                                      |    |  | 2004  |    |  | 2003  |   
|Revenues:                                               |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|Product                                                 |  | 30.4                                       | % |  | 28.9                                      | %  |  | 28.8  | %  |  | 35.0  | % 
|Services and maintenance                                |  | 69.6                                       |   |  | 71.1                                      |    |  | 71.2  |    |  | 65.0  |   
|                                                        |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|                                                        |  |                                            |   | 
|Total revenues                                          |  | 100.0                                      |   |  | 100.0                                     |    |  | 100.0 |    |  | 100.0 |   
|                                                        |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|Cost of revenues:                                       |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|Product                                                 |  | 3.9                                        |   |  | 6.4                                       |    |  | 4.6   |    |  | 5.9   |   
|Services and maintenance                                |  | 31.1                                       |   |  | 37.6                                      |    |  | 33.6  |    |  | 34.9  |   
|Amortization of purchased product rights                |  | 0.8                                        |   |  |                                          |    |  | 0.3   |    |  | 0.9   |   
|                                                        |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|                                                        |  |                                            |   | 
|Total cost of revenues                                  |  | 35.8                                       |   |  | 44.0                                      |    |  | 38.5  |    |  | 41.7  |   
|                                                        |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|                                                        |  |                                            |   | 
|Gross profit                                            |  | 64.2                                       |   |  | 56.0                                      |    |  | 61.5  |    |  | 58.3  |   
|                                                        |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|Operating expenses:                                     |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|Sales and marketing                                     |  | 27.0                                       |   |  | 43.7                                      |    |  | 29.1  |    |  | 43.2  |   
|Research and development                                |  | 18.5                                       |   |  | 29.7                                      |    |  | 20.1  |    |  | 28.3  |   
|General and administrative                              |  | 15.5                                       |   |  | 16.1                                      |    |  | 15.3  |    |  | 15.7  |   
|Impairment of purchased product rights                  |  |                                           |   |  |                                          |    |  |      |    |  | 1.8   |   
|Restructuring charges and adjustments                   |  |                                           |   |  | 11.1                                      |    |  |      |    |  | 21.2  |   
|                                                        |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|                                                        |  |                                            |   | 
|Total operating expenses                                |  | 61.0                                       |   |  | 100.6                                     |    |  | 64.5  |    |  | 110.2 |   
|                                                        |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|                                                        |  |                                            |   | 
|Income (loss) from operations                           |  | 3.2                                        |   |  | (44.6                                     | )  |  | (3.0  | )  |  | (51.9 | ) 
|                                                        |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|                                                        |  |                                            |   | 
|Other income (expense):                                 |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|Interest income                                         |  | 1.7                                        |   |  | 1.9                                       |    |  | 1.4   |    |  | 2.2   |   
|Foreign exchange gain (loss)                            |  | (0.6                                       | ) |  | (0.5                                      | )  |  | 0.7   |    |  | (0.6  | ) 
|Loss from equity investment                             |  | (1.4                                       | ) |  | (1.0                                      | )  |  | (1.1  | )  |  | (0.7  | ) 
|Write-down of long-term strategic investments           |  |                                           |   |  |                                          |    |  |      |    |  | (4.3  | ) 
|                                                        |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|                                                        |  |                                            |   | 
|Total other income (expense)                            |  | (0.3                                       | ) |  | 0.4                                       |    |  | 1.0   |    |  | (3.4  | ) 
|                                                        |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|                                                        |  |                                            |   | 
|Income (loss) before income taxes and minority interest |  | 2.9                                        |   |  | (44.2                                     | )  |  | (2.0  | )  |  | (55.3 | ) 
|Minority interest in subsidiary                         |  |                                           |   |  |                                          |    |  |      |    |  |      |   
|                                                        |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|                                                        |  |                                            |   | 
|Income (loss) before income taxes                       |  | 2.9                                        |   |  | (44.2                                     | )  |  | (2.0  | )  |  | (55.3 | ) 
|Provision for income taxes                              |  | 0.6                                        |   |  | 0.5                                       |    |  | 0.4   |    |  | 0.7   |   
|                                                        |  |                                            |   |  |                                           |    |  |       |    |  |       |   
|                                                        |  |                                            |   | 
|Net income (loss)                                       |  | 2.3                                        | % |  | (44.7                                     | )% |  | (2.4  | )% |  | (56.0 | )%
|                                                        |  |                                            |   |  |                                           |    |  |       |    |  |       |   



REVENUES



We generate revenues from licensing the rights to our software products
to end-users and, to a lesser extent, from sublicense fees from resellers. We also generate revenues from consulting, training and post-contract support, or maintenance, performed for customers who license our products. We recognize revenues in
accordance with the provisions of the SOP No. 97-2, Software Revenue Recognition, SOP No. 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions and related accounting guidance and
pronouncements.



Revenues from perpetual software license agreements are
recognized as revenue when we have received a copy of 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 probable 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. This policy is applicable to all sales transactions, including sales to resellers and end user customers. We are notified of a sale by a reseller to the
end user customer in the same period that the actual sale took place. We do not offer a right of return on sales of our software products.



The Company is sometimes subject to fiscal funding clauses in its software licensing transactions with the United States government and its agencies. Such clauses
generally provide that the license is cancellable if the legislature or funding authority does not appropriate the funds necessary for the governmental unit to fulfill 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 a remote contingency. If the likelihood of cancellation is
assessed as remote, then the software licensing arrangement is considered non-cancellable and the related software licensing revenue is recognized when all other revenue recognition criteria have been met.



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For arrangements involving multiple elements, we allocate revenue to each component of the arrangement using the residual
value method, based on the vendor-specific objective evidence of the fair value of the various elements. These elements may include one 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 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 separate sales of renewals of separate maintenance and support contracts. Fair
value of future services training or consulting services is based upon separate 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.



Revenues from maintenance services are recognized ratably over the term of the maintenance period, which is typically one year. If
maintenance services are included free of charge or discounted in a license agreement, such amounts are unbundled from the license fee at their fair market value based upon the value established by independent sales of such maintenance services to
other customers. Revenues from the sale of Web server certificates are also recognized ratably over the term of the certificate, which is typically one to two years.



Consulting and training revenues are generally recognized as the services are performed. Consulting services are typically performed under
separate service agreements and are usually performed on a time and materials basis. Such services primarily consist of implementation services related to the installation and deployment of our products and do not include significant customization
or development of the underlying software code. These services are not essential to the functionality of the underlying software licensed to the customer.



We use the percentage-of-completion method to account for fixed price custom development contracts. Under this method, we recognize revenue and profit as the work on the
contract progresses. Revenues are recognized by applying the percentage of the total cost incurred to date divided by the total estimated contract cost to the total contract value, and any projected loss is recognized immediately. The projects cost
estimates are reviewed on a regular basis.



Total Revenues



Total revenues were $21.3 million for the three months ended
September 30, 2004, which represented an increase of 7% from the $20.0 million of total revenues for the three months ended September 30, 2003. Total revenues were $63.9 million for the nine months ended September 30, 2004, which represented a
decrease of 1% from the $64.2 million of total revenues for the nine months ended September 30, 2003. Total revenues derived from North America of $16.0 million for the three months ended September 30, 2004 represented an increase of 12% from the
$14.3 million for the three months ended September 30, 2003, while the total revenues derived from outside of North America of $5.3 million for the three months ended September 30, 2004 represented a decrease of 16% from the $5.7 million for the
three months ended September 30, 2003. Total revenues derived from North America of $47.5 million for the nine months ended September 30, 2004 represented an increase of 8% from the $44.1 million for the nine months ended September 30, 2003, while
total revenues derived from outside of North America of $16.4 million for the nine months ended September 30, 2004 represented a decrease of 18% from the $20.1 million for the nine months ended September 30, 2003. The overall decline in total
revenues in the nine months ended September 30, 2004 was driven by a reduced closure rate for software transactions, particularly in the second quarter of 2004. However, our software transaction closure rate improved in the third quarter of 2004,
particularly in North America. The overall decrease in revenues year to date is largely due to the effect of a decline in license revenues, which was felt most strongly in Europe, Asia and other international locales, due to the continued soft
economic climate internationally. The level of non-North American revenues has fluctuated from period to period and this trend is expected to continue for the foreseeable future. In addition, extended government revenues, which includes healthcare,
generated in the United States decreased from $15.0 million for the nine months ended September 30, 2003 to $13.7 million from the nine months ended September 30, 2004, or a decrease of 9%, while these revenues increased from $3.9 million for the
third quarter of 2003 to $5.0 million for the same quarter of 2004, or an increase of 28%. The United States and Canadian governments represented 19% and 8% of total revenues in the third quarter of 2004, when including revenues sold through
resellers to the government end users. However, direct sales to the United States and Canadian governments represented only 12% and 6% of total revenues in the third quarter of 2004. Overall, the United States and Canadian governments represented
18% and 9% of total revenues in the first nine months of 2004, when including revenues sold through resellers to the government end users. However, direct sales to the United States and Canadian governments represented only 12% and 6% of total
revenues in the first nine months of 2004. One other individual customer accounted for 10% of total revenues in the three months ended September 30, 2004, while no other individual customer accounted for 10% or more of total revenues in the nine
months ended September 30, 2004 or in the three and nine months ended September 30, 2003, respectively.



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Product Revenues



Product revenues of $6.5 million for the three months ended September 30, 2004 represented an increase of 12% from the $5.8 million for the three months ended
September 30, 2003, representing 30% and 29% of total revenues in the respective periods. Product revenues of $18.4 million for the nine months ended September 30, 2004 represented a decrease of 18% from the $22.5 million for the nine months ended
September 30, 2003, representing 29% and 35% of total revenues in the respective periods. The decrease in product revenues in the first nine months of 2004 in absolute dollars when compared to the same period of 2003 is primarily due to reduced U.S.
government spending resulting from continued delays in budget approvals, the soft economic climate internationally and concerns over the war in Iraq. New project purchases have remained subject to governmental budgetary constraints, particularly in
the United States. In addition, the global downturn experienced from 2001 through 2003 continues to have a significant impact on information technology projects and the commitments that customers have made to expenditures in this area, with
customers buying for their immediate needs, as opposed to buying for a total project or enterprise. Highlighting this trend, we had 157 product revenue transactions (a product revenue transaction is defined as a product sale in excess of $10
thousand) in the first nine months of 2004, down from 206 in the first nine months of 2003, or a 24% decrease. Additionally, this decline reflected a lower volume of software license transactions representing greater than $1.0 million in product
revenue in the first nine months of 2004. However, we did experience improved product revenues in the three months ended September 30, 2004 compared to the same quarter of 2003, primarily due to increased penetration into the Enterprise customer
market, despite the fact that product revenue transactions in the third quarter of 2004 of 56 trailed the closure rate of 61 in the same quarter last year, representing a 8% decline. This was because the average license revenue transaction size
increased from $79 thousand in the third quarter of 2003 to $93 thousand in the third quarter of 2004, or an increase of 18%. The top-five license revenue transactions as a percentage of total revenues increased from 13% to 14% for the three months
ended September 30, 2004 compared to the same period in 2003, but declined from 18% for the nine months ended September 30, 2004 to 14% for the nine months ended September 30, 2003. Product revenues as a percentage of total revenues for the third
quarter of 2004 was consistent with the same quarter of the previous year, but decreased for the nine months ended September 30, 2004 compared to the same period in 2003 due to a stronger demand for services, primarily maintenance and support
services, relative to the demand for software.



Services and Maintenance
Revenues



Services and maintenance revenues of $14.8 million for the
three months ended September 30, 2004 represented an increase of 3% from the $14.3 million for the three months ended September 30, 2003, representing 70% and 71% of total revenues in the respective periods. Services and maintenance revenues of
$45.5 million for the nine months ended September 30, 2004 represented an increase of 9% from the $41.7 million for the nine months ended September 30, 2003, representing 71% and 65% of total revenues in the respective periods. The increase in
services and maintenance revenues is due to strong demand for Entrusts architecture and deployment services, as well as significantly improved support and maintenance revenue. The increase in services revenue in the three and nine months ended
September 30, 2004 when compared to the same periods of 2003 has been driven by increased professional services revenue in the United States, including record revenue from our Entrust CygnaCom division, and support and maintenance revenues, and
related support contract renewals, which continue to be at the highest levels in our history. We believe this support revenue performance reflects the value our products provide to our customers globally, the increasing customer deployment of
solutions and the level of service quality that our support and maintenance team delivers. Support and maintenance revenues grew $0.9 million for the first nine months of 2004 when compared to the same period of 2003 partly due to the acquisition of
Entrust Japan during the third quarter, while professional services revenues increased $2.9 million primarily due to a $2.4 million growth in revenues in our Entrust CygnaCom division. Services and maintenance revenues as a percentage of total
revenues for the third quarter of 2004 was consistent with the same quarter of the previous year, but such percentage increased for the nine months ended September 30, 2004 compared to the same period in 2003, reflecting the shift in the mix of
revenues from product to services and maintenance revenues, largely due to the strength of demand for our services and maintenance business relative to the demand for software.



EXPENSES



Total Expenses



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, impairment of purchased products rights and restructuring charges. Total expenses of $20.6 million for the three months ended September 30, 2004 represented a decrease of 29% from $29.0 million for the three
months ended September 30, 2003. Total expenses of $65.9 million for the nine months ended September 30, 2004 represented a decrease of 34% from $97.5 million for the nine months ended September 30, 2003. The decrease from the first nine months of
2003 was due primarily to costs of $14.8 million associated with our May 2003 restructuring that we incurred in the second and



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third quarters of 2003, as well as the impact of cost savings associated with our May 2003 restructuring plan of
approximately $16.8 million and the collection of a long outstanding receivable for which bad debt expense had been recorded in a previous year, which netted approximately $1.3 million reduction in selling and marketing expenses in the first quarter
of 2004. These savings were partially offset by increased costs in the first quarter of 2004 of $1.3 million related to our corporate bonus plan. As of September 30, 2004, we had 511 full-time employees globally, compared to 522 full-time employees
at September 30, 2003. No employees are covered by any collective bargaining agreements.



Cost of Product Revenues



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 $0.8 million for the three months ended September 30, 2004, which
represented a 38% decrease from $1.3 million for the three months ended September 30, 2003, representing 4% and 6% of total revenues in each of the respective periods. Cost of product revenues of $3.0 million for the nine months ended September 30,
2004 represented a 21% decrease from $3.8 million for the nine months ended September 30, 2003, representing 5% and 6% of total revenues in each of the respective periods. The net decrease in third-party royalties in the third quarter of 2004 was
the result of a $0.1 million increase due to the overall higher level of product revenues in the third quarter of 2004 compared to the same quarter of 2003, offset by a $0.6 million decrease due to a large third party royalty associated with one
product transaction in the third quarter of 2003. This also accounted for the decrease in cost of product revenues as a percentage of total revenues for the third quarter of 2004. For the nine months ended September 30, 2004, cost of product
revenues decreased, both in absolute dollars and as a percentage of total revenues, due to a general shift in the mix of product sales away from products that incorporate third party technology, which resulted in additional savings of $0.7 million
over and above the savings associated with the overall lower level of product revenues in the first nine months of 2004 compared to the same period of 2003. The mix of 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



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 $6.6 million for the three months ended September 30, 2004, which represented a 12% decrease from $7.5 million for
the three months ended September 30, 2003, representing 31% and 38% of total revenues for the respective periods. Cost of services and maintenance revenues was $21.5 million for the nine months ended September 30, 2004, which represented a 4%
decrease from $22.4 million for nine months ended September 30, 2003, representing 34% and 35% of total revenues for the respective periods. The decrease in the cost of services and maintenance revenues in absolute dollars in the third quarter of
2004 compared to the same quarter of 2003 was due to the net effect of decreased costs associated with operating efficiencies, which resulted in a $1.0 million reduction in the cost structure of our professional services team, despite improved
revenue performance for services and maintenance, offset by increased investment in our support and maintenance team and our Entrust CygnaCom services team of $0.1 million in the third quarter of 2004. Cost of services and maintenance revenues in
absolute dollars in the first nine months of 2004 decreased when compared to the same period of 2003, due to the net effect of decreased costs associated the operating efficiencies and with our May 2003 restructuring, which resulted in a $2.0
million reduction in the cost structure of our professional services team, despite improved revenue performance, offset by increased investment in our support and maintenance team and our Entrust CygnaCom services team of $1.1 million in the first
nine months of 2004. The decrease in the cost of services and maintenance revenues as a percentage of total revenues in the three months ended September 30, 2004 compared to the same period of 2003 is primarily due to the cost savings achieved, as
discussed above. The decrease in the cost of services and maintenance revenues as a percentage of total revenues in the nine months ended September 30, 2004 compared to the same period of 2003 was largely due to the fact that we were able to grow
services and maintenance revenues while not increasing our overall services and maintenance cost in the first nine months of 2004 and, in fact, decreasing these expenses in the second and third quarters of 2004 when compared to the same periods in
the prior year, through improved utilization of existing resources. The cost of services and maintenance revenues as a percentage of total revenues in the nine months ended September 30, 2004 decreased 4-percentage points due to this effect,
compared to the same period of the previous year. However, this effect was partially offset by the lower product revenue performance, particularly as a result of the reduced closure rate for software transactions in the first nine months of 2004,
and the shift in the mix of revenues from license to services and maintenance revenues compared to the same period of 2003, whereby services and maintenance revenues as a percentage of total revenues increased to 71% in the first nine months of 2004
from 65% in the first nine months of 2003. As the services and maintenance revenues represented the larger proportion of total revenues and declined less than total revenues, the cost of generating those services and maintenance revenues represented
a much larger percentage when compared against total revenues. Without this effect, services and maintenance expenses would have decreased 3% in relation to total revenues for the nine months ended September 30, 2004 compared to the same period of
the previous year.



Services and maintenance gross profit as a percentage of
services and maintenance revenues was 55% for the three months



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ended September 30, 2004 compared to 47% for the three months ended September 30, 2003. Services and maintenance gross
profit as a percentage of services and maintenance revenues was 53% and 46% for the nine months ended September 30, 2004 and 2003, respectively. The increase in services and maintenance gross profit as a percentage of services and maintenance
revenues for the three and nine months ended September 30, 2004, compared to the same periods of 2003, was primarily due to improved professional services revenues and operating efficiencies achieved in the form of higher productivity and
utilization of available professional services resources, particularly in North America, meaning lower relative costs associated with professional services in light of these improved revenues, which resulted in higher margin attainment by our
professional services team. These increases in professional services revenues accounted for an eight- and nine-percentage point increase in the services and maintenance gross profit as a percentage of services and maintenance revenues for the three
and nine months ended September 30, 2004, respectively, when compared to the same periods of 2003. However, support and maintenance margins declined for the nine months ended September 30, 2004 due to the significant investment made in this team
early in 2004 to ensure continued quality of service, which resulted in an offsetting two-percentage point decrease in the services and maintenance gross profit as a percentage of services and maintenance revenues, compared to the same period of the
previous year. We plan to continue to optimize the utilization of existing professional services resources, while addressing significant incremental customer opportunities that may arise in the near future with the help of partners and other
sub-contractors, until the 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 of services and maintenance revenues may vary from period to period and from transaction to transaction and, consequently, our gross margins and results of operations could be adversely affected.



Operating ExpensesSales and Marketing



Sales and marketing expenses decreased to $5.8 million for the three months ended September
30, 2004 from $8.8 million for the comparable period in 2003. Sales and marketing expenses decreased to $18.6 million for the nine months ended September 30, 2004 from $27.7 million for the nine months ended September 30, 2003. Sales and marketing
expenses represented 27% and 29% of total revenues for the three and nine months ended September 30, 2004, compared to 44% and 43% for the comparable periods in 2003. The decrease in sales and marketing expenses in absolute dollars was mainly due to
the continued management discipline with respect to spending, savings achieved as a result of our May 2003 restructuring and corresponding reduction in headcount, and the collection of a long outstanding receivable, which netted an approximate $1.3
million reduction in selling and marketing expenses in the first quarter of 2004. In addition, sales and marketing expenses were decreased by reductions in the provision for aged receivables of $0.6 million and $2.0 million in the three and nine
months ended September 30, 2004. Savings were also realized related to reduced sales commissions due to the lower product revenue achievement in the three and nine months ended September 30, 2004, respectively. The decrease in sales and marketing
expenses as a percentage of total revenues for the three and nine months ended September 30, 2004, compared to the same periods of 2003, reflected the effect of cost savings realized through our May 2003 restructuring and reduced spending through
efficiencies and discipline implemented in our sales processes, which decreased sales and marketing expenses as a percentage of total revenues by ten-percentage points (10% in the first nine months of 2004), a one-percentage point (1% in the first
nine months of 2004) decrease due to lower sales commission costs, and a four-percentage point (3% in the first nine months of 2004) decrease due to the bad debt recovery. In addition, these savings were complemented by a two-percentage point
decrease in sales and marketing expenses as a percentage of total revenues for the three months ended September 30, 2004, due to improved revenue achievement compared to the same period of 2003. We intend to continue to focus on improving the
productivity of these organizations with a view to gaining efficiencies in the related processes in light of current economic conditions. 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 direct and partner sales organizations in anticipation of future market growth, and (b) investing in
marketing efforts in support of new product launches. We feel 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 third quarter of 2004, the
allowance for doubtful accounts decreased $0.6 million to $1.1 million primarily as a result of a reduction in the allowance because of the significant improvement in our accounts receivable aging at September 30, 2004. During the first quarter of
2004, the allowance for doubtful accounts decreased to $2.0 million primarily due to the settlement of a long outstanding receivable discussed above, which had been fully provided for in fiscal 2001, and also due to effective cash collections during
the period. As a result, we recorded a net bad debt recovery of $1.2 million in the first quarter of 2004, after providing for the settlement costs related to the recovered bad debt and recording a provision for other aged receivables.



Operating ExpensesResearch and Development



Research and development expenses decreased to $3.9 million and $12.9 million for the three
and nine months ended



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September 30, 2004 from $6.0 million and $18.2 million for the comparable periods in 2003. Research and development
expenses represented 19% and 20% of total revenues for the three and nine months ended September 30, 2004, respectively, compared to 30% and 28% for the comparable periods in 2003. The decrease in research and development expenses in absolute
dollars for the three and nine months ended September 30, 2004, compared to the same periods in 2003, was mainly due to the continued management discipline in spending and savings achieved as a result of our May 2003 restructuring, which reduced
expenses in this area by approximately $2.1 million and $5.6 million in the three and nine months ended September 30, 2004. This decrease for the first nine months of 2004 was partially offset by increased compensation costs associated with our
corporate bonus plan of approximately $0.3 million recorded in the first quarter of 2004. Research and development expenses as a percentage of total revenues for the three and nine months ended September 30, 2004 decreased compared to the same
periods in 2003, mainly due to a ten- and eight-percentage point decrease in spending in this area, respectively, as a result of the May 2003 restructuring. This effect was augmented by the improved revenue achievement during the third quarter of
2004, which accounted for a one-percentage point decrease in these expenses as a percentage of total revenues in the three months ended September 30, 2004. 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 absolute dollars in the future if additional experienced
security experts and software engineers are required.



Operating
ExpensesGeneral and Administrative



General and administrative
expenses increased to $3.3 million for the three months ended September 30, 2004 from $3.2 million for the three months ended September 30, 2003 and decreased to $9.8 million for the nine months ended September 30, 2004 from $10.1 million for the
comparable periods in 2003. General and administrative expenses represented 16% and 15% of total revenues for the three and nine months ended September 30, 2004, compared to 16% for each of the comparable periods in 2003. The increase in general and
administrative expenses in absolute dollars for the third quarter of 2004 and decline in these expenses for the nine months ended September 30, 2004 compared to the same periods in 2003 was due to net effect of continued management discipline in
this area, with savings of $0.1 million in the third quarter ($0.5 million in the first nine months of 2004), and the implementation of our restructuring plan in May 2003, which resulted in reduced spending of $0.7 million for the first nine months
of 2004, offset by increased costs associated with Entrust Japan of $0.2 million in the third quarter of 2004 and increased compensation costs associated with the corporate bonus plan of $0.7 million recorded in the first quarter of 2004. General
and administrative expenses as a percentage of total revenues increased for the third quarter of 2004 compared to the same period of 2003, due to the additional Entrust Japan expenses, which accounted for a one-percentage point decrease in general
and administrative expenses as a percentage of revenue. General and administrative expenses as a percentage of total revenues for the first nine months of 2004 was consistent with the same period of 2003, largely due to the reduced spending that
resulted from our May 2003 restructuring, which translated into a three-percentage point decrease, which was offset by the increased costs related to the bonus plan in the first quarter of 2004 and Entrust Japan in the third quarter of 2004. 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 Impairment of Purchased Product Rights



Amortization of purchased product rights was $178 thousand and $201 thousand for the three and nine months ended September 30, 2004,
respectively, related to the acquisition of certain business assets from AmikaNow. This expense was recorded as a component of cost of revenues.



As a result of actions undertaken in the restructuring in the second quarter of 2003, coupled with the commercial release of a next generation software product, we
reviewed the estimated future cash flows from the developed technology acquired in 2000 from enCommerce, Inc. (enCommerce). Based on these events, the net present value of the estimated future cash flows from the purchased product rights
is negative. Therefore, we recorded an impairment charge in the second quarter of 2003 related to this asset in the amount of the remaining carrying value of $1.1 million, as we determined the asset had minimal fair value. Amortization of purchased
product rights in connection with the enCommerce acquisition of $568 thousand was expensed for the nine months ended September 30, 2003. This expense was recorded as a component of cost of revenues in those periods.



Restructuring and Adjustments



Following the first quarter of 2003, when our revenues fell short of our expectations, we
began a re-assessment of our operations to ensure that our expenses were optimally aligned to our customers and markets, and structured such that we could achieve our financial break even target for the fourth quarter of 2003.



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 through layoffs and attrition to lower operating costs, the closing of under-utilized office space and reassessing the useful life of related excess long-lived assets,
and review of the realizability of developed technology impacted by the restructuring.



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The workforce portion included severance and related costs of $4.8 million for 151 positions from all functional areas
and had been 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 excess space in our 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, we recorded $4.1 million of charges during 2003 relating to these facilities, including $1.3
million for accelerated amortization on leaseholds and equipment whose estimated useful lives had been impacted by the plan to cease using the related excess space in our facilities. The total amount of the workforce and facilities charges was $8.9
million. Of this amount, $4.6 million had been incurred by June 30, 2003 and charged to the restructuring charges line in the consolidated statement of operations for the second quarter of 2003, while the remaining $4.3 million was recorded in the
third quarter of 2003.



The restructuring resulted in a reduction of all
expense lines including: total cost of revenues, sales and marketing expenses, research and development expenses and general and administrative expenses. As a result of the implementation of the restructuring plan, our total expenses (operating
expenses plus cost of revenues) were $23.7 million in the fourth quarter of 2003, a reduction of $5.1 million from the $28.8 million incurred during the second quarter of 2003.



The May 2003 restructuring plan reduced quarterly expenses by approximately $4.8 million with savings distributed as follows:



|                                          |  |   |            
|----------------------------------------- |  | - | -----------
|Cost of services and maintenance revenues |  | $ | 1.1 million
|Sales and marketing                       |  | $ | 1.5 million
|Research and development                  |  | $ | 1.6 million
|General and administrative                |  | $ | 0.6 million



In July 2003, we signed a settlement
and general release agreement with Zix Corporation, that resulted in the remaining contractual obligation under the Companys marketing and distribution agreement with Zix Corporation being settled at a value significantly less than the accrued
$2.8 million obligation at June 30, 2003. Under the settlement agreement, we paid Zix Corporation $700 thousand in July in fulfillment of all remaining obligations. This settlement resulted in the reversal of an accrual by us of $2.1 million, which
was recorded through the restructuring charges line in our condensed consolidated statement of operations for the third quarter of 2003.



In connection with the May 2003 restructuring plan, which included a further reduction in space utilized at our Santa Clara, California facility, we reviewed market
sublease rates in that region. Based on information supplied to us by our external real estate advisors, we concluded that the sublease market would not recover in the timeframe that we had originally estimated due to the continued softening of
sublease rates in that market, requiring an adjustment to increase the facility related accrual recorded in June 2001 by $6.7 million. This adjustment was charged to the restructuring charges line in the condensed consolidated statement of
operations for the second quarter of 2003.



Write-down of Long-term
Strategic Investments



We recorded a non-cash charge in the second
quarter of 2003 related to the impairment of a long-term strategic investment made in Brazil in fiscal 2000. Due to a decline in market conditions and a restructuring of the investee by its management, we concluded that the investment had suffered
an other than temporary decline in fair value as determined by third party market transactions, and as such, we recorded an impairment in the second quarter of 2003 of $2.8 million. As a result, we have no remaining balance on this long-term
strategic investment.



Interest Income



Interest income decreased to $359 thousand and $904 thousand for the three and nine months
ended September 30, 2004, respectively, from $377 thousand and $1.4 million for the three and nine months ended September 30, 2003, respectively, representing 2% and 1% of total revenues for the three and nine months ended September 30, 2004,
respectively, compared to 2% of total revenues for each of the three and nine months ended September 30, 2003. The decrease in investment income reflected the reduced balance of funds invested, as these amounts have been drawn down to fund cash flow
from operations, stock repurchases and cash used in the acquisition of Entrust Japan and certain assets from AmikaNow. The funds invested decreased to $100.6 million at September 30, 2004 from $110.4 million at September 30, 2003. In addition, the
decrease was due to lower interest rates that have been available for the first nine months of 2004, compared to the same period in 2003. The rate of return on our marketable investments dropped to approximately 1.1% in the first nine months of 2004
compared to a rate of return of approximately 1.3% in the first nine months of 2003.



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Loss from Equity Investment



We recorded $174 thousand and $551 thousand of losses related to our investment in Entrust Japan for the three and nine months ended
September 30, 2004, respectively, compared to $212 thousand and $450 thousand for the three and nine months ended September 30, 2003. This investment was accounted for under the equity method of accounting for investments in common stock until
acquisition on September 13, 2004, since we had the potential to significantly influence the operations and management of Entrust Japan. These losses represent our share of the operating losses of Entrust Japan for the three and nine months ended
September 30, 2004 on an equity accounting basis, based on an approximate 37% ownership interest in the voting capital of Entrust Japan up to the date of acquisition.



In addition, we recorded $122 thousand of losses related to our investment in Ohana for the three and nine months ended September 30, 2004.
We began accounting for this investment under the equity method of accounting for investments in common stock in the third quarter of 2004, since we had the potential to significantly influence the operations and management of Ohana.



Provision for Income Taxes



We recorded a net income tax provision of $143 thousand and $206 thousand for the three and
nine months ended September 30, 2004, compared to income tax provisions of $91 thousand and $411 thousand for the three and nine months ended September 30, 2003. These provisions represent primarily the taxes payable in certain foreign
jurisdictions. The effective income tax rates differed from statutory rates in these periods primarily due to the amortization of purchased product rights and the impairment of long-term strategic investments and purchased product rights, 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.



LIQUIDITY AND CAPITAL RESOURCES



We generated cash of $6.3 million in operating activities during the nine months ended September 30, 2004. This cash inflow was primarily a result of a net income before
non-cash charges of $1.0 million, a decrease in accounts receivable of $5.8 million, an increase in deferred revenue of $5.7 million, partially offset by cash outflows resulting from a decrease in accounts payable and accrued liabilities of $2.2
million, and a decrease in accrued restructuring charges of $4.0 million. Our average days sales outstanding at September 30, 2004 was 67 days, which represents a decrease from the 72 days that we reported at June 30, 2004. The overall decrease in
days sales outstanding from June 30, 2004 was the combined effect of higher revenues, significantly improved in-quarter collections during the third quarter of 2004, and strong overall collection efforts during the same 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.



During the nine months ended September 30, 2004, we generated $2.4 million of cash from
investing activities, primarily due to cash provided by reductions in our marketable investments in the amount of $7.9 million (net of $61.4 million of marketable investment purchases). This was partially offset by $1.1 million invested in property
and equipment, primarily for computer hardware upgrades throughout our organization, and $0.9 in other long-term assets. In addition, we invested $2.7 million of cash in the acquisition of intellectual property and certain other assets from AmikaNow
and $0.8 million in the acquisition of Entrust Japan.



We used cash of $5.1
million in financing activities during the nine months ended September 30, 2004 primarily for the repurchase of our Common stock in the amount of $5.8 million, offset by $0.7 million of cash provided by the exercise of employee stock options.



As of September 30, 2004, our cash, cash equivalents and marketable
investments in the amount of $100.6 million provided our principal sources of liquidity. Overall, we used $4.0 million of cash, cash equivalents and marketable investments during the first nine months of 2004. Although we continue to target
operating breakeven, based on sustaining current revenue and operating expense structures, we estimate that we will continue to use cash in fiscal 2004 to satisfy the obligations provided for under our restructuring program. However, if operating
losses do occur, then cash, cash equivalents and marketable investments will be negatively affected.



In addition, we announced in the third quarter of 2002 that we intend to repurchase up to an aggregate of 7.0 million shares of



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our Common stock over the 12-month period ending July 28, 2003, or an earlier date determined by our Board of Directors,
in open market, negotiated or block transactions. In July 2003, we announced that our Board of Directors had agreed to extend the expiry date of the stock repurchase program to September 1, 2004 and to permit the purchase of up to 7,000,000 shares
of the Companys common stock in addition to the 2,229,200 shares already purchased up to that time. In August 2004, we announced that our Board of Directors had authorized an extension of this stock repurchase program to permit the purchase of
up to 10,000,000 shares of our common stock through September 15, 2005 in addition to the 3,412,940 shares already purchased prior to this extension. The timing and amount of shares repurchased under this program will be determined by our management
based on its evaluation of market and business conditions, and will be funded using available working capital. Since the announcement of the program in 2002, we have repurchased 3,490,640 shares of Common stock for an aggregate purchase price of
$11.7 million, of which 77,700 and 1,261,440 shares were repurchased during the three and nine months ended September 30, 2004, respectively, at an aggregate purchase price of $0.2 million and $5.8 million, respectively.



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 $31.4 million of
accrued restructuring charges at September 30, 2004 through fiscal 2011, as detailed below. This amount is net of estimated sublet recoveries on restructured facilities of $23.3 million. The lease obligations included in these accrued restructuring
charges are disclosed in the table of contractual commitments below. In addition, we forecast a requirement to spend approximately $1.8 million per year into the foreseeable future 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 capital resources to fund these long-term requirements.



We have commitments that will expire at various times through 2011. We lease administrative
and sales offices and certain property and equipment under non-cancellable operating leases that will expire in 2011 with certain renewal options. Other significant contractual obligations or commitments that were not recorded in our financial
statements are listed below. A summary of our contractual commitments at September 30, 2004 is as follows:



|                                                            |  |                                                |        |                 |   |          |  |          |        |                  |   |        |  |   |       
|----------------------------------------------------------- |  | ---------------------------------------------- | ------ | --------------- | - | -------- |  | -------- | ------ | ---------------- | - | ------ |  | - | ------
|                                                            |  | As of September 30, 2004 Payment Due by Period
|                                                            |  | Total                                          |        | Less than1 Year |   | 1-3Years |  | 3-5Years |        | More than5 Years
|                                                            |  | (in thousands)                                
|Operating lease obligations  currently utilized facilities |  | $                                              | 17,972 |                 | $ | 2,543    |  | $        | 5,266  |                  | $ | 6,858  |  | $ | 3,305 
|Operating lease obligations  restructured facilities       |  |                                                | 38,659 |                 |   | 6,027    |  |          | 12,383 |                  |   | 11,259 |  |   | 8,990 
|Other contractual obligations                               |  |                                                | 1,500  |                 |   | 1,500    |  |          |       |                  |   |       |  |   |      
|                                                            |  |                                                |        |                 |   |          |  |          |        |                  |   |        |  |   |       
|Total                                                       |  | $                                              | 58,131 |                 | $ | 10,070   |  | $        | 17,649 |                  | $ | 18,117 |  | $ | 12,295
|                                                            |  |                                                |        |                 |   |          |  |          |        |                  |   |        |  |   |       



In addition to the lease commitments
included above, we have provided letters of credit totaling $10.7 million as security deposits in connection with certain office leases.



In August 2004, we signed a Distribution Agreement with Pointsec Mobile Technologies (Pointsec) to jointly develop and market data security products designed
to protect information in laptop, desktop, PDA and server environments. Under this agreement, we have committed to certain payments to Pointsec totaling $1.5 million, due as follows: $1.0 million in the fourth quarter of 2004, $250 thousand in the
first quarter of 2005 and $250 thousand in the second quarter of 2005.



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 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



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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, 2004.



We generally warrant for ninety days from delivery to a customer that our software products will perform free from material errors which 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, 2004.



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.



CERTAIN
FACTORS THAT MAY AFFECT OUR BUSINESS



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



Our quarterly revenues and operating results have varied in the past and may continue to fluctuate in the future. We believe that period-to-period comparisons of our
operating results are not necessarily meaningful, but securities analysts and investors often rely upon these comparisons as indicators of future performance. If our operating results in any future period fall below the expectations of securities
analysts and investors, or the guidance that we provide, the market price of our securities would likely decline. Factors that have caused our results to fluctuate in the past and which are likely to affect us in the future include the following:



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



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



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



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



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



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



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



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



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



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



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



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



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



Estimating future revenues is difficult because we ship our products soon
after an order is received and, as such, we do not have a significant order backlog. Thus, quarterly license revenues depend heavily upon orders received and shipped within the same quarter. Moreover, we historically have recorded 50% to 70% 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.



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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.



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.



Historically, a limited number of customers have accounted for a significant percentage of our revenues. In 2003, 2002 and 2001, our three largest customers accounted for 29%, 18% and 18% of revenues, respectively. In the three months ended
September 30, 2004 and 2003, our three largest customers accounted for 28% and 28% 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.



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 26% of
our software revenue in the third quarter of 2004 and 45% of software revenue in fiscal 2003. The U.S. and Canadian governments represented 19% and 8% of total revenues, respectively, in the third quarter of 2004, 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. Finally, failure to properly
monitor pricing on government contracts could result in liability for penalties to the government for non-compliance.



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



We sometimes enter into complex contracts with our Government customers that contain clauses that provide that if a customer who falls within a specific category (known as a Relevant Customer) is offered better terms on the Companys
software products and related services that had been offered to the Government customer, then the Government customer will be able to buy additional quantities of those software products and services for the same length of time, from the same
effective date and on the better terms that were offered to the Relevant Customer. The Company monitors compliance with these contracts on a continuous basis. The Company also conducts periodic self-assessments to ensure that the contracts are being
properly administered and that there are no accruing liabilities for non-compliance. If these contracts are not properly monitored and administered, they may be breached and could result in damages payable by us which, depending on their magnitude,
could have a material adverse effect on our business, financial condition and results of operations.



The outbreak of war, significant threat of war, or a terrorist act could adversely affect our business.



Historically, the outbreak of war has had an adverse affect upon the economy. In the event of war or significant terrorist act, any of the following may 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 of products and could
have unforeseen economic impacts.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



A decline or delay in economic
spending due to the outbreak of war, significant threat of war or a terrorist act could reduce demand for our products, materially adversely affecting our revenues and 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 expansion of Internet usage and the number of organizations adopting or expanding intranets and extranets;
|- | ------------------------------------------------------------------------------------------------------------------------



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



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



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



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



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



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



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



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



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As our products contain errors or bugs, sales of our products would likely decline if some of these bugs or the number
of bugs were significant.



Like virtually all software systems, our
products contain errors, failures or bugs that our existing testing procedures have not detected. The 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 would 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 whose
products and technology may not succeed with the result that we lose all or substantially all of our investments.



We have invested in several privately held companies, 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. 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 investments in these companies.



In July 2004, we
increased our investment in Ohana to $1.225 million, which is held in the form of a convertible loan. This amount was increased by $275 thousand in the fourth quarter of 2004 (see Note 5 to our Condensed Consolidated Financial Statements). We
determined that the loan was unlikely to be repaid but rather expect it to be converted into equity in Ohana Holdco, once Ohana becomes a wholly owned subsidiary of Ohana Holdco in connection with the Ohana Restructuring (see Note 5 to our Condensed
Consolidated Financial Statements), which is expected to close on or about November 5, 2004 subject to customary closing conditions. On an as-converted basis at September 30, 2004 we would have held the equivalent of approximately 12% ownership
share of Ohana Holdco. We have concluded that because of the additional investment and additional rights obtained, in July 2004 we gained the potential ability to exercise significant influence over the operations of Ohana. Therefore, beginning the
third quarter of 2004, we have 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 have included our share of post-acquisition losses of Ohana, in the amount of $122 thousand in our consolidated losses for the current fiscal year. If the demand for the technologies and
products offered by Ohana materializes slowly, to a minimum extent, or not at all in the relevant market, we could lose all or substantially all of our investment in this company. To date, we have not recorded any impairment in connection with this
investment.



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



We target our products at the rapidly
evolving market for digital identity and information security solutions. Many of our current and potential competitors have longer operating histories, greater name recognition, larger installed bases and significantly greater financial, technical,
marketing and sales resources than we do. As a result, they may be able to react more quickly to emerging technologies and changes in customer requirements, or to devote greater resources to the promotion and sale of their products. In addition,
certain of our current competitors in particular segments of the security marketplace may in the future broaden or enhance their offerings to provide a more comprehensive solution competing more fully with our functionality.



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



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



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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, including the separation of our
headquarters in Addison, Texas, from our research and development facilities in Ottawa, Canada, and Santa Clara, California and from our European headquarters in Reading, United Kingdom, may make it more difficult to manage our growth.



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



Our future success depends upon our ability to continue to
attract and retain highly qualified scientific, technical, sales and managerial personnel. Competition for such personnel is intense, particularly in the field of cryptography, 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 the substantial majority of outstanding stock options is below the current market price of our stock. If we cannot retain or are unable to hire such key personnel, our business, financial
condition and results of operations could be significantly adversely affected.



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



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



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



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



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



Policing piracy and other unauthorized use of our products is difficult, particularly in international markets and as a result of the growing use of the Internet. 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.



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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. For example, our ability to provide Web server certificates in the future is
dependent upon a licensing agreement we have with Baltimore Technologies, one of our primary competitors. Our success will depend in part on our continued ability to have access to such technologies that are or may become important to the
functionality of our products. Any inability to continue to procure or use such technology could have a significant adverse effect on our ability to sell some of our products.



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



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



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



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



In June 2004, we acquired intellectual property and certain other assets of AmikaNow for $4.0 million, plus potential additional payments in the future of up to $1.5
million based on revenue generated from products that incorporate the intellectual property acquired. In addition, in September 2004, we acquired majority ownership of Entrust Japan for $1.7 million. While management expects the integration of the
acquired technology and people to go smoothly, each of the above risks apply to these acquisitions as well.



As a result of our June 2001 and May 2003 restructuring plans, we have made certain assumptions in estimating the accrued restructuring charges. If these assumptions change, they could have a material effect on our
reported results.



In recent periods, we announced two major restructuring
plans in June 2001 and in May 2003 as a result of the slowdown in the global electronics industry and the worldwide economy. The restructuring plans included a workforce reduction, the consolidation of excess facilities, the reassessment of the
value of related excess long-lived assets and discontinuance of non-core products and programs.



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As a result of the June 2001 restructuring plan, we recorded restructuring and other special non-recurring charges,
excluding goodwill impairment, of $106.6 million in the second quarter of 2001. Our assessment of the accounting effects of the June 2001 restructuring plan required assumptions in estimating the original accrued restructuring charges, including
estimating future recoveries of sublet income from excess facilities, liabilities from employee severances, and costs to exit business activities. Changes in these assumptions, with respect to the accrued restructuring charges for the June 2001
restructuring plan of $29.7 million at September 30, 2004, could have a material effect on our reported results.



As a result of the May 2003 restructuring plan, we recorded restructuring charges, excluding impairments, of $8.9 million. Our assessment of the accounting effect of the
May 2003 restructuring plan required assumptions in estimating the original incurred and expected restructuring charges of $8.9 million, including estimating liabilities from employee severances, future recoveries of sublet income from excess
facilities, and other costs to exit activities. Changes in these assumptions, with respect to the accrued restructuring charges for the May 2003 restructuring plan of $1.7 million at September 30, 2004, could have a material effect on our reported
results.



If our business does not improve or declines, we may further
restructure our operations, which may adversely affect our financial condition and operating results.



We may need to take additional restructuring charges in the future if our business does not improve or declines or if the expected benefits of the restructuring plans do not materialize. These benefits may not
materialize if we incur unanticipated costs in closing facilities or transitioning operations from closed facilities to other facilities or if customers cancel orders as a result of facility closures. If we are unsuccessful in implementing our
restructuring plans, we may experience disruptions in our operations and higher ongoing costs, which may adversely affect our operating results.



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



In the future, we may establish
additional foreign operations, hire additional personnel and establish relationships with additional partners internationally. This expansion would require significant management attention and financial resources and could have an adverse effect on
our business, financial condition and results of operations. Although our international sales currently are primarily denominated in 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 could significantly and adversely affect our business, financial condition or results of operations.



We face additional risks in the Asia Pacific market due to our reliance on joint ventures
and other factors.



Our $1.5 million investment in Ohana is subject to
risk associated with joint ventures. Joint ventures have additional 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.



Also, another outbreak of SARS in the region could have an impact on our
ability to travel to, and work with, customers in the region. These restrictions could affect our ability to transact business in the region.



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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 laws of the U.S., 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, U.S. governmental controls on the exportation of encryption products and technology may in the future restrict our ability to freely export some of our products with the most powerful information security encryption
technology.



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 your best interests.



Our charter and bylaws contain provisions, including a staggered board of directors that may
make it more difficult for a third party to acquire us, or may discourage bids to do so. We think these measures enable us to review offers for our shares of Common stock to determine if they are in the best interests of our stockholders. These
provisions could limit the price that investors might be willing to pay for shares of our Common stock and could make it more difficult for a third party to acquire, or could discourage a third party from acquiring, a majority of our outstanding
voting stock. Our Board of Directors also has the authority to issue up to 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 stockholders. The rights of the holders of Common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock
could make it more difficult for a third party to acquire, or may discourage a third party from acquiring, a majority of our outstanding voting stock.



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. 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.



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The following table presents the cash, cash equivalents and marketable investments that we held at September 30, 2004,
that would have been subject to interest rate risk, and the related ranges of maturities as of those dates:



|                                                                  |  |                         |        |            |   |            |  |             |        |  |   |      
|----------------------------------------------------------------- |  | ----------------------- | ------ | ---------- | - | ---------- |  | ----------- | ------ |  | - | -----
|                                                                  |  | MATURITY (in thousands)
|                                                                  |  | Within 3 Months         |        | 3-6 Months |   | > 6 Months |  | > 12 Months
|Investments classified as cash and cash equivalents               |  | $                       | 29,895 |            | $ |           |  | $           |       |  | $ |     
|Investments classified as held to maturity marketable investments |  |                         | 1,501  |            |   | 18,773     |  |             | 33,198 |  |   | 5,384
|                                                                  |  |                         |        |            |   |            |  |             |        |  |   |      
|Total amortized cost                                              |  | $                       | 31,396 |            | $ | 18,773     |  | $           | 33,198 |  | $ | 5,384
|                                                                  |  |                         |        |            |   |            |  |             |        |  |   |      
|Fair value                                                        |  | $                       | 31,396 |            | $ | 18,762     |  | $           | 33,176 |  | $ | 5,370
|                                                                  |  |                         |        |            |   |            |  |             |        |  |   |      



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, and the European Union. This exposure is not considered to be material with respect to the United Kingdom and European 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 the Companys 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 the 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 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 $4.9 million in 2003, when compared to 2002, due to fluctuations in the exchange rate between the United
States and Canadian dollars. During the fourth quarter of 2004, we have engaged in forward contracts to purchase Canadian dollars, covering exposures on approximately $7.3 million of our Canadian subsidiarys expenses 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. None of the related foreign exchange contracts extend past December 31, 2004. We did not engage in
any forward contracts to purchase Canadian dollars to cover exposures on expenses denominated in Canadian dollars in the third quarter of 2004.



Risk Associated with Equity Investments



In July, 2004, we increased our investment in Ohana to $1.225 million, which is held in the form of a convertible loan. This amount was increased by $275 thousand in the
fourth quarter of 2004 (see Note 5 to our Condensed Consolidated Financial Statements). We determined that the loan was unlikely to be repaid but rather expect it to be converted into equity in Ohana Holdco, once Ohana becomes a wholly owned
subsidiary of Ohana Holdco in connection with the Ohana Restructuring (see Note 5 to our Condensed Consolidated Financial Statements), which is expected to close on or about November 5, 2004 subject to customary closing conditions. On an
as-converted basis at September 30, 2004 we would have held the equivalent of approximately 12% ownership share of Ohana Holdco. We have concluded that because of the additional investment and additional rights obtained in July 2004 we gained the
potential ability to exercise significant influence over the operations of Ohana. Therefore, beginning the third quarter of 2004, we have 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 have included our share of post-acquisition losses of Ohana, in the amount of $122 thousand in
our consolidated losses for the current fiscal year. Ohana is a company in the start-up or development stage. If the demand for the technologies and products offered by this company materializes slowly, to a minimum extent, or not at all in the
relevant market, we could lose all or substantially all of our investment in this company or that the remaining balance of the equity investment of $1.1 million at September 30, 2004 may be expensed through our operating earnings in future quarters
as a result of our recognition of our equity share of losses in Ohana. To date, we have not recorded any impairment in connection with this investment.



ITEM 4. CONTROLS AND PROCEDURES



As required by
Rule 13a-15(b), Entrust management, with the participation of the Chief Executive Officer and Chief Financial Officer, conducted an evaluation as of September 30, 2004 (the end of the period covered by this quarterly report), of the effectiveness of
the Companys disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures
were effective in all material respects as of September 30, 2004.



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PART II. OTHER INFORMATION



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, 2004.



|                                                   |  |                                |  |                            |      |                                                                                   |        |                                                                                    |          
|-------------------------------------------------- |  | ------------------------------ |  | -------------------------- | ---- | --------------------------------------------------------------------------------- | ------ | ---------------------------------------------------------------------------------- | ---------
|Period                                             |  | Total Numberof SharesPurchased |  | AveragePrice Paidper Share |      | Total Number of SharesPurchased as Part ofPublicly AnnouncedPlans or Programs (1) |        | Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programs (1)
|Month #1 (July 1, 2004 to July 31, 2004)           |  |                               |  |                            |     |                                                                                   |       |                                                                                    | 5,816,260
|Month #2 (August 1, 2004 to August 31, 2004)       |  | 45,895                         |  |                            | 2.45 |                                                                                   | 45,895 |                                                                                    | 9,954,105
|Month #3 (September 1, 2004 to September 30, 2004) |  | 31,805                         |  |                            | 2.65 |                                                                                   | 77,700 |                                                                                    | 9,922,300
|                                                   |  |                                |  |                            |      |                                                                                   |        |                                                                                    |          
|Total                                              |  | 77,700                         |  | $                          | 2.50 |                                                                                   | 77,700 |                                                                                    | 9,922,300
|                                                   |  |                                |  |                            |      |                                                                                   |        |                                                                                    |          

---

|(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. On July 22,
2003, the Company announced that its board of directors had authorized an extension to this stock repurchase program. Entrusts original stock repurchase program would have expired on July 28, 2003. The extended plan permits the purchase of up
to 7,000,000 shares of the Companys Common stock through September 1, 2004, in addition to the 2,229,200 shares already purchased prior to the extension. On August 2, 2004, the Company announced that its board of directors had authorized an
extension of this stock repurchase program to permit the purchase of up to 10,000,000 shares of the Companys Common Stock through September 15, 2005 in addition to the 3,412,940 shares already purchased prior to this extension. Repurchases
under the stock repurchase program may take place from time to time until September 15, 2005, 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.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



ITEM 6. EXHIBITS



|              |  |                                                                                                                                                                    
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                        
|10.1          |  | Separation Agreement and Release with Dave Carey, dated August 30, 2004                                                                                            
|              | 
|10.2          |  | Executive Confidentiality, Non-solicitation, Non-competition, Intellectual Property Rights, and Code of Conduct Agreement with Jim Contardi, dated October 15, 2004
|              | 
|10.3          |  | Executive Severance Agreement with Jim Contardi, dated October 15, 2004                                                                                            
|              | 
|10.4          |  | Employment Agreement with Jim Contardi, dated October 15, 2004                                                                                                     
|              | 
|31.1          |  | Rule 13a-14(a) Certification of Chief Executive Officer                                                                                                            
|              | 
|31.2          |  | Rule 13a-14(a) Certification of Chief Financial Officer                                                                                                            



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|     |  |                                                                                                                                                                                     
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|32.1 |  | Section 1350 Certification of Chief Executive Officer                                                                                                                               
|     | 
|32.2 |  | Section 1350 Certification of Chief Financial Officer                                                                                                                               
|     | 
|99   |  | Master Software Supply and CA Services Agreement between Entrust Limited and Aerostrong Technology Co., Ltd., a subsidiary of China Spacesat Technology Limited, dated June 22,
2004



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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 5, 2004



/s/ David J. WagnerDavid J. WagnerChief Financial Officer and Senior Vice President (Principal Financial and Accounting Officer)




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EXHIBIT INDEX



|              |  |                                                                                                                                                                                     
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                         
|10.1          |  | Separation Agreement and Release with Dave Carey, dated August 30, 2004                                                                                                             
|              | 
|10.2          |  | Executive Confidentiality, Non-solicitation, Non-competition, Intellectual Property Rights, and Code of Conduct Agreement with Jim Contardi, dated October 15, 2004                 
|              | 
|10.3          |  | Executive Severance Agreement with Jim Contardi, dated October 15, 2004                                                                                                             
|              | 
|10.4          |  | Employment Agreement with Jim Contardi, dated October 15, 2004                                                                                                                      
|              | 
|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                                                                                                                               
|              | 
|99            |  | Master Software Supply and CA Services Agreement between Entrust Limited and Aerostrong Technology Co., Ltd., a subsidiary of China Spacesat Technology Limited, dated June 22,
2004



49