10-Q 1 d10q.txt FORM 10-Q FOR 10/31/01 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended October 31, 2001 or [_] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ___ to ___ Commission File Number: 001-15010 CERTICOM CORP. -------------------------------------------------------------- (Exact name of registrant as specified in its charter) Yukon Territory, Canada Not Applicable ----------------------- ---------------------- (Province or other (I.R.S. Employer jurisdiction of Identification No.) incorporation) 25821 Industrial Boulevard Hayward, California 94545 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (510) 780-5400 ----------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No ___ As of November 30, 2001, there were 31,429,557 of registrant's common shares, no par value, outstanding. TABLE OF CONTENTS

Unless otherwise indicated, all information in this Form 10-Q gives effect to the 2-for-1 split of the Company's outstanding common shares, which occurred on July 12, 2000. Certicom(R) and Security Builder(R) are our registered trademarks, and certicom encryption(TM), SSL Plus(TM), WTLS Plus(TM), Certilock(TM), Certifax(TM), MobileTrust(TM), Trustpoint(TM), movian(TM), movianVPN(TM) and movianCrypt(TM) are our trademarks. In this Form 10-Q, the terms "Certicom", "the Company", "we", "us", and "our" refer to Certicom Corp., a Yukon Territory, Canada corporation, and/or its subsidiaries. EXCHANGE RATE INFORMATION Unless otherwise indicated, all dollar amounts in this Form 10-Q are expressed in United States dollars. References to "$" or "U.S.$" are to United States dollars, and references to "Cdn.$" are to Canadian dollars. The following table sets forth, for each period indicated, information concerning the exchange rates between U.S. dollars and Canadian dollars based on the inverse of the noon buying rate in the City of New York on the last business day of each month during the period for cable transfers as certified for customs purposes by the Federal Reserve Bank of New York (the "Noon Buying Rate"). The table illustrates how many U.S. dollars it would take to buy one Canadian dollar. On October 31, 2001, the Noon Buying Rate was U.S. $0.6287 per Cdn.$1.00. U.S.$ per Cdn.$ Noon Buying Rate ----------------------------------------------------- Average Low High Period End -------------- ---------- ---------- ------------- Fiscal year ended ----------------- April 30, 2001 0.6616 0.6831 0.6333 0.6510 Six months ended ---------------- October 31, 2000 0.6717 0.6831 0.6531 0.6548 October 31, 2001 0.6468 0.6622 0.6287 0.6287 Three months ended ------------------ October 31, 2000 0.6694 0.6793 0.6531 0.6548 October 31, 2001 0.6411 0.6547 0.6287 0.6287 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Certain statements contained in this Form 10-Q constitute "forward-looking statements" within the meaning of the United States Private Securities Litigation Reform Act of 1995. When used in this document, the words "may", "would", "could", "will", "intend", "plan", "anticipate", "believe", "estimate", "expect" and similar expressions, as they relate to us or our management, are intended to identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions. Many factors could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements, including, among others, those which are discussed in "Factors That May Affect Operating Results" beginning on page 22 of this Form 10-Q, in our Annual Report on Form 10-K and in other documents that we file with the Securities and Exchange Commission and Canadian securities regulatory authorities. Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking statements prove incorrect, actual results may vary materially from those described herein as intended, planned, anticipated, believed, estimated or expected. We do not intend, and do not assume any obligation, to update these forward-looking statements. 1 PART I. FINANCIAL INFORMATION Item 1. Financial Statements CERTICOM CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands of U.S. dollars, except common share amounts)

See accompanying notes to condensed consolidated financial statements. 2 CERTICOM CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands of U.S. dollars, except per share data) (Unaudited)

See accompanying notes to condensed consolidated financial statements. 3 CERTICOM CORP. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands of U.S. dollars) (Unaudited)

See accompanying notes to condensed consolidated financial statements. 4 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements include the accounts of Certicom Corp., and it's wholly owned subsidiaries (Certicom or the Company). Intercompany transactions and balances are eliminated upon consolidation. The condensed consolidated financial statements included in this document are unaudited and reflect all adjustments (consisting only of normal recurring adjustments, except as noted) which are, in the opinion of our management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods shown. Certain reclassifications have been made to the prior year consolidated financial statements to conform to the current year's presentation. Such reclassifications had no effect on previously reported results of operations. The accompanying condensed consolidated financial statements have been prepared pursuant to the rules and regulations of Securities and Exchange Commission regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with our consolidated financial statements and notes thereto, Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended April 30, 2001 and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Item 2 of this Form 10-Q. The results of operations for the three months and six months ended October 31, 2001 are not necessarily indicative of the results expected for the entire fiscal year ending April 30, 2002. Revenue Recognition and Deferred Revenues We recognize software licensing revenue in accordance with all applicable accounting regulations including the American Institute of Certified Public Accountants Statement of Position (SOP) 97-2, "Software Revenue Recognition," as amended by SOP 98-4 and SOP 98-9. Following the requirements of SOP 97-2, we recognize license revenues when all of the following have occurred: . we have signed a non-cancelable license agreement with the customer; . delivery of the software product to the customer has occurred; . the amount of the fees to be paid by the customer are fixed or determinable; and . collection of these fees is probable. If an acceptance period is contractually provided, license revenues are recognized upon the earlier of customer acceptance or the expiration of that period. In instances where delivery is electronic and all other criteria for revenue recognition have been achieved, the product is considered to have been delivered when the customer either takes possession of the software via a download or the access code to download the software from the Internet has been provided to the customer. Our software does not require significant production, customization or modification. SOP 97-2, as modified, generally requires revenue earned on software arrangements involving multiple elements such as software products, upgrades, enhancements, post contract customer support (PCS), or installation and training to be allocated to each element based on the relative fair values of the elements. The fair value of an element must be based on evidence that is specific to the vendor. If evidence of fair value does not exist for all elements of a license agreement and PCS is the only undelivered element, then all revenue for the license arrangement is recognized ratably over the term of the agreement. If evidence of fair value of all undelivered elements exists but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred, and the remaining portion of the arrangement fee is recognized as revenue. When arrangements require us to deliver specified additional upgrades the entire fee related to the arrangement is deferred until delivery of the specified upgrade has occurred, unless we have vendor-specific objective evidence of fair value for the upgrade. Fees related 5 to contracts that require us to deliver unspecified additional products are deferred and recognized ratably over the contract term. Revenue from consulting and training services are recognized using the percentage-of-completion method for fixed fee development arrangements or as the services are provided for time-and-materials arrangements. The fair value of professional services, maintenance and support services have been determined using specific objective evidence of fair value based on the price charged when the elements are sold separately. Revenues for maintenance and support services are deferred and recognized ratably over the term of the support period. Revenues from professional services are recognized when the services are performed. In June 2001, we began to offer our enabling technologies products using primarily subscription-based licenses. In addition, our trust services and enterprise application software product lines are accounted for under the subscription model. Subscription licenses provide our customers with rights to use our software for a specified period of time. Customers are entitled to use the license and receive certain customer support services over the license term. In addition, depending on the type of license, our customers have access to unspecified upgrades on an "if and when available" basis. We expect the average duration of the subscription licenses to be between one and two years. Under subscription licenses, we bill our customers for the current year's product and service fees. The billed product and service fees are recognized as revenues ratably over the billed period, generally one year. Deferred revenues generally result from the following: subscription licenses for which we have invoiced our customers and we are recognizing revenue ratably over the license term, deferred maintenance and support services, cash received for professional services not yet rendered and license revenues deferred relating to arrangements where we have received cash and are required to deliver either unspecified additional products or specified upgrades for which we do not have vendor-specific objective evidence of fair value. Impairment of Long-Lived Assets We evaluate the recoverability of our property and equipment and intangible assets when there are indications that the carrying value of those assets may not be recoverable. We recognize impairment of long-lived assets when the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. Accordingly, we evaluate asset recoverability at each balance sheet date or when an event occurs that may impair recoverability of the asset. Research and Product Development Cost We expense all research and development costs as they are incurred. Scientific research tax credits are recognized at the time the related costs are incurred and recovery is reasonably assured. We have capitalized certain costs associated with the filing of approximately sixty patent applications in various jurisdictions. These patent filings relate to Elliptic Curve Cryptography (ECC), various mathematical computational methodologies, security protocols and other cryptographic inventions. After the patent is granted, we amortize the individual patent cost over three years. We capitalize patents not yet granted at their cost less a provision for the possibility of the patent not being granted or abandoned. Reclassifications Certain reclassifications have been made to the fiscal year 2001 financial statement presentation to conform to the fiscal year 2002 presentation. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of 6 revenues and expenses during the reporting period. Actual results could differ materially from those estimates and could materially affect future operating results. Note 2. Net Loss per Common Share Basic net loss per common share is computed using the weighted average number of common shares outstanding during the period. Diluted net loss per common share is computed using the weighted average number of common shares outstanding during the period and, when dilutive, potential common shares from options and warrants to purchase common shares or conversation of debentures, using the treasury stock method. The following potential common shares have been excluded from the calculation of diluted net loss per share for all periods presented because the effect would have been anti-dilutive:

The weighted average exercise price of stock options was $1.52 and $10.16 at October 31, 2001 and 2000, respectively. The purchase price of restricted stock was $38.94. The exercise price of outstanding warrants was Cdn.$38.13 per share ($23.97 based on the exchange rate on October 31, 2001). The conversion price of the convertible debentures was Cdn.$3.85 ($2.42 based on the exchange rate on October 31, 2001). The following table sets forth the computation of basic and diluted net loss per common share (in thousands of U.S. dollars except per share data)

Note 3. Comprehensive Income (Loss) Other comprehensive loss refers to revenues, expenses, gains and losses that under generally accepted accounting principles are recorded as an element of shareholders' equity but are excluded from net loss. The following table sets forth the components of comprehensive loss for the three and six month periods ended October 31, 2001 and 2000, respectively (in thousands of U.S. dollars):

Note 4. Impairment of Goodwill and Other Intangibles In connection with our restructuring program announced on June 4, 2001, we identified indicators of possible impairment of goodwill and other acquired intangible assets relating to previous acquisitions. These indicators included the deterioration in the business climate, changes in sales and cash flow forecasts, revised strategic plans for certain acquired business and significant declines in the market values of companies in the security, wireless and general technology industries. As a result, we performed an impairment assessment of the identifiable intangible assets and goodwill recorded in connection with the acquisitions of DRG Resources Group, Inc. and Uptronics, Inc. Accordingly, Certicom compared the undiscounted cash flows associated with the acquired intangible assets and goodwill with the respective carrying amounts and determined that an impairment of certain assets existed. As a result, we recorded an impairment of intangible assets and goodwill of $9.4 million, measured as the amount by which the carrying amount exceeded the present value of the estimated future cash flows associated with goodwill and intangible assets. The assumptions supporting the cash flows, including the discount rate, were determined using our best estimates as of June 4, 2001. We will continue to assess the recoverability of the remaining goodwill and intangible assets in accordance with our policy. Note 5. Restructuring Costs On June 4, 2001, we announced a restructuring program to prioritize our initiatives, reduce costs not directly associated with selling and developing product and services, decrease discretionary spending and improve efficiency. This restructuring program includes a reduction of our full-time employee headcount, consolidation of excess facilities and reengineering of certain business functions, including a consolidation of distribution channels and a redeployment of product development to focus on our enabling technologies. On August 16, 2001 and November 9, 2001, we announced additional workforce reductions as part of our restructuring program. As a result of the restructuring program, we recorded restructuring costs of approximately $9.5 million for the three months ended July 31, 2001 and $12.0 million for three months ended October 31, 2001. We recorded restructuring expenses in the following areas: 1) reduction in workforce; 2) consolidation of excess facilities and non-productive property and equipment; and 3) elimination of deferred compensation. In addition, we recorded a non-cash charge of $0.5 million to write-down non-software product inventory related to businesses we are exiting. Since June 4, 2001, we have announced reductions in our work force of approximately 63% across all business functions and geographic regions. During the six months ended October 31, 2001, we recorded an estimated charge of approximately $3.3 million relating primarily to severance and fringe benefits. During the six months ended October 31, 2001, we recorded a restructuring charge of approximately $14.1 million for property and equipment that will be disposed of or removed from operations and excess facilities including computer equipment and software no longer in use due to the reduction in workforce and downsizing of infrastructure, leasehold improvements and lease inducements related to facilities we no longer plan to occupy. Included in the $14.1 million restructuring charge is a $2.8 million accrued restructuring charge for future leasehold improvements that we are contractually obligated to pay. For the six months ended October 31, 2001 we also wrote off $1.1 million of lease inducements related to these leasehold improvements. Lease inducements are reimbursements received from the landlord for certain leasehold improvements. During the six months ended October 31, 2001, we recorded a charge of $4.2 million for non-cancelable lease costs, of which we have paid $0.4 million, under the assumption that we will not be able to sublease certain of our excess facilities in the next two years. The term of this lease extends to April 2011 and the total lease payments for the full term of this lease are approximately $9.5 million based on the exchange rate as of October 31, 2001. During our second fiscal quarter ended October 31, 2001, we made adjustments to our non-cancelable lease estimates made during our first fiscal quarter ended July 31, 2001. We made these adjustments to reflect agreements 8 with certain sub-tenants of our facilities for which agreements were entered into subsequent to July 31, 2001. The restructuring adjustment related to these sub-tenant agreements was a $1.4 million reduction. In connection with the acquisition of DRG Resources Group, Inc., we recorded approximately $7.7 million of deferred compensation expense in connection with shares subject to restriction under employment agreements signed with the former owners of DRG Resources Group, Inc. These amounts are being amortized over an eighteen month period. As a result of the restructuring program announced in June 2001, certain former owners of DRG Resources Group, Inc. left our company. The unvested shares that were restricted under the terms of these employment agreements were immediately vested upon termination of the employees. As a result, approximately $2.3 million of deferred compensation charges were recorded in the first quarter of fiscal 2002. For the three and six months ended October 31, 2001, the Company recorded charges for restructuring activities and the write-down of inventory, goodwill and other intangible assets. There were no such charges for the three and six months ended October 31, 2000. The following table summarizes these charges (in thousands of U.S. dollars):

Note 6. Segment Information and Significant Customer We operate in one reportable segment. We are a developer, manufacturer and vendor of digital information security products, technologies and services within the industry segment of electronic commerce. Information about our geographic operations is given below (in thousands of U.S. dollars): Three Months Ended Six months ended October 31, October 31, ---------------------- ----------------------- 2001 2000 2001 2000 -------- --------- ----------------------- U.S. $ 2,312 $ 4,317 $ 4,211 $ 8,706 Canadian 126 730 674 760 International 270 1,254 367 1,888 -------- --------- --------- ---------- Total revenue $ 2,708 $ 6,301 $ 5,252 $ 11,354 ======== ========= ========= ========== 9 For the three months ended October 31, 2001, one of our professional services customers accounted for approximately 12% of our total revenue. For the three months ended October 31, 2000, two customers each accounted for more then 10% of our total revenue. For the six month period ended October 31, 2001, one of our professional services customer accounted for more than 10% of our total revenue. For the six month period ended October 31, 2000, two of our customers each accounted for more than 10% of our total revenue. Note 7. Public Offering and Stock Split In May 2000, we completed a public offering of 2,500,000 of our common shares at a per share price of $23.15 in the United States and Canada for an aggregate offering price of approximately $57.9 million. Our net proceeds from the offering were approximately $51.5 million after deducting underwriting discounts and commissions and offering expenses. In March 2001, we issued 4,000,000 of our common shares in Canada and the United States at a per share price of Cdn.$12.50 (approximately $8.14 based on the exchange rate on April 30, 2001). The common shares have not been registered under the United States Securities Act of 1933, as amended. The gross proceeds of this offering were Cdn.$50.0 million (approximately $32.5 million based on the exchange rate on April 30, 2001). After deducting underwriting discounts and commissions and offering expenses, the net proceeds of this offering were Cdn.$47.2 million (approximately $30.8 million based on the exchange rate on April 30, 2001). On July 12, 2000, we completed a two-for-one split of our outstanding common shares. All share and per share amounts in this document have been adjusted to give effect to this split. Note 8. Stock Option Repricing In March 2000, the FASB issued Interpretation No. 44, "Accounting for Certain Transactions involving Stock Compensation," an interpretation of APB Opinion No. 25, "Accounting for Stock Issued to Employees," which, among other things, requires variable-award accounting for repriced options from the date the options are repriced until the date of exercise. This interpretation became effective on July 1, 2000 to cover specific events that occur after December 15, 1998. On March 17, 1999, our Board of Directors approved the exchange of options to acquire an aggregate of 1,106,240 of our common shares for options having a right to acquire 382,914 common shares. Because these options were repriced after December 15, 1998, they are covered by the interpretation. Accordingly, these options will be accounted for as variable until the date they are exercised, forfeited or expire unexercised. Additional compensation cost will be measured for the full amount of any increases in share price after July 1, 2001 and will be recognized over the remaining vesting period. Any adjustment to the compensation cost for further changes in share price after the options vest will be recognized immediately. Stock compensation amortization expense of $499,000 was recorded for the three months ended October 31, 2000. As of July 31, 2001, the price of our common shares was less than the exercise price of the repriced stock options. As a result, a credit of approximately $311,000 was recorded to stock compensation amortization expense in the first quarter of fiscal 2002. Deferred compensation expense related to this repricing of options was $0 for the second quarter of fiscal 2002. As of October 31, 2001, the price of our common shares was less than the exercise price of the repriced options and therefore no compensation expense was recorded during the second quarter of fiscal 2002. On July 6, 2001, we announced a voluntary stock option exchange program to be offered to employees in which employees were able to exchange current outstanding options for new options to be issued no sooner than six months and one day after the end of the exchange period. For existing options with exercise prices over $23.00, program participants received one new option for each two options tendered for exchange. For options with exercise prices between $10.00 and $22.99, program participants received two new options for each three options tendered for exchange. Options with exercise prices below $10.00 could not be voluntarily tendered for exchange under this program. Each of the new options will have a vesting schedule whereby 25% will vest immediately upon issue, and the balance will vest monthly on a prorated basis for 24 months. The new options will be exercisable for a period of 5 years from the date of grant. The stock option exchange period ended on October 25, 2001. Employees tendered approximately 902,346 stock options and, in exchange for such options, Certicom intends to issue approximately 530,900 new stock options no sooner than April 29, 2002. Because no stock options have been issued to these employees since cancellation and the strike price of the stock options issued to these employees in the six months preceding the cancellations are above the fair market value of Certicom's common stock at October 31, 2001, Certicom has not recorded stock compensation expense related to the cancellation of these stock options. 10 Note 9. Convertible Debentures On August 30, 2001, we issued and sold Cdn.$13.5 million (approximately U.S.$8.7 million based on the exchange rate on August 30, 2001) aggregate principal amount of 7.25% senior unsecured convertible notes (the Notes) on a private placement basis. Subsequently, the Notes were converted by the holders thereof, without payment of additional consideration, into an equal principal amount of 7.25% senior convertible unsecured subordinated debentures (the Debentures). The Debentures mature on August 30, 2004 and are convertible into our common shares at the holder's option at any time before the close of business on the earlier of August 30, 2004 and the last business day before the date specified for redemption at a conversion price of Cdn.$3.85 ($2.42 based on the exchange rate at October 31, 2001) per common share. Certicom can redeem the Debentures at any time after August 30, 2003 at a price per Debenture equal to the principal amount thereof to be redeemed, together with accrued and unpaid interest on the principal amount of the Debenture so redeemed if the price of the Company's common shares is not less than 125% of the conversion price. The Debentures provide for semi-annual payments of interest beginning February 28, 2002. The debt issuance costs are being amortized over the term of the Debentures using the interest method. After deducting underwriting commissions and offering expenses, the net proceeds of this offering were Cdn.$12.3 million (approximately $7.7 million based on the exchange rate on October 31, 2001). The net proceeds from the offering will be used for working capital and general corporate purposes. Note 10. Contingencies The nature of our business subjects us to numerous regulatory investigations, claims, lawsuits and other proceedings in the ordinary course of our business. The results of these legal proceedings cannot be predicted with certainty. There can be no assurance that these matters will not have a material adverse effect on our results of operations in any future period, depending partly on the results for that period, and a substantial judgment could have a material adverse impact on our financial condition. In April 2000, we received a letter on behalf of Carnegie Mellon University asserting that it owns the trademark "CERT", and that it believes our use of the stock symbol "CERT" will cause confusion with and/or dilute its purported trademark. Although we intend to defend our use of the stock symbol "CERT" vigorously, there can be no assurance that we will be successful in doing so, or that this dispute with the University will not have a material adverse impact on us. We have also received a letter on behalf of Geoworks Corporation asserting that it holds a patent on certain aspects of technology that are part of the WAP standard. Our WTLS Plus(TM) toolkit may be used to implement WAP-compliant technology. After an internal investigation based upon the description of Geoworks' purportedly patented technology provided by Geoworks, it is our belief that our toolkits do not include implementation of the Geoworks technology. We have also become aware of a letter circulated on behalf of a Mr. Bruce Dickens asserting that he holds a patent on certain aspects of technology that are implemented within certain portions of the SSL standard. After an internal investigation, it is our belief that we do not implement any validly patented technology. We have received a letter on behalf of eSignX (eSignX) Corporation drawing our attention to a patent which it purports to hold on certain aspects of technology related to the use of WAP-enabled portable electronic authorization devices for approving transactions. The letter states that, based upon a review of a press release announcing our Trustpoint(TM) PKI product, that our product may be covered by eSignX's patent. We have conducted an initial investigation and due to the vague description of the suggested infringement by our products, we were unable to determine the validity of such suggestions. We requested further elaboration from eSignX, and while a response was recently provided, this matter is complex in nature and we have not had an opportunity to perform an appropriate analysis. Although we intend to vigorously defend any litigation that may arise in connection with these matters, there can be no assurance that we will be successful in doing so, or that such disputes will not have a material adverse impact on us. On October 18 2001, we were served with a lawsuit commenced by Mr. Leon Stambler against several companies, asserting that Mr. Stambler holds enforceable patents on certain aspects of technology related to online transactions, and seeking unspecified damages (U.S. District Court- Delaware/ Case # 01-0065-SLR). We have retained counsel and filed an answer to that complaint. Although we intend to vigorously defend our right to the use the indicted technology, there can be no assurance that we will be successful in doing so. Continued litigation is likely to be expensive and time-consuming. In general, there can be no assurance that such asserted patents will not have a material adverse impact on us. 11 In addition, one of our former employees retained counsel and demanded payment of approximately $375,000 in settlement of a claim for discrimination and wrongful termination. Although we intend to vigorously defend any litigation that may arise in connection with these matters, there can be no assurance that we will be successful in doing so, or that such disputes will not have a material adverse impact on us. The Company has not set aside any financial reserves related to the actions discussed above. Note 11. Recent Accounting Pronouncement In July 2001, the FASB issued SFAS No. 141. "Business Combinations". SFAS No. 141 requires that all business combinations be accounted for under the purchase method for business combinations initiated after June 30, 2001 for which the date of acquisition is July 1, 2001 or later. Use of the pooling-of-interest method is no longer permitted. In July 2001 the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 142 requires that goodwill no longer be amortized to earnings, but instead be periodically reviewed for impairment. SFAS No. 142 must be adopted starting with fiscal years beginning after December 15, 2001. The impact of adopting SFAS 141 and SFAS 142 has not been determined. In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long lived assets and for the associated asset retirement costs. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. The impact of adopting SFAS 143 has not been determined. In October, 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets", which addresses financial accounting and reporting for the impairment or disposal of certain long lived assets. This statement is effective for fiscal years beginning after December 15, 2001. The impact of adopting SFAS No. 144 has not been determined. Note 12. Subsequent Events On November 9, 2001, we announced that we would further reduce our workforce by 30% by the end of the third quarter of fiscal 2002 such that total workforce reductions since June 4, 2001 are approximately 63%. As of November 30, 2001 the number of active employees was 194. 12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation Certain statements contained in this Form 10-Q constitute "forward-looking statements" within the meaning of the United States Private Securities Litigation Reform Act of 1995. When used in this document, the words "may", "would", "could", "will", "intend", "plan", "anticipate", "believe", "estimate", "expect" and similar expressions, as they relate to us or our management, are intended to identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions. Many factors could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements, including, among others, those which are discussed in "Factors That May Affect Operating Results" beginning on page 22 of this Form 10-Q, in our Annual Report on Form 10-K and in other documents that we file with the Securities and Exchange Commission and Canadian securities regulatory authorities. Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking statements prove incorrect, actual results may vary materially from those described herein as intended, planned, anticipated, believed, estimated or expected. We do not intend, and do not assume any obligation, to update these forward-looking statements. Overview We are a leading provider of information security software and services, specializing in solutions for mobile e-business and the mobile workforce. Our products and services are specifically designed to address the challenges imposed by a wireless data environment. We offer comprehensive solutions that incorporate our efficient encryption technology and are based on industry standards for information security that utilize public-key cryptography. We believe that the addition of our products to wireless infrastructures will help to build the trust and confidence necessary for the success of mobile e-business and the mobile workforce. Historically, we have focused on the development and marketing of cryptographic and information security protocol toolkits. Today, our comprehensive product offering includes an enabling technologies suite, which allows original equipment manufacturers, or OEMs, to develop secure e-business applications; our trust services, which provide OEMs and enterprises with the necessary public-key infrastructure, or PKI, management tools and certificate services to authenticate users and servers; and our enterprise application software, which provides virtual private network, or VPN, security and strong personal digital assistant, or PDA, data security for enterprises wanting to enable a mobile workforce. In addition, we provide consulting and systems integration services to assist our customers in designing and implementing efficient security solutions. Our products and services solve difficult security problems for the world's leading providers of computing and communication products. OEM customers integrate our enabling technologies into their hardware and software products, then sell the finished products to consumers or enterprise customers. In addition, we sell our enterprise application software directly to Fortune 100 companies. We were founded in 1985 and are governed by the laws of the Yukon Territory, Canada. We determined that commencing May 1, 1999 our functional currency was the U.S. dollar and, accordingly, we began measuring and reporting our results of operations in U.S. dollars from that date. We changed our functional currency as we derive a majority of our revenues and incur a significant portion of our expenses in U.S. dollars. On January 26, 2000, we acquired all the outstanding shares of common stock of Trustpoint, a corporation based in Mountain View, California. Trustpoint is a private developer of PKI products. OEMs use PKI products to develop authentication and certification applications and services. In connection with this acquisition, we issued 201,120 of our common shares in exchange for all of the outstanding shares of Trustpoint and we also assumed Trustpoint's outstanding employee stock options. The transaction was accounted for as a purchase and, accordingly, the total consideration of approximately $10.5 million has been allocated to the tangible and intangible assets acquired based on their respective fair values on the acquisition date. Trustpoint's results of operations have been included in the consolidated financial statements from the date of acquisition. As a result of our acquisition of Trustpoint, we recorded goodwill and other intangible assets of approximately $10 million. These amounts are being amortized over a three to five year period. As of October 31, 2001, we have approximately $6.2 million of recorded goodwill and other intangible assets. On September 12, 2000, we completed our acquisition of DRG Resources Group, Inc., a corporation based in Redwood City, California. DRG Resources Group, Inc. is an e-commerce security consulting company. In connection with this acquisition, we issued 397,595 of our common shares in exchange for all of the outstanding 13 shares of DRG Resources Group, Inc. and we also assumed DRG Resources Group, Inc.'s outstanding stock options. The transaction was accounted for as a purchase and, accordingly, the total consideration of approximately $18.0 million has been allocated to the tangible and intangible assets acquired based on their respective fair values on the acquisition date. The results of operations of DRG Resources Group, Inc. have been included in the consolidated financial statements from the date of acquisition. As a result of our acquisition of DRG Resources Group, Inc., we recorded goodwill, deferred compensation expense, and other intangible assets of approximately $17.9 million. As a result of our restructuring program in June 2001, certain former owners and employees of DRG Resources Group, Inc. left our company and we wrote-off all goodwill and intangible assets and decreased deferred compensation expense such that, as of October 31, 2001, only $0.7 million remains. Our consolidated financial statements contained in this Form 10-Q are reported in U.S. dollars and are presented in accordance with U.S. generally accepted accounting principles, or U.S. GAAP. The following discussion and analysis relates to our financial statements that have been prepared in accordance with U.S. GAAP. Results of Operations We have incurred substantial operating losses since our inception and we expect to continue to incur operating losses in the future and we may never achieve profitability. As of October 31, 2001, we had an accumulated deficit of approximately $151 million as determined in accordance with U.S. GAAP. The following table sets out, for the periods indicated, selected financial information from our consolidated financial statements as a percentage of revenue.

14 Revenues We recognize software licensing revenue in accordance with all applicable accounting regulations including the American Institute of Certified Public Accountants Statement of Position (SOP) 97-2, "Software Revenue Recognition," as amended by SOP 98-4 and SOP 98-9. Following the requirements of SOP 97-2, we recognize license revenues when all of the following have occurred: . we have signed a non-cancelable license agreement with the customer; . delivery of the software product to the customer has occurred; . the amount of the fees to be paid by the customer are fixed or determinable; . and collection of these fees is probable. If an acceptance period is contractually provided, license revenues are recognized upon the earlier of customer acceptance or the expiration of that period. In instances where delivery is electronic and all other criteria for revenue recognition has been achieved, the product is considered to have been delivered when the customer either takes possession of the software via a download or the access code to download the software from the Internet has been provided to the customer. Our software does not require significant production, customization or modification. SOP 97-2, as modified, generally requires revenue earned on software arrangements involving multiple elements such as software products, upgrades, enhancements, post contract customer support, or PCS, installation and training to be allocated to each element based on the relative fair values of the elements. The fair value of an element must be based on evidence that is specific to the vendor. If evidence of fair value does not exist for all elements of a license agreement and PCS is the only undelivered element, then all revenue for the license arrangement is recognized ratably over the term of the agreement. If evidence of fair value of all undelivered elements exists but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred, and the remaining portion of the arrangement fee is recognized as revenue. When arrangements require us to deliver specified additional upgrades the entire fee related to the arrangement is deferred until delivery of the specified upgrade has occurred, unless we have vendor-specific objective evidence of fair value for the upgrade. Fees related to contracts that require us to deliver unspecified additional products are deferred and recognized ratably over the contract term. Revenue from consulting and training services are recognized using the percentage-of-completion method for fixed fee development arrangements or as the services are provided for time-and-materials arrangements. The fair value of professional services, maintenance and support services have been determined using specific objective evidence of fair value based on the price charged when the elements are sold separately. Revenues for maintenance and support service are deferred and recognized ratably over the term of the support period. Revenues from professional services are recognized when the services are performed. In June 2001, we converted our enabling technologies products primarily to subscription-based licenses. In addition, our trust services and enterprise application software product lines are accounted for under the subscription model. Subscription licenses provide our customers with rights to use our software for a specified period of time. Customers are entitled to use the license and receive certain customer support services over the license term. In addition, depending on the type of license, our customers have access to unspecified upgrades on an "if and when available" basis. We expect the average duration of the subscription licenses to be between one and two years. Under subscription licenses, we bill our customers for the current year's product and service fees. The billed product and service fees are recognized as revenues ratably over the billed period, generally one year. Deferred revenues generally result from the following: deferred maintenance and support service, cash received for professional services not yet rendered and license revenues deferred relating to arrangements where we have 15 received cash and are required to deliver either unspecified additional products or specified upgrades for which we do not have vendor-specific objective evidence of fair value. We operate in one reportable segment. We derive our revenues from a variety of sources that we generally classify as products and services. We earn products revenues from one-time base license fees or technology access fees, royalties, and hardware products. Our hardware products are manufactured by third parties to our specifications and resold by us to our customers. In addition, we earn revenues on a transaction basis through the sale of our authentication service offerings, which are primarily digital certificates. Services revenues are derived from the performance of contracted services for customers, maintenance, and support and training fees. We negotiate most of our customer contracts on a case-by-case basis. Prior to June 2001, most of our contracts (other than our contracts for professional services or hardware sales) include provisions for us to receive an up-front license fee and royalties. Our royalties for software licenses for mobile and wireless devices vary based on a number of factors, including the size of the contract and the nature of the contract, the customer, the device and the application. In June 2001, we converted our enabling technologies products primarily to subscription-based licenses. In addition, our trust services and enterprise application software product lines are accounted for under the subscription model. Under our subscription license model, we expect a significant percent of customers to renew their licenses upon license expiration. The change from perpetual licenses to subscription licenses has impacted our reported quarterly and annual revenues and will continue to do so on a going-forward basis as subscription license revenue will be amortized over the term of the subscription license. In the past, the majority of our perpetual license revenues have been recognized in the quarter of product delivery. Therefore, a subscription license order will result in substantially less current-quarter revenue than an equal-sized order for a perpetual license. We invoice our customers upfront for the full amount of a twelve-month subscription license period and collect the invoice within our standard payment terms. Although we expect that over the long term our cash flow from operations under the subscription license model will be equal to or greater than under the perpetual license model, in the near term we expect our cash flow from operations to decrease and deferred revenue to increase. The following table sets forth our revenues by category and by geography for the periods indicated: Three months ended Six months ended October 31, October 31, --------------------- ------------------- 2001 2000 2001 2000 ------ -------- -------- -------- Products 39% 80% 38% 79% Services 61 20 62 21 ------ -------- -------- -------- Total revenue 100% 100% 100% 100% ====== ======== ======== ======== U.S. 85% 68% 80% 77% Canadian 5 12 13 7 International 10 20 7 16 ------ -------- -------- -------- Total revenue 100% 100% 100% 100% ====== ======== ======== ======== Total revenues for the three months and six month periods ended October 31, 2001 were $2.7 million and $5.3 million, respectively, a 57% and 54% decrease compared to $6.3 million and $11.4 million for the comparable periods in the prior fiscal year. The decrease in total revenue was primarily attributable to our transition from the perpetual license model to the subscription license model. In addition, due to the economic recession, we experienced a reduction in the total number of deals sold and the number of large deals sold compared to the three and six month periods ended October 31, 2000. For the three months ended October 31, 2001, one of our professional services customers accounted for approximately 12% of our total revenue. For the six month period ended October 31, 2001, one of our professional services customer accounted for more than 10% of our total revenue. For the six month period ended October 31, 2000, two of our customers each accounted for more than 10% of our total revenue. Product revenues were $1.1 million and $2.0 million for the three and six month periods ended October 31, 2001, respectively, a 79% and 78% decrease compared to $5.1 million and $9.0 million for the same periods in the 16 prior fiscal year. The decrease was due to a majority of our new license contracts being recognized using our subscription license. Under our new subscription license, we recognize revenue ratably over the term of the contract whereas under the perpetual license model we recognize revenue when the product is delivered. In addition, the decrease in revenue was due to a reduction in the total number of deals completed including fewer purchases of prepaid royalties and the number of large deals sold compared to the same periods in the prior fiscal year. As a result of the downturn in wireless spending and the high technology sector some Certicom customers have either deferred projects to future dates or have experienced budget constraints which caused a reduction in their purchases of Certicom products. Services revenues were $1.7 million and $3.3 million for the three and six month periods ended October 31, 2001, respectively, a 33% and 39% increase compared to $1.2 million and $2.3 million for the three and six month periods ended October 31, 2000. The increase in services revenue was due to an increase in contract development work by our professional services organization, a larger customer base, and to a lesser extent, increases in maintenance fees. Deferred revenues result primarily from customer prepayments under subscription licenses and software maintenance which are recognized ratably over the life of the agreements; certain royalty agreements which are recognized as royalty license criteria are met; and professional services contracts, which are recognized as the services are performed. Deferred revenue is recognized only when collection of the receivables is reasonably assured. Revenues from international sales for the three and six month periods ended October 31, 2001 were $0.3 million and $0.4 million, respectively compared to $1.3 million and $1.9 million for the same periods in fiscal 2001. International revenue accounted for 10% and 7% of total revenues for the three and six month periods October 31, 2001 compared to 20% and 16% for the same periods in fiscal 2001. Certicom expects international sales to continue to remain constant as a percentage of total revenues in fiscal 2002. We expect to continue to invest in our international operations as we plan for growth in international markets. Cost of Revenues Total cost of revenues increased 1% to $2.6 million and $35% to $5.1 million for the three and six month periods ended October 31, 2001, respectively, compared to $2.6 million and $3.8 million for the same periods in the prior fiscal year. Cost of revenues consists of cost of the products and services. Cost of product revenues was $0.6 million for each of the three and six month periods ended October 31, 2001, respectively, a 150% and 39% increase as compared to $0.2 million and $0.5 million for the same periods of fiscal 2001. Our cost of products consists primarily of the cost of hardware products manufactured by third parties to our specifications as well as the costs of third-party hardware technology. In October 2001, we wrote-down $0.5 million of inventory related to businesses which we exited. Cost of services revenue was $2.0 million and $4.5 million for the three and six month periods ended October 31, 2001 respectively, a 14% decrease and 34% increase compared to $2.3 million and $3.4 million for the same periods in the prior fiscal year. Services costs of revenues consists primarily of personnel related costs associated with providing professional services, customer support and our MobileTrust hosting services to customers and the infrastructure to manage these organizations as well as costs to recruit, develop and retain our services employees. In addition, cost of services revenue includes the amortization of deferred compensation expense in connection with the acquisition of DRG Resources Group, Inc. The decrease for the three months ended October 31, 2001 is primarily due to the decrease in deferred compensation to $516,000 from $860,000, and the reduction in services employees as a result of the June 4, 2001 and August 9, 2001 restructuring programs. The increase for the six months ended October 31, 2001 is primarily due to the increase in services employees for the three months ended July 31, 2001 as compared to the three months ended July 31, 2000. Operating Expenses Our operating expenses consist of sales and marketing, product development and engineering, general and administrative, depreciation and amortization, impairment of goodwill and other intangibles and restructuring costs. Sales and Marketing 17 Sales and marketing expenses consist primarily of employee salaries and commissions, related travel, public relations and corporate communications, trade shows, marketing programs and market research and related infrastructure to manage these operations. Sales and marketing expenses were $3.5 million and $9.2 million for the three and six month periods ended October 31, 2001, respectively, compared to $4.3 million and $7.5 million for the same periods in fiscal 2001, a decrease of 18% and an increase of 22%, respectively. The decrease in sales and marketing expenses for the three months ended October 31, 2001, was primarily due to a decrease in sales and marketing employees and a reduction in trade shows and marketing programs. The increase in sales and marketing for the six months ended October 31, 2001, was primarily due to the increase in sales employees for the three months ended July 31, 2001 as compared to the three months ended July 31, 2000. Product Development and Engineering Product development and engineering expenses consist primarily of employee salaries, sponsorship of cryptographic research activities at various universities, participation in various cryptographic, wireless and e-business standards associations and related travel and other costs. We have capitalized certain costs associated with the filing of patent applications in various jurisdictions. These patent filings are in the areas of ECC, various mathematical computational methodologies, security protocols and other cryptographic inventions. Once granted, we amortize the individual patent cost over three years. We capitalize patents not yet granted at their cost less a provision for the possibility of the patent not being granted or abandoned. Product development and engineering expenses were $1.9 million and $4.4 million for the three and six month period ended October 31, 2001, respectively, compared to $3.0 million and $5.4 million for the same periods in fiscal 2001, a decrease of 37% and 19% respectively. The decrease is due to the cost savings related to the Company's restructuring efforts. General and Administrative General and administrative expenses consist primarily of salaries and other personnel-related expenses for executive, financial, legal, information services and administrative functions, amortization of stock compensation expense and bad debt expense. For the three and six month period ended October 31, 2001, general and administrative expenses were $2.7 million and $5.3 million, respectively, a decrease of 18% and 9% compared to $3.3 million and $5.8 million for the same periods in fiscal 2001. The decreases in fiscal 2002, which include $0.4 million for bad debt expense in the three and six month periods ended October 31, 2001, respectively, are the result of the implementation of our restructuring program announced on June 4, 2001. Since that time we have reduced the number of general and administrative employees and the associated costs. Depreciation and Amortization Depreciation and amortization represent the allocation to income of the cost of fixed assets and intangibles including patents cost over their estimated useful lives. Depreciation and amortization were $3.2 million and $6.8 million for the three and six month periods ended October 31, 2001, respectively, an increase of 7% and 18% compared to $3.0 million and $5.7 million for the same periods in fiscal 2001. Impairment of Goodwill and Other Intangibles In connection with our restructuring program announced on June 4, 2001, we identified indicators of possible impairment of goodwill and other acquired intangible assets relating to previous acquisitions. These indicators included the deterioration in the business climate, changes in sales and cash flow forecasts, revised strategic plans for certain acquired business and significant declines in the market values of companies in the security, wireless and general technology industries. As a result, we performed an impairment assessment of the identifiable intangible assets and goodwill recorded in connection with the acquisitions of DRG Resources Group, Inc. and Uptronics, Inc. Accordingly, Certicom compared the undiscounted cash flows associated with the acquired intangible assets and goodwill with the respective carrying amounts and determined that an impairment of certain assets existed. As a result, we recorded an impairment of intangible assets and goodwill of $9.4 million, measured as the amount by which the carrying amount exceeded the present value of the estimated future cash flows associated with goodwill and intangible assets. The assumptions supporting the cash flows, including the discount rate, were determined using our best estimates as of June 4, 2001. We will continue to assess the recoverability of the remaining goodwill and intangible assets in accordance with our policy. 18 Restructuring Costs On June 4, 2001, we announced a restructuring program to prioritize our initiatives, reduce costs not directly associated with selling and developing product and services, decrease discretionary spending and improve efficiency. This restructuring program includes a reduction of our full-time employee headcount, consolidation of excess facilities and reengineering of certain business functions, including a consolidation of distribution channels and a redeployment of product development to focus on our enabling technologies. On August 16, 2001 and November 9, 2001, we announced additional workforce reductions as part of our restructuring program. As a result of the restructuring program, we recorded restructuring costs of approximately $9.5 million for the three months ended July 31, 2001 and $12.0 million for three months ended October, 2001. We recorded restructuring expenses in the following areas: 1) reduction in workforce; 2) consolidation of excess facilities and non-productive property and equipment; and 3) elimination of deferred compensation. In addition, we recorded a non-cash charge of $0.5 million to write-down non-software product inventory related to businesses we are exiting. Since June 4, 2001, we have announced reductions in our workforce of approximately 63% across all business functions and geographic regions. During the six months ended October 31, 2001, we recorded an estimated charge of approximately $3.3 million relating primarily to severance and fringe benefits. During the six months ended October 31, 2001, we recorded a restructuring charge of approximately $13.0 million for property and equipment that will be disposed of or removed from operations and excess facilities including computer equipment and software no longer in use due to the reduction in workforce and downsizing of infrastructure,leasehold improvements related and lease inducements to facilities we no longer plan to occupy. For the six months ended October 31, 2001, we also wrote off $1.1 million of lease inducements related to these leasehold improvements. Lease inducements are reimbursements received from the landlord for certain leasehold improvements. During the six months ended October 31, 2001, we recorded a charge of $4.2 million for non-cancelable lease costs, of which we have paid $0.4 million under the assumption that we will not be able to sublease certain of our excess facilities in the next two years. During our second fiscal quarter ended October 31, 2001, we made adjustments to our non-cancelable lease estimates made during our first fiscal quarter ended July 31, 2001. We made these adjustments to reflect agreements with certain sub-tenants of our facilities for which agreements were entered into subsequent to July 31, 2001. The restructuring adjustment related to these sub tenant agreements was a $1.4 million reduction. In connection with the acquisition of DRG Resources Group, Inc., we recorded approximately $7.7 million of deferred compensation expense in connection with shares subject to restriction under employment agreements signed with the former owners of DRG Resources Group, Inc. These amounts are being amortized over an eighteen month period. As a result of the restructuring program announced in June 2001, certain former owners of DRG Resources Group, Inc. left our company. The unvested shares that were restricted under the terms of these employment agreements were immediately vested upon termination of the employees. As a result, approximately $2.3 million of deferred compensation charges were recorded in the first quarter of fiscal 2002. For the three and six months ended October 31, 2001, the Company recorded charges for restructuring activities and the write-down of inventory, goodwill and other intangible assets. There were no such charges for the three and six months ended October 31, 2000. The following table summarizes these charges (in thousands of U.S. dollars):

19 Write down of lease Inducements: (1,105) (1,105) - (1,105) - Future lease commitments and lease exit costs: 1,872 4,165 359 - 3,806 Sub tenant lease adjustment: (1,413) (1,413) - (1,413) Deferred compensation: - 2,322 - 2,322 - Other items: 203 203 8 120 75 -------- -------- -------- -------- -------- 12,047 21,580 2,963 12,655 5,962 -------- -------- -------- -------- -------- Deferred compensation: - 2,322 - 2,322 - Other items: 203 203 8 120 75 -------- -------- -------- -------- -------- 12,047 21,580 2,963 12,655 5,962 -------- -------- -------- -------- -------- Write down of inventory: 486 486 - 486 - Impairment of goodwill and other intangible assets: - 9,352 - 9,352 - -------- -------- -------- -------- -------- Total charges $ 12,533 $ 31,418 $ 2,963 $ 22,493 $ 5,962 ======== ======== ======== ======== ========

As a result of our on-going restructuring program, we expect to realize a total quarterly expense reduction of approximately $9.3 million as compared to the fourth quarter of fiscal year 2001, excluding non-cash related expenses such as depreciation, amortization, and deferred compensation. As discussed above, expenses include both cost of revenues and operating expenses. The expected quarterly expense reduction began in our first quarter of fiscal year 2002; however the full effect will not be realized until our fourth quarter of fiscal year 2002 Interest and Other Income (Expense) For the three and six month periods ended October 31, 2001, interest income was $150,000 and $866,000, respectively, compared to $833,000 and $1.8 million for the same periods in the prior fiscal year. The decline in interest income is the result of a decrease in cash and marketable securities invested and the decline in interest rates on short term investments for the three and six month periods ended October 31, 2001. Interest expense for the three and six months ended October 31, 2001, was $171,000 as compared to no interest expense and $423,000 of interest expense for the three and six months ended October 31, 2000. In August 2001, Certicom issued Cdn $13.5 million aggregate principal amount of 7.25% senior unsecured convertible notes (the Notes) on a private placement basis. The Notes were subsequently converted by the holders thereof, without payment of additional consideration into an equal principal amount of 7.25% senior convertible unsecured subordinated debentures (the Debentures). The Debentures mature on August 30, 2004 and are convertible into our common shares at the holder's option at a conversion price of Cdn $3.85 ($2.42 based on the exchange rate on October 31, 2001) per common share. As of the end of fiscal year 2000, we had borrowed $10 million from Sand Hill Capital II, LP (Sand Hill). In connection with this financing, we issued a warrant which entitles Sand Hill to purchase 50,000 of our common shares at an exercise price of Cdn $38.13 ($23.97 based on the exchange rate on October 31, 2001) per share until April 27, 2005. The warrant was valued at $423,000 at the time of issuance based on the Black-Scholes option valuation model. In the first quarter of fiscal 2001, we recorded a one-time, non-cash interest expense of $0.4 million related to the warrant issued to Sand Hill. The value of the warrant was charged to interest expense in the first quarter of fiscal 2001 as the loan was re-paid with proceeds from our public offering in May 2000. Provision for Income Taxes For each of the three and six month periods ended October 31, 2001, the provision for income taxes was $45,000 as compared to $55,000 and $135,000 for the same periods in the prior fiscal year. We pay taxes in accordance with U.S. federal, state and local tax laws and Canadian federal, provincial and municipal tax laws. We do not expect to pay significant corporate income taxes in both Canada and the United States in the foreseeable future because we have significant tax credits and net operating loss carry forwards for Canadian, U.S. federal and U.S. state income tax purposes. Financial Condition, Liquidity and Capital Resources In May 2000, we completed a public offering of 2,500,000 common shares at a per share price of $23.15 in the United States and Canada for an aggregate offering price of approximately $57.9 million. Our net proceeds from the offering were approximately $51.5 million after deducting underwriting discounts and commissions and offering expenses. On April 27, 2000, we borrowed $10 million from Sand Hill, at the prime rate of interest plus 3%. As partial consideration for making advances to us under this credit facility, we granted Sand Hill a warrant to purchase up to 50,000 of our common shares at an exercise price of Cdn.$38.13 ($23.97 based on the exchange rate on October 31, 2001) per share until April 27, 2005. We repaid the loan and interest on May 5, 2000, using a portion of the proceeds received from our public offering, and terminated this facility. 20 In March 2001, we issued 4,000,000 of our common shares in Canada and the United States at a per share price of Cdn.$12.50 ($7.86 based on the exchange rate on October 31, 2001). The common shares have not been registered under the United States Securities Act of 1933, as amended. The gross proceeds of this offering were Cdn.$50.0 million ($31.4 million based on the exchange rate on October 31, 2001). After deducting underwriting discounts and commissions and offering expenses, the net proceeds of this offering were Cdn.$47.2 million ($29.7 million based on the exchange rate on October 31, 2001). On August 30, 2001, we issued and sold Cdn.$13.5 million (approximately U.S.$8.7 million based on the exchange rate on August 30, 2001) aggregate principal amount of 7.25% senior unsecured convertible notes (the Notes) on a private placement basis. Subsequently, the Notes were converted by the holders thereof, without payment of additional consideration, into an equal principal amount of 7.25% senior convertible unsecured subordinated debentures (the Debentures). The Debentures mature on August 30, 2004 and are convertible into our common shares at the holder's option at any time before the close of business on the earlier of August 30, 2004 and the last business day before the date specified for redemption at a conversion price of Cdn.$3.85 ($2.42 based on the exchange rate at October 31, 2001) per common share. Certicom can redeem the Debentures at any time after August 30, 2003 at a price per Debenture equal to the principal amount thereof to be redeemed, together with accrued and unpaid interest on the principal amount of the Debenture so redeemed if the price of the Company's common shares is not less than 125% of the conversion price. The Debentures provide for semi-annual payments of interest beginning February 28, 2002. The debt issuance costs are being amortized over the term of the Debentures using the interest method. After deducting underwriting commissions and offering expenses, the net proceeds of this offering were Cdn.$12.3 million (approximately $7.7 million based on the exchange rate on October 31, 2001). The net proceeds from the offering will be used for working capital and general corporate purposes. At October 31, 2001, total cash and available-for-sale marketable securities were $28.9 million, excluding $2.0 million of restricted cash. During the six months ended October 31, 2001, Certicom's operating activities used net cash of $19.6 million. Net cash used in operating activities was primarily due to our net loss of $55.8 million, which was offset by non-cash charges of $30.3 million. The non-cash charges included $6.8 million of depreciation and amortization, $9.4 million of impairment of goodwill and other intangibles, $13.1 million of non-cash restructuring costs, and $1.0 million of stock compensation expense. Net changes in assets and liabilities consisted primarily of an increase in accrued restructuring charges of $6.0 million and a decrease in accounts receivable of $3.8 million, offset by a decrease in accounts payable of $4.2 million. During the six months ended October 31, 2001, Certicom's investing activities provided net cash of $8.6 million. Net cash provided by investing activities was primarily due to $22.0 million of net sales and maturities of marketable securities. The cash generated from sales and maturities of marketable securities was offset by $13.4 million of capital expenditures for property, equipment and patents, net of $0.8 million in lease inducements received. These consisted primarily of $10.9 million of leasehold improvements and related costs and $2.5 million of software and hardware cost. During the six months ended October 31, 2001, Certicom's financing activities provided net cash of $9.8 million. Net cash provided by financing activities was primarily due to the issuance of convertible debentures of $7.7 million and the issuance of common shares, including these related to the exercise of stock options of $2.2 million. We lease premises totaling approximately 111,000 square feet in Hayward, California. These leases expire in July, 2007. Through October 31, 2001, we had capitalized leasehold improvements and related construction costs totaling approximately $11.5 million for our Hayward facilities of which $2.7 million have been written-down due to restructuring initiatives which indicate we will not occupy 43,000 square feet for one of the buildings. We have a lease for approximately 30,300 square feet of office space in Mississauga, Ontario, which expires on December 25, 2009. Currently, our Canadian offices occupy this space. In addition, we have a ten year lease for a building of approximately 130,000 square feet located in Mississauga, Ontario. At this time, the facility is being constructed at our expense and we expect the total construction cost will be approximately $8.1 million. In addition, we anticipate incurring approximately an additional $2.8 million subsequent to October 31, 2001 to complete the build-out of the facility. If the landlord intends to sell the leased premises, we have a right of first refusal with respect of any sale of this property on terms to be negotiated. As a result of our restructuring initiatives, we intend to sublease the entire 21 130,000 square feet or structure a transaction to buy-out the lease. The annual rental fee for the new site varies between approximately Cdn.$10.85 to Cdn.$13.05 per square foot ($6.82 to $8.20 per square foot based on the exchange rate on October 31, 2001) over the life of the lease. We began paying rent on this lease in May 2001. We also have a lease for approximately 6,000 square feet in Herndon, Virginia that expires on October 2007. The total annual base rent for all facilities is approximately $3.1 million. In November 2001, we signed two sublease agreements. One sublease was for one of our buildings in Hayward for approximately 43,000 square feet. The sublease expires in July 2007 and the sublease rent per square foot exceeds the rent per square foot we pay to our landlord under our current lease agreement. The other sublease agreement is for our Herndon facility. The sublease expires in October 2007 and the sublease rent per square foot is less than the rent per square foot we pay to the landlord. In June 2001, we converted our enabling technologies products primarily to subscription-based licenses. Currently, our trust services and enterprise application software product lines are accounted for under the subscription model. Subscription licenses provide our customers with rights to use our software for a specified period of time. Customers are entitled to use the license and receive certain customer support services over the license term. In addition, depending on the type of license, our customers have access to unspecified upgrades on an "if and when available" basis. We expect the average duration of the subscription licenses to be between one and two years. At this time, we expect a significant percent of customers to renew their licenses upon license expiration. The change from perpetual licenses to subscription licenses has impacted our reported quarterly and annual revenues and will continue to do so on a go-forward basis, as subscription license revenue will be amortized over the term of the subscription license. In the past, the majority of our perpetual license revenues have been recognized in the quarter of product delivery. Therefore, a subscription license order will result in substantially less current-quarter revenue than an equal-sized order for a perpetual license. We invoice our customers upfront for the full amount of a twelve-month subscription license period and collect the invoice within our standard payment terms. Although we expect that over the long term our cash flow from operations under the subscription license model will be equal to or greater than under the perpetual license model, in the near term we expect our cash flow from operations to decrease and deferred revenue to increase. We believe our current cash and cash equivalents and marketable securities position will be sufficient to meet our liquidity needs for the near term. In the future, we may need to raise additional funds through public or private financings, strategic partnerships, as well as collaborative relationships, borrowings and other available sources. There can be no assurance that additional or sufficient financing will be available, or, if available, that it will be available on acceptable terms. If we raise funds by issuing additional equity securities, the percentage of our stock owned by our then current shareholders will be reduced. If adequate funds are not available, we may be required to significantly curtail one or more of our research and development programs or commercialization efforts or to obtain funds through arrangements with collaborative partners or others on less favorable terms. Factors That May Affect Operating Results We operate in a dynamic, rapidly changing environment that involves risks and uncertainties. You should carefully consider the risks described below and the other information in this Form 10-Q. These risks and uncertainties are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition or results of operations could be materially harmed. Risks Related to Our Company We have a limited operating history and have incurred losses since inception and anticipate incurring losses for the foreseeable future Although we have been engaged in the cryptographic security industry since 1985, we did not ship our first commercial toolkit or enter the U.S. market until 1997. Accordingly, our business operations are subject to all of the risks inherent in a new business enterprise, such as competition and viable operations management. These risks and uncertainties are often worse for a company engaged in new and evolving product markets. 22 Since our inception, we have incurred substantial net losses. As of October 31, 2001, we had an accumulated deficit of approximately $150.8 million (as determined in accordance with U.S. generally accepted accounting principles). We expect to incur additional losses for the foreseeable future and we may never achieve profitability. If we do achieve profitability, we may not be able to sustain it. You should not consider our historical growth indicative of our future revenue levels or operating results. Our success will depend in large part upon our ability to generate sufficient revenue to achieve profitability, to maintain existing customer relationships and to develop new customer relationships. Because our quarterly operating results are subject to fluctuations, period-to-period comparisons of our operating results are not necessarily meaningful and you should not rely on them as an indication of future performance Our quarterly operating results have historically fluctuated and may fluctuate significantly in the future. Accordingly, our operating results in a particular period are difficult to predict and may not meet the expectations of securities analysts or investors. If this were to occur, our share price would likely decline significantly. Factors that may cause our operating results to fluctuate include: . our transition to a subscription license business model; . the level of demand for our products and services as well as the timing of new releases of our products; . our dependence in any quarter on the timing of a few large sales; . our ability to maintain and grow a significant customer base; . the fixed nature of a significant portion of our operating expenses, particularly personnel, research and development, and leases; . costs related to our facilities consolidation; . unanticipated product discontinuation or deferrals by our OEM customers; . changes in our pricing policies or those of our competitors; . currency exchange rate fluctuations; and . timing of acquisitions, our effectiveness at integrating acquisitions with existing operations and related costs. Accordingly, we believe that quarter-to-quarter comparisons of our results of operations are not necessarily meaningful. You should not rely on the results of one quarter as an indication of our future performance. Because our revenues are difficult to predict, we may not be able to adjust spending in a timely manner to compensate for a shortfall in revenue We derive our revenue primarily from sales of our products and services to our OEM customers. Our sales vary in frequency, and OEM customers may or may not purchase our products and services in the future. The sale to, and implementation by, OEMs of our products and services typically involve a lengthy education process, along with significant technical evaluation and commitment of capital and other resources by them. This process is also subject to the risk of delays associated with (a) their internal budgeting and other procedures for approving capital expenditures, (b) deploying new technologies and (c) testing and accepting new technologies that affect key operations. As a result, the sales and implementation cycles associated with many of our products and services are generally lengthy, and we may not succeed in closing transactions on a timely basis, if at all. If orders expected from a specific customer for a particular period are not realized, our revenues could fail to materialize. In addition, our customers may defer the purchase of, stop using or not renew the subscription license of our products and services at any time, and certain license agreements may be terminated by the customer at any time. We negotiate most of our customer contracts on a case-by-case basis, which makes our revenues difficult to predict. Our existing customer contracts typically provide for base license fees on a subscription or perpetual basis, technology access fees and/or royalties based on a per-unit or per-usage charge or a percentage of revenue from 23 licensees' products containing our technology. In June 2001, we converted our enabling technologies products to primarily subscription-based licenses. Additionally, a number of our large contracts provide that we will not earn additional royalty revenues from those contracts until these customers' shipments exceed certain thresholds. As a result, a portion of our revenues are not recurring from period to period, which makes them more difficult to predict. Our expense levels are based, in part, on our expectations of future revenues and are largely fixed in the short term. We may not be able to adjust spending in a timely manner to compensate for any unexpected shortfall in revenues. The recent introduction of a subscription business model may result in a decrease in our reported revenue and cash flow from operations In June 2001, we converted our enabling technologies products to primarily subscription-based licenses. In addition, our trust services and enterprise application solutions product lines are accounted for under the subscription model. Subscription licenses provide our customers with rights to use our software for a specified period of time. Customers are entitled to use the license and receive certain customer support services over the license term. In addition, depending on the type of license, our customers have access to unspecified upgrades on an "if and when available" basis. We expect the average duration of the subscription licenses to be between one and two years. In addition, we expect a significant percent of our customers to renew their licenses upon license expiration. The change from perpetual licenses to subscription licenses will impact our reported quarterly and annual revenues on a going-forward basis, as subscription license revenue will be amortized over the term of the subscription license. In the past, the majority of our perpetual license revenues have been recognized in the quarter of product delivery. Therefore, a subscription license order will result in substantially less current-quarter revenue than an equal-sized order for a perpetual license. We expect to invoice our customers upfront for the full amount of a twelve-month subscription license period and collect the invoice within our standard payment terms. Although we expect that over the long term our cash flow from operations under the subscription license model will be equal to or greater than under the perpetual license model, in the near term we expect our cash flow from operations to decrease and deferred revenue and backlog to increase. The current economic downturn has reduced demand for our products and services, increased the average length of our sales cycle and may adversely affect future revenue The majority of our revenue has been, and is expected to continue to be, derived from customers in the United States. Recent economic indicators, including decreases in gross domestic product, reflect a recessionary economy in the United States. Some reports have indicated an even more significant decline in spending by corporations in the area of information technology, which includes the encryption technology and wireless communications markets. While we cannot specifically correlate the impact of macro-economic conditions on our sales activities, we believe that the economic conditions in the United States have resulted in decreased demand in our target markets and, in particular, have increased the average length of our sales cycle and reduced the dollar amount of contracts we sign. To the extent that the current downturn continues or increases in severity, or results in a similar downturn worldwide, we believe demand for our products and services, and therefore future revenue, will be reduced. Our restructuring of operations may not achieve the results we intend and may harm our business In June 2001, we announced a restructuring of our business, which included a reduction in our workforce of approximately 30% as well as other steps to reduce expenses. In August 2001 and November 2001, we announced additional workforce reductions, representing a decrease of approximately 63% of our workforce from June 2001 to further reduce costs to a level commensurate with our expected revenues. The planning and implementation of our restructuring has placed, and may continue to place, a significant strain on our managerial, operational, financial and other resources. Additionally, the restructuring may negatively affect our employee turnover, recruiting and retention of important employees. If we are unable to implement our restructuring effectively or if we experience difficulties in effecting the restructuring, our expenses could decrease less quickly than we expect. If we find that our restructuring activities announced in June, August and November do not sufficiently decrease our expenses, we may find it necessary to implement further streamlining of our expenses, to perform further reductions in our workforce or to undertake another restructuring of our business. If our restructuring activities are not successful in effectively reducing our expenses or result in the loss of key personnel or employee morale, our business, financial condition and results of operations would be materially adversely affected. 24 A limited number of customers account for a high percentage of our revenue and the failure to maintain or expand these relationships could harm our business Five customers comprised approximately 42% of our revenue for the fiscal year ended April 30, 2001, and approximately 31% of our revenue for the fiscal year ended April 30, 2000. For the six months ended October 31, 2001, five customers accounted for approximately 31% of our revenue. For the three month ended October, 2001, one of our professional services customers accounted for approximately 12% of our total revenue. For the three months ended October 31, 2000, two customers each accounted for more then 10% of our total revenue. For the six month period ended October 31, 2001, one of our professional services customers accounted for more than 10% of our total revenue. For the six month period ended October 31, 2000, two of our customers each accounted for more than 10% of our total revenue. The loss of one or more of our major customers, the failure to attract new customers on a timely basis, or a reduction in usage and revenue associated with the existing or proposed customers would harm our business and prospects. We are contractually obligated to complete certain leasehold improvements In October 2000 we signed a ten-year lease, effective May 2001, for approximately 130,000 square feet located in Mississauga, Ontario. At this time, the facility is being constructed at our expense and we expect the total cost will be approximately $8.7 million. Through October 31, 2001, we have incurred $5.9 million of the total construction costs. We anticipate incurring approximately $2.8 million in additional construction costs subsequent to October 31, 2001 to complete the build-out of the facility. At this time, we do not plan to occupy the facility. Therefore, we are in the process of subleasing 100% of the facility as well as discussing other alternatives with the landlord to terminate the lease. We may not be able to find suitable sub-tenants to occupy this space in a timely manner in the future, if at all, or otherwise sublease these properties without a loss. If we are unable to find suitable sub-tenants, we may experience greater than anticipated operating expenses in the future, which could materially adversely affect our financial condition and operating results. We may be unable to find sub-tenants to sublease currently leased and vacant space In March 2000, we entered into a lease covering 68,000 square feet of office space adjacent to our then existing 43,000 square foot Hayward facility. This lease expires in July 2007 and has an initial monthly rent of approximately $61,000, with 3% annual increases. The lease on our adjacent Hayward facility expires in July 2007 and has current monthly base rent payments of approximately $54,000, increasing to approximately $57,000 in March 2002 and approximately $60,000 in March 2004. In August 2001, we relocated our Hayward operations to the 68,000 square foot facility and in November 2001, subleased our 43,000 square foot Hayward office space at a rental rate slightly above our rental rate. The sub-tenant is a privately financed medical device manufacturer which was started in 1998. The sub-tenant is not yet profitable and there is no assurance the sub-tenant will become profitable. If the sub-tenants were to discontinue paying rent, we would experience greater than planned operating expenses which could materially adversely affect our financial condition and operating results. We signed in October 2001 a ten-year lease for approximately 130,000 square feet located in Mississauga, Ontario. If the landlord intends to sell the leased premises, we have a right of first refusal with respect of any sale of this property on terms to be negotiated. The annual rental fee for the new site varies between approximately Cdn.$10.85 to Cdn.$13.05 per square foot ($6.82 to $8.20 per square foot based on the exchange rate on October 31, 2001) over the life of the lease. We began paying rent on this lease in May 2001. At this time we do plan to occupy this facility. We are currently searching for tenants to sublease our current Hayward and new Mississauga spaces. We may not be able to find suitable sub-tenants to occupy this space in a timely manner in the future, if at all, or otherwise sublease these properties without a loss. If we are unable to find suitable sub tenants, we may experience greater than anticipated operating expenses in the future, which could materially adversely affect our financial condition and operating results. Our success depends on an increase in the demand for digital signatures in m-business transactions and ECC-based technology becoming accepted as an industry standard For handheld devices, many of the advantages our ECC-based technology has over conventional security technology are not applicable to a transaction that does not involve the creation of a digital signature on a handheld device. Currently, the vast majority of e-business and m-business transactions do not involve such digital signatures. Participants in mobile e-business have only recently begun to require client digital signatures in some applications, 25 such as enterprise data access and certain high-value transactions. Unless the number of mobile e-business transactions involving client digital signatures increases, the demand for our products and services, and consequently, our business, financial condition and operating results could be materially adversely affected. In order for our business to be successful, ECC technology must become accepted as an industry standard. This has not happened to date, and may never happen. The technology of our principal competitor, RSA Security Inc., is and has been for the past several years, the de facto standard for security over open networks like the Internet. The patent related to this competing technology expired in September 2000, making this technology freely available. The free availability of such security technology could significantly delay or prevent the acceptance of ECC as a security standard, which could reduce the demand for some of our products and, consequently, our business, financial condition and results of operations could be materially adversely affected. Some of our products are new, unproven and currently generate little or no revenue In late 2000 and early 2001, we launched our PKI products, CA service and VPN client software product. We continue to invest in and develop future versions of these products which add features and functionality and to support our current versions of these products. We cannot predict the future level of acceptance, if any, of these new products, and we may be unable to generate significant revenue from these products. We have only recently begun to sell directly to enterprise customers, and we may not be successful in developing the products and services necessary to serve this new customer base We have recently started to sell certain products directly to enterprises other than OEMs. The direct-to-enterprise sales efforts will require that we attract, hire, train, manage and adequately compensate a larger group of professionals. We may not be successful in managing our sales effort so that the revenues produced by our direct sales will offset our increased expenses. These non-OEM, or enterprise, customers will require different products, support services and integration services than our existing OEM customer base. We may not be successful in developing the products and services necessary to serve this new customer base. Our business depends on continued development of the Internet and the continued growth of m-business Our future success is substantially dependent upon continued growth in Internet usage and the acceptance of mobile and wireless devices and their use for m-business. The adoption of the Internet for commerce and communications, particularly by individuals and companies that have historically relied upon alternative means of commerce and communication, generally requires the understanding and acceptance of a new way of conducting business and exchanging information. In particular, companies that have already invested substantial resources in other means of conducting commerce and exchanging information may be reluctant or slow to adopt a new, Internet-based strategy that may make their existing infrastructure obsolete. To the extent that individuals and businesses do not consider the Internet to be a viable commercial and communications medium, our business may not grow. Furthermore, building a wireless-based strategy requires significant investment. Many companies may not have resources and capital to build the infrastructure required to support a wireless-based strategy. If this infrastructure build out does not occur, our revenue may not grow. In addition, our business may be harmed if the number of users of mobile and wireless devices does not increase, or if e-business and m-business do not become more accepted and widespread. The use and acceptance of the Internet and of mobile and wireless devices may not increase for any number of reasons, including: . actual or perceived lack of security for sensitive information, such as credit card numbers; . traffic or other usage delays on the Internet; . competing technologies; . governmental regulation; and . uncertainty regarding intellectual property ownership. 26 Capacity constraints caused by growth in the use of the Internet may impede further development of the Internet to the extent that users experience delays, transmission errors and other difficulties. If the necessary infrastructure, products, services and facilities are not developed, if the Internet does not become a viable and widespread commercial and communications medium, or if individuals and businesses do not increase their use of mobile and wireless devices for mobile e-business, our business, financial condition and operating results could be materially adversely affected. We have recently issued convertible debentures and our increased debt may place restrictions on our operations and limit our growth On August 30, 2001, we issued and sold Cdn.$13.5 million ($8.7 million based on exchange rate on August 30, 2001) aggregate principal amount of 7.25% convertible notes (the Notes) on a private placement basis. The Notes were subsequently converted by the holders thereof, without payment of additional consideration, into an equal principal amount of 7.25% senior convertible unsecured subordinated debentures (the Debentures) mature on August 30, 2004 and are convertible into our common shares at the holder's option at any time before the close of business on the earlier of August 30, 2004 and the last business day before the date specified for redemption at a conversion price of Cdn.$3.85 ($2.42 based on the exchange rate on October 31, 2001) per common share. If all of the Debentures are converted into common shares, holders of our outstanding common shares could have substantial dilution of their interest in the Company. Our total liabilities on a consolidated basis as at October 31, 2001 were approximately $25.9 million. The level of our indebtedness could have important consequences on our ability to operate and grow our business including the following: (i) our ability to obtain additional financing in the future could be restricted: (ii) our cash flow from operations dedicated to the payment of the principal of, an interest on, our indebtedness will not be available for other purpose; (iii) our flexibility in planning for, or reacting to, changes in our business and market conditions could be restricted. In addition, we may be more highly leveraged than certain of our competitors which might place us at a competitive disadvantage, and we could be more vulnerable in the event of further downturns in our business. We may not generate the required cash flow to service our debt We will be required to make our first payment of interest on the Debentures on February 28, 2002. Annual cash interest requirements on the Debentures will be approximately Cdn. $978,750 ($615,340 based on the exchange rate on October 31, 2001) There can be no assurance that we will achieve or sustain profitability or positive cash flow from operating activities, we may not be able to meet our debt service or working capital requirements or to obtain additional capital required in order to execute our business plan. We must manage our growth Despite our recent workforce reductions, we have experienced a period of significant growth in our sales and personnel that has placed strain upon our management systems and resources. Subject to future prevailing economic conditions, we may pursue potential market opportunities. Our growth has placed, and will place, demands on our management and operational resources, particularly with respect to: . training, supervising and retaining skilled technical, marketing and management personnel; . strengthening our financial and management controls in a manner appropriate for a larger enterprise; . maintaining a cutting edge research and development staff; . developing and managing a larger, more complex international organization; and . preserving our culture, values and entrepreneurial environment. Our revenue may not continue to grow at a pace that will support our planned costs and expenditures. To the extent that our revenue does not increase at a rate commensurate with these additional costs and expenditures, our results of operations and liquidity would be materially adversely affected. Our management has limited experience managing a business of our size and, in order to manage our growth effectively, we must concurrently develop more sophisticated operational systems, procedures and controls. If we 27 fail to develop these systems, procedures and controls on a timely basis, it could impede our ability to deliver products in a timely fashion and fulfill existing customer commitments and, as a result, our business, financial condition and operating results could be materially adversely affected. Acquisitions could harm our business We acquired Consensus Development Corporation and Uptronics Incorporated in fiscal year 1999, Trustpoint in fiscal year 2000, and DRG Resources Group, Inc. in fiscal year 2001. We may acquire additional businesses, technologies, product lines or services in the future either in the United States or abroad. Acquisitions involve a number of risks, potentially including: . disruption to our business; . inability to integrate, train, retain and motivate key personnel of the acquired business; . diversion of our management from our day-to-day operations; . inability to incorporate acquired technologies successfully into our products and services; . additional expense associated with completing an acquisition and amortization of any acquired intangible assets; . impairment of relationships with our employees, customers and strategic partners; and . inability to maintain uniform standards, controls, procedures and policies. In addition, we may not be able to maintain the levels of operating efficiency that any acquired company achieved or might have achieved separately. Successful integration of the companies we acquire will depend upon our ability to eliminate redundancies and excess costs. As a result of difficulties associated with combining operations, we may not be able to achieve cost savings and other benefits that we might hope to achieve with these acquisitions. We may satisfy the purchase price of any future acquisitions through the issuance of our common shares, which may result in dilution to our existing shareholders. We may also incur debt or assume liabilities. We cannot assure you that we will be able to obtain any additional financing on satisfactory terms, or at all. Incurring debt or assuming additional liabilities would make us more vulnerable to economic downturns and may limit our ability to withstand competitive pressures. The terms of any additional indebtedness may include restrictive financial and operating covenants, which could limit our ability to compete and expand our business. Our business strategy also includes entering into strategic investments and joint ventures with other companies. These transactions are subject to many of the same risks identified above for acquisitions. Our success depends on attracting and retaining skilled personnel Our success is largely dependent on the performance of our management team and other key employees. Our success also depends on our ability to attract, retain and motivate qualified personnel. Most of our key technical and senior management personnel are not bound by employment agreements. Loss of the services of any of these key employees would harm our business, financial condition and operating results. We do not maintain key person life insurance policies on any of our employees. Competition for qualified personnel in the digital information security industry is intense, and finding and retaining qualified personnel in the San Francisco Bay Area and the Greater Toronto Area are difficult. We believe there are only a limited number of individuals with the requisite skills to serve in many of our key positions, and it is becoming increasingly difficult to hire and retain such persons. Competitors and others have in the past and may attempt in the future to recruit our employees. A major part of our compensation to our key employees is in the form of stock option grants. A prolonged depression in our share price could make it difficult for us to retain employees and recruit additional qualified personnel. In addition, the volatility and current market price of our common shares may make it difficult to attract and retain personnel. 28 We face risks related to our international operations For the six months ended October 31, 2001 and the fiscal year ended April 30, 2001, we derived approximately 7% and 10%, respectively, of our revenue from international operations. An important component of our long-term strategy is to further expand into international markets, and we must continue to devote resources to our international operations in order to succeed in these markets. To date, we have limited experience in international operations and may not be able to compete effectively in international markets. This future expansion is expected to involve opening foreign sales offices, which may cause us to incur substantial costs. International sales and operations may be limited or disrupted by increased regulatory requirements, the imposition of government and currency controls, export license requirements, political instability, labor unrest, transportation delays and interruptions, trade restrictions, changes in tariffs and difficulties in staffing and coordinating communications among international operations. In addition, these foreign markets may require us to develop new products or modify our existing products. There can be no assurance that we will be able to manage effectively the risks associated with our international operations or that those operations will contribute positively to our business, financial condition or operating results. We face risks related to intellectual property rights We rely on one or more of the following to protect our proprietary rights: patents, trademarks, copyrights, trade secrets, confidentiality procedures and contractual provisions. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy and may succeed in copying aspects of our product designs, products or trademarks, or obtain and use information we regard as proprietary. Preventing the unauthorized use of our proprietary technology may be difficult in part because it may be difficult to discover such use. Stopping unauthorized use of our proprietary technology may be difficult, time-consuming and costly. In addition, the laws of some countries in which our products are licensed do not protect our products and services and related intellectual property to the same extent as the laws of Canada, the United States and countries of the European Union. While we believe that at least some of our products are covered by one or more of our patents and these patents are valid, a court may not agree if the matter is litigated. There can be no assurance that we will be successful in protecting our proprietary rights and, if we are not, our business, financial condition and operating results could be materially adversely affected. We occasionally receive communications from third parties alleging patent or copyright infringement, and there is always the chance that third parties may assert infringement claims against us. Currently, we are defending a claim filed against us by Leon Stambler. Any such claims, with our without merit, could result in costly litigation, expense of significant resources to develop non-infringing technology, cause product shipment delays or require us to enter into royalty or licensing agreements. We cannot be certain that the necessary licenses will be available or that they can be obtained on commercially reasonable terms. If we were to fail to obtain such royalty or licensing agreements in a timely manner and on reasonable terms, our business, financial condition and results of operations would be materially adversely affected. The industry in which we compete has many participants who own, or claim to own, intellectual property. We indemnify our licensees against third-party intellectual property claims based on our technology. At this time, we are defending one of our licensees for a claim filed against them by Leon Stambler. Claims relating to intellectual property by any third-party business, individual or university, whether or not with merit, could be time-consuming to evaluate, result in costly litigation, cause shipment delays for products or the cessation of the use and sale of products or services, or require us to obtain licenses by paying license fees and/or royalties to the owners of the intellectual property. Such licensing agreements, if required, may not be available on royalty or other terms acceptable to us. Any of these situations could materially adversely affect our business, financial condition and operating results. We also currently license third party technology for use in some of our products and services. These third party technology licenses may not continue to be available on commercially reasonable terms or may not be available at all. Our business, financial condition and operating results could be materially adversely affected if we lose the right to use certain technology. We are engaged in joint development projects with certain companies. One of these projects has resulted in the issuance of jointly owned patents. There is a risk that the companies with which we are working could decide not to commercialize the joint technology and that we may be unable to commercialize joint technology without their consent and/or involvement. 29 We belong to certain organizations that set standards. As part of the standards process, the participants are requested to file statements identifying any patents they consider to be essential to implementation of the standard. As such, we may be required to disclose and license patents that we own which are necessary for practice of the standard. Further, to provide products that are compliant with standards that have been adopted or will be adopted in the future, we may have to license patents owned by others. As a part of some standards processes, other companies have disclosed patents that they believe are required to implement those standards. We cannot assure you that we will be able to gain licenses to these patents, if needed, on terms acceptable to us. Such licensing requirements may materially adversely affect the value of our products, and, consequently, our business, financial condition and operating results. Our products could have defects which could delay their shipment, harm our reputation and increase costs Our products are highly complex and, from time to time, may contain design defects that are difficult to detect and correct. Errors, failures or bugs may be found in our products after commencement of commercial shipments. Even if these errors are discovered, we may not be able to correct such errors in a timely manner or at all. The occurrence of errors and failures in our products could result in damage to our reputation, lost revenue and the loss of, or delay in achieving, market acceptance of our products, and correcting such errors and failures in our products could require significant expenditure of capital by us. The sale and support of these products may entail the risk of product liability or warranty claims based on damage to such equipment. In addition, the failure of our products to perform to customer expectations could give rise to warranty claims. Our insurance may not cover or its coverage may be insufficient to cover any such claims successfully asserted against us, and therefore the consequences of such errors, failures and claims could have a material adverse effect on our business, financial condition and operating results. System interruptions and security breaches could harm our business We are in the process of constructing a secure data center for issuing certificates. We will depend on the uninterrupted operation of that data center. We will need to protect this center and our other systems from loss, damage, or interruption caused by fire, power loss, telecommunications failure or other events beyond our control. In addition, most of our systems and the data center are located, and most of our customer information is stored, in the San Francisco Bay Area, which is susceptible to earthquakes. Any damage or failure that causes interruptions in our data center and our other computer and communications systems could materially adversely affect our business, financial condition and operating results. Our success also depends upon the scalability of our systems. Our systems have not been tested at the usage volumes that we expect will be required in the future. As a result, a substantial increase in demand for our products and services could cause interruptions in our systems. Any such interruptions could materially and adversely affect our ability to deliver our products and services and our business, financial condition and operating results. Although we intend to periodically perform, and retain accredited third parties to perform, evaluations of our operational controls, practices and procedures, we may not be able to meet or remain in compliance with our internal standards or those set by these third parties. If we fail to maintain these standards, we may have to expend significant time and money to return to compliance, and our business, financial condition and operating results could be materially adversely affected. We will retain certain confidential customer information in our planned data center. It is important to our business that our facilities and infrastructure remain secure and be perceived by the marketplace to be secure. Despite our security measures, our infrastructure may be vulnerable to physical break-ins, computer viruses, attacks by hackers or other disruptive problems. It is possible that we may have to expend additional financial and other resources to address these problems. Any physical or electronic break-ins or other security breaches or compromises of the information stored at our planned data center may jeopardize the security of information stored on our premises or in the computer systems and networks of our customers. In such an event, we could face significant liability and damage to our reputation, and customers could be reluctant to use our products and services. Such an occurrence could also result in adverse publicity and adversely affect the market's perception of our products and services, which could materially adversely affect our business, financial condition and operating results. We must continue to develop and maintain strategic and other relationships 30 One of our business strategies has been to enter into strategic or other collaborative relationships with many of our OEM customers to develop new technologies and leverage their sales and marketing organizations. We may need to enter into additional relationships to execute our business plan. We may not be able to enter into additional, or maintain our existing, strategic relationships on commercially reasonable terms. As a result, we may have to devote substantially more resources to the development of new technology and the distribution, sales and marketing of our security products and services than we would otherwise. The failure of one or more of our strategic relationships could materially adversely affect our business, financial condition and operating results. We compete with some of our customers We regularly license some of our products to customers who compete with us in other product categories. For example, we license our Security Builder(R) cryptographic toolkit to Baltimore Technologies for incorporation into its UniCERT(TM) product, which competes with our Trustpoint(TM) product line. This potential conflict may deter existing and potential future customers from licensing some of our component products, most notably our Security Builder(R) cryptographic toolkit. We expect to compete with a greater number of our customers as we further expand our product line. Our share price has been, and will likely continue to be, volatile The market price of our common shares has declined significantly in recent months, and we expect that the market price of our common shares may fluctuate substantially as a result of variations in our quarterly operating results. These fluctuations may be exaggerated if the trading volume of our common shares is low. In addition, due to the technology-intensive and emerging nature of our business, the market price of our common shares may fall dramatically in response to a variety of factors, including: . announcements of technological or competitive developments; . acquisitions or entry into strategic alliances by us or our competitors; . the gain or loss of a significant customer or strategic relationship; . changes in estimates of our financial performance; . changes in recommendations from securities analysts regarding us, our industry or our customers' industries; and . general market or economic conditions. This risk may be heightened because our industry is new and evolving, is characterized by rapid technological change and is susceptible to the introduction of new competing technologies or competitors. In addition, equity securities of many technology companies have experienced significant price and volume fluctuations. These price and volume fluctuations are sometimes unrelated to the operating performance of the affected companies. Volatility in the market price of our common shares could result in securities class action litigation. This type of litigation, regardless of the outcome, could result in substantial costs to us as well as a diversion of our management's attention and resources. We have limited financial resources and may require additional financing that may not be available on acceptable terms or at all We may require additional equity or debt financing in the future. There can be no assurance that we will be able to obtain on satisfactory terms, or at all, the additional financing required to compete successfully. Failure to obtain such financing could result in the delay or abandonment of some or all of our business plans, which could have a material adverse effect on our business, financial condition and operating results. Risks Related to Our Industry 31 Public key cryptographic technology is subject to risks Our products and services are largely based on public-key cryptographic technology. With public-key cryptographic technology, a user has both a public-key and a private-key. The security afforded by this technology depends on the integrity of a user's private-key and on it not being stolen or otherwise compromised. The integrity of private keys also depends in part on the application of certain mathematical principles such as factoring and elliptic curve discrete logarithms. This integrity is predicated on the assumption that solving problems based on these principles is difficult. Should a relatively easy solution to these problems be developed, then the security of encryption products using public-key cryptographic technology could be reduced or eliminated. Furthermore, any significant advance in techniques for attacking cryptographic systems could also render some or all of our products and services obsolete or unmarketable. Even if no breakthroughs in methods of attacking cryptographic systems are made, factoring problems or elliptic curve discrete logarithm problems can theoretically be solved by computer systems that are significantly faster and more powerful than those currently available. In the past, there have been public announcements of the successful decoding of certain cryptographic messages and of the potential misappropriation of private keys. Such publicity could also adversely affect the public perception as to the safety of public-key cryptographic technology. Furthermore, an actual or perceived breach of security at one of our customers, whether or not due to our products, could result in adverse publicity for us and damage to our reputation. Such adverse public perception or any of these other risks, if they actually occur, could materially adversely affect our business, financial condition and operating results. Our future success will depend upon our ability to anticipate and keep pace with technological changes The information security industry is characterized by rapid technological change. Technological innovation in the marketplace, such as in the areas of mobile processing power or wireless bandwidth, or the development of new cryptographic algorithms, may reduce the comparative benefits of our products and could materially adversely affect our business, financial condition and operating results. Our inability, for technological or other reasons, to enhance, develop and introduce products in a timely manner in response to changing market conditions, industrial standards, customer requirements or competitive offerings could result in our products becoming obsolete, or could otherwise have a material adverse effect on our business, financial condition and operating results. Our ability to compete successfully will depend in large measure on our ability to maintain a technically competent research and development staff and to adapt to technological changes and advances in the industry, including providing for the continued compatibility of our products with evolving industry standards and protocols. We face significant competition, which could harm our ability to maintain or increase sales of our products or reduce the prices we can charge for our products We operate in a highly competitive industry. Many of our competitors have greater name recognition, larger customer bases and significantly greater financial, technical, marketing, public relations, sales, distribution and other resources than we do. We anticipate that the quality, functionality and breadth of our competitors' product offerings will improve, and there can be no assurance that we will be able to compete effectively with such product offerings. In addition, we could be materially adversely affected if there were a significant movement towards the acceptance of open source solutions or other alternative technologies that compete with our products. We expect that additional competition will develop, both from existing businesses in the information security industry and from new entrants, as demand for information products and services expands and as the market for these products and services becomes more established. Moreover, as competition increases, the prices that we charge for our products may decline. If we are not able to compete successfully, our business, financial condition and operating results could be materially adversely affected. Our most significant direct competitors include RSA Security, Inc., VeriSign, Inc., Baltimore Technologies plc, and Entrust Inc. Our business could be adversely affected by United States and foreign government regulation The information security industry is governed by regulations that could have a material adverse effect on our business. Both the U.S. and Canadian governments regulate the export of cryptographic equipment and software, including many of our products. It is also possible that laws could be enacted covering issues such as user privacy, pricing, content, and quality of products and services in these markets. Such regulations and laws could cause us to compromise our source code protection, minimize our intellectual property protection, negatively impact our plans for global expansion, and consequently materially adversely affect our business. 32 Risks Related to Our Corporate Charter; Limitations on Dividends The anti-takeover effect of certain of our charter provisions could delay or prevent our being acquired Our authorized capital consists of an unlimited number of common shares and an unlimited number of preferred shares issuable in one or more series. Although we currently do not have outstanding any preferred shares, our board of directors has the authority to issue preference shares and determine the price, designation, rights, preferences, privileges, restrictions and conditions, including voting and dividend rights, of these shares without any further vote or action by shareholders. The rights of the holders of common shares will be subject to, and may be adversely affected by, the rights of holders of any preferred shares that may be issued in the future. The issuance of preferred shares, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, or the issuance of additional common shares could make it more difficult for a third party to acquire a majority of our outstanding voting shares. This could deprive our shareholders of a control premium that might otherwise be realized in connection with an acquisition of our company. Our shareholder rights plan could delay or prevent our being acquired We have adopted a shareholder rights plan. The provisions of this plan could make it more difficult for a third party to acquire a majority of our outstanding voting shares, the effect of which may be to deprive our shareholders of a control premium that might otherwise be realized in connection with an acquisition of our company. We do not currently intend to pay any cash dividends on our common shares in the foreseeable future We have never paid or declared any cash dividends on our common shares and we currently intend to retain any future earnings to finance the development and expansion of our business. We do not anticipate paying any cash dividends on our common shares in the foreseeable future. In addition, any dividends paid to residents of the United States would be subject to Canadian withholding tax, generally at the rate of 15%. Item 3. Quantitative and Qualitative Disclosure About Market Risk Foreign Exchange Risk Currency fluctuations may materially adversely affect us. In fiscal 2000, approximately 33% of our total operating expenses were paid in currencies other than the U.S. dollars. In fiscal 2001, approximately 29% of our total operating expenses were paid in currencies other than the U.S. dollar In the first six months of fiscal 2002, approximately 30% of our total operating expenses were paid in currencies other than the U.S. dollar. Fluctuations in the exchange rate between the U.S. dollar and such other currencies may have a material adverse effect on our business, financial condition and operating results. In particular, we may be materially adversely affected by a significant strengthening of the Canadian dollar against the U.S. dollar. We currently do not use financial instruments to hedge operating expense in foreign currencies. We intend to assess the need to utilize financial instruments to hedge currency exposures on an ongoing basis. Interest Rate Risk We hold a significant portion of our cash in interest-bearing instruments and are exposed to the risk of changing interest rates. The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. We place our investment with high credit quality issuers and, by policy, limit the amount of the credit exposure to any one issuer. All highly liquid investments with a maturity of less than three months at the date of purchase are considered to be cash equivalent. All investments with maturities of three months or greater are classified as available-for-sale and considered to be short-term investments. Some of the securities that we have invested in may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. We believe that an immediate 100 basis point move in interest rates would not materially affect the fair market value of our portfolio. To minimize this risk, we maintain our portfolio of cash equivalent and short-term investments in a variety of securities, including commercial paper, medium-term notes, and corporate bonds. As of October 31, 2001, our interest rate risk was further limited by the fact that approximately 100% of our investments mature in less than one year. We do not use any derivative instruments to reduce our exposure to interest rate fluctuations. 33 PART II. OTHER INFORMATION Item 1. Legal Proceedings The nature of our business subjects us to numerous regulatory investigations, claims, lawsuits and other proceedings in the ordinary course of our business. The results of these legal proceedings cannot be predicted with certainty. There can be no assurance that these matters will not have a material adverse effect on our results of operations in any future period, depending partly on the results for that period, and a substantial judgment could have a material adverse impact on our financial condition. In April 2000 we received a letter on behalf of Carnegie Mellon University asserting that it owns the trademark "CERT", and that it believes our use of the stock symbol "CERT" will cause confusion with and/or dilute its purported trademark. Although we intend to defend our use of the stock symbol "CERT" vigorously, there can be no assurance that we will be successful in doing so, or that this dispute with the University will not have a material adverse impact on us. We have also received a letter on behalf of Geoworks Corporation asserting that it holds a patent on certain aspects of technology that are part of the WAP standard. Our WTLS Plus(TM) toolkit may be used to implement WAP-compliant technology. After an internal investigation based upon the description of Geoworks' purportedly patented technology provided by Geoworks, it is our belief that our toolkits do not include implementation of the Geoworks technology. We have also become aware of a letter circulated on behalf of a Mr. Bruce Dickens asserting that he holds a patent on certain aspects of technology that are implemented within certain portions of the SSL standard. After an internal investigation, it is our belief that we do not implement any validly patented technology. We have received a letter on behalf of eSignX Corporation drawing our attention to a patent which it purports to hold on certain aspects of technology related to the use of WAP-enabled portable electronic authorization devices for approving transactions. The letter states that, based upon a review of a press release announcing our Trustpoint(TM) PKI product, that our product may be covered by eSignX's patent. We have conducted an initial investigation and due to the vague description of the suggested infringement by our products, we were unable to determine the validity of such suggestions. We requested further elaboration from eSignX, and while a response was recently provided, it is complex in nature and we have not had an opportunity to perform an appropriate analysis. Although we intend to vigorously defend any litigation that may arise in connection with these matters, there can be no assurance that we will be successful in doing so, or that such disputes will not have a material adverse impact on us. On October 18 2001, we were served with a lawsuit commenced by Mr. Leon Stambler against several companies asserting that Mr. Stambler holds enforceable patents on certain aspects of technology related to online transactions, and seeking unspecified damages (U.S. District Court- Delaware/ Case # 01-0065-SLR). We have retained counsel and filed an answer to that complaint. Although we intend to vigorously defend our right to the use the indicted technology, there can be no assurance that we will be successful in doing so. In general, there can be no assurance that such asserted patent will not have a material adverse impact on us. Continued litigation is likely to be expensive and time-consuming. In general, there can be no assurance that such asserted patents will not have a material adverse impact on us. In addition, one of our former employees retained counsel and demanded payment of approximately $375,000 in settlement of a claim for discrimination and wrongful termination. Although we intend to vigorously defend any litigation that may arise in connection with these matters, there can be no assurance that we will be successful in doing so, or that such disputes will not have a material adverse impact on us. The Company has not set aside any financial reserves related to the actions discussed above. Item 4. Submission of Matters to a Vote of Security Holders At our Annual Meeting of Shareholders held on October 22, 2001, each of Bernard W. Crotty, William T. Dodds, Louis E. Ryan, William J. Stewart, Scott A. Vanstone and Robert P. Wiederhold was elected as a Director by the number of votes set forth in item 1 of the table below. The following proposals were adopted by the margins required under applicable law: 34

35 Item 6. Exhibits and Reports on Form 8-K (a) Index to Exhibits Exhibit Number Description -------------- --------------------------------------------------- 10.1 Sublease Agreement between Certicom Corp. as Sub- landlord, and Guava Technologies Inc. as Subtenant, dated November 1, 2001. 10.2 Trust Indenture - Debentures, dated August 30, 2001 10.3 Trust Indenture - Notes, dated August 30, 2001 10.4 First Supplemental Indenture, dated August 30, 2001 (b) Reports on Form 8-K None 36 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 14th day of December 2001. Certicom Corp. /s/ Gregory M. Capitolo ----------------------- Gregory M. Capitolo Vice President, Finance, Chief Financial Officer and Secretary (Principal Financial and Accounting Officer) 37

CERTICOM CORP 10-Q