UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
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 0-27074
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SECURE COMPUTING CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 52-1637226
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
ONE ALMADEN BLVD, SUITE 400
SAN JOSE, CA 95113
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (408) 918-6100
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
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Indicate by check mark whether the Registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|
The aggregate market value of the Common Stock held by non-affiliates
of the Registrant as of March 10, 1999 was $259,349,736, based on the closing
sale price for the Company's Common Stock on that date. For purposes of
determining this number, all officers and directors of the Registrant are
considered to be affiliates of the Registrant, as well as individual
stockholders holding more than 10% of the Registrant's outstanding Common Stock.
This number is provided only for the purpose of this report on Form 10-K and
does not represent an admission by either the Registrant or any such person as
to the status of such person.
As of March 10, 1999 the Registrant had 16,732,241 shares of Common
Stock issued and outstanding which number includes 743,636 Exchangeable Shares
that have the same voting and other rights as Common Stock and are immediately
exercisable for shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for its Annual Meeting of
Stockholders to be held May 13, 1999 for the year ended December 31, 1998 are
incorporated by reference in Part III hereof.
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PART I
This Annual Report on Form 10-K contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934, including statements regarding the
Company's expectations, beliefs, intentions or strategies regarding the future.
Forward-looking statements include, without limitation, statements regarding the
extent and timing of future revenues and expenses and customer demand. These
statements include, but are not limited to, statements concerning expectations
of intensifying future competition, the Company's belief in the performance
capabilities of its products and the Company's expectation of increased sales
through indirect sales channels, and the Company's plans to improve and enhance
existing products and develop new products.
All forward-looking statements included in this document are based
on information available to the Company as of the date hereof, and the Company
assumes no obligation to update any such forward-looking statements. It is
important to note that the Company's actual results could differ materially from
those in such forward-looking statements. The forward-looking statements of the
Company are subject to risks and uncertainties. Some of the factors that could
cause future results to materially differ from the Company's recent results or
those projected in the forward-looking statements are described in the "Certain
Factors that May Affect Future Results" section of this Form 10-K.
ITEM 1. BUSINESS
Secure Computing Corporation ("Secure Computing" or the "Company")
designs, develops, markets and sells a comprehensive offering of interoperable,
standards-based products for end-to-end network solutions, including firewalls,
Web filters, authentication, extranet access control and security related
professional services. Today, the Company enables business security solutions
through its advanced technologies, professional services and partner programs.
The Company's goal is to provide a complete portfolio of integrated enterprise
security solutions for corporate networks.
Originating as a small division of Honeywell Inc. that pioneered the
principles of modern data security in the 1970s, the Company spun off in 1989 to
develop and market core security for the National Security Agency (NSA) and
other departments and agencies of the United States government. Recognizing the
market need for an integrated suite of product solutions to address the growing
productivity and security concerns of today's enterprise information systems,
the Company acquired authentication and URL filtering companies in 1996, along
with a robust international distribution network with the acquisition of Border
Network Technologies Inc.
The Company markets a range of interoperable, standards-based
network security products to the global marketplace. The Company's customers
include Fortune 500 companies, small branch offices, and government agencies all
of whom rely on the Company's suite of network security solutions to maximize
their productivity on the Internet without compromising information security.
INDUSTRY BACKGROUND
PRIVATE NETWORKS. Enterprise computing has evolved over the past
twenty-five years from mainframe computers supporting a number of terminals to
networks of inter-connected personal computers. As the cost of personal
computers has decreased, businesses and other organizations increasingly have
begun to connect personal computers into local-area networks ("LANs") in order
to share data and applications within work groups. As network technology has
advanced, organizations have connected together geographically dispersed LANs
into wide-area networks ("WANs"). Originally each vendor provided network
support using its own proprietary suite of network, transport, and application
protocols, Novell IPX/SPX, IBM SNA, etc. Today, most vendors support the
standard TCP/IP protocol suite either by providing an implementation with their
products and/or by providing gateways that translate between their proprietary
protocol suite and the TCP/IP suite. As a result, an increasing number of
businesses are using the standard TCP/IP protocol suite for at least some of
their internal network communications.
Private networks present several advantages to an organization. They
can combine mainframes, UNIX servers and personal computers running on different
operating systems such as DOS, Windows 95 or Windows NT, and the Macintosh
operating system into a single network. They can support remote access from
other private networks to provide customer support bulletin board services,
ordering and acknowledgment using electronic data interchange ("EDI"), and
database sharing. Because TCP/IP is an open standard maintained by the Internet
Engineering Task Force ("IETF"), there is a large number of researchers and
vendors developing new protocols to support applications ranging from electronic
commerce and digital cash to video conferencing. Thus, the utility of corporate
networks and the opportunities to use them in support of enterprise critical
operations are rapidly increasing. More importantly, the adoption of the TCP/IP
protocol suite enables an organization to use the Internet to implement a WAN,
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thereby extending its internal information systems and enterprise applications
to geographically dispersed facilities, remote offices and mobile employees. The
Internet provides a lower cost, though insecure, alternative to private company
networks.
THE INTERNET. The Internet allows any computer connected to it to
communicate with any other computer. Much of the recent rapid growth of the
Internet and the related World Wide Web is attributed to an increase in
commercial access providers and to organizations seeking to exploit the Internet
for commercial gain. Common uses of the Internet include intra- and
inter-organizational communication and data sharing, product marketing and
advertising, interactive customer feedback, and e-commerce.
However, there are limits to how some organizations have chosen to
use the Internet. Many commercial organizations have established a "home page"
giving them a presence on the Internet but have not connected mission critical
internal networks to the Internet. As a result, these organizations' personnel
do not have full access to the resources of the Internet, and the organizations'
customers, suppliers, and other business partners do not have timely access to
the organizations' personnel and data. The Company believes that, due to the
sensitive nature of the information involved, the growth of the number of
commercial organizations fully connected to the Internet and the broad
introduction of significant additional commercial uses of the Internet have been
slowed by security concerns, and will continue to be slowed by such concerns
until use of the Internet can be made significantly more secure.
NETWORK SECURITY. Networks and network transmissions are vulnerable
to a variety of attacks that can compromise the secrecy and/or the integrity of
mission critical data or that can cause the loss of services critical to the
organization. The National Institute of Standards and Technology (the "NIST")
has identified the TCP/IP protocol suite and the Internet as particularly
vulnerable to attack. Individuals have been able to exploit weaknesses in the
protocol suite and network configurations to gain unauthorized access to network
transmissions and individual computers, and have used such access to alter or
steal data or, in some cases, to launch destructive attacks on data and
computers within a compromised network. Moreover, the Internet itself serves as
a threat multiplier. Knowledge of attacks and the software required to mount
these attacks spreads quickly through the hacker community. Thus, an attacker
does not need to be especially sophisticated. Moreover, the attacker can launch
the attack from anywhere on the Internet, often hopping from site to site to
hide his/her identity and true location.
Security conscious industries such as financial services, insurance,
healthcare, telecommunications and defense have typically addressed network
security concerns by using private networks. This is not an alternative for some
organizations that want to take advantage of the business opportunities provided
by networked computing in general and the Internet in particular. Even within
private networks, the increasing number of authorized users having direct access
to expanding networks and the data contained on such networks has increased the
need to provide protection for financial results, personnel files, research and
development projects and other sensitive data. Moreover, these private networks
do not lend themselves to the rapid reconfiguration necessary to support the
dynamic needs of companies as they form new alliances and terminate old ones in
a constantly shifting sea of virtual enterprises. The solution is an integrated
set of security products that enables a corporation to connect safely to the
Internet and to rapidly reconfigure its information security policy as the
business climate and alliances change.
The Company believes that the combination of security concerns and
the relatively small number of businesses offering comprehensive, flexible,
enterprise-wide security solutions presents a significant commercial opportunity
for providers of network security products and services.
ELEMENTS OF NETWORK SECURITY. The Company has identified what it
believes are the key elements of an effective network security solution that
should be addressed by an organization in order for it to secure its information
networks from unauthorized access. These features are security policy,
identification and authentication, access control, encryption, administration,
audit, accounting, and network services.
* SECURITY POLICY -- the means by which an organization determines
which users and other network principals have access to its network,
which actions each principal is permitted to take, and how the
network will be managed. Security products must be flexible enough
to support a variety of policies and easy to reconfigure when an
organization's policies change.
* IDENTIFICATION AND AUTHENTICATION -- the means by which the
organization identifies principals attempting to gain access to a
network and confirms the source of transmissions over the network.
* ACCESS CONTROL -- the means by which a principal is prevented from
taking unauthorized actions, such as importing (exporting)
information from (to) the Internet.
* ENCRYPTION -- the means by which information, whether in storage
or in transmission, is kept private and its integrity is maintained
in the event that a transmission is intercepted or the storage
medium is stolen or tampered with.
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* ADMINISTRATION -- the ability of a network administrator to
configure the network's security features to implement the
organization's security policy.
* AUDIT AND ACCOUNTING -- the ability to monitor activity in the
network, to detect and respond to abuse of information assets, and
to hold principals accountable for their actions.
* NETWORK SERVICES -- professional network security expertise,
support and education services, to enable ongoing management and
evolution of security policies and enforcement measures.
SECURE COMPUTING'S SOLUTION
Based on its understanding of competitive products, product features
and service capabilities, the Company believes that its current portfolio of
products and services enables comprehensive network security while offering
innovations in architecture, interfaces and features. These innovations can
translate into strategic business benefits -- such as ease of management,
reduced human error and lower total cost of ownership -- in addition to flexible
and comprehensive network security.
All elements of network security are addressed by each Secure
Computing product, either by direct integration of key features or through
inter-operability with other Secure Computing products. Education and support
services are tailored to each product, and professional services address the
life span of a security policy.
TECHNOLOGY
FIREWALLS
Secure Computing offers firewalls designed to provide an optional
set of capabilities to meet varying requirements. The Company's firewalls which
use a firewall-specific operating system integrated with the firewall
application deliver robust security for security-conscious organizations. The
Company's firewalls that run on a commercial operating system are designed for
companies that want ease of use and administration. The Company's range of
firewalls are multi-homed application-level gateways that understand and
interpret network protocols, increase access control in any direction, support a
comprehensive suite of network services and enable Network Address Translation
and Multiple Address Translation to hide addresses from untrusted networks.
ACCESS CONTROL. Access control rules determine how the firewall
reacts to user connection requests from internal and external networks.
Versatile, configurable access control features enable organizations to define
unique and simple-to-complex rules for enforcing security policy on internal and
external network connection attempts. The Company's access control features
ensure consistent and automatic enforcement of security policy, regardless of
policy complexity.
VIRTUAL PRIVATE NETWORKS ("VPN"). The Company has regularly
introduced IPSec-compliant VPN innovations, adding new value to this proven
approach to using lower-cost Internet connections for secured business network
connections. VPNs are encrypted connections between firewalls, or between a
firewall and an end user computer, which can reduce the costs of creating a
private network for connecting geographically dispersed resources. The Company
introduced dynamic VPN support with integrated third party software for local
access to the Internet from any major business center in the world, an important
option for organizations with remote and roaming employees. The Company also
engineered firewall support for embedded VPNs with granular access control
options, automated key management, X.509 digital certificate handling and
inter-operability with standard certificate authorities.
SECUREOS(TM). SecureOS, the Company's operating system designed for
delivering robust security, removes the inherent risks of layering a firewall on
top of a discrete commercial operating system. These risks escalate over time,
usually through normal operating system upgrades, exposing the firewall
integrity to threat agents from inside and outside the organization. With
SecureOS, the Company enables security-sensitive organizations in every industry
to avoid the risks and costs associated with maintaining separate operating
systems.
REGIONS. The Company introduced an approach called "Regions" in its
new family of firewalls in March 1998 to view configurations, establish rules,
and set policies at increasing levels of detail through a powerful, visual
object-based design. Regions are groupings of physical interfaces (network
cards) and VPNs into entities of similar trust.
Regions allow administrators to define both physically and virtually
connected global networks into grouped items for easy management. Regions can be
named as desired, and network access policies can be applied for any Region to
Region
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communication. Furthermore, administrators can define Network Address
Translation to hide addresses between any Regions, rather than specifying one as
the trusted network and exposing untrusted network addresses.
TYPE ENFORCEMENT(TM). Initially developed for classified government
agencies and now incorporated into the Company's Unix firewall architectures,
Secure Computing's patented Type Enforcement technology secures the underlying
firewall operating system and protects network services by segmenting them into
individual domains. Each domain is granted permission to access specific file
types and domains. As a result, each domain provides a self-contained, discrete
layer of protection which cannot be altered. Firewalls with Type Enforcement
protect against known network penetration and denial of service attacks,
including the most common, destructive and malicious attacks.
INTRUSION DETECTION AND STRIKEBACK(TM) RESPONSE. The Company's
Strikeback feature responds to intrusion attempts with selectable alarms and
captures as much information as possible about the intruder, including their
source and the route used to reach the system. Strikeback has proven its value
in permitting organizations to take direct corrective action against individual
attackers and organizations employing them.
CENTRALIZED AND REMOTE MANAGEMENT. Centralized control features
include an easy-to-use management interface, encrypted and authenticated remote
management, remote systems configuration, and real-time monitoring of suspicious
activities on the network. Administrators can use SNMP agents to send alarms to
SNMP-compliant network management stations located on an internal or external
network. Comprehensive audit, reporting and diagnostics support proactive and
productive management, as well as user access billing.
COMPREHENSIVE AUDIT AND LOGGING. Comprehensive audit and logging
technology allows the Company's firewalls to provide comprehensive audit,
logging and report generation tools to enable effective management reporting of
all access attempts. Special security alarms and alert notifications bring
unauthorized access attempts to the immediate attention of the administrator.
For example, an organization may configure its firewall with traps which trigger
an alarm, alerting a network administrator (by paging the administrator if
desired) to the attack in progress. Moreover, the firewall can be configured to
lure the unauthorized user to continue the attack by making it appear that the
attack is succeeding, while implementing software countermeasures which log the
attack and trace the attack to its source. The triggers can also be configured
to immediately terminate access.
TRANSPARENCY. Transparency technology enables the Company's
firewalls to provide unobtrusive security by seamlessly integrating a firewall
into a new or existing network without interfering with legitimate corporate
network services and business requirements. As a result, the Company's firewalls
do not alter the work behavior of internal users nor do they require
modification to existing or new software in use on the protected network.
IDENTIFICATION AND AUTHENTICATION
The Company's identification and authentication technology results
from more than a decade of efforts in network authenticating technology.
Authentication products enable corporations to identify remote users and
business partners and to authorize their access to enterprise network resources.
The Company has three patents for this technology. The authentication offering
consists of an authentication server, hard tokens, soft tokens and a management
console.
DYNAMIC PASSWORDS. Dynamic password technology is compatible with
existing computing and networking equipment utilized by most organizations.
Since each password can only be used one time, methods of electronically trying
many passwords have an extremely low mathematical probability of being
successful. Physical observation or electronic interception of the entered
password will not enable the eavesdropper to gain access, without calculating a
subsequent authorized dynamic password. This process is made extremely unlikely
by the use of the Data Encryption Standard ("DES") algorithm, which is widely
recognized as a government certified and industry-tested standard. Databases of
user authentication codes and authorizations are themselves encrypted utilizing
the DES algorithm for further protection from unauthorized access.
AUTHENTICATION PROTOCOLS AND INTERFACE MODULES. This technology
supports existing and emerging authentication protocols, including four TCP/IP
based protocols, XTACACS, TACACS+, RADIUS and EASSP. Certain of these
authentication protocols have been adopted by many manufacturers of access
equipment, and permit transmission of a user's name and password from numerous
connection points and through various network connectors, gateways, routers,
servers and ports to the authentication server. In addition, a linkable library
of files allows customers to create support for other levels of authentication
at either the application or the transaction level. The application interface
can be linked by a customer with virtually any application or new or customized
authentication products. After such linkage, execution of the application will
permit the application or product to pass a user-entered name and dynamic
password to the application interface, which, after communicating through the
software, returns the result of the authentication query to the application or
product.
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OPEN ARCHITECTURE AND INTER-OPERABILITY. The Company's
identification and authentication technology has been designed to operate on a
wide variety of platforms and to be compatible with a wide range of
telecommunications products and protocols. This allows multiple solutions for
different types of security needs, which is important to organizations operating
a heterogeneous computing environment. Moreover, it supports multiple token
types manufactured by the Company and others within a single network.
SCALABILITY. The ability to support large numbers of simultaneous
users is a major requirement for enterprises who need to manage hundreds of
thousands of users without performance degradation. One database can support
greater than one million users, and each authentication server can contain
several databases. In addition, the Company's authentication software allows the
support of a high volume of user authentication requests through the use of
multiple servers which are automatically synchronized.
FULLY DOWN-LOADABLE, ALL SOFTWARE SOLUTION. The technology permits a
down-loadable, all software solution. Through a combination of the Company's
network authentication software and software password generators, or "tokens,"
an organization can achieve an all-software authentication solution for its
network. An all software solution reduces the aggregate cost of the
authentication systems.
FAULT TOLERANCE. With this feature, databases are automatically
mirrored on up to four servers on a network to achieve fault tolerance. As a
result, a hardware failure of one server does not prevent the authentication of
users.
WEB MONITORING AND FILTERING
The Company's Web monitoring and filtering product resides on a
proxy server and blocks access to objectionable Web sites or alternatively
"deprioritizes" requests to a non-work site.
CONTROL LIST. This is a database of URLs for major Internet
protocols (HTTP, FTP, NNTP, and Gopher) representing sites, portions of sites,
or discrete documents available on the Internet that meet the criteria of one or
more of the 27 categories that the control list currently supports. The
distributed form of the control list is binary, using a secure hash algorithm to
both protect the actual contents of the database, and to form the basis of
efficient runtime access for URL filtering. Proprietary tools are used to
perform updates to the control list efficiently and effectively, including
Human-Computer Interface and automated Web robots (variations on the spiders
used by most Internet search engines), which provide candidate URLs from a
variety of sources for review by list technicians.
MULTIPLE PLATFORM FUNCTIONALITY. This feature includes Web proxies
for Unix and Windows NT, plug-ins for leading general-purpose proxies such as
Netscape Proxy Server and Microsoft Proxy Server, and proxy-based enhancements
to the Company's line of firewall products. In all cases the monitoring and
filtering applications leverage the widely accepted concept of proxies for
fundamental Internet protocols.
PROGRAMMING TOOLKIT. This toolkit is an application programming
interface to the core functionality of the control list which is used as a
high-level development tool for developing customized monitoring and filtering
applications. The Programming Toolkit is used internally and externally by
third-party vendors.
PRODUCTS AND SERVICES
The Company's security products are designed to provide integrated
enterprise security solutions for corporate networks.
SECUREZONE(TM). The first of the Company's new family of network
security solutions, SecureZone delivers comprehensive, robust security with
revolutionary ease of use and lower cost of ownership to organizations requiring
a highly sophisticated level of security protection. The intuitive, visual
interface simplifies and speeds all aspects of security administration,
including access control, entities of trust and VPNs. SecureZone is the first
network security solution to deliver application gateway strengths with embedded
VPNs and commercially available integrated X.509 digital certificate management.
SecureZone delivers advanced security technologies developed for government and
military agencies, including the Company's patented Type Enforcement, SecureOS,
and Strikeback intrusion detection/response.
SIDEWINDER(TM) SECURITY SERver. Sidewinder employs features such as
SecureOS, Type Enforcement and Strikeback intrusion detection/response.
Sidewinder delivers robust power and versatility for enforcing complex security
policies and stringent security thresholds for both government and commercial
organizations. Sidewinder permits highly granular control over network access
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rules, message filtering and intrusion detection. It provides all the features
of a robust application gateway firewall plus additional technologies and
filters, allowing safe connections to and through untrusted networks.
SECURE COMPUTING FIREWALL(TM) FOR NT. Secure Computing Firewall for
NT is the only commercially available application gateway firewall which is
Microsoft BackOffice compliant. Secure Computing Firewall for NT is a native
Windows NT server application, built to take full advantage of the NT server
architecture. It delivers a cost effective, highly secure solution without the
complexity of firewalls ported to Windows NT environments from UNIX platforms.
Fitting naturally into Windows NT environments, it addresses business,
technology and skills requirements with a native Windows NT graphical user
interface and native facilities.
SAFEWORD(TM). The SafeWord family of strong authentication products
provides server software, hard tokens and soft tokens for secured access to
networks. SafeWord features built-in replication to enable load balancing,
real-time mirroring and recovery. It combines one-time encrypted password
protection with standards-based inter-operability, resulting in a wide choice of
servers and tokens. SafeWord runs on a wide range of platforms and supports
multiple token types from other manufacturers.
SMARTFILTER(TM). SmartFilter helps organizations manage
productivity, preserve network bandwidth and reduce legal liability through
industry-leading Web monitoring and filtering. Organizations can manage and
monitor Internet access through the SmartFilter Control List. For ease of
administration, the Control List is organized into 27 selectable content
categories and can be customized to organizational needs, interests and
policies. SmartFilter capabilities combine in unique ways with each of the
Company's network security solutions and complement a selection of recognized
firewalls participating in the Company's Partner's First program.
SECUREWIRE(TM). SecureWire is the first commercially available
business solution combining the capabilities of intranet and extranet
technologies for sharing internal Web data with external users, such as
partners, customers, suppliers and agencies. SecureWire enables organizations to
grant authorized access to specific pages or URLs on the internal network, while
denying access to all other data. As a result, each external user can be granted
a portal to internal Web data in keeping with the security policy.
PROFESSIONAL SERVICES. The Company provides a rich portfolio of
professional services, ranging from internal and external network penetration
testing to security site assessment, security policy development and secure
architecture services. Services are provided by the Company's team of
accredited, certified security experts, including 28 Certified Information
Systems Security Professionals ("CISSP").
The standard professional service offering of the Company is the
investigation and analysis of a client's operational and information security
issues. The investigation includes a variety of interviews, observations, and
technical tools. The Company's security experience is applied to the analysis of
a client's critical information assets and systems, business objectives and
operational environment, and the subsequent identification of potential threats
and risks. The process is documented in written reports and oral presentations
which clearly describe what action the client should take to improve their
security posture. Recommended actions may include network redesign, policies,
procedures, and training, as well as specific technology such as cryptography,
authentication tools and firewalls. Additional professional services include
customized security policies, security architecture, and a variety of either
standard or customized security related training, as well as fully customized
consulting, based on specific customer needs.
SECURESUPPORT(TM). SecureSupport provides expert customer support
resources through diverse access options, including telephone, email and
Web-based support. Service options are tailored for each of the Company's
network security products.
Customers may purchase software support and upgrade service for an
annual fee. Product feature upgrades are released when new features or
capabilities are made available to software support subscribers. Basic hardware
support is provided pursuant to the Company's basic warranty terms. Extended
warranties are available for an annual fee. Enhanced hardware support may be
purchased at varying rates either to provide service during normal business
hours or at all times (24 hours a day, 7 days a week) for up to three years. The
Company currently provides hardware support through contracts with third party
support vendors and by using Company employees. Software updates and technical
support are provided through program fix releases to customers when necessary to
fix bugs or to provide enhancements to existing software features.
The Company provides limited hardware and software warranties to
users for one year from acceptance of a product, and will provide contractual
maintenance, service of the hardware and upgrades of software for a fee after
warranty expiration. In many instances, the Company's warranties are in turn
supported by warranties received by the Company from its manufacturers and
suppliers.
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EDUCATION AND TRAINING SERVICES. The Company hosts extensive product
training and security education opportunities through classes, workshops and
seminars around the world for customers and Channel Partners. These services
assist in maintaining security integrity, from updating security policy to
configuring products to integrating products into cohesive solutions.
ADVANCED TECHNOLOGY CONTRACTS
From its inception, the Company has been engaged in research and
development of information security technology by acquiring and executing
contracts with departments and agencies of the United States government,
including the NSA. These contracts have provided the Company with the financial
resources to establish a group of scientists and engineers specializing in
computer systems security. As a result, the Company has been able to bridge the
technology acquired under government contracts into its commercial product and
service offerings.
The majority of the Company's contracts require the Company to
perform specified services, for which the Company is reimbursed for actual cost
plus a fee. Under these cost-reimbursement contracts, the Company bears the risk
that increased or unexpected costs that are beyond the scope of a contract but
are to required to perform the contracts specified services may reduce the
Company's profitability. Pursuant to their terms, these contracts generally are
also subject to termination at the convenience of the applicable government
agency. If a contract is terminated, the Company typically is reimbursed for its
costs to the date of its termination plus the cost of an orderly termination and
is paid a portion of the fee. The Company's United States government contracts
are subject to audit by the Defense Contract Audit Agency (DCAA). The DCAA has
periodically audited the Company's contracts without any material cost
disallowances.
CUSTOMERS
The Company's current commercial customers and prospects are likely
to consider network security solutions a high priority, because they routinely
deal with proprietary or highly sensitive information.
Customers within the United States government for the Company's
products and services include the Department of Defense (both directly and
through the NSA), which is the single largest government user of classified
processing systems, and the Department of Energy. The Company also targets other
agencies within the United States government.
The Company's customers also include foreign governments and
businesses. The Company sells its products in western Europe, the Middle East,
Australia and the Pacific Rim, mainly through reseller channels.
SALES AND MARKETING
SALES
The Company sells its products and services through both indirect
and direct channels, using a worldwide sales organization of 61 individuals, as
of February 28, 1999. For 1998, indirect channel sales comprised 63% of total
product sales, while direct sales to major end-users comprised the remaining
37%. Indirect channels include sales made to domestic and international
distributors, value-added resellers, major integrators and original equipment
manufacturers (OEM's).
Direct sales include sales made by the Company directly to end-users
of the Company's products. The typical profile of the end-user buying directly
from the Company are larger, Fortune 1000 companies requiring both professional
services and product sales for an enterprise-wide solution.
The Company has continued its emphasis toward an indirect sales
model, by forming dedicated sales teams that manage each segment of the indirect
sales channels. In addition, in 1998 the Company launched a new `Partners First'
channel program, that provides increased benefits to business partners selling
the Company's products. In 1998, a dedicated corporate sales team was formed to
target only named-accounts. This strategy provides greater customer attention to
larger corporate customers, reduces possible channel conflicts, and allows the
end-user to decide how best to acquire the Company's products.
The Company continues to have a United States federal government
sales team. Since the United States government continues to be the world's
largest buyer of security products, having a dedicated account team has proven
to be a strategic advantage for the Company. Major awards resulted from this
effort during 1998, including the United States Air Force, the National Security
Agency, the National Institute of Standards and Technology, and the United
States Army. Beginning in 1999, the Company has initiated a state government
level sales program.
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International sales accounted for 29% of total product and services
sales during 1998. Major foreign markets for the Company's products include
Europe and the Pacific Rim, with the United Kingdom, Germany, Scandinavia and
Japan being particularly strong. In each country, the Company has independent
channel partners who are responsible for marketing, selling and supporting the
Company's products to resellers and end-users within their defined territories.
Independent market analyst reports have indicated that international markets
will continue to provide increased opportunities for security products in the
years ahead. The Company expects to continue its investment in international
sales during 1999.
The following table summarizes information about the Company's international and
domestic sales and operations:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
(In thousands) 1998 1997 1996
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
United States products and services sales ...... $ 36,522 $ 18,171 $ 14,711
International products and services sales ...... 14,978 15,032 8,579
Government contracts ........................... 9,942 13,773 16,972
--------------------------------------------
$ 61,442 $ 46,976 $ 40,262
============================================
Net Loss:
United States operations ....................... $ 4,892 $ 4,363 $ (17,709)
International operations ....................... (8,154) (8,614) (7,385)
--------------------------------------------
$ (3,262) $ (4,251) $ (25,094)
============================================
Identifiable Assets:
United States operations ....................... $ 53,463 $ 28,905 $ 32,259
International operations ....................... 885 2,149 4,516
--------------------------------------------
$ 54,348 $ 31,054 $ 36,775
============================================
</TABLE>
MARKETING
The Company markets its products using a wide variety of mediums
including, advertisements, direct mail, seminars, trade shows, symposiums and
Web-based marketing. Marketing campaigns are created and implemented by
dedicated marketing personnel in each of the Company's major functional market
areas. Corporate marketing, product marketing, channel marketing and
co-marketing with industry partners are centralized functions performed out of
corporate headquarters in San Jose, California. An active public relations
program ensures that the Company receives appropriate press coverage for its
various programs and announcements and is responsible for securing product
reviews and speaking engagements.
As of February 28, 1999, the Company had 20 marketing employees. The
Company deploys comprehensive targeted marketing programs to generate sales
leads and brand awareness. Programs include direct marketing, Web marketing,
advertising, seminars and trade shows and ongoing customer, channel and partner
communications programs. Through the Partners First alliance program, the
Company has entered into strategic marketing relationships with various vendors
of communications, security, and network management products. Certain of these
vendors recommend Secure Computing products along with their solutions to meet
customers' security needs. The potential increased revenues from such
relationships may be reduced by requirements to provide volume price discounts
and other allowances, and significant costs incurred in customizing the
Company's products. Although the Company does not intend that such relationships
be exclusive, the Company may be required to enter into an exclusive
relationship or forego a significant sales opportunity. To the extent the
Company becomes dependent on actions by such parties, the Company could be
adversely affected if the parties fail to perform as expected.
The Company also seeks to stimulate interest in network security
through its public relations program, speaking engagements, white papers,
technical notes, and other publications.
COMPETITION AND MARKET CONSOLIDATION
The market for network security products is intensely competitive
and characterized by rapid technological change. The Company believes that
competition in this market is likely to persist and to intensify as a result of
increasing demand for network security products. Each of the Company's
individual products competes with a different group of competitors and products.
The
8
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principal competitors for the Company's existing products include ActivCard,
Axent, CheckPoint Software Technologies Ltd., Network Associates, and Security
Dynamics Inc.
The Company may also face competition from these and other parties
in the future that develop, or acquire computer and network security products
based upon approaches similar to or different from those employed by the
Company. There can be no assurance that the market for network security products
will not ultimately be dominated by approaches other than the approach marketed
by the Company. While the Company believes that it does not compete against
manufacturers of other classes of security products (such as encryption) due to
the complementary functions performed by such other classes, there can be no
assurance that the Company's customers will not perceive such other companies as
competitors of the Company.
The Company believes that the principal competitive factors
affecting the market for computer and network security products include level of
security, technical features, ease of use, capabilities, reliability, customer
service and support, distribution channels, price and total cost of ownership.
Current and potential competitors have established or may in the
future establish cooperative relationships among themselves or with third
parties to increase the ability of their products to address the security needs
of the Company's prospective customers. Accordingly, it is possible that new
competitors or alliances may emerge and rapidly acquire significant market
share. If this were to occur, the financial condition or results of operations
of the Company could be materially adversely affected.
The trend toward enterprise-wide network security solutions may
result in a consolidation of the network security market around a smaller number
of vendors who are able to provide the necessary software and support
capabilities. In the event that the Company is unable to internally develop all
of the products needed for an enterprise-wide security solution, the Company may
need to acquire such technology, or be acquired by a larger entity. However,
there can be no assurance that, in the event that the Company proves unable to
internally develop all of the products needed for an enterprise-wide security
solution, the Company will be able to acquire or merge with other entities on
terms favorable to the Company and its shareholders.
BACKLOG
The Company's backlog for commercial products at any point in time
is not significant since products are shipped on receipt of order. The Company
does not believe that its commercial backlog at any particular point in time is
indicative of future sales levels. The Company's backlog relating to its
government contracts as of February 28, 1999 was approximately $2.7 million,
compared to $6.1 million as of February 28, 1998. Backlog historically has
represented firm government orders for research and development services. Funded
backlog represents that portion of backlog for which the Company's government
customers have actually obligated payment. At February 28, 1999, approximately
$2.2 million of the Company's government contract backlog was funded, compared
to $3.6 million as of February 28, 1998. The timing and volume of customer
orders are difficult to forecast because the Company's customers typically
require prompt delivery of products and a substantial majority of the Company's
sales are booked, and shipped in the same quarter. In addition, sales are
generally made pursuant to standard purchase orders that can be rescheduled,
reduced or canceled with little or no penalty.
MANUFACTURING
The Company's manufacturing operations consist primarily of light
assembly and packaging associated with its software products. The Company uses
subcontractors to duplicate its software media and print its user documentation
and product packaging. The Company then assembles the final software products at
its facilities in New Brighton, MN. The Company also performs some limited
hardware manufacturing operations which consist of purchasing hardware
components, final assembly and test. Hardware components include commercially
available computers, memory, monitors and third party peripherals.
The majority of the materials utilized in its manufacturing
operations are industry standard parts that are widely available. Typical
materials required are media and media duplication services, user documentation
and other printed materials, product packaging, and computer systems (PC's and
computer peripherals, memory disk drives, storage devices). Interruptions or
delays in shipments of software supplies, certain computer systems or
peripherals could materially adversely affect the results of operations.
The Company's SafeWord product line includes a small calculator
style token which is used for user authentication. The Company has two
subcontractors for these tokens: ReachOut Ltd., an electronics assembly
manufacturer located in the Peoples Republic of China, and Lan Plus, Inc., a
California company with manufacturing facilities located in Taiwan. While the
Company has generally been able to obtain adequate supplies of these products in
a timely manner, delays, interruptions in supply, or a significant increase in
manufacturing costs could materially adversely affect the results of operations.
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RESEARCH AND DEVELOPMENT
Internal development of new products and features is performed by
the Company's internal engineering staff. Of the Company's total of 113
engineering employees at February 28, 1999, 32 held post-graduate degrees.
The Company intends to keep its products broadly compatible with a
variety of host computer configurations and other network security products and
other network applications, and will introduce new products as market demand
develops for such products. The Company researches and attempts to design its
products to be able to support emerging security standards, such as the Public
Key Infrastructure, IP Security, and Content Vector Protocol.
The Company will continue to seek government research and
development contracts to maintain its high technology base. The Company
currently has research and development contracts with government agencies,
including the NSA. These contracts address information security for operating
systems, secure applications for database management systems and security policy
research. The Company continuously pursues additional contracts with these
organizations.
PATENTS AND PROPRIETARY TECHNOLOGY
The Company relies on patent, trademark, copyright and trade secret
laws, employee and third-party non-disclosure agreements and other methods to
protect its proprietary rights. The Company currently holds ten patents and has
eighteen patent applications pending in the United States relating to computer
security software and hardware products. The Company has also filed patent
applications in the European Union, Canada, Japan, Germany, and the United
Kingdom. The Company believes that its patents are broad and fundamental to
network security computer products. While the Company believes that the pending
applications relate to patentable devices or concepts, there can be no assurance
that any pending or future patent applications will be granted or that any
current or future patent, regardless of whether the Company is an owner or a
licensee of such patent, will not be challenged, invalidated or circumvented or
that the rights granted thereunder or under licensing agreements will provide
competitive advantages to the Company.
The Company's success is dependent, in part, upon its proprietary
software and security technology. The Company also relies on trade secrets and
proprietary know-how which it seeks to protect, in part, through confidentiality
agreements with employees, consultants and other parties. There can be no
assurance that these agreements will not be breached, that the Company will have
adequate remedies for any breach, or that the Company's trade secrets will not
otherwise become known to or independently developed by competitors. In
addition, under its contract with the Company, U.S. government agencies have the
right to disclose certain technology developed with government funding to
competitors of the Company as part of the establishment by the government of
second-source manufacturing arrangements or competitive bidding.
The Company is not aware of any patent infringement charge or any
violation of other proprietary rights claimed by any third party relating to the
Company or the Company's products. However, the computer technology market is
characterized by frequent and substantial intellectual property litigation.
Intellectual property litigation is complex and expensive, and the outcome of
such litigation is difficult to predict. In the event that a third party were to
make a claim of infringement against the Company, the Company could be required
to devote substantial resources and management time to the defense of such
claim, which could have a material adverse effect on the Company's business and
results of operations.
The Company has received or applied for trademark protection in the
United States for its SafeWord, Secure Computing Firewall, SecureWire, SecureOS,
SecureSupport, SecureZone, Sidewinder, SmartFilter, SofToken, e.id(TM),
Strikeback, Type Enforcement and Nobody Comes Close trademarks.
REGULATION AND GOVERNMENT CONTRACTS
Other than government contracting regulations described above under
"Advanced Technology Contracts," the Company is not currently subject to direct
regulation by any government agency, other than regulations generally applicable
to businesses. Currently, there are few laws or regulations directly applicable
to access to or commerce on the Internet. However, due to the increasing
popularity and use of the Internet, it is possible that a number of laws and
regulations may be adopted with respect to the Internet, covering issues such as
user privacy, pricing and characteristics and quality of products and services.
In addition, the adoption of laws or regulations may decrease the growth of the
Internet, which could in turn decrease the demand for the Company's products and
increase the Company's cost of doing business or otherwise have an adverse
effect on the Company's business, operating results or financial condition.
10
<PAGE>
EMPLOYEES
At February 28, 1999, the Company had 321 employees. No employee of
the Company is represented by a labor union or is subject to a collective
bargaining agreement. The Company believes that it maintains good relations with
its employees.
EXECUTIVE OFFICERS
The executive officers of the Company are:
<TABLE>
<CAPTION>
Name Age Position
-------------------------------------------------------------------------------------------
<S> <C> <C>
Jeffrey H. Waxman 52 Chairman and Chief Executive Officer
Timothy P. McGurran 36 Senior Vice President of Operations, Chief Financial Officer
Christine Hughes 52 Senior Vice President of Marketing and Business Development
Gary D. Taggart 45 Vice President of Worldwide Sales
Patrick Regester 50 Vice President of International Operations
Howard Smith 58 Executive Vice President of Research & Product Group
</TABLE>
JEFFREY H. WAXMAN has been Chairman of the Board since January 1997
and Chief Executive Officer of the Company since November 1996. From June 1995
through August 1996, Mr. Waxman was the Executive Vice President and General
Manager of the Application Group of Novell Inc., a network software provider.
From November 1992 through June 1995, Mr. Waxman was the President and Chief
Executive Officer of ServiceSoft Corporation, a diagnostics software company.
From June 1988 through January 1992, Mr. Waxman was the Chief Executive Officer
of Uniplex, Inc., a UNIX office automation software provider.
TIMOTHY P. MCGURRAN has been the Senior Vice President of Operations
and Chief Financial Officer of the Company since May 1996. Mr. McGurran was at
Ernst & Young LLP from December 1984 to May 1996, where his last position was
Senior Manager.
CHRISTINE HUGHES has been the Senior Vice President of Marketing
since November 1996. Ms. Hughes was the Senior Vice President, Corporate
Marketing at Novell, Inc., a network software provider from December 1994 to
August 1996. From June 1991 to November 1994, Ms. Hughes was a Vice President at
Xerox Corporation. Ms. Hughes currently serves on the Board of Directors of
Sulcus Hospitality Technologies Corporation.
GARY D. TAGGART has been Vice President of Worldwide Sales since
January 1997. Prior to joining Secure, Mr. Taggart was Vice President of
Americas Sales for Eicon Technology Inc., a Canadian manufacturer of
communications products, from December 1994 through September 1996. From 1989 to
1994, Mr. Taggart was Vice President of Worldwide Sales for Storage Dimensions,
Inc., a San Jose-based manufacturer of network storage subsystems.
PATRICK REGESTER has been the Vice President of International
Operations since February 1997. From November 1995 to January 1997 Mr. Regester
was Vice President of Sales and International Operations for Process Software
Corporation, a TCP/IP applications developer. From March 1989 to October 1995,
Mr. Regester held various positions most recently as the Group Managing Director
for Uniplex Inc., a UNIX office automation software provider.
HOWARD SMITH has been the Executive Vice President of Research and
Product Group since February 1998. Prior to joining Secure, Mr. Smith was the
President and CEO of Clarity Software, Inc. from January 1990 through February
1998.
Executive officers are elected annually by the Board of Directors
and serve a term of one year or until their successors are elected. None of the
above executive officers is related to each other or to any director of the
Company.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
The following important factors, among others, could cause actual
results to differ materially from those indicated by forward-looking statements
made in this Annual Report on Form 10-K and presented elsewhere by management
from time to time.
A number of uncertainties exist that could affect the Company's
future operating results, including, without limitation, general economic
conditions, the Company's continued ability to develop and introduce products,
the introduction of new products by competitors, pricing practices of
competitors, expansion of the Company's sales distribution capability, the cost
and availability of components and the Company's ability to control costs.
11
<PAGE>
FLUCTUATION IN OPERATING RESULTS. The Company's quarterly operating
results may vary significantly depending on a number of factors, including the
timing of the introduction or enhancement of products by the Company or its
competitors, the sizes, timing and shipment of individual orders, market
acceptance of new products, changes in the Company's operating expenses,
personnel changes, mix of products sold, changes in product pricing, development
of the Company's direct and indirect distribution channels and general economic
conditions.
DEPENDENCE ON PRINCIPAL PRODUCTS AND LIMITED SOURCES OF SUPPLY. The
Company's success is highly dependent on its ability to enhance its existing
products and to develop and introduce new products in a timely manner. If the
Company were to fail to introduce new products on a timely basis, the Company's
operating results could be adversely affected. The Company currently derives
substantially all of its revenue from sales of its enterprise network and data
security products, and the provision of related services. Existing and new
versions of such products are expected to continue to represent a high
percentage of the Company's revenue for the foreseeable future. As a result, any
factor adversely affecting sales of these products and services, or any factor
impeding or delaying the Company's ability to diversify its product offerings to
lessen its dependency on those products, would have a material adverse effect on
the Company's financial condition and results of operations.
Certain components of the Company's products are currently purchased
from limited sources and any interruption in the supply of such components could
adversely affect the Company's operating results.
RISKS ASSOCIATED WITH ENTERPRISE NETWORK AND DATA SECURITY MARKET.
The rapid development of enterprise-wide and remote computing as well as
increased use of the Internet, intranets and extranets has enhanced the ability
of users to access proprietary information and resources and has in recent years
increased demand for enterprise network and data security products. Declines in
demand for the Company's products, whether as a result of competition,
technological change, the public's perception of the need for security products,
developments in the hardware and software environments in which these products
operate, general economic conditions or other factors, could have a material
adverse effect on the Company's financial condition and results of operations.
A well publicized actual or perceived breach of enterprise network
or data security could trigger a heightened awareness of computer abuse,
resulting in an increased demand for security products such as those offered by
the Company. Similarly, an actual or perceived breach of enterprise network or
data security at one of the Company's customers, regardless of whether such
breach is attributable to the Company's products, could adversely affect the
market's perception of the Company and the Company's financial condition or
results of operations.
TECHNOLOGICAL CHANGE AND NEW PRODUCTS. The market for security
products, especially in the Internet, intranet and extranet markets, is
characterized by rapidly changing technology, emerging and evolving industry
standards, new product introductions, relatively short product life cycles and
rapid and constant changes in customer requirements and preferences. To the
extent that specific methods other than those employed by the Company are
adopted as standards for implementing enterprise network data security, sales of
the Company's existing and planned products in those market segments may be
adversely impacted, which could have a material adverse effect on the Company's
financial condition and results of operations.
In the future, vendors of hardware and of operating system software
may continue to enhance their products or bundle separate products to include
functionality that is currently provided primarily by network security software.
Such enhancements may be achieved through the addition of functionality to
operating system software or other software or the bundling of network security
software with operating system software or other products. The widespread
inclusion of the functionality of the Company's products as standard features of
computer hardware or of operation system software or other software could render
the Company's products obsolete and unmarketable, particularly if the quality of
such functionality were comparable to that of the Company's products.
Furthermore, even if the network security and/or management functionality
provided as standard features by hardware providers or operating systems or
other software is more limited than that of the Company products, there can be
no assurance that a significant number of customers would not elect to accept
such functionality in lieu of purchasing additional software. If the Company
were unable to develop new network security and management products to further
enhance operating systems or other software and to replace successfully any
obsolete products, the Company's business, financial condition and results of
operations would be materially adversely affected.
Software products may also contain undetected errors or bugs when
first introduced or as new versions are released, and software products or media
may contain undetected viruses. Errors or bugs may also be present in software
licensed by the Company from third parties and incorporated into the Company's
products. Errors, bugs or viruses may result in loss of or delay in market
acceptance, recalls of hardware products incorporating the software or loss of
data. Delays or difficulties associated with new product introductions or
product enhancements could have a material adverse effect on the Company's
financial condition and results of operations.
12
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COMPETITION. The market for enterprise network and data security
products is highly competitive and subject to rapid change. The Company believes
that the principal competitive factors affecting the market for enterprise
network and data security products include technical features, ease of use,
quality/reliability, level of security, customer service and support,
distribution channels and price. The Company's competitors and potential
competitors include organizations that provide or may seek to provide enterprise
network and data security products based upon approaches similar to and
different from those employed by the Company, and could in the future include
operating systems or network suppliers not currently offering competitive
enterprise-wide security products. There can be no assurance that the market for
enterprise network and data security products will not ultimately be dominated
by approaches other than the approach marketed by the Company.
Certain of the Company's potential competitors have significantly
greater financial, marketing, technical and other competitive resources than the
Company. As a result, they may be able to leverage an installed customer base
and/or other existing or future enterprise-wide products, adapt more quickly to
new or emerging technologies and changes in customer requirements, or devote
greater resources to the promotion and sale of their products than can the
Company. Competition could increase if new companies enter the market or if
existing competitors expand their product lines. Any reduction in gross margins
resulting from competitive factors could have a material adverse effect on the
Company's financial condition and results of operations.
POTENTIAL VOLATILITY OF STOCK PRICE. The trading of the Company's
Common Stock has been and may continue to be subject to wide fluctuations in
response to quarter to quarter variations in operating results, announcements of
technological innovations or new products by the Company or its competitors,
developments with respect to patents or proprietary rights, general conditions
in the information security systems industry, changes in earnings estimates by
analysts, or other events or factors. In addition, the stock market has
experienced extreme price and volume fluctuations, which have particularly
affected the market prices of many technology companies and which have often
been unrelated to the operating performance of such companies. The Company's
sales or operating results in future quarters may be below the expectations of
public market securities analysts and investors. In such event, the price of the
Company's Common Stock would likely decline, perhaps substantially. These
Company-specific factors or broad market fluctuations may have a material
adverse effect on the market price of the Company's Common Stock.
LENGTHY SALES CYCLE. Sales of the Company's products generally
involve a significant commitment of capital by customers, with the attendant
delays frequently associated with large capital expenditures. For these and
other reasons, the sales cycle associated with the Company's product is
typically lengthy and subject to a number of significant risks over which the
Company has little or no control. The Company is often required to ship products
shortly after it receives orders and consequently, order backlog at the
beginning of any period has in the past represented only a small portion of that
period's expected revenue. As a result, product revenue in any period is
substantially dependent on orders booked and shipped in that period. The Company
typically plans its production and inventory levels based on internal forecasts
of customer demand, which are highly unpredictable and can fluctuate
substantially. If revenue falls significantly below anticipated levels, the
Company's financial condition and results of operations would be materially and
adversely affected. In addition, the Company's operating expenses are based on
anticipated revenue levels and a high percentage of the Company's expenses are
generally fixed in the short term. Based on these factors, a small fluctuation
in the timing of sales can cause operating results to vary significantly from
period to period.
FLUCTUATIONS IN QUARTERLY REVENUE TRENDS. Secure Computing has
experienced significant quarterly fluctuations in its operating results and
anticipates such fluctuations in the future. As a rule, revenues, operating
income and net income have been higher in the fourth quarter of each year than
in the first quarter of the following year. The Company believes that fourth
quarter revenues are positively impacted by the end of year budgeting cycles of
some large corporate customers. Revenues also tend to be lower in the summer
months, particularly in Europe, when businesses often take holidays resulting in
deferred purchasing patterns. Quarterly revenues and operating results depend on
the volume and timing of orders received, which may be affected by large
individual transactions and which sometimes are difficult to predict. The
Company historically has recognized a substantial portion of its license
revenues in the last week of each quarter. The Company expects that this will
continue for the foreseeable future as the portion of revenues from indirect
distribution channels increases. As a result, the Company's inability to control
the quarterly fluctuations of its business could have a material and adverse
impact on the Company's financial condition and results of operations.
PRODUCT LIABILITY RISKS. Customers rely on the Company's information
security products to prevent unauthorized access to their networks and data
transmissions. A malfunction or the inadequate design of the Company's products
could result in tort or warranty claims. Although the Company seeks to reduce
the risk of such losses by attempting to negotiate warranty disclaimers and
liability limitation clauses in its sales agreements and by maintaining product
liability insurance, there can be no assurance that such measures will be
effective in limiting the Company's liability for such damages. Any liability
for damages resulting from security breaches could be substantial and could have
a material adverse effect on the Company's financial condition and results of
operations.
13
<PAGE>
EVOLVING INFORMATION SECURITY MARKET. The market for the Company's
information security products is only beginning to emerge. This market is
characterized by rapidly changing technology, emerging industry standards, new
product introductions and changes in customer requirements and preferences. The
Company's future success will depend in part upon end users' demand for
information security products in general and upon the Company's ability to
enhance its existing products and to develop and introduce new products and
technologies that meet customer requirements. To the extent that a specific
method other than the Company's is adopted as the standard for implementing
information security in any segment of the information security market, sales of
the Company's existing and planned products in that market segment may be
adversely impacted, which could have a material adverse effect on the Company's
financial condition and results of operations. There can be no assurance that
information security-related products or technologies developed by others will
not adversely affect the Company's competitive position or render its products
or technologies noncompetitive or obsolete.
In addition, a portion of the sales of the Company's information
security products will depend upon a robust industry and infrastructure for
providing access to public switched networks, such as the Internet. There can be
no assurance that the infrastructure or complementary products necessary to make
these networks into viable commercial marketplaces will be developed, or, if
developed, that these networks will become viable commercial marketplaces.
YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. These date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements. Although the Company
believes that its products and systems sold after December 31, 1998 will be Year
2000 compliant, has completed preparation and testing of its products and
systems, and has verified compliance of third party computer software utilized
by the Company, the Company has not verified Year 2000 compliance of certain
semiconductors embedded in other third-party equipment used by the Company, nor
has the Company established the costs and risks associated with such third party
equipment.
Failure of such third-party equipment to operate properly with
regard to the Year 2000 and thereafter could require the Company to incur
unanticipated expenses to remedy any problems, which could have a material
adverse effect on the Company's business, operating results and financial
condition. The business, operating results and financial condition of the
Company's customers could be adversely affected to the extent that they utilize
third-party software and other products which are not Year 2000 compliant.
Further, the purchasing patterns of customers or potential customers
may be affected by Year 2000 issues as companies expend significant resources to
correct their current systems for Year 2000 compliance. These expenditures may
result in reduced funds available to purchase products and services such as
those offered by the Company, which could have a material adverse effect on the
Company's business, operating results and financial condition.
INTERNATIONAL MARKETS. International sales constitute a substantial
portion of the business of the Company. Although almost all sales by the Company
are payable in U.S. dollars, in the event of a severe decline in one of the
Company's major foreign markets, customers from those countries may be unable to
satisfy their U.S. dollar obligations. Such non-payment would have a materially
adverse effect upon the Company's operations and financial condition. In 1998,
twenty-nine percent (29%) of the Company's total product and services sales were
derived from international sales.
EFFECT OF CERTAIN PROVISIONAL ANTI-TAKEOVER EFFECTS OF CERTIFICATE
OF INCORPORATION, BYLAWS AND DELAWARE LAW. The Board of Directors of the Company
has the authority to issue up to 2,000,000 shares of Preferred Stock and to
determine the price, rights, preferences, privileges and restrictions, including
voting rights, of those shares without any further vote or action by its
stockholders. The rights of the holders of Company Common Stock will be subject
to, and may be adversely affected by, the rights of the holders of any Preferred
Stock that may be issued in the future. The issuance of Preferred Stock, while
providing desirable flexibility in connection with possible acquisitions and
other corporate purposes, could have the effect of making it more difficult for
a third party to acquire a majority of the outstanding voting stock. Further,
certain provisions of Delaware law, the Company's Certificate of Incorporation
and Bylaws, such as a classified board and certain provisions of the Company's
Share Rights Agreement could delay or make more difficult a merger, tender offer
or proxy contest involving the Company. While such provisions are intended to
enable the Company's Board to maximize stockholder value, they may have the
effect of discouraging takeovers which could be in the best interest of certain
stockholders. There is no assurance that such provisions will not have an
adverse effect on the market value of the Company's Common Stock.
RISKS ASSOCIATED WITH PREFERRED STOCK FINANCING. In June 1998, the
Company raised gross proceeds of $16.0 million through the issuance of a newly
designated Series C Convertible Preferred Stock (the "Series C Preferred").
While the issuance of the Series C Preferred in this transaction provided the
Company with additional working capital required to fund the Company's
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continuing operations, the Company's agreements with the purchasers of the
Series C Preferred contain covenants that could impair the Company's ability to
engage in various corporate transactions in the future, including financing
transactions and certain transactions involving a change-in-control or
acquisition of the Company, or that could otherwise disadvantage the Company and
the holders of its Common Stock. In particular, any "leveraged buy-out," and
certain consolidations, mergers or other business combinations with or into
another entity that has a trading volume equal to less than 90% of the Company's
average daily trading volume over a specified 90-day period, will give rise to a
right of redemption in the holders of the Series C Preferred. These provisions
may make an acquisition of the Company more difficult and expensive and could
discourage some potential acquirers. Certain covenants of the Company made in
connection with the issuance of the Preferred Stock may also have the effect of
limiting the Company's ability to obtain additional financing by, for example,
providing the holders of Series C Preferred Stock certain rights of first offer.
In addition, certain protective provisions set forth in the Certificate of
Designation prohibit the Company, without the consent of holders of two-thirds
of the outstanding Series C Preferred, from (a) increasing the authorized
Preferred Stock of the Company, (b) issuing securities with a liquidation
preference which is senior to or pari-passu with the Series C Preferred (other
than debt securities which are not convertible into or exchangeable for Common
Stock or any other equity or convertible security of the Company), or (c)
creating any new class or series of capital stock having a liquidation
preference senior to or pari-passu with the Series C Preferred.
The terms of the financing agreements pursuant to which the
Preferred Stock was issued also include certain penalty provisions that are
triggered in the event the Company fails to satisfy certain obligations. In
particular, the holders of the Series C Preferred shall have the right to
require the Corporation to redeem all or any portion of the Series C Preferred
at a price equal to the greater of: (a) 125% of the $1,000 stated price of each
share of Series C Preferred (the "Stated Price") and (b) an amount determined by
dividing the Stated Price by the Conversion Price (as defined in the Series C
Certificate of Designation) and multiplying the resulting quotient by the
average closing bid price for the Common Stock on the five (5) days preceding
the date of redemption. Such redemption obligation arises upon certain events,
including breach by the Company of representations and warranties and covenants,
including the failure to maintain the effectiveness of the registration
statement covering the Common Stock issuable upon conversion of the Series C
Preferred Stock. In the event that the holders of Series C Preferred Stock
become entitled to have their Series C Preferred Stock redeemed, there can be no
assurances that the Company will be able to fund such redemption, and even if
funding is available, the substantial payment required to fund such redemption
could have a material adverse effect on the Company's business and financial
condition.
The Series C Preferred is convertible into shares of the Company's
Common Stock based on the trading prices of the Common Stock during future
periods that are described in the financing agreement. The number of shares of
Common Stock that may ultimately be issued upon conversion is therefore
presently indeterminable. If, in accordance with the terms of the financing
agreements, the conversion price of the Preferred Stock is determined during a
period when the trading price of the Common Stock is low, the resulting number
of shares of Common Stock issuable upon conversion of the Preferred Stock could
result in substantial dilution to the holders of the Common Stock.
RECEIVABLES AND DISTRIBUTOR SALES. As the Company's revenues grow,
its receivables balances increase. In turn, the Company is subject to increased
general credit risks. Although the Company's management provides for a bad debt
reserve, there can be no assurance that this reserve will accurately reflect
subsequent credit write-offs which could have a material and adverse effect on
its financial conditions and operating results. The Company has and may from
time to time take various forms of action to manage its receivables including
the sale of its receivables at a discount and the granting of customer
discounts.
The Company recognizes product revenues at the time of shipment in
instances where the Company has evidence of a contract, the fee charged is fixed
and determinable and collection is probable. The Company has entered into
customer support and maintenance agreements with various customers. The Company
recognizes the obligations either ratably as the obligations are fulfilled or
upon completion of performance. Revenue generated through distributors and
resellers with a right of return for stock balancing and rotation is reduced by
a reserve for estimated returns. These reserves are based on estimates made by
the Company's management and are based on historical and known trends. There can
be no assurance that these reserves will accurately reflect subsequent product
returns.
Although Company sales to its distributors and resellers are final,
such channel customers generally are permitted stock balancing and stock
rotation rights, but are typically required to place offsetting orders of equal
value. The Company increasingly relies on resellers and distributors to market
and support its products. These increased sales to resellers and distributors
will likely increase the Company's days sales outstanding as collection terms
generally are longer than the collection terms of other customers. The Company's
agreements with its distributors are not exclusive and may be terminated by
either party without cause. There can be no assurance that any distributors will
continue to represent the Company's products.
15
<PAGE>
ADVANCED TECHNOLOGY CONTRACTS. Advanced Technology contract revenues
for cost-plus-fixed-fee contracts are recognized on the basis of costs incurred
during the period plus the fee earned. Award fees are recognized based upon the
percentage of completion and forecasted profit. A provision is made for the
estimated loss, if any, on government contracts. Under its government contracts,
the Company bears the risk that increased or unexpected costs required to
perform specified services may reduce the amount of the Company's fee. In
addition, recoverable expenses billed by the Company are subject to review and
audit by the Defense Contract Audit Agency, which could result in amounts
previously billed being renegotiated. Pursuant to their terms, these contracts
are generally also subject to termination at the convenience of the applicable
government agency. If the contract is terminated, the Company typically would be
reimbursed for its costs to the date of its termination plus the cost of an
orderly termination, and paid a portion of the fee. There can be no assurance
that the Defense Contract Audit Agency will not disallow the costs claimed by
the Company under its government contracts.
A substantial portion of the Company's basic research efforts are
funded by government contracts. In the event those contracts were to cease for
any reason, such an event could be expected to reduce the new product stream
which could have a material and adverse affect on the Company's results of
operations.
DEPENDENCE UPON KEY PERSONNEL. The success of the Company depends to
a significant extent upon a number of key technical and management employees.
The ability of the Company to achieve its revenue and operating performance
objectives depends in large part on its ability to attract and retain
technically qualified and highly skilled engineers, sales, consulting,
technical, marketing and management personnel. Such personnel are particularly
important to the Company's research and development efforts, and to its growing
professional service business, where the Company employs a large number of
technical personnel holding advanced degrees and special professional
certification. Competition for such personnel is intense and is expected to
remain so for the foreseeable future. There can be no assurance the Company will
be successful in retaining its existing key personnel and in attracting and
retaining the personnel it requires, and failure of the Company to retain and
increase its key employee population could adversely affect the Company's
business and operating results. Further, additions of new and departures of
existing personnel, particularly in key positions, can be disruptive and can
result in further departures of company personnel, which could have a material
adverse effect upon the Company's business operating results and financial
condition.
ITEM 2. PROPERTIES
The Company is headquartered in approximately 13,000 square feet of
office space in San Jose, California. The annual rent for this facility is
approximately $296,000. The Company has 3 separate facilities with a combined
square footage of approximately 73,000 in St. Paul, Minnesota that are occupied
by production, research and development, and administration with an annual base
rent of $960,000. The Company has a research facility located in Concord,
California that occupies 8,000 square feet at an approximate annual cost of
$100,000. The Company occupies these premises under leases expiring at various
times through the year 2006. Not included in the aforementioned space is 29,500
square feet that has been sublet. In support of its U.S. field sales and
professional services organizations the Company also leases 11,000 of office
space in Vienna, Virginia; Dallas, Texas; Mountain Lakes, New Jersey; and
Seattle, Washington with an approximate annual cost of $324,000. The Company
also has foreign offices in London, England; Toronto, Canada; Sydney, Australia;
and Munich, Germany, with an approximately annual cost of $306,000.
ITEM 3. LEGAL PROCEEDINGS
On August 26, 1998, a purported class action complaint was filed in
the Delaware Chancery Court in and for New Castle County by Rosalyn Golaine
against the Company, certain of its present officers, present directors, and
former directors (the "Golaine Action"), alleging that the provisions of the
July 24, 1997 shareholder rights plan (the "Plan") permitting only those
directors who voted for the Plan (or their designated successors) to redeem the
Rights granted therein, violates Delaware law. The complaint in the Golaine
Action seeks injunctive relief and damages of an unspecified amount.
The Company has amended the Plan which will render moot the
injunctive relief requested. In November, 1998, the defendants moved to dismiss
the Golaine Action. On March 22, 1999, the parties submitted a proposed
settlement of the Golaine Action for court approval. The proposed settlement
would require the Company to pay up to $100,000 in attorney fees and the costs
of notifying the class of the proposed settlement.
16
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
In November, 1998, a Special Meeting of Stockholders was held to
amend the Company's Restated Certificate of Incorporation to increase the number
of shares of Common Stock from 25,000,000 shares to 50,000,000 shares and to
ratify and approve the issuance of 16,000 shares of the Company's Series C
Preferred Stock pursuant to the Securities Purchase Agreement dated June 30,
1998 by and among the Company and certain investors. Both matters were approved
by the Stockholders of the Company. The number of shares of Common Stock
outstanding and entitled to vote at the Special Meeting was 16,276,291, and
13,544,869 shares were represented in person or by proxy. The results of the
voting on each of the matters presented to Stockholders at the Special Meeting
are set forth below:
<TABLE>
<CAPTION>
Broker
Votes For Votes Against Abstain Non-Vote
--------- ------------- ------- --------
<S> <C> <C> <C> <C>
Amendment to Company Certificate -
Increased Number of Common Shares ........... 13,112,464 379,913 52,491 ---
Ratify and Approve Issues of 16,000 shares
Series C Preferred Stock .................... 9,801,042 468,777 54,216 3,220,833
</TABLE>
17
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's Common Stock is traded on the Nasdaq Stock Market
under the symbol SCUR. The following table sets forth, for the periods
indicated, the high and low sale prices per share of the Common Stock on the
Nasdaq Stock Market.
High Low
---- ---
1997
First Quarter ....................... $ 8.88 $5.00
Second Quarter ...................... $ 8.75 $5.00
Third Quarter ....................... $ 8.94 $5.56
Fourth Quarter ...................... $14.69 $9.06
1998
First Quarter ....................... $15.25 $8.00
Second Quarter ..................... $15.25 $7.75
Third Quarter ....................... $13.63 $6.38
Fourth Quarter ...................... $22.25 $8.88
As of March 10, 1999, the Company had 463 stockholders of record
which includes 1 holder of Exchangeable Shares and approximately 7,220
beneficial holders of its Common Stock.
The Company has never declared or paid any dividends on its Common
Stock. The Company currently intends to retain any earnings for use in its
business and therefore does not anticipate paying any dividends in the
foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The consolidated statement of operations data set forth below for
the fiscal years ended December 31, 1998, 1997 and 1996 and the consolidated
balance sheet data at December 31, 1998 and 1997 are derived from the audited
consolidated financial statements included elsewhere in this Form 10-K. The
consolidated statement of operations data set forth below for the fiscal years
ended December 31, 1995 and 1994 and the consolidated balance sheet data at
December 31, 1996, 1995 and 1994 are derived from audited consolidated financial
statements which are not included in this Form 10-K. The consolidated statement
of operations for the fiscal years ended December 31, 1995 and 1994 and the
consolidated balance sheet data at December 31, 1995 and 1994 have been restated
to give effect to the acquisition of Border Network Technologies, Inc. and
Enigma Logic, Inc. in August 1996. The data set forth below should be read in
conjunction with the Financial Statements and notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this Form 10-K.
18
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue:
Products and services .............. $ 51,500,000 $ 33,203,000 $ 23,290,000 $ 13,081,000 $ 4,051,000
Advanced Technology
contracts ............. 9,942,000 13,773,000 16,972,000 14,849,000 13,744,000
------------------------------------------------------------------------------------
Total revenue ................ 61,442,000 46,976,000 40,262,000 27,930,000 17,795,000
Gross profit .......................... 40,304,000 28,210,000 21,465,000 13,079,000 7,120,000
Acquisition costs ..................... -- -- 13,069,000 -- --
Operating income (loss) ............... (4,933,000) (5,734,000) (26,473,000) (633,000) 1,220,000
Net income (loss) ..................... (3,262,000) (4,251,000) (25,094,000) (632,000) 1,541,000
Net income (loss) per share:
Basic .................... (.20) (.27) (1.76) (.05) .17
Diluted .................. (.20) (.27) (1.76) (.05) .17
BALANCE SHEET DATA:
Working capital ....................... $ 34,017,000 $ 17,175,000 $ 18,886,000 $ 34,292,000 $ 1,991,000
Total assets .......................... 54,348,000 31,054,000 37,775,000 44,261,000 7,727,000
Long-term debt, less current
portion and redeemable
convertible preferred stock ....... -- -- -- 1,879,000 10,659,000
Stockholders' equity (deficit) ........ 43,053,000 24,800,000 26,232,000 36,208,000 (5,996,000)
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Secure Computing Corporation ("Secure Computing" or the "Company")
designs, develops, markets and sells a comprehensive offering of interoperable,
standards-based products for end-to-end network solutions, including firewalls,
Web filters, authentication, extranet access control and security related
professional services. Today, the Company enables business security solutions
through its advanced technologies, professional services and partner programs.
The Company's goal is to provide a complete portfolio of integrated enterprise
security solutions for corporate networks.
PRODUCTS AND SERVICES. The Company markets a range of interoperable,
standards-based network security products to the global marketplace. The
Company's customers include Fortune 500 companies, small branch offices, and
government agencies all of whom rely on the Company's suite of network security
solutions to maximize their productivity on the Internet without compromising
information security. The Company expects that the percentage of its revenues
derived from products and related services will increase in future years as the
Company increasingly focuses on product sales.
During 1999, the Company plans to increase its actual spending in
selling and marketing and research and development over 1998, however, these
expenses will decrease as a percentage of revenue over 1998 levels. The Company
expects its actual general and administrative spending to remain at 1998 levels
while decreasing as a percentage of revenue over the 1998 levels.
ADVANCED TECHNOLOGY CONTRACTS. From the time of its organization,
the Company has been engaged in research and development of information security
technology by acquiring and executing contracts with departments and agencies of
the United States government. The Company expects that the percentage of its
revenues derived from Advanced Technology contracts will decrease in future
years as the Company increasingly focuses on product and services sales.
19
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
items from the statements of operations of the Company expressed as a percentage
of revenue:
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
-----------------------------------------------------------------------
Revenue:
Products and Services 83.8% 70.7% 57.8%
Advanced Technology contracts 16.2 29.3 42.2
-----------------------------------------------------------------------
Total revenue 100.0 100.0 100.0
Cost of revenue 34.4 39.9 46.7
-----------------------------------------------------------------------
Gross profit 65.6 60.1 53.3
Operating expenses:
Selling and marketing 37.2 43.6 45.8
Research and development 12.2 18.6 23.8
General and administrative 8.1 8.2 17.1
Stock option expense 3.5 1.9 --
Restructure expense 12.7 -- --
Acquisition costs -- -- 32.4
-----------------------------------------------------------------------
Total operating expenses 73.7 72.3 119.1
-----------------------------------------------------------------------
Operating loss (8.1) (12.2) (65.8)
Interest and other income 0.8 1.1 3.8
Interest expense -- -- (0.3)
-----------------------------------------------------------------------
Loss before income taxes (7.3) (11.1) (62.3)
Income tax benefit 2.0 2.1 --
-----------------------------------------------------------------------
Net loss (5.3)% (9.0)% (62.3)%
=======================================================================
COMPARISON OF YEARS ENDED DECEMBER 31, 1998 AND 1997.
REVENUE. The Company's revenue increased 30.8 percent to $61.4
million in 1998, up from $47.0 million in 1997. Products and services revenue
was $51.5 million in 1998, an increase of 55.1 percent over 1997, and was
attributable to increased sales of firewall and authentication products and
related services as well as increased professional services. The decrease in
Advanced Technology contracts revenue in 1998 reflects the continuation of
efforts to reduce reliance on government contracts.
GROSS PROFIT. Gross profit as a percentage of revenue increased to
65.6 percent in 1998 from 60.1 percent in 1997. The increase in 1998 was
primarily the result of increased products and services revenue which carries a
higher gross margin than government contracts.
SELLING AND MARKETING. Selling and marketing expenses as a percent
of revenue decreased to 37.2 percent in 1998 from 43.6 percent in 1997. The
decrease was due primarily to sustained revenue growth resulting from prior year
selling and marketing efforts.
RESEARCH AND DEVELOPMENT. Research and development expenses as a
percent of revenue decreased to 12.2 percent in 1998 from 18.6 percent in 1997.
The decrease resulted primarily from improved efficiencies due to consolidation
of the Company's operations.
GENERAL AND ADMINISTRATIVE. General and administrative expenses as a
percent of revenue decreased to 8.1 percent in 1998 from 8.2 percent in 1997.
STOCK OPTION COMPENSATION EXPENSE. The stock option compensation
expense in 1998 and 1997 reflects vesting by a certain portion of performance
based options triggered by stock price targets being met.
20
<PAGE>
RESTRUCTURE COSTS. In the first quarter of 1998, the Company
announced plans to implement a restructuring plan designed to facilitate further
integration of acquired businesses, and recorded a pre-tax expense of $7.8
million to account for these actions, which include costs of lease terminations,
streamlining its product offerings and reducing the Company's cost structure to
increase operational efficiency. The plan resulted in the separation of some
employees worldwide and the closing of certain facilities.
INTEREST AND OTHER INCOME. The difference in interest and other
income between the periods reflects interest earned in 1998 by the Company on
declining cash and investment balances for the first half of the year.
INCOME TAX BENEFIT. The Company recognized income tax benefits in
1998 and 1997 related to reductions in the valuation allowance against the
Company's deferred tax assets. The allowance was reduced based on the Company's
estimate of the amount of net operating loss carryforwards more likely than not
to be utilized to offset future taxable income. Management believes it is more
likely than not that net deferred tax assets, which total $3.6 million at
December 31, 1998, will be realized. The computation of the Company's deferred
tax assets and valuation allowance are based in part on taxable income expected
to be earned on existing government contracts and projected interest income. The
amount of the deferred tax assets considered realizable could be reduced in the
near term if estimates of future taxable income are reduced. The Company had
total net operating loss carryforwards of approximately $44.4 million at
December 31, 1998. Of these carryforwards, $11.4 million relates to stock option
exercises. As these deductions are realized, the benefit will not reduce income
tax expense, rather it will be recorded as additional paid-in-capital. Of the
remaining benefit associated with the carryforwards, approximately $24.0 million
had yet to be recognized as a benefit in the statement of operations. However,
there can be no assurance that these carryforwards will be available to offset
future income tax expense when taxable income is realized.
COMPARISON OF YEARS ENDED DECEMBER 31, 1997 AND 1996.
REVENUE. The Company's revenue increased 16.7 percent to $47.0
million in 1997, up from $40.3 million in 1996. Products and services revenue
was $33.2 million in 1997, an increase of 42.6 percent over 1996, and was
attributable mainly to increased sales of authentication products and related
services. The decrease in Advanced Technology contracts revenue in 1997 reflects
the continuation of efforts to reduce reliance on government contracts.
GROSS PROFIT. Gross profit as a percentage of revenue increased to
60.1 percent in 1997 from 53.3 percent in 1996. The increase in 1997 was
primarily the result of increased products and services revenue which carries a
higher gross margin than government contracts.
SELLING AND MARKETING. Selling and marketing expenses increased 11.1
percent to $20.5 million in 1997, from $18.4 million in 1996. The increase was
due primarily to additions to the Company's sales and marketing staff and higher
expenditures for advertising, trade shows and seminars, and product literature.
RESEARCH AND DEVELOPMENT. Research and development expenses
decreased by 8.8 percent to $8.7 million in 1997 from $9.6 million in 1996. The
decrease resulted primarily from improved efficiencies due to consolidation of
the Company's operations.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
decreased by 44.1 percent to $3.8 million in 1997 from $6.9 million in 1996. The
decrease was primarily the result of improved efficiencies from the
consolidation of the Company's operations.
ACQUISITION COSTS. Certain acquisition costs were recognized in the
second quarter of 1996 relating to the Webster, Border and Enigma acquisitions.
Purchased research and development in process of $3.9 million was expensed in
connection with the Webster acquisition. Also, $9.2 million of acquisition costs
were recorded for investment banking, professional fees and other expenses for
the Border and Enigma acquisitions.
INTEREST AND OTHER INCOME. The difference in interest and other
income between the periods reflects interest earned in 1997 by the Company on
declining cash and investment balances.
STOCK OPTION COMPENSATION EXPENSE. The stock option compensation
expense in 1997 reflects vesting by a certain portion of options triggered by
stock price performance.
INCOME TAX BENEFIT. The Company recognized an income tax benefit in
1997 compared to no income tax expense or benefit in 1996. The income tax
benefit recognized in 1997 related to a reduction in the valuation allowance
against the Company's deferred tax assets. The allowance was reduced based on
the Company's estimate of the amount of net operating loss carryforwards more
likely than not to be utilized to offset future taxable income. Management
believes it is more likely than not that net deferred tax
21
<PAGE>
assets, which total $2.4 million at December 31, 1997, will be realized. The
computation of the Company's deferred tax assets and valuation allowance are
based in part on taxable income expected to be earned on existing government
contracts and projected interest income. The amount of the deferred tax assets
considered realizable could be reduced in the near term if estimates of future
taxable income are reduced. The Company had total net operating loss
carryforwards of approximately $38.9 million at December 31, 1997. Of these
carryforwards, $9.9 million relates to stock option exercises. As these
deductions are realized, the benefit will not reduce income tax expense, rather
it will be recorded as additional paid-in-capital. Of the remaining benefit
associated with the carryforwards, approximately $23.0 million had yet to be
recognized as a benefit in the statement of operations. However, there can be no
assurance that these carryforwards will be available to offset future income tax
expense when taxable income is realized.
LIQUIDITY AND CAPITAL RESOURCES
Since its organization, the Company has financed its operations
through the issuance of equity securities and notes to stockholders, long-term
debt, short-term borrowings and cash generated from operations. The Company's
cash and cash equivalents increased by approximately $5.1 million from 1997 to
1998. The increase resulted primarily from $15.3 million of proceeds from the
sale of preferred stock and $4.1 million of proceeds from sales of common stock,
the proceeds from sales of common stock being primarily from employees upon
exercise of stock options. The increase was partially offset by $2.0 million of
purchases of capital equipment and $10.9 million of investments in commercial
paper. As of December 31, 1998, the Company had working capital of $34.0
million. At December 31, 1998, the Company had available a $5 million line of
credit. The Company anticipates using available cash to fund growth in
operations, invest in capital equipment and to acquire businesses or license
technology or products related to the Company's line of business.
Capital expenditures for property and equipment were $2.0 million,
$2.3 million and $5.0 million for the years ended December 31, 1998, 1997 and
1996, respectively. These expenditures have generally consisted of computer
workstations, office furniture and equipment, and leasehold improvements.
At its current level of operations, the Company believes that its
existing cash and cash equivalents are sufficient to meet the Company's current
working capital and capital expenditure requirements through at least the next
12 months.
INFLATION
To date, the Company has not been significantly affected by
inflation.
YEAR 2000 COMPLIANCE
The Company has completed testing of its products and systems and
believes that its products and systems sold after December 31, 1998 are and will
be Year 2000 compliant. The Company has also verified compliance of third party
computer software and hardware utilized by the Company. The Company has not
verified Year 2000 compliance of certain semiconductors embedded in other
third-party equipment used by the Company, nor has the Company established the
costs and risks associated with such third party equipment.
FORWARD LOOKING STATEMENTS
Certain statements made above, which are summarized below, are
forward-looking statements that involve risks and uncertainties, and actual
results may be materially different. Factors that could cause actual results to
differ include those identified in "Certain Factors that May Affect Future
Results" section of this Form 10-K and those identified below:
* THE COMPANY EXPECTS THAT THE PERCENTAGE OF ITS REVENUES DERIVED FROM
PRODUCTS AND RELATED SERVICES WILL INCREASE IN FUTURE YEARS, AS THE
COMPANY INCREASINGLY FOCUSES ON PRODUCT SALES. Meeting this
expectation depends upon the Company's ability to achieve a higher
level of products and services revenue, which may not occur for a
variety of reasons, including general market conditions for the
Company's products and services, delays or difficulties in the
development, inability to obtain market acceptances of new products
offered by the Company, and introduction of new products by
competitors.
* THE COMPANY EXPECTS THAT THE PERCENTAGE OF ITS REVENUES DERIVED FROM
ADVANCED TECHNOLOGY CONTRACTS WILL DECREASE IN FUTURE YEARS, AS THE
COMPANY INCREASINGLY FOCUSES ON PRODUCT AND SERVICES SALES. Meeting
this expectation depends upon the Company's ability to achieve a
higher level of products and services revenue, which may not occur
for a variety of reasons, including general market conditions for
the Company's products and services, delays or difficulties in the
development, inability to obtain market acceptances of new products
offered by the Company, and introduction of new products by
competitors.
22
<PAGE>
* DURING 1999, THE COMPANY PLANS TO INCREASE ITS ACTUAL SPENDING IN
SELLING AND MARKETING AND RESEARCH AND DEVELOPMENT OVER 1998,
HOWEVER, THESE EXPENSES WILL DECREASE AS A PERCENTAGE OF REVENUE
OVER 1998 LEVELS. THE COMPANY EXPECTS ITS ACTUAL GENERAL AND
ADMINISTRATIVE SPENDING TO REMAIN AT 1998 LEVELS WHILE DECREASING AS
A PERCENTAGE OF REVENUE OVER THE 1998 LEVELS. This expectation
depends on the Company maintaining the current anticipated level of
product development, which may not occur due to unexpected increases
in such costs or because of a need to accelerate or begin new
product development and also may be affected by current plans for a
full scale product marketing and branding campaign being curtailed
or delayed or decreased products and services revenue resulting in
lower selling expense. Fluctuations in revenue from quarter to
quarter will likely have an increasingly significant impact on the
Company's results of operations. Additionally, meeting this
expectation depends upon the Company's ability to control costs and
achieve a higher level of revenue, which may not occur for a variety
of reasons, including general market conditions for the Company's
products and services, development and acceptance of new products
offered by the Company, and introduction of products by competitors.
* MANAGEMENT BELIEVES IT IS MORE LIKELY THAN NOT THAT DEFERRED TAX
ASSETS, WHICH TOTAL $3.6 MILLION AT DECEMBER 31, 1998, WILL BE
REALIZED. This expectation depends mainly on the Company
maintaining, at current levels, its existing government contract
business. If these contracts are terminated or adjusted downward,
deferred tax assets will be reduced and a corresponding charge to
income tax expense will be recorded.
* AT ITS CURRENT LEVEL OF OPERATIONS, THE COMPANY BELIEVES THAT ITS
EXISTING CASH AND CASH EQUIVALENTS ARE SUFFICIENT TO MEET THE
COMPANY'S CURRENT WORKING CAPITAL AND CAPITAL EXPENDITURE
REQUIREMENTS THROUGH AT LEAST THE NEXT 12 MONTHS. The Company's
ability to generate revenue as currently expected, unexpected
expenses and the need for additional funds to react to changes in
the marketplace, including unexpected increases in personnel costs
and selling and marketing expenses or currently unplanned
acquisitions may impact whether the Company has sufficient cash
resources to fund its product development and marketing and sales
plans for 1999 and early 2000.
* THE COMPANY HAS NOT VERIFIED YEAR 2000 COMPLIANCE OF CERTAIN
SEMICONDUCTORS EMBEDDED IN OTHER THIRD-PARTY EQUIPMENT USED BY THE
COMPANY, NOR HAS THE COMPANY ESTABLISHED THE COSTS AND RISKS
ASSOCIATED WITH SUCH THIRD PARTY EQUIPMENT. Failure of such
third-party equipment to operate properly with regard to the Year
2000 and thereafter could require the Company to incur unanticipated
expenses to remedy any problems, which could have a material adverse
effect on the Company's business, operating results and financial
condition. The business, operating results and financial condition
of the Company's customers could be adversely affected to the extent
that they utilize third-party software and other products which are
not Year 2000 compliant. Further, the purchasing patterns of
customers or potential customers may be affected by Year 2000 issues
as companies expend significant resources to correct their current
systems for Year 2000 compliance. These expenditures may result in
reduced funds available to purchase products and services such as
those offered by the Company, which could have a material adverse
effect on the Company's business, operating results and financial
condition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not have material exposure to quantitative and
qualitative market risks.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Part IV, Item 14 of this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
23
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference is the information under the
heading "Election of Directors" and "Section 16(a) Reporting", in the
Registrant's Proxy Statement to be filed on or about April 14, 1999. See also
Part I, Item 1 "Executive Officers" of this Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference is the information appearing in the
Registrant's Proxy Statement which the Registrant anticipates filing on or about
April 14, 1999 under the headings "Election of Directors -- Committees of the
Board of Directors and Meeting Attendance", "Executive Compensation", "Summary
Compensation Table", "Option Grants in Last Fiscal Year", "Aggregated Option
Exercises in Last Fiscal Year and Fiscal Year-End Option Values", "Employment
Contracts; Severance, Termination of Employment and Change-in-Control
Arrangements", and "Performance Evaluation".
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference is the information appearing under
the heading "Security Ownership of Principal Stockholders and Management", in
the Registrant's Proxy Statement which the Registrant anticipates filing on or
about April 14, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference is the information appearing under
the heading "Certain Transactions", in the Registrant's Proxy Statement which
the Registrant anticipates filing on or about April 14, 1999.
24
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED AS PART OF THIS REPORT:
1. Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1998 and 1997
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996
Consolidated Statement of Stockholders' Equity for the years
ended December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements
Report of Independent Auditors
2. Consolidated Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts. Such schedule
should be read in conjunction with the Consolidated Financial
Statements. All other supplemental schedules are omitted
because of the absence of conditions under which they are
required.
(b) REPORTS ON FORM 8-K
A Form 8-K was not filed during the quarter ended December 31, 1998.
(c) EXHIBITS
The following exhibits are filed as part of this Annual Report on
Form 10-K for the fiscal year ended December 31, 1998:
2.1 Agreement and Plan of Merger among Secure Computing
Corporation, Owl Acquisition, Inc. and Enigma Logic,
Inc. dated as of June 24, 1996, as amended as of July
31, 1996.(1)
2.2 Acquisition and Pre-Amalgamation Agreement among Secure
Computing Corporation, Edge Acquisition Inc. and Border
Network Technologies, Inc. dated as of May 28, 1996, as
amended as of July 31, 1996.(1)
2.3 Amalgamation Agreement dated as of August 29, 1996.(2)
3.1 Restated Certificate of Incorporation of Registrant.(3)
3.2 By-Laws of the Registrant.(4)
4.1 Specimen of Common Stock certificate.(5)
- ------------------------------
(1) Incorporated by reference to Appendix A to the Company's Definitive Proxy
Statement dated August 5, 1996 and filed August 7, 1996 with the
Securities and Exchange Commission (File No. 0-27074).
(2) Incorporated herein by reference to Exhibit 2.3 to the Company's Current
Report on Form 8-K filed September 12, 1996 (File No. 0-27074).
(3) Incorporated herein by reference to Exhibit 3.1 to the Company's form 10-K
filed on March 28, 1996 (File No. 0-27074), as amended pursuant to (i) the
Certificate of Designation of Series A Preferred Stock, incorporated
herein by reference to Exhibit 4.1 to the Company's Form 8-K filed on
September 12, 1996, (ii) the Certificate of Designation of Series C
Preferred Stock, incorporated herein by reference to Exhibit 3.1 to the
Company's Form 8-K filed on July 15, 1998, (iii) the Amended and Restated
Certificate of Designation of Series B Preferred Stock, incorporated
herein by reference to Exhibit 1 to the Company's Form 8-A filed on
November 9, 1998, and (iv) the Certificate of Amendment filed with the
Delaware Secretary of State of December 11, 1998, incorporated herein by
reference to Exhibit 4.1 to the Company's Registration Stated on Form S-8
filed on February 5, 1999.
(4) Incorporated herein by reference to Exhibit 3.3 to the Company's
Registration Statement on Form S-1 (Registration Number 33-97838).
(5) Incorporated herein by reference to the same numbered Exhibit to Amendment
No. 2 to the Company's Registration Statement on Form S-1 (Registration
Number 33-97838).
25
<PAGE>
4.3 Securities Purchase Agreement dated June 30, 1998(6)
4.4 Registration Rights Agreement dated June 30, 1998(7)
4.5 Warrant to purchase shares of Common Stock dated June
30, 1998(8)
4.6 Amended and Restated Rights Agreement dated October 22,
1998(9)
4.7 Amended and Restated 1995 Omnibus Stock Plan(10)
10.1 Registration Rights Agreement among ITI, Incorporated,
GroTech Partners II, L.P., Ideas, Inc. and Bernard
Farkas dated July 14, 1989.(11)
10.2 Purchase Agreement among ITI Incorporated, Grotech
Partners II, L.P., Ideas Inc. and Bernard Farkas dated
July 14, 1989.(12)
10.3 Purchase Agreement among ITI Incorporated and Corporate
Venture Partners dated December 13, 1989.(13)
10.4 First Amendment dated December 13, 1989 among ITI,
Incorporated, GroTech Partners II, L.P., Ideas, Inc.,
and Bernard Farkas and Corporate Venture Partners to
Registration Rights Agreement among ITI, Incorporated,
Grotech Partners II, L.P., Ideas, Inc. and Bernard
Farkas dated July 14, 1989.(14)
10.5 Software Agreement between AT&T Information Systems Inc.
and ITI, Incorporated, Agreement No. SOFT-01701, dated
April 2, 1990, including Supplement No. 1, UNIX System V
Release 3.0, Supplement No. 2 dated August 10, 1990;
Sublicensing Agreement between AT&T Information Systems,
Inc.; Letter between UNIX System Laboratories, Inc. and
ITI, Inc. dated April 15, 1991; Letter Agreement
modifying Software Agreement No. SOFT-01701 dated
October 22, 1992; and Software Agreement between AT&T
Information Systems Inc. and ITI, Incorporated,
Agreement No. SOFT-02036, dated July 26, 1991.(15)
10.6 Agreement and Plan of Merger and Reorganization among
ITI Incorporated and Secure Computing Technology Company
dated May 29, 1992.(16)
- ------------------------------
(6) Incorporated herein by reference to Exhibit 10.1 to the Company's Form 8-K
filed on July 15, 1998.
(7) Incorporated herein by reference to Exhibit 10.1 to the Company's Form 8-K
filed on July 15, 1998.
(8) Incorporated herein by reference to Exhibit 10.1 to the Company's Form 8-K
filed on July 15, 1998.
(9) Incorporated herein by reference to Exhibit 10.1 to the Company's Form 8-K
filed on November 9, 1998.
(10) Incorporated herein by reference to Exhibit 4.7 to the Company's
Registration Statement on Form S-8 dated February 5, 1999.
(11) Incorporated herein by reference to Exhibit 10.2 to the Company's
Registration Statement on Form S-1 (Registration Number 33-97838).
(12) Incorporated herein by reference to Exhibit 10.4 to the Company's
Registration Statement on Form S-1 (Registration Number 33-97838).
(13) Incorporated herein by reference to Exhibit 10.6 to the Company's
Registration Statement on Form S-1 (Registration Number 33-97838).
(14) Incorporated herein by reference to Exhibit 10.7 to the Company's
Registration Statement on Form S-1 (Registration Number 33-97838).
(15) Incorporated herein by reference to Exhibit 10.9 to the Company's
Registration Statement on Form S-1 (Registration Number 33-97838).
(16) Incorporated herein by reference to Exhibit 10.12 to the Company's
Registration Statement on Form S-1 (Registration Number 33-97838).
26
<PAGE>
10.7 Secure Computing Corporation Profit Sharing and
Retirement Plan--Summary Plan Description dated February
1, 1994.(17)
10.8 Software License Agreement between Berkeley Software
Design, Inc. and Secure Computing Corporation, dated
February 7, 1994.(18)
10.9 Second Amendment to Purchase Agreement among Secure
Computing Corporation, GroTech Partners II, L.P.,
Corporate Venture Partners, L.P., Ideas, Inc. and
Bernard Farkas dated September 19, 1994, to Purchase
Agreement dated July 14, 1989 among ITI, Incorporated,
GroTech Partners II, L.P., Ideas, Inc. and Bernard
Farkas.(19)
10.10 Purchase Agreement between Secure Computing Corporation
and FBL Ventures of South Dakota, Inc. dated September
20, 1994.(20)
10.11 Employment Agreement between Secure Computing
Corporation and Jeffrey H. Waxman dated November 4,
1997.(21)
10.12 Employment Agreement between Secure Computing
Corporation and Christine Hughes dated November 8, 1997,
including the letter agreement dated November 7, 1996.
(22)
10.13 Employment Agreement between Secure Computing
Corporation and Timothy P. McGurran dated August 27,
1996.(23)
10.14 Employment Agreement between Secure Computing
Corporation and Gary D. Taggart dated October 2, 1996.+
10.15 Employment Agreement between Secure Computing
Corporation and Howard Smith dated April 29, 1998.+
10.16 Employment Agreement between Secure Computing
Corporation and Patrick Regester dated October 1, 1998.+
10.17 Description of Secure Computing Corporation Management
Incentive Plan.(24)
10.18 Secure Computing Corporation Employee Stock Purchase
Plan.(25)
23.1 Consent of Ernst & Young LLP.
27.0 Financial Data Schedule - 1998.
- ------------------------------
(17) Incorporated herein by reference to Exhibit 10.15 to the Company's
Registration Statement on Form S-1 (Registration Number 33-97838).
(18) Incorporated herein by reference to Exhibit 10.16 to the Company's
Registration Statement on Form S-1 (Registration Number 33-97838).
(19) Incorporated herein by reference to Exhibit 10.21 to the Company's
Registration Statement on Form S-1 (Registration Number 33-97838).
(20) Incorporated herein by reference to Exhibit 10.22 to the Company's
Registration Statement on Form S-1 (Registration Number 33-97838).
(21) Incorporated herein by reference to Exhibit 10.4 to the Company's Form
10-Q filed on November 14, 1996 (File No. 0-27074).
(22) Incorporated herein by reference to Exhibit 10.3 to the Company's Form
10-Q filed on November 14, 1996 (File No. 0-27074).
(23) Incorporated herein by reference to Exhibit 10.8 to the Company's Form
10-Q filed on November 14, 1996 (File No. 0-27074).
(24) Incorporated herein by reference to Exhibit 10.28 to the Company's
Registration Statement on Form S-1 (Registration Number 33-97838).
(25) Incorporated herein by reference to Exhibit 4.03 to the Company's
Registration Statement on Form S-8 (Registration Number 333-114151).
+ Management Contract or compensatory plan or arrangement required to be
filed as an exhibit hereto pursuant to Item 14(c of Form 10-K and Item 601
of Regulation S-K).
27
<PAGE>
SECURE COMPUTING CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
ASSETS
December 31,
-------------------------
1998 1997
-------------------------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents ................................................... $ 9,992 $ 4,880
Investments ................................................................. 10,886 --
Accounts receivable, (net of allowance for doubtful accounts
of 1998 -- $900; 1997 -- $417) ............................................. 19,712 13,553
Deferred income taxes ....................................................... 1,323 2,113
Inventories ................................................................. 2,361 1,123
Other current assets ........................................................ 1,038 1,760
---------- ----------
Total current assets ................................................... 45,312 23,429
PROPERTY AND EQUIPMENT
Equipment ................................................................... 7,261 8,008
Furniture & fixtures ........................................................ 2,059 2,595
Leasehold improvements ...................................................... 1,037 1,301
---------- ----------
10,357 11,904
Accumulated depreciation .................................................... (6,563) (6,286)
---------- ----------
3,794 5,618
INTANGIBLE ASSETS (net of accumulated amortization of
1998 -- $522; 1997 $561) ...................................................... 1,971 1,221
DEFERRED INCOME TAXES ......................................................... 2,277 290
EMPLOYEE NOTES RECEIVABLE ..................................................... 481 --
OTHER ASSETS .................................................................. 513 496
---------- ----------
TOTAL ASSETS ................................................................ $ 54,348 $ 31,054
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable ............................................................ $ 3,820 $ 2,175
Accrued payroll liability ................................................... 3,004 1,170
Other accrued liabilities ................................................... 1,918 1,094
Deferred revenue ............................................................ 2,553 1,815
---------- ----------
Total current liabilities .............................................. 11,295 6,254
STOCKHOLDERS' EQUITY
Preferred Stock, par value $.01 per share:
Authorized---2,000,000 shares; issued and outstanding shares --
December 31, 1998 -- 16,000 and December 31, 1997 - None ............... -- --
Common Stock, par value $.01 per share:
Authorized - 50,000,000 shares; issued and outstanding shares --
December 31, 1998 -- 16,545,987 and December 31, 1997 -- 15,762,820 .... 165 158
Additional paid-in capital .................................................. 89,730 68,131
Accumulated deficit ......................................................... (46,640) (43,378)
Accumulated other comprehensive income ...................................... (202) (111)
---------- ----------
Total stockholders' equity ............................................. 43,053 24,800
---------- ----------
Total liabilities and stockholders' equity ............................. $ 54,348 $ 31,054
========== ==========
</TABLE>
SEE ACCOMPANYING NOTES.
28
<PAGE>
SECURE COMPUTING CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1998 1997 1996
--------------------------------------------------
<S> <C> <C> <C>
REVENUE
Products and Services .................... $ 51,500 $ 33,203 $ 23,290
Advanced Technology contracts ............ 9,942 13,773 16,972
--------------------------------------------------
61,442 46,976 40,262
COSTS OF REVENUE .............................. 21,138 18,766 18,797
--------------------------------------------------
GROSS PROFIT .................................. 40,304 28,210 21,465
OPERATING EXPENSES
Selling and marketing .................... 22,835 20,469 18,425
Research and development ................. 7,477 8,736 9,575
General and administrative ............... 4,965 3,839 6,869
Stock option expense ..................... 2,160 900 --
Restructure costs ........................ 7,800 -- --
Acquisition costs ........................ -- -- 13,069
--------------------------------------------------
45,237 33,944 47,938
--------------------------------------------------
OPERATING LOSS ................................ (4,933) (5,734) (26,473)
Interest expense ......................... -- -- (129)
Interest and other income ................ 474 506 1,508
--------------------------------------------------
Loss before income tax benefit ........... (4,459) (5,228) (25,094)
Income tax benefit ....................... (1,197) (977) --
--------------------------------------------------
NET LOSS ...................................... $ (3,262) $ (4,251) $ (25,094)
==================================================
NET LOSS PER SHARE -- BASIC AND DILUTED ....... $ (0.20) $ (0.27) $ (1.76)
WEIGHTED AVERAGE SHARES OUTSTANDING--
BASIC AND DILUTED ........................ 16,106 15,480 14,222
</TABLE>
SEE ACCOMPANYING NOTES.
29
<PAGE>
SECURE COMPUTING CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Accumulated
Preferred stock Common stock Additional Other Total
------------------ -------------------- paid-in Comprehensive Accumulated stockholders'
Shares Amount Shares Amount capital Income Deficit equity
-------- -------- ---------- -------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995 ........... -- $ -- 12,542,196 $ 125 $ 50,116 $ -- $ (14,033) $ 36,208
Exercise of incentive stock
options ......................... -- -- 426,394 4 991 -- -- 995
Common Stock issued under
Employee Stock Purchase Plan .... -- -- 34,155 -- 277 -- -- 277
Compensation expense on options ... -- -- -- -- 197 -- -- 197
Common Stock issued ............... -- -- 1,142,908 12 6,350 -- -- 6,362
Exercise of Common Stock warrants . -- -- 955,499 10 7,277 -- -- 7,287
Net loss for the year ............. -- -- -- -- -- -- (25,094) (25,094)
-------- -------- ---------- -------- ---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1996 ........... -- -- 15,101,152 151 65,208 -- (39,127) 26,232
Comprehensive loss
Net loss for the year ........... -- -- -- -- -- -- (4,251) (4,251)
Foreign currency translation
adjustment .................... -- -- -- -- -- (111) -- (111)
----------
Total comprehensive loss .......... (4,362)
Exercise of incentive stock
options ......................... -- -- 552,111 6 1,447 -- -- 1,453
Common Stock issued under
Employee Stock Purchase Plan .... -- -- 109,557 1 576 -- -- 577
Compensation expense on options ... -- -- -- -- 900 -- -- 900
-------- -------- ---------- -------- ---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1997 ........... -- -- 15,762,820 158 68,131 (111) (43,378) 24,800
Comprehensive loss
Net loss for the year ........... -- -- -- -- -- -- (3,262) (3,262)
Foreign currency translation
adjustment .................... -- -- -- -- -- (91) -- (91)
----------
Total comprehensive loss .......... (3,353)
Exercise of incentive stock
options ......................... -- -- 687,995 6 3,295 -- -- 3,301
Common Stock issued under
Employee Stock Purchase Plan .... -- -- 95,172 1 799 -- -- 800
Compensation expense on options ... -- -- -- -- 2,160 -- -- 2,160
Preferred Stock issued ............ 16,000 -- -- -- -- -- 15,345 15,345
-------- -------- ---------- -------- ---------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1998 ........... 16,000 $ -- 16,545,987 $ 165 $ 89,730 $ (202) $ (46,640) $ 43,053
======== ======== ========== ======== ========== ========== ---------- ==========
</TABLE>
SEE ACCOMPANYING NOTES.
30
<PAGE>
SECURE COMPUTING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------
1998 1997 1996
-------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss ...................................................... $ (3,262) $ (4,251) $ (25,094)
Adjustments to reconcile net loss to net cash used in
operating activities:
Purchased research and development in process and
goodwill write-off ..................................... -- -- 4,994
Depreciation ............................................... 1,533 2,373 2,030
Loss on disposals of property and equipment ................ 1,724 159 --
Loss on disposals of intangible assets ..................... 268 731 187
Amortization ............................................... 325 -- --
Deferred income tax ........................................ (1,197) (1,030) 409
Stock option expense ....................................... 2,160 900 --
Changes in operating assets and liabilities:
Accounts receivable ........................................ (6,159) (6,455) (1,348)
Inventories ................................................ (1,238) 785 (1,302)
Other current assets ....................................... 722 (485) (1,315)
Accounts payable ........................................... 1,645 (1,552) 1,608
Accrued liabilities and reserves ........................... 2,491 (2,797) 2,009
Deferred revenue ........................................... 738 60 290
-------------------------------------------
Net cash used in operating activities .................. (250) (11,562) (17,532)
INVESTING ACTIVITIES
Purchases of investments ................................... (10,886) -- (8,645)
Proceeds from sales of investments ......................... -- 5,935 3,000
Cash paid in purchase of Webster Network Strategies, Inc. .. -- -- (759)
Cash paid in purchase of remaining interest in Border
Network Technologies Europe Ltd. ....................... -- -- (989)
Purchase of property and equipment ......................... (1,994) (2,304) (5,030)
Increase in intangibles and other assets ................... (1,842) (1,238) (885)
-------------------------------------------
Net cash provided by (used in) investing activities .... (14,722) 2,393 (13,308)
FINANCING ACTIVITIES
Payments on notes payable and long-term debt ............... -- -- (1,943)
Proceeds from issuance of Preferred Stock .................. 15,345 -- --
Proceeds from issuance of Common Stock ..................... 4,101 2,030 11,989
Proceeds from sales-lease-back transaction ................. 729 -- --
-------------------------------------------
Net cash provided by financing activities .............. 20,175 2,030 10,046
EFFECT OF FOREIGN CURRENCY TRANSLATION .......................... (91) (111) --
-------------------------------------------
Increase (decrease) in cash and cash equivalents ........... 5,112 (7,250) (20,794)
Cash and cash equivalents beginning of year ................ 4,880 12,130 32,924
-------------------------------------------
Cash and cash equivalents end of year ...................... $ 9,992 $ 4,880 $ 12,130
===========================================
</TABLE>
SEE ACCOMPANYING NOTES.
31
<PAGE>
SECURE COMPUTING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Secure Computing Corporation ("Secure Computing" or the "Company")
designs, develops, markets and sells a comprehensive offering of interoperable,
standards-based products for end-to-end network solutions, including firewalls,
Web filters, authentication, extranet access control and security related
professional services. Today, the Company enables business security solutions
through its advanced technologies, professional services and partner programs.
The Company's goal is to provide a complete portfolio of integrated enterprise
security solutions for corporate networks. The Company's principal markets are
commercial companies and the United States government for its network security
products and the United States government under development contracts.
BASIS OF PRESENTATION
The consolidated financial statements are presented giving
retroactive effect to the Company's 1996 acquisitions of Border Network
Technologies Inc. (now known as Secure Computing Canada Ltd.) and Enigma Logic,
Inc. which have been accounted for under the pooling of interests method (see
Note 2.). The consolidated financial statements include the accounts of the
Company and its subsidiaries. All inter-company balances and transactions have
been eliminated in consolidation.
REVENUE RECOGNITION
PRODUCTS AND SERVICES
The Company recognizes product revenues at the time of shipment in
instances where the Company has evidence of a contract, the fee charged is fixed
and determinable and collection is probable. The Company has entered into
customer support and maintenance agreements with various customers. The Company
recognizes the related revenues either ratably as the obligations are fulfilled
or upon completion of performance.
Revenue generated through traditional channels with a right of
return for stock balancing and rotations is reduced by a reserve for estimated
returns. These reserves are based on estimates made by the Company's management
and are subject to change.
ADVANCED TECHNOLOGY CONTRACTS
Advanced Technology contract revenues for cost-plus-fixed-fee
contracts are recognized on the basis of costs incurred during the period plus
the fee earned. Award fees are recognized based upon the percentage of
completion and forecasted profit. A provision is made for the estimated loss, if
any, on the contracts.
Under its Advanced Technology contracts, the Company bears the risk
that increased or unexpected costs required to perform specified services may
reduce the Company's profitability. In addition, recoverable expenses billed by
the Company for government contracts are subject to review and audit by the
Defense Contract Audit Agency, which could result in amounts previously billed
being renegotiated. Pursuant to their terms, these contracts are generally also
subject to termination at the convenience of the applicable government agency.
If the contract is terminated, the Company typically would be reimbursed for its
costs to the date of its termination plus the cost of an orderly termination,
and paid a portion of the fee.
At December 31, 1998 and 1997, the Company had deferred revenue of
$102 and $144, respectively, related to Advanced Technology contracts.
32
<PAGE>
SECURE COMPUTING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity
of three months or less when purchased to be cash equivalents.
INVENTORIES
Inventories consist mainly of purchased components and prepaid
licenses and are valued at the lower of cost, (first-in, first-out method) or
market.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost. Depreciation is
calculated using straight line and accelerated depreciation methods with
estimated useful lives ranging from 3 to 10 years.
INTANGIBLE ASSETS
Intangible assets consist of patents and trademarks and are
amortized using the straight-line method over the estimated useful lives of the
assets, which range up to ten years.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews its long-lived assets for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Recoverability of assets to be held and used is measured
by a comparison of the carrying amount of an asset to undiscounted future net
cash flows expected to be generated by the assets. If such assets are considered
to be impaired, the impairment to be recognized is measured by the amount by
which the carrying amount of the assets exceeds the fair value of the assets.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
Foreign assets and liabilities are translated using the year-end
exchange rate. Results of operations are translated using the average exchange
rates throughout the year. Translation gains or losses, net of applicable
deferred taxes, are accumulated as a separate component of stockholders' equity.
RESEARCH AND DEVELOPMENT
Research and development expenditures are charged to operations as
incurred. Statement of Financial Accounting Standards No. 86, "Accounting for
the Costs of Computer Software to be Sold, Leased or Otherwise Marketed",
requires capitalization of certain software development costs subsequent to the
establishment of technological feasibility.
Based on the Company's product development process, technological
feasibility is established upon completion of a working model. Costs incurred by
the Company between completion of the working model and the point at which the
product is generally available for sale are capitalized and amortized over their
estimated useful life of three years. The Company has capitalized software
development costs net of accumulated amortization of $1,304 and $547 at December
31, 1998 and 1997, respectively. Amortization and expense was $366, $682 and
$187 for the years ended December 31, 1998, 1997, and 1996, respectively.
33
<PAGE>
SECURE COMPUTING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
NET LOSS PER SHARE
Basic earnings per share is computed using the weighted average
number of common shares outstanding. Diluted earnings per share is computed
using the combination of dilutive common share equivalents and the weighted
average number of common shares outstanding. Diluted earnings per share is not
presented as the effect of outstanding options, warrants and preferred stock are
antidilutive.
COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." Statement No.
130 established new rules for the reporting and display of comprehensive income
and its components; however, the adoption of this Statement had no impact on the
Company's net income or stockholders' equity. Statement 130 requires the foreign
currency translation adjustments, which prior to adoption were reported
separately in stockholders' equity, to be included in other comprehensive
income. Prior year financial statements have been reclassified to conform to the
requirements of Statement 130.
STOCK OPTIONS
The Company follows the disclosure only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" regarding disclosure of pro-forma information for stock
compensation. As permitted by Statement No. 123, the Company measures
compensation cost using the methods described in Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees".
2. ACQUISITIONS
In May 1996, the Company acquired Webster Network Strategies, Inc.
("Webster"), a Florida based Internet software developer, for 102,000 shares of
Common Stock and $749 cash, which included expenses of $249, in exchange for all
outstanding common stock of Webster. The acquisition was been accounted for
using the purchase method. Subsequent to the acquisition, the Company expensed
all purchased research and development in process of $3,894 based upon an
independent appraisal.
In August 1996, the Company acquired network security software
developers Border Network Technologies, Inc. ("Border") and Enigma Logic, Inc.
("Enigma"). Both Border and Enigma were merged directly into the Company in a
pooling of interests. As a result of the mergers, the Company exchanged
approximately 6,000,000 shares of Common Stock for all of the outstanding common
stock of Border and approximately 2,060,000 shares of Common Stock for all of
the outstanding common stock of Enigma. In addition, outstanding Border and
Enigma stock options were converted into options to purchase approximately
1,160,000 shares of the Company's Common Stock. Separate results of operations
for the periods prior to the mergers are as follows:
34
<PAGE>
SECURE COMPUTING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
2. ACQUISITIONS (CONTINUED)
SIX MONTHS ENDED JUNE 30, 1996
Revenue: (UNAUDITED)
---------------
Secure ................. $ 13,438
Border ................. 4,506
Enigma ................. 2,478
---------------
Combined .................. $ 20,422
===============
Net loss:
Secure ................. $ (9,189)
Border ................. (4,474)
Enigma ................. (2,857)
---------------
Combined .................. $ (16,520)
===============
Also in May 1996, the Company acquired the remaining 68% interest it
did not own in Border Network Technologies Europe Limited for 40,908 shares
Common Stock and $989 in cash. Goodwill of $1,100 that was recorded in this
transaction was subsequently expensed as acquisition costs.
3. INVESTMENTS
At December 31, 1998, investments consisted of commercial paper with
maturities of less than one year. The investments are considered available for
sale and are stated at cost plus accrued interest which approximates fair market
value.
4. ACCOUNTS RECEIVABLE
Approximately 9% of accounts receivable were due from the United
States government at December 31, 1998 and 1997. Unbilled accounts receivable
from all customers were $2,254 and $644 at December 31, 1998 and 1997,
respectively.
The Company may take various forms of action to manage its
receivables such as selling its receivables at a discount to a third party that
the Company entered into an agreement with in 1998.
5. LINE OF CREDIT
The Company has a $5,000 line of credit agreement with a bank.
Borrowings under the line of credit incur interest at the prime rate plus .5%.
The line of credit expires in April, 2001. As of December 31, 1998, the line of
credit has no borrowings under it.
35
<PAGE>
SECURE COMPUTING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
6. LEASES
The Company leases office space for all of its locations. Future
lease payments for all operating leases, excluding executory costs such as
management and maintenance fees, are as follows:
Future Lease Net Future Lease
Obligations Subleases Obligations
---------------- ----------------- ----------------
1999 $ 2,472 $ (252) $ 2,220
2000 2,352 (210) 2,142
2001 1,950 (156) 1,794
2002 1,900 (168) 1,732
2003 1,802 (168) 1,634
Thereafter 3,876 (476) 3,400
---------------- ----------------- ----------------
$ 14,352 $ (1,430) $ 12,922
================ ================= ================
Rent expense was $1,865, $2,191 and $2,488 for the years ended
December 31, 1998, 1997 and 1996, respectively.
In addition, in February 1998, the Company entered into a
sales-lease-back agreement pertaining to certain previously acquired computer
equipment and software. Proceeds from the sale were $729, which approximated the
assets carrying value. The remaining lease term of approximately thirteen
months, with monthly rental payments of $32, results in a remaining future
minimum lease obligation of $416.
7. CAPITAL STOCK
On November 30, 1998, at a special meeting of Stockholders, an
amendment to the Company's Restated Certificate of Incorporation to increase the
common shares authorized from 25,000,000 to 50,000,000 was approved. In
addition, 16,000 shares of Series C Preferred stock were designated for the June
1998 issuance described below.
PREFERRED STOCK
In June 1998, the Company sold 16,000 shares of newly issued Series
C Convertible Preferred Stock (the "Series C Preferred") and warrants to acquire
174,464 shares of Common Stock to two investors. The exercise price of the
warrants is $11.92 per share. The warrants expire on the earlier of June 29,
2001 or the date on which the closing of a consolidations, merger or other
business combination of the Company with or into another entity that is not
currently an affiliate of the Company. The offer and sale of these securities
were completed pursuant to the exemption provided by Regulation D under the
Securities Act of 1933.
The Series C Preferred is convertible at the election of the holder
into shares of Common Stock beginning six months after issuance. The Series C
Preferred is senior to the Company's Series A and Series B Convertible Preferred
Stock, should any be issued, and to the Company's Common Stock in respect of the
right to receive dividend payments and liquidation preferences. The issuance of
the Series C Preferred may result in dilution to existing stockholders.
36
<PAGE>
SECURE COMPUTING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
8. STOCK OPTIONS
In September 1995, the Board of Directors and the stockholders
approved the Company's 1995 Omnibus Stock Plan (the "Stock Plan"). Under the
terms of the Stock Plan, key employees and non-employees may be granted options
to purchase up to 7,744,131 shares of the Company's Common Stock. The majority
of options granted typically have ten year terms and vest annually over three
years. In addition, the Company has programs where options are subject to
accelerated vesting based on the performance of the Company's stock price over a
specified period of time ranging from one to three years.
A summary of changes in outstanding options and common shares reserved under the
Plan are as follows:
<TABLE>
<CAPTION>
WEIGHTED
SHARES AVAILABLE OPTIONS AVERAGE EXERCISE
FOR GRANT OUTSTANDING PRICE PER SHARE
------------------------------------------------------
<S> <C> <C> <C>
Balance at December 31, 1995 ......... 372,149 1,251,961 $ 2.14
Shares authorized ................. 2,084,570 -- --
Granted ........................... (2,397,152) 2,397,152 10.29
Exercised ......................... -- (426,394) 2.33
Canceled .......................... 188,188 (188,188) 6.88
------------------------------------------------------
Balance at December 31, 1996 ......... 247,755 3,034,531 $ 9.01
Shares authorized ................. 1,300,000 -- --
Granted ........................... (3,282,073) 3,282,073 6.44
Exercised ......................... -- (552,111) 2.71
Canceled .......................... 1,866,233 (1,866,233) 11.96
------------------------------------------------------
Balance at December 31, 1997 ......... 131,915 3,898,260 $ 6.24
Shares authorized ................. 2,500,000 -- --
Granted ........................... (1,896,307) 1,896,307 10.41
Exercised ......................... -- (687,995) 4.86
Canceled .......................... 859,380 (859,380) 7.91
------------------------------------------------------
Balance at December 31, 1998 ......... 1,594,988 4,247,192 $ 7.75
======================================================
</TABLE>
The following table summarizes information about the stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------------------- ---------------------------
Weighted- Weighted-
Weighted- Average Average
Number Average Remaining Exercise Number Exercise
Range of Exercise Price Outstanding Contactual Life Price Exercisable Price
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ .01 - $ 3.02 158,368 5.0 years $ 1.11 158,368 $ 1.11
$ 3.03 - $ 6.05 139,846 8.1 years 5.51 120,973 5.53
$ 6.06 - $ 9.07 2,398,951 8.1 years 6.35 869,937 6.24
$ 9.08 - $12.10 1,322,179 9.2 years 10.10 329,158 9.88
$12.11 - $15.13 151,634 9.7 years 13.18 5,514 12.88
$15.14 - $18.15 33,714 9.9 years 17.00 -- --
$18.16 - $21.18 42,500 8.7 years 19.02 -- --
- -----------------------------------------------------------------------------------------------------------
$ .01 - $21.18 4,247,192 8.4 years $ 7.75 1,483,950 $ 6.47
===========================================================================================================
</TABLE>
37
<PAGE>
SECURE COMPUTING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
8. STOCK OPTIONS (CONTINUED)
Options outstanding under the Stock Plan expire at various dates
from 2000 to 2008. The number of options exercisable as of December 31, 1998,
1997 and 1996 were 1,483,950, 693,520, and 1,062,920 at weighted average
exercise prices of $6.47, $6.31, $3.32, respectively. The weighted average fair
value of options granted and the weighted average remaining contractual life of
options granted during 1998, 1997 and 1996 are $8.09, $5.05, and $10.29 and 8.4,
8, and 9.5 years, respectively.
The Company also has an Executive Stock Option program under which
1,110,000 options are subject to accelerated vesting based on the performance of
the Company's stock price over a period ranging from one to three years. The
number of options exercisable under this program, as of December 31, 1998 was
500,000 of which 180,000 have an exercise price of $6.125 and 320,000 have an
exercise price of $10.25. For the year ended December 31, 1998 and 1997, the
Company recognized $2,160 and $900 respectively, of compensation expense related
to the accelerated vesting of options under this program.
The Company also has an Employee Stock Purchase Plan under which
400,000 shares have been reserved for purchase by employees. The purchase price
of the shares under the Plan is the lesser of 85% of the fair market value on
the first or last day of the offering period. Offering periods are each three
months. Employees may designate up to 10% of their compensation for the purchase
of stock under the Plan.
Pro forma information regarding net loss and loss per share is
required by Statement No. 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions for 1998, 1997 and 1996, respectively: risk-free interest rates of
6.0%; volatility factors of the expected market price of the Company's Common
Stock of 1.00, .80, .80; and a weighted average expected life of the option of 5
years.
For purposes of pro forma disclosures, the estimated fair value of
the options is amortized to expense over the options' vesting period. The
Company's pro forma information is as follows:
YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
------------------------------------
Pro forma net loss $(10,739) $(9,105) $(30,217)
====================================
Pro forma basic and diluted loss per share $(.67) $(.59) $(2.12)
====================================
The pro forma effect on the net loss for all years shown is not
representative of the pro forma effect on net income (loss) in future years
because it does not take into consideration pro forma compensation expense
related to grants made prior to 1995.
38
<PAGE>
SECURE COMPUTING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
9. INCOME TAXES
The Company's income tax benefit for the year ended December 31,
1998 consists of a deferred benefit of $1,197. The tax benefit of $977 for the
year ended December 31, 1997 represents current foreign income taxes of $53 and
a deferred federal benefit of $1,030.
The effective tax rate differs from the statutory tax rate primarily
as a result of the following:
YEAR ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
---------------------------------------
Income taxes at statutory rate ........ $ (1,516) $ (1,778) $ (8,785)
State taxes, net of federal benefit ... (150) (223) (1,255)
Foreign taxes ......................... -- (180) --
Change in valuation allowance ......... 440 (1,110) 5,539
Non-deductible acquisition costs ...... -- -- 4,470
Other ................................. 29 94 31
---------------------------------------
Income tax benefit .................... $ (1,197) $ (977) $ --
=======================================
Deferred income tax assets and liabilities result from temporary
differences between the carrying values of assets and liabilities for financial
statement and income tax purposes. Significant components of the Company's net
deferred tax assets are as follows:
DECEMBER 31,
-------------------------
1998 1997
-------------------------
Deferred tax assets:
Accrued liabilities ............................... $ 465 $ 492
Stock option compensation expense ................. 1,224 360
Contract loss reserve ............................. 23 70
Payroll liabilities ............................... 149 187
Tax over book amortization ........................ (463) (124)
Book over tax depreciation ........................ 171 114
Income tax credits ................................ 478 478
Net operating loss carryforward ................... 17,754 15,675
-------------------------
Total deferred tax assets before valuation allowance . 19,801 17,252
Less valuation allowance ............................. (16,201) (14,849)
-------------------------
Net deferred tax assets .............................. $ 3,600 $ 2,403
=========================
SFAS 109 "Accounting for Income Taxes" requires the consideration of
a valuation allowance for deferred tax assets if it is "more likely than not"
that benefits of deferred tax assets will not be realized. Management believes
it is more likely than not that the net deferred tax assets of $3,600 at
December 31, 1998 will be realized. However, the amount of the deferred tax
assets considered realizable could be reduced in the near term if estimates of
future taxable income are reduced.
39
<PAGE>
SECURE COMPUTING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
9. INCOME TAXES (CONTINUED)
At December 31, 1998, the Company had net operating loss
carryforwards (NOL) of $44,400 which are available to offset taxable income
through 2013. These carryforwards are subject to the limitations of Internal
Revenue Code Section 382. This section provides limitations on the availability
of net operating losses to offset current taxable income if significant
ownership changes have occurred for federal tax purposes. Included in the NOL is
approximately $11,400 related to stock option exercises. These deductions
currently have a full valuation allowance and, when realized for financial
statement purposes, they will not result in a reduction in income tax expense.
Rather, the benefit will be recorded as an increase to additional
paid-in-capital.
Federal income taxes were not paid in 1998, 1997 or 1996.
10. EMPLOYEE BENEFIT PLAN
The Company has a voluntary defined contribution plan under Section
401(k) of the Internal Revenue Code which covers substantially all U.S.
employees of the Company. The Company also has voluntary defined contribution
plans which cover substantially all employees of the Company. Contributions to
the latter are limited to the employer's discretionary annual contribution.
The Company recognized expense for contributions to the plans as
follows:
YEAR ENDED DECEMBER 31,
-----------------------------
1998 1997 1996
-----------------------------
Defined contribution plan (401K) ...... $ 275 $ 50 $ 61
Voluntary contribution plans .......... -- -- 367
-----------------------------
$ 275 $ 50 $ 428
=============================
11. FOREIGN SALES
Sales to foreign customers accounted for 24%, 32% and 21% of total
revenue in the years ended December 31, 1998, 1997 and 1996, respectively.
12. CONTINGENCIES
The Company is engaged in certain legal proceedings and claims
arising in the ordinary course of its business. The ultimate liabilities, if
any, which may result from these or other pending or threatened legal actions
against the Company cannot be determined at this time. However, in the opinion
of management, the facts known at the present time do not indicate that such
litigation will have a material effect on the financial position of the Company.
13. RESTRUCTURING
Early in 1998, the Company announced plans to implement a
restructuring plan designed to facilitate further integration of acquired
businesses, and recorded a pre-tax expense of $7,800 to account for these
actions, which include costs of lease terminations, streamlining its product
offerings and reducing the Company's cost structure to increase operational
efficiency. The plan resulted in the separation of some employees worldwide and
the closing of three North American facilities.
40
<PAGE>
SECURE COMPUTING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
13. RESTRUCTURING (CONTINUED)
Asset impairment and restructuring costs for the year ended December
31, 1998, are as follows:
<TABLE>
<CAPTION>
Total Cash Write- Accrued
Costs Related To: Charges Payments Downs Cost
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Compensation costs for severance and
other termination benefits ....... $ 1,276 $ 1,276 $ -- $ --
Consulting and legal costs .............. 679 679 -- --
Write-off of property, plant and
equipment ........................ 1,764 -- 1,764 --
Write-off of other assets ............... 713 -- 713 --
Lease termination costs ................. 745 745 -- --
Facility reconfigurations ............... 723 105 -- 618
Employee relocations .................... 358 358 -- --
Canceled contracts ...................... 536 300 236 --
Additional travel ....................... 196 196 -- --
Other charges ........................... 810 810 -- --
-----------------------------------------------------
Total Costs ........................ $ 7,800 $ 4,469 $ 2,713 $ 618
=====================================================
</TABLE>
As of December 31, 1998, approximately 45 employee terminations were
related to restructuring actions. Accrued restructuring at December 31, 1998
totaled approximately $618, which is considered adequate to cover the facilities
related costs which remain as a result of the 1998 restructuring plan. The
Company's management believes that these costs will be complete by the end of
the second quarter in 1999.
14. SEGMENT INFORMATION
The Company has two reportable segments consisting of Products and
Services and Advanced Technology. The Company's Products and Services segment
markets a range of interoperable, standards-based network security products and
services to the global marketplace including customers from Fortune 500
companies, small branch offices, and government agencies. The Company's Advanced
Technology segment engages in research and development of information security
technology by acquiring and executing contracts with departments and agencies of
the United States government. Cash, investments, deferred tax assets, merger
related intangibles, general and administrative expenses, acquisition costs and
stock option compensation costs cannot be readily identified to the two business
segments, therefore, they are presented separately in a Corporate segment.
The Company evaluates segment performance based on gross profit.
Resources are allocated based on contractual requirements as the Advanced
Technology segment is reimbursed on a cost plus basis from the various agencies
of the United States government. The accounting policies of the reportable
segments are the same as those described in Note 1, "Summary of Significant
Accounting Policies". Revenue is recognized at time of shipment and/or when
performance of services are complete for the Products and Services segment. For
Advanced Technology, contract revenue is recognized on the basis of costs
incurred for the government contracts serviced by Advanced Technology and
intersegment transfers are recorded at cost; there are no intercompany profits
or losses recorded on intersegment transfers.
41
<PAGE>
SECURE COMPUTING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
14. SEGMENT INFORMATION (CONTINUED)
The Company's reportable segments are business units that offer
distinct product and services to very different customer groups. The reportable
segments are each managed separately because they require different managerial
skill sets and are focused toward different markets.
Significant components of the Company's segments are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------------------------------------
Products and Advanced
Services Technology
Segment Segment Corporate Total
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues from external customers ....... $ 51,500 $ 9,942 $ -- $ 61,442
Restructuring charge ................... -- -- 7,800 7,800
Depreciation expense ................... 1,241 273 19 1,533
Segment gross profit ................... 37,174 3,130 -- 40,304
Segment operating income/(loss) ........ 10,689 (697) (14,925) (4,933)
Interest income ........................ -- -- 474 474
Segment assets ......................... 27,594 2,227 24,527 54,348
Expenditures for long lived assets ..... 3,674 137 25 3,836
- --------------------------------------------------------------------------------------------------------------
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------------------------------------
Products and Advanced
Services Technology
Segment Segment Corporate Total
- --------------------------------------------------------------------------------------------------------------
Revenues from external customers ....... $ 33,202 $ 13,773 $ -- $ 46,976
Depreciation expense ................... 1,533 809 31 2,373
Segment gross profit ................... 24,033 4,177 -- 28,210
Segment operating income/(loss) ........ 1,267 (2,262) (4,739) (5,734)
Interest income ........................ -- -- 506 506
Segment assets ......................... 20,906 2,720 7,428 31,054
Expenditures for long lived assets ..... 3,166 346 30 3,542
- --------------------------------------------------------------------------------------------------------------
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
- --------------------------------------------------------------------------------------------------------------
Products and Advanced
Services Technology
Segment Segment Corporate Total
- --------------------------------------------------------------------------------------------------------------
Revenues from external customers ....... $ 23,290 $ 16,972 $ -- $ 40,262
Depreciation expense ................... 1,030 958 42 2,030
Segment gross profit ................... 17,231 4,234 -- 21,465
Segment operating income/(loss) ........ 1,034 (7,569) (19,938) (26,473)
Interest income ........................ -- -- 1,508 1,508
Segment assets ......................... 12,412 4,701 19,662 36,775
Expenditures for long lived assets ..... 3,451 2,364 100 5,915
- --------------------------------------------------------------------------------------------------------------
</TABLE>
42
<PAGE>
SECURE COMPUTING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
14. SEGMENT INFORMATION (CONTINUED)
International sales accounted for 24%, 32% and 21% of total revenue
for the years 1998, 1997 and 1996 respectively. Major foreign markets for the
Company's products include Europe and the Pacific Rim, with the United Kingdom,
Germany, Scandinavia and Japan being particularly strong. In each country, the
Company has independent channel partners who are responsible for marketing,
selling and supporting the Company's products to resellers and end-users within
their defined territories.
The following table summarizes information about the Company's international and
domestic sales and operations:
YEAR ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
- ---------------------------------------------------------------------------
Revenues:
United States sales ............ $ 46,464 $ 31,944 $ 31,683
International sales ............ 14,978 15,032 8,579
---------------------------------------
$ 61,442 $ 46,976 $ 40,262
=======================================
Identifiable Assets:
United States operations ....... $ 53,463 $ 28,905 $ 32,259
International operations ....... 885 2,149 4,516
---------------------------------------
$ 54,348 $ 31,054 $ 36,775
=======================================
15. RELATED PARTY TRANSACTIONS
In 1998, the Company relocated several key employees to California.
To mitigate cost of living differences, the Company provided interest free loans
totaling $481 to these employees. These loans are to be repaid within five years
of the date of issuance.
In January 1998, the Company agreed to guarantee a bank loan to the
Company's Chairman and Chief Executive Officer, in an amount of $250, which
guarantee expired upon the payment of bonuses by the Company in 1998.
43
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Secure Computing Corporation
We have audited the accompanying consolidated balance sheets of Secure Computing
Corporation as of December 31, 1998 and 1997, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1998. Our audit also included the
financial statement schedule listed in the Index at Item 14(a). These
consolidated financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Secure
Computing Corporation at December 31, 1998 and 1997, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
January 29, 1999
44
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
SECURE COMPUTING CORPORATION
Date: March 23, 1999 By /s/ Jeffrey H. Waxman
Jeffrey H. Waxman
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant, and
in the capacities indicated on March 23, 1999.
Signature Title
/s/ Jeffrey H. Waxman Chairman and Chief Executive Officer
- ------------------------------ (Principal Executive Officer)
Jeffrey H. Waxman
/s/ Timothy P. McGurran Senior Vice President of Operations, Chief
- ------------------------------ Financial Officer
Timothy P. McGurran (Principal Financial and Accounting Officer)
/s/ Betsy Atkins Director
- ------------------------------
Betsy Atkins
/s/ Robert J. Frankenberg Director
- ------------------------------
Robert J. Frankenberg
/s/ Stephen M. Puricelli Director
- ------------------------------
Stephen M. Puricelli
/s/ Eric P. Rundquist Director
- ------------------------------
Eric P. Rundquist
/s/ Alexander Zakupowsky, Jr. Director
- ------------------------------
Alexander Zakupowsky, Jr.
45
<PAGE>
SECURE COMPUTING CORPORATION
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
Additions
Balance at Charged to
Beginning Costs and Less Balance at
Description of Year Expenses Deductions End of Year
- ----------- -------- --------- ---------- -----------
<S> <C> <C> <C> <C>
Year ended December 31, 1998:
Contract loss reserves ................ $ 176,000 $ -- $ (118,000) $ 58,000
Warranty reserves ..................... 30,000 -- -- 30,000
Sales return allowance ................ -- 527,000 -- 527,000
Allowance for doubtful accounts ....... 417,000 1,152,000 (669,000) 900,000
Inventory reserve ..................... 50,000 67,000 -- 117,000
Restructure reserve ................... -- 7,800,000 (7,182,000) 618,000
=======================================================================
Total ............................. $ 673,000 $ 9,546,000 $ (7,969,000) $ 2,250,000
=======================================================================
Year ended December 31, 1997:
Contract loss reserves ................ $ 250,000 $ -- $ (74,000) $ 176,000
Warranty reserves ..................... 65,000 -- (35,000) 30,000
Sales return allowance ................ 120,000 -- (120,000) --
Allowance for doubtful accounts ....... 290,000 179,000 (52,000) 417,000
Inventory reserve ..................... 150,000 60,000 (160,000) 50,000
=======================================================================
Total ............................. $ 875,000 $ 239,000 $ (441,000) $ 673,000
=======================================================================
Year ended December 31, 1996:
Contract loss reserves ................ $ 250,000 $ -- $ -- $ 250,000
Warranty reserves ..................... 120,000 35,000 (90,000) 65,000
Sales return allowance ................ 70,000 50,000 -- 120,000
Allowance for doubtful accounts ....... 131,000 462,000 (303,000) 290,000
Inventory reserve ..................... -- 150,000 -- 150,000
=======================================================================
Total ............................. $ 571,000 $ 697,000 $ (393,000) $ 875,000
=======================================================================
</TABLE>
46
EXHIBIT 10.16
SECURE COMPUTING CORPORATION EMPLOYMENT AGREEMENT
(Effective If and When Hired)
Name Gary Taggart Social Security No.
-------------------- -------------------
In consideration of my employment by Secure Computing Corporation, I agree that:
(1) Secure Computing Corporation policies and handbooks which may from time to
time be applicable to me shall be a guide regarding my employment but shall not
constitute or imply an agreement between me and Secure Computing Corporation nor
shall any representations made to me individually, before or during my
employment which are not made in writing and authorized by Secure Computing
Corporation, constitute an agreement.
(2) Except as required in the performance of my duties for Secure Computing
Corporation, or as authorized by it in writing, I will not during the course of
employment by Secure Computing Corporation or any time thereafter use or
disclose to others proprietary or trade secret information of Secure Computing
Corporation or others, including but not limited to customer furnished
information which has been provided to Secure Computing Corporation with
restrictions on its use or further disclosure, and CLASSIFIED INFORMATION OF THE
UNITED STATES. Secure Computing Corporation proprietary or trade secret
information is information used or useful in the conduct of Secure Computing
Corporation business which is not generally known to the public or in a relevant
industry, such as, but not limited to, information relating to its research,
development, manufacturing, purchasing, finances, acquisition activity,
accounting, engineering, marketing, merchandising, selling and present and
prospective customers (including listing of, proposals to, agreements with, and
relationships with such customers).
(3) I hereby certify, that in the performance of my duties and responsibilities
for Secure Computing Corporation, I will not disclose, publish, or use any
confidential information, proprietary data, or trade secrets that I may have
obtained from my previous employer(s) or association(s).
(4) I will return to Secure Computing Corporation and stop using upon request or
upon termination of my employment, all papers, notebooks, reports, manuals,
computer files, software, vehicles, tools, keys and entry cards, identification
cards or badges, credit authorization, apparatus, computer user identifiers,
passwords and other property furnished to me by Secure Computing Corporation, or
which was prepared or made in whole or in part by me in connection with my
employment by Secure Computing Corporation.
(5) While employed by Secure Computing Corporation, I will not engage in any
business or service similar to Secure Computing Corporation's business, nor
design, assemble, manufacture, distribute, research, or develop products for any
person, firm, or corporation other than Secure Computing Corporation which are
the same or similar to those manufactured or provided by Secure Computing
Corporation.
(6) I will promptly disclose to Secure Computing Corporation all product,
process, hardware and software inventions, designs, computer programs and
related documentation, other works of authorship and mask works (hereafter
Developments) relating to its business which I made individually or jointly with
others, while I am employed by it or within a period of six (6) months following
termination of my employment. (See back side of agreement for listing prior
Developments to which this agreement. does not apply.) I hereby assign and agree
to assign all my interest in such Developments to Secure Computing Corporation,
and upon the request and at the expense of Secure Computing Corporation, do all
other acts reasonably necessary to assist it in obtaining and enforcing rights
in Developments in any and all countries; provided, however, this paragraph (5)
shall not apply to Developments for which no equipment, supplies, facility or
trade secret information of Secure Computing Corporation was used and which is
developed entirely on my own time and (1) which does not relate (a) directly to
Secure Computing Corporation's business or (b) to Secure Computing Corporation's
actual or demonstrably anticipated research or development, or (2) which does
not result from any work performed by me for Secure Computing Corporation. I
acknowledge that the obligation of this paragraph (5) shall be in effect whether
or not I receive or am considered for the award of any additional compensation
for the Development.
(7) The wages or salary and any other benefits which I receive during my
employment by Secure Computing Corporation shall be my full compensation for
this agreement.
I ACKNOWLEDGE THAT I HAVE READ THIS AGREEMENT, I understand that to the extent
applicable it remains in effect following the cessation of my employment with
Secure Computing Corporation, is binding on my heirs and that it may be
transferred by Secure Computing Corporation to any of its successors or
assignees.
Date: 10/2/96 Signature: /s/ Gary Taggart
--------------- --------------------------
EXHIBIT 10.17
SECURE COMPUTING CORPORATION
EMPLOYMENT AGREEMENT
SECURE COMPUTING CORPORATION, its subsidiaries, affiliates, successors or
assigns (together the "Company"), and HOWARD SMITH agree as follows:
1. Revised Employment Agreement. This Employment Agreement supersedes in its
entirety the Employment, Confidential Information, Invention Assignment and
Arbitration Agreement signed by you on January 23, 1998.
2. Positions and Responsibilities.
2.1 You shall serve as Executive Vice President of Research and Product
Development and perform the duties customarily associated with such capacity
from time to time and at such place or places as the Company shall designate or
as shall be appropriate and necessary in connection with such employment.
2.2 You will, to the best of your ability, devote your full time and best
efforts to the performance of your duties hereunder and the business and affairs
of the Company.
2.3 You will duly, punctually and faithfully perform and observe any and
all rules and regulations which the Company may now or shall hereafter establish
governing the conduct of its business.
3. Term of Employment.
3.1 The term of your employment agreement shall commence on January 26,
1998 and terminate in one year, subject to automatic renewal for successive one
year terms unless either party shall have notified the other in writing not less
than thirty (30) days prior to the then current expiration date of this
Agreement of such party's determination not to renew this Agreement.
3.2 The Company shall have the right, on written notice to you,
(a) to terminate your employment immediately at any time for
cause, or
(b) to terminate your employment at any time after January 26,
1998, or to not renew this Agreement at any time, without
cause provided the Company shall be obligated in either case
to pay to you as severance an amount equal to six month's base
salary less applicable taxes and other required withholdings
and any amount you may owe to the Company, payable in full
immediately upon such termination. Such severance payment
shall be contingent upon you signing a Separation and Release
Agreement in a form satisfactory to the Company which assures,
among other things, that you will not commence any type of
litigation or other claims as a result of the termination.
3.3 For purposes of this Section 3.2, you may be terminated for cause if,
in the reasonable determination of the Company's Chief Executive Officer (CEO),
you are convicted of any felony or of any crime involving moral turpitude, or
participate in fraud against the Company, or intentionally damage any property
of the Company, or wrongfully disclose any trade secrets or other confidential
information of the Company to any of its competitors, or materially breach
Sections 5 (Confidential Information) or 6 (Other Activities During Employment)
of this Agreement.
4. Compensation.
4.1 The Company shall pay to you for the services to be rendered hereunder
a base salary at an annual rate of
<PAGE>
$200,000, subject to increase in accordance with the policies of the Company,
payable in installments in accordance with Company policy.
(a) The CEO will review the base salary from time to time, no less
frequently than annually, and may in his sole discretion adjust the base
salary upward, but not downward, to reflect performance, appropriate
industry guideline data and other factors.
(b) If certain personal and corporate performance goals established
from time to time by the CEO are met, you will be entitled to a cash
performance bonus of up to 50% of annual base salary, with respect to each
fiscal year, prorated for the remainder of fiscal 1998. The amount of such
bonus percentage may be increased but not decreased by the CEO.
4.2 You shall also be entitled to all rights and benefits for which you
shall be eligible under deferred bonus, pension, group insurance, profit-sharing
or other Company benefits which may be in force from time to time and provided
for the Company's executives generally.
4.3 You will be reimbursed for reasonable expenses incurred on behalf of
the Company upon presentation of appropriate receipts.
4.4 Subject to Board of Director approval, you will be granted a stock
option to purchase 110,000 shares of Secure Computing Common Stock. In addition,
you will be eligible to participate in the Executive Incentive Option Program,
wherein you may earn an additional ninety thousand (90,000) shares of stock .
5. Confidential Information.
5.1 You represent and warrant that at all times during the term of your
employment and thereafter, to hold in strictest confidence, and not to use or
disclose, except for the benefit of the Company, to any person, firm or
corporation without written authorization of the Chief Executive Officer of the
Company, any Confidential Information of the Company. You understand that
"Confidential Information" means any Company proprietary information, technical
data, trade secrets or know-how, including, but not limited to, research,
product plans, products, services, customer lists and customers (including, but
not limited to, customers of the Company on whom you called or with whom you
became acquainted during the term of your employment), markets, software,
developments, inventions, processes, formulas, technology, designs, drawings,
engineering data, hardware configuration information, marketing, financial or
other business information disclosed to you by the Company either directly or
indirectly in writing, orally or by drawings or observation of parts or
equipment. You further understand that Confidential Information does not include
any of the foregoing items which has become publicly known and made generally
available through no wrongful act of yours or of others who were under
confidentiality obligations as to the item or items involved or improvements or
new versions thereof.
5.2 You recognize that the Company has received and in the future will
receive from third parties their confidential or proprietary information subject
to a duty on the Company's part to maintain the confidentiality of such
information and to use it only for certain limited purposes. You agree to hold
all such confidential or proprietary information in the strictest confidence and
not to disclose it to any person, firm or corporation or to use it except as
necessary in carrying out your work for the Company consistent with the
Company's agreement with such third party.
6. Other Activities During Employment.
6.1 Except as stated herein or with the prior written consent of the CEO,
you will not during the term of this Agreement undertake or engage in any other
employment, occupation or business enterprise other than ones in which you are a
passive investor.
2
<PAGE>
6.2 Except as permitted by Section 6.3, you will not acquire, assume or
participate in, directly or indirectly, any position, investment or interest
adverse or antagonistic to the Company, its business or prospects, financial or
otherwise, or take any action toward or looking toward any of the foregoing.
6.3 During the term of your employment by the Company except on behalf of
the Company or its subsidiaries, you will not directly or indirectly, whether as
an officer, director, stockholder, partner, proprietor, associate,
representative, consultant, or otherwise, become or be interested in any other
person, corporation, firm, partnership or other entity whatsoever which
manufacturers, markets, sells, distributes or provides consulting services
concerning products or services which compete with those of the Company or any
of its subsidiaries. However, nothing in this Section 6.3 shall preclude you
from holding less than one percent of the outstanding capital stock of any
corporation required to file periodic reports with the Securities Exchange
Commission under Sections 13 or 15(d) of the Securities Exchange Act of 1934, as
amended, the securities of which are listed on any securities exchange, quoted
on the National Association of Securities Dealers Automated Quotation System or
traded in the over-the-counter market. During the term of your employment with
the Company you will also not directly or indirectly intentionally solicit,
endeavor to entice away from the Company, or any of its subsidiaries, or
otherwise interfere with the relationship of the Company, or any of its
subsidiaries with, any person who is employed by or otherwise engaged to perform
services for the Company, or any of its subsidiaries (including, but not limited
to, any independent sales representatives or organizations), or any other person
or entity who is, or was within the then most recent 12-month period, a customer
or client of the Company, or any of its subsidiaries, whether for your own
account or for the account of any other person, corporation, firm, partnership
or other entity whatsoever.
7. Former Employment.
7.1 You represent and warrant that your employment by the Company will not
conflict with and will not be constrained by any prior employment or consulting
agreement or relationship. You represent and warrant that you do not possess
confidential information arising out of prior employment which, in your best
judgment, would be utilized in connection with your employment by the Company in
the absence of Section 7.2.
7.2 If, in spite of the second sentence of Section 7.1, you should find
that confidential information belonging to any former employer might be usable
in connection with the Company's business, you will not intentionally disclose
to the Company or use on behalf of the Company any confidential information
belonging to any of your former employers; but during your employment by the
Company you will use in the performance of your duties all information which is
generally known and used by persons with training and experience comparable to
your own and all information which is common knowledge in the industry or
otherwise legally in the public domain.
8. Survival. Your duties under Section 5 (Confidential Information) shall
survive termination of your employment with the Company to the extent provided
above.
9. Assignment. This Agreement and the rights and obligations of the parties
hereto shall bind and inure to the benefit of any successor or successors of the
Company by way of reorganization, or merger and any assignee of all or
substantially all or its business and properties, but, except as to any such
successor or assignee of the Company, neither this Agreement nor any rights or
benefits hereunder may be assigned by the Company or by you.
10. Interpretation. In case any one or more of the provisions contained in the
agreement shall, for any reason, be held to be invalid, illegal or unenforceable
in any respect, such invalidity, illegality or unenforceability shall not affect
the other provisions of this Agreement, and this Agreement shall be construed as
if such invalid, illegal or unenforceable provision had never been contained
herein. If, moreover, any one or more of the provisions contained in this
Agreement shall for any reason be held to be excessively broad as to duration,
geographical scope, activity or subject, it shall be construed by limiting and
reducing it so as to be enforceable to the extent compatible with the applicable
law as it shall then appear.
3
<PAGE>
11. Notices. Any notice which the Company is required or may desire to give to
you shall be given by personal delivery or registered or certified mail, return
receipt requested, addressed to you at the address of record with the Company,
or at such other place as you may from time or time designate in writing. Any
notice which you are required or may desire to give to the Company hereunder
shall be given by personal delivery or by registered or certified mail, return
receipt requested, addressed to the Company at its principal office, or at such
other office as the Company may from time to time designate in writing, to the
attention of the Chairman of the Compensation Committee. The date of personal
delivery or the date of mailing such notice shall be deemed to be the date of
delivery thereof.
12. Waiver. If either party should waive any breach of any provisions of this
Agreement, he or it shall not thereby be deemed to have waived any preceding or
succeeding breach of the same or any other provisions of this Agreement.
13. Complete Agreement; Amendments. The foregoing is the entire agreement of the
parties with respect to the subject matter hereof. This Agreement may not be
amended, supplemented, canceled or discharged except by written instrument
executed by both parties hereto.
14. Applicable Law. This agreement has been negotiated in, and shall be governed
by the laws of, the State of California, without giving effect to conflict of
law principles.
15. Heading. The heading of the sections hereof are inserted for convenience
only and shall not be deemed to constitute a part hereof nor to affect the
meaning thereof.
SECURE COMPUTING CORPORTION
By: /s/Jeffrey H. Waxan
------------------------------------
Jeffrey H. Waxman
Chairman and Chief Executive Officer
Accepted and agreed as of the _____
day of _____________, 1998
/s/ Howard Smith
- -----------------------------------
Howard Smith
4
EXHIBIT 10.18
SECURE COMPUTING CORPORATION
EMPLOYMENT AGREEMENT
THIS AGREEMENT is made the first day of October, 1998 BETWEEN SECURE COMPUTING
CORPORATION of One Almaden Blvd., San Jose, California 95113, United States of
America, its subsidiaries, affiliates, successors and assigns (together "the
Company"); and PATRICK REGESTER, 71 Copperkins Lane, Amersham, HP6 5RA England,
("the Employee").
WHEREBY it is agreed as follows:
1. COMMENCEMENT AND TERM
1.1 Your employment began on 2/1/97 ("the Start Date") and your period of
continuous employment for statutory purposes also began on 2/1/97.
1.2 Your employment shall (subject to the provisions of Clause 9) be for an
indefinite period and shall be terminable by either the Company giving to
you or you giving to the Company twelve (12) months notice in writing,
such notice to expire at any time.
1.3 The Company may at its absolute discretion elect to terminate your
employment with immediate effect by paying you salary in lieu of notice.
2. OBLIGATIONS DURING EMPLOYMENT
2.1 You shall during the continuance of your employment:
2.1.1 serve the Company to the best of your ability in the capacity of
Vice President, International Operations, and perform the duties
associated with such position; and
2.1.2 work at the Company's UK Headquarters office at 9 Shaftesbury Court,
Chalvey Park, Slough, Berkshire SL1 2ER, and travel to such other
place of business of the Company as the CEO may reasonably require
for the proper performance and exercise of your duties;
2.1.3 on reasonable notice attend Executive Staff meetings at such
locations as shall be directed by the CEO or the Company;
2.1.4 at all times and in all respects comply with the lawful and
reasonable directions of the CEO or the Company; and
2.1.5 shall devote your full time and attention to the business of the
Company and shall not, without the prior written consent of the CEO
or the Company, engage in any other trade or business.
3. REMUNERATION
3.1 The Company shall pay you during the continuance of your employment a
salary (which shall accrue from day to day) at the rate of US $160,000 per
year. Your salary shall be
1
<PAGE>
payable by equal monthly installments in arrears on or about the 30th of
each calendar month and subject to annual review by the CEO may be
adjusted upwards only.
3.2 You shall be entitled to a car allowance of US $9,000 per year, taxes on
this amount are your responsibility.
3.3 Your commission plan will be determined by the CEO and may be revised
annually at the sole discretion of the CEO.
3.4 You shall also be entitled to all rights and benefits for which you shall
be eligible under deferred bonus, pension, group insurance, profit-sharing
or other Company benefits which may be in force from time to time and
provided for the Company's executives generally.
3.5 You have been granted a total of one hundred twenty-nine thousand, six
hundred forty-one (129,641) stock options in the following increments: a)
sixty thousand (60,000) non-qualified options vesting over three (3)
years, one-third (1/3rd) each year; b) participation in the Secure
Computing Executive Stock Option Program under which you are eligible for
an additional sixty thousand (60,000) options upon the achievement of
stock price points as described in the option agreement letter; and c)
nine thousand, six hundred and forty-one (9,641) non-qualified options
vesting over three (3) years, one-third (1/3rd) each year.
4. EXPENSES
4.1 The Company shall refund to you out of pocket expenses properly and
reasonable incurred by you (including all reasonable traveling,
accommodation, entertainment and other similar out-of-pocket expenses) in
or about the performance of your duties, provided you submit appropriate
evidence including receipts, invoices, tickets and/or vouchers (as may be
appropriate) of the expenditure.
5. HOLIDAYS
5.1 You will be entitled to 20 working days paid annual holiday to be taken at
times approved of by and agreed with the CEO in advance. Unused vacation
does not carry over into the following year. The holiday year is 1st
January to 31st December.
6. INCAPACITY
6.1 During periods of absence from work due to sickness or injury you will be
entitled to Statutory Sick Pay (SSP) subject to and in accordance with the
relevant statutory rules which apply for time to time. Your qualifying
days for SSP purposes are Monday to Friday inclusive of both days.
7. INTELLECTUAL PROPERTY
7.1 Subject to the relevant provisions of the Patents Act 1977 the Registered
Designs Act 1949 and the Copyright Designs and Patent Act 1988 if at any
time in the course of your employment you make or discover or participate
in the making or discovery of any Intellectual Property relating to or
capable of being used in the business of the Company you shall immediately
disclose full details of such Intellectual Property to the Company and at
2
<PAGE>
the request and expense of the Company you shall do all things which may
be necessary or desirable for obtaining appropriate forms of protection
for the Intellectual Property in such parts of the world as may be
specified by the Company and for vesting all rights in the same in the
Company or its nominee.
7.2 You irrevocably appoint the Company to be your attorney in your name and
on your behalf to sign execute or do any instrument or thing and generally
to use your name for the purpose of giving to the Company or its nominee
the full benefit of the provisions of this Clause and in favour of any
third party a certificate in writing signed by any director or the
secretary of the Company that any instrument or act falls within the
authority conferred by this Clause shall be conclusive evidence that such
is the case.
7.3 You waive all moral rights (as defined in the Copyright Designs and
Patents Act 1988) in respect of any acts of the Company or any acts of
third parties done with the Company's authority in relation to any
Intellectual Property which is the property of the Company by virtue of
Clause 7.1 above.
7.4 All rights and obligations under this Clause in respect of Intellectual
Property made or discovered by you during your employment shall continue
in full and force and effect after the termination of your employment and
shall be binding upon your personal representatives.
8. CONFIDENTIALITY
8.1 You acknowledge that the Company possess and will continue to possess
confidential information which is of commercial value to the business of
the Company and that your employment creates a relationship of confidence
and trust between you and the Company in respect thereof.
8.2 You must not (other than in the proper performance of your duties or
without the written consent of the Company or unless ordered by a court of
competent jurisdiction) at any time whether during the continuance of your
employment or after its termination disclose or communicate to any person
or use for your own benefit or the benefit of any person other than the
Company any Confidential Information which may come to your knowledge in
the course of your employment and you shall during the continuance of your
employment use your best endeavors to prevent the unauthorized publication
or misuse of any confidential information provided that such restrictions
shall cease to apply to any confidential information which may enter the
public domain other that through your default.
8.3 All notes and memorandum of any trade secret or confidential information
concerning the business of the Company and or any of its suppliers,
agents, distributors, customers or others which shall have been acquired
received or made by you during the course of your employment shall be the
property of the Company and shall be surrendered by you to someone duly
authorized in the behalf at the termination of your employment or at the
request of the Company at any time during the course of your employment.
9. TERMINATION OF EMPLOYMENT
9.1 Your employment may be terminated by the Company without notice or
payments in lieu of notice:
3
<PAGE>
9.1.1 if you are guilty of any gross default or misconduct in connection
with or affecting the business of the Company to which you are
required by this Agreement to render services; or
9.1.2 in the event that you commit any serious or repeated breach or
non-observance of any of the stipulations contained in this
Agreement; or
9.1.3 if you are convicted of any arrestable criminal offense (other than
an offense under road traffic legislation in the United Kingdom or
elsewhere for which a fine or non-custodial penalty is imposed).
9.2 On the termination of your employment you must return all Company property
including, but not limited to, any Company equipment, company car,
computer discs, books, keys, documents, correspondence, records, credit
cards and passes which are in your possession or under your control and,
if required to do so by the Company, sign a declaration that you have
complied with these obligations.
9.3 You shall not at any time after the termination of your employment
represent yourself as being interested in or employed by or in any way
connected with the Company.
10. DISCIPLINARY AND GRIEVANCE PROCECURES
10.1 For statutory purposes there is not formal disciplinary procedure in
relation to your employment. You shall be expected to maintain the highest
standards of integrity and behavior.
10.2 If you are not satisfied with any disciplinary decision taken in relation
to your employment you may apply in writing within 14 days of that
decision to the CEO whose decision shall be final.
10.3 If you have any grievance in relation to your employment you may raise it
in writing with the CEO whose decision shall be final.
11. NOTICES
11.1 Any notice to be given under this Agreement shall be given in writing and
shall be deemed to be sufficiently served by one party on the other if it
is delivered personally or is sent by registered or recorded delivery
pre-paid post (air mail if overseas) addressed to either the Company's
principal office for the time being (marked for the attention of the
Chairman of the Compensation) or the Employee's last known address as the
case may be.
11.2 Any notice sent by post shall be deemed (in the absence of evidence of
earlier receipt) to be received 2 days after posting (6 days if sent air
mail) and in proving the time such notice was sent it shall be sufficient
to show that the envelope containing it was properly addressed, stamped
and posted.
12. ASSIGNMENT
4
<PAGE>
12.1 This Agreement and the rights and obligations of the parties hereto shall
bind and inure to the benefit of any successor or successors of the
Company by way of reorganization, or merger and any assignee of all or
substantially all or its business and properties, but, except as to any
such successor or assignee of the Company, neither this Agreement nor any
rights or benefits hereunder may be assigned by the Company or by you.
13. MISCELLANEOUS
13.1 You warrant that by virtue of entering into this Agreement you will not be
in breach of any express or implied terms of any Court Order, contract or
of any other obligation legally binding upon him.
13.2 Any benefits provided by the Company to you or your family which are not
expressly referred to in this Agreement shall be regarded as ex gratia
benefits provided at the entire discretion of the Company and shall not
form part of your contract of employment.
14. DEFINITIONS AND INTERPRETATION
14.1 In this Agreement unless the context otherwise requires words and phrases
defined in Part XXVI of the Companies Act 1985 have the same meanings
thereby attributed to them and the following expressions have the
following meanings:
"the CEO"
the Chief Executive Officer of the Company
"Confidential Information"
includes, but is not limited to any Company proprietary information,
technical data, trade secrets or know-how (including, but not limited to,
research, product plans, products, services, customers lists and customers
(including, but not limited to, customers of the Company whom you dealt
with or became acquainted during the term of your employment), markets,
software, developments, inventions, processes, formulas, technology,
designs, drawings, engineering data, hardware configuration information,
marketing, financial or other business information disclosed to you by the
Company either directly or indirectly in writing, orally or by drawings or
observation of parts or equipment).
"Intellectual Property"
letters, patent, trademarks, service marks, designs, copyrights,
utility models, design rights, applications for registration of any of the
foregoing and the right to apply for them in any part of the world,
inventions, drawings, computer programs, Confidential Information,
know-how and rights of like nature arising or subsisting anywhere in the
world in relation to all of the foregoing whether registered or
unregistered.
14.2 The headings in this Agreement are for convenience only and shall not
affect its construction or interpretation and references in this Agreement
to Clauses are references to Clauses to this Agreement.
14.3 This Agreement contains the entire understanding between the parties and
supersedes all (if any) subsisting agreements, arrangements and
understandings (written or oral) relating to your employment (which shall
be deemed to have been terminated by mutual consent).
5
<PAGE>
14.4 This Agreement is governed by and shall be construed in accordance with
English law and the parties to this Agreement hereby submit to the
exclusive jurisdiction of the English courts.
AS WITNESS the hands of a duly authorized representative of the Company and the
Employee the above written.
For and on behalf of
SECURE COMPUTING CORPORATION /s/ Jeffrey H. Waxman
-----------------------------------------
Jeffrey H. Waxman, Chairman & CEO
Signed by
PATRICK REGESTER /s/ Patrick Regester
-----------------------------------------
Patrick Regester
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements on
Form S-8 (Nos. 33-80065, 333-06563, 333-114151, 333-35651, 333-28929, 333-28927
and 333-71913) and the Registration Statements on Form S-3 (Nos. 333-16767,
333-26293 and 333-61585), respectively, of our report dated January 29, 1999,
with respect to the consolidated financial statements and schedule of Secure
Computing Corporation included in the Annual Report (Form 10-K) for the year
ended December 31, 1998.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
March 25, 1999
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<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 20,878,000
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<RECEIVABLES> 20,612,000
<ALLOWANCES> 900,000
<INVENTORY> 2,361,000
<CURRENT-ASSETS> 45,312,000
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<TOTAL-LIABILITY-AND-EQUITY> 54,348,000
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