UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
------------------
FORM 10-Q
------------------
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 27, 1996
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____ to _____.
Commission File Number: 000-21067
TRUSTED INFORMATION SYSTEMS, INC.
(Exact Name of Registrant as specified in its charter)
Delaware 51-0375640
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3060 Washington Road (Rt. 97)
Glenwood, Maryland 21738
(Address of Principal Executive Offices and Zip Code)
(301) 854-6889
(Registrant's telephone number, including area code)
Indicate by check mark whether the issuer (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Exchange Act 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 last 90
days.
Yes ____ No X
Indicate the Number of shares of the issuer's classes of common stock
outstanding as of the latest practicable date: 11,479,430 shares of common stock
were outstanding as of October 31, 1996.
<PAGE>
TRUSTED INFORMATION SYSTEMS, INC.
FORM 10-Q
Index
Page
PART I. FINANCIAL INFORMATION Number
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of
December 29, 1995, September 27, 1996 and
September 27, 1996 (as adjusted) 3
Condensed Consolidated Statements of Operations
for the three months and nine months ended
September 27, 1996 and September 29, 1995 4
Condensed Consolidated Statements of Cash Flows
for the three months and nine months ended
September 27, 1996 and September 29, 1995 5
Notes to Unaudited Condensed Consolidated
Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 7
PART II OTHER INFORMATION
Item 6. Exhibits 16
SIGNATURES 18
<PAGE>
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Trusted Information Systems, Inc.
Condensed Consolidated Balance Sheets
<S> <C> <C> <C>
September 27,
September 27, 1996
December 29, 1996 as adjusted
1995 (unaudited) (unaudited)
----------------- ---------------- -----------------
Assets
Current assets:
Cash and cash equivalents $53,859 $239,955 $539,955
Marketable securities --- 3,000,000 43,848,200
Accounts receivable, net of allowance of
$44,000 and $144,000 for December 29, 1995 and
September 27, 1996, respectively 4,304,536 3,606,521 3,606,521
Unbilled receivables 1,401,418 929,919 929,919
Prepaid expenses and other current assets 258,438 1,252,307 1,252,307
Deferred financing costs --- 1,021,462 ---
Refundable income taxes --- 1,233,910 1,233,910
Deferred income taxes 426,390 --- ---
---------------- ---------------- ----------------
Total current assets 6,444,641 11,284,074 51,410,812
----------------- ---------------- ----------------
Property and equipment, net 3,715,090 6,419,898 6,419,898
Other assets 62,072 56,788 56,788
----------------- ---------------- ----------------
Total assets $10,221,803 $17,760,760 $57,887,498
================= ================ ================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 689,537 $ 630,374 $630,374
Accrued Payroll and related expenses 1,384,738 2,904,257 2,904,257
Other accrued expenses 1,342,421 2,252,244 1,752,244
Income taxes payable 122,174 --- ---
Deferred income taxes --- 743,117 743,117
Deferred revenue 1,011,992 1,257,762 1,257,762
Short-term borrowings 1,523,000 3,423,700 ---
Notes payable, current portion 160,662 538,878 243,878
----------------- ---------------- ----------------
Total current liabilities 6,234,524 11,750,332 7,491,815
Notes payable, net of current portion 1,580,000 2,815,619 1,510,619
----------------- ---------------- -----------------
Total liabilities 7,814,524 14,565,951 9,002,434
Commitments --- --- ---
Shareholders' equity
Preferred Stock $.01 par value; 5,000,000
shares authorized: no shares issued or outstanding --- --- ---
Common Stock, $.01 par value; 40,000,000
shares authorized; 6,933,611, 7,552,341 and
11,462,341 shares issued and outstanding as of
December 29, 1995, September 27, 1996 and "as
adjusted", respectively 69,336 75,523 114,623
Additional paid-in capital --- 1,409,725 47,021,063
Unrealized gains, net of income taxes of $1,206,528 --- 1,793,472 1,793,472
Foreign currency translation adjustment (5,121) (6,931) (6,931)
Retained earnings 2,343,064 936,396 936,396
Deferred stock compensation --- (1,013,376) (1,013,376)
---------------- --------------- ----------------
Total shareholders' equity 2,407,279 3,194,809 48,845,247
---------------- --------------- ----------------
Total liabilities and shareholders' equity $10,221,803 $17,760,760 $57,887,498
================= =============== ================
See notes to unaudited condensed consolidated financial
statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Trusted Information Systems, Inc.
Condensed Consolidated Statements of Operations
(unaudited)
<S> <C> <C> <C> <C>
For the Three Months Ended For the Nine Months Ended
September 29, September 27, September 29, September 27,
1995 1996 1995 1996
------------------ ---------------- ------------------ ------------------
Revenues:
Government contracts ....... $3,424,806 $2,881,138 $9,466,603 $8,232,814
Commercial products......... 1,218,569 3,958,832 2,630,280 7,690,874
Commercial consulting services... 285,081 504,935 1,120,085 1,038,912
------------------ ---------------- ------------------ ------------------
4,928,456 7,344,905 13,216,968 16,962,600
Cost of revenues:
Government contracts......... 2,505,639 1,979,092 7,026,389 5,843,475
Commercial products.......... 277,821 929,439 687,310 2,127,316
Commercial consulting services... 201,650 266,784 628,749 596,434
------------------ ---------------- ------------------ ------------------
2,985,110 3,175,315 8,342,448 8,567,225
------------------ ---------------- ------------------ ------------------
Gross profit.................. 1,943,346 4,169,590 4,874,520 8,395,375
Operating expenses:
Selling, general and
administrative............ 835,641 3,667,763 2,403,219 8,345,411
Research and development..... 244,503 1,177,944 820,581 2,184,696
------------------ ---------------- ------------------ ------------------
1,080,144 4,845,707 3,223,800 10,530,107
------------------ ---------------- ------------------ ------------------
Income (loss) from operations.... 863,202 (676,117) 1,650,720 (2,134,732)
Other income (expense):
Interest income.............. 12,850 8,152 25,090 21,867
Interest expense............. (32,519) (171,970) (98,392) (334,880)
------------------ ---------------- ------------------ ------------------
(19,669) (163,818) (73,302) (313,013)
------------------ ---------------- ------------------ ------------------
Income (loss) before income taxes 843,533 (839,935) 1,577,418 (2,447,745)
Income tax provision (benefit)... 355,152 (353,484) 617,611 (1,041,077)
------------------ ---------------- ------------------ ------------------
Net income (loss)............... $488,381 $(486,451) $959,807 $(1,406,668)
================== ================ ================== ==================
Net income (loss) per share...... $0.06 $(0.06) $0.11 $(0.18)
================== ================ ================== ==================
Weighted average shares
outstanding................... 8,611,428 7,540,849 9,008,068 7,915,561
================== ================ ================== ==================
See notes to unaudited condensed consolidated financial
statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Trusted Information Systems, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited)
<S> <C> <C> <C> <C>
Three months ended Nine months ended
September 29 September 27 September 29 September 27
1995 1996 1995 1996
Operating Activities
Net income (Loss) $ 488,381 $ (486,451) $ 959,807 ($ 1,406,668)
Adjustments
Depreciation 72,017 177,453 193,314 340,171
Deferred Income Taxes 70,217 (29,671) (52,460) (26,141)
Amortization of Stock compensation 69,093 92,124
Changes in:
Accounts receivable and unbilled
receivables (739,030) (795,804) (1,846,948) 1,169,514
Prepaid expenses and other
current assets (44,123) (357,207) (56,410) (993,869)
Other assets (2,217) (537,922) 52,837 (1,016,178)
Accounts payable 45,669 (268,928) 69,309 (59,163)
Accrued payroll and related
expenses 109,113 418,376 816,207 1,519,519
Other accrued expenses (12,020) 782,477 (63,910) 909,823
Income taxes payable/refundable 5,761 (326,611) (315,139) (1,356,084)
Deferred revenues 42,073 339,057 133,052 245,770
Net cash provided by (used in) ------------------ ----------------- ------------------ -----------------
operating activities 35,841 575,470 (110,341) (581,182)
------------------ ----------------- ------------------ -----------------
Investing Activities
Purchases of property and equipment (383,288) (500,524) (717,278) (3,044,979)
Purchases of marketable securities --- --- --- (10,880)
Cash provided by (used in) ------------------ ----------------- ------------------ -----------------
investing activities (383,288) (500,524) (717,278) (3,055,859)
------------------ ----------------- ------------------ -----------------
Financing activities
Proceeds from exercise of stock options 3,233 5,094 3,233 310,412
Repurchase of common stock (407,520) (407,520)
Net borrowings (repayments) of
short-term borrowings (269,000) (255,800) 782,000 1,900,700
Proceeds from issuance of notes payable 221,235 309,752 321,234 1,757,219
Repayments of notes payable (22,849) (74,298) (66,875) (143,384)
Net Cash provided by (used in) ------------------ ----------------- ------------------ -----------------
financing activities 63,099 (15,252) 632,072 3,824,947
------------------ ----------------- ------------------ -----------------
Effect of exchange rate changes on cash (4,264) 2,575 (7,000) (1,810)
------------------ ----------------- ------------------ -----------------
Net Change in cash and cash equivalents (288,612) 62,269 (202,547) 186,096
Cash and cash equivalents at
beginning of period 347,603 177,686 261,538 53,859
------------------ ----------------- ------------------ -----------------
Cash and cash equivalents at ------------------ ----------------- ------------------ -----------------
end of period $58,991 $239,955 $58,991 $239,955
------------------ ----------------- ------------------ -----------------
Supplemental disclosures of
cash flow information
------------------ ----------------- ------------------ -----------------
Interest paid during the period $34,480 $173,849 $98,392 $334,880
------------------ ----------------- ------------------ -----------------
------------------ ----------------- ------------------ -----------------
Income Taxes paid during the period $284,060 $ --- $957,946 $325,537
------------------ ----------------- ------------------ -----------------
See notes to unaudited condensed consolidated financial
statements.
</TABLE>
<PAGE>
Trusted Information Systems, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include
the accounts of Trusted Information Systems, Inc. and its subsidiaries, all of
which are wholly owned (collectively, "TIS" or the "Company"). Such financial
statements, including comparative information for the three and nine month
periods ended September 29, 1995, where applicable, have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission ("SEC").
Certain information and footnote disclosures normally included in consolidated
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such SEC rules and
regulations. All material intercompany accounts and transactions have been
eliminated in consolidation.
These unaudited condensed consolidated financial statements should be read in
conjunction with Company's audited financial statements and footnotes thereto
which are included in Amendment No. 3 to the Company's registration statement on
Form S-1 that was filed with the SEC on October 4, 1996. The accompanying
unaudited condensed consolidated financial statements reflect all the
adjustments that, in the opinion of management, are necessary for a fair
presentation of the results for the interim periods presented. The results for
interim periods are not necessarily indicative of the results for the full year.
Initial Public Offering and Related Matters
In June 1996, the Company filed a registration statement with the SEC permitting
the Company to sell 3,910,000 shares of its common stock to the public,
including up to 510,000 shares to cover over-allotments. The registration
statement became effective on October 9, 1996. The initial public offering
resulted in proceeds to the Company of approximately $45.6 million net of
approximately $1.6 million in underwriting fees and offering expenses. The
effects of the initial public offering, including the repayment of approximately
$5,000,000 of the Company's short-term borrowings and notes payable out of the
proceeds thereof, are reflected in the "as adjusted" column contained in the
unaudited condensed consolidated balance sheet.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Management's Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements which involve risks and
uncertainties. The Company's actual results could differ materially from the
results discussed in forward-looking statements.
Overview
Trusted Information Systems, Inc., founded in 1983, provides comprehensive
security solutions for protection of computer networks, including global
Internet-based systems, internal networks and individual workstations and
laptops and is a leading provider of firewall products. The Company currently
has two operating divisions: the Commercial Division and the Advanced Research
and Engineering ("AR&E") Division.
The Commercial Division
The Commercial Division derives revenues from the Company's Gauntlet(TM) family
of firewall products, from its commercial consulting services and from its
RecoverKey exportable cryptography enabling products. During the three months
ended September 27, 1996, revenues from the Commercial Division exceeded
revenues from the AR&E Division for the first time and the Company expects that
the Commercial Division will account for an increased percentage of total
revenues over the remainder of the current year and in future years.
Prior to 1996, the Company distributed its only revenue producing product, the
Gauntlet Internet Firewall which was introduced in 1994, exclusively through
resellers and a sales administration staff. The Company presently has more than
80 persons to develop, promote, sell and deliver its network security products
and services, including the Gauntlet family of firewall products. The Company's
Gauntlet Internet Firewall is licensed as software or as software and hardware
on one platform and was previously frequently combined (or "bundled") with
installation for pricing purposes. Since April 15, 1996, installation for the
Gauntlet family of firewall products has been offered as a separate (or
"unbundled") optional service provided to customers.
During 1996 the Company has begun to incur and expects to continue to incur
substantial increases in its selling, general and administrative expenses as it
builds its commercial marketing and sales efforts to support sales of the
Gauntlet Internet Firewall product and of its other products introduced in 1996:
the Gauntlet Intranet Firewall, the Gauntlet Net Extender, the Gauntlet PC
Extender and the RecoverKey(TM) exportable cryptography enabling products. The
Company began shipping the Gauntlet Net Extender, Gauntlet PC Extender and
RecoverKey exportable cryptography enabling products during the three months
ended September 27, 1996. In addition, the Company expects to further expand its
research and development organization and efforts, particularly with regard to
its RecoverKey exportable cryptography enabling products, and make additional
investments in its general and administrative infrastructure.
<PAGE>
The amount and timing of these additional expenditures are likely to result in
fluctuations in operating margins. Any material reduction in gross or operating
margins could materially adversely affect the Company's operating results.
The Company obtained export licenses during 1996 for its RecoverKey exportable
cryptography enabling products. These products, which enable U.S. and foreign
corporations to establish Global Virtual Private Networks, are based on the
Company's RecoverKey(TM) technology. The Company received two patents for its
Gauntlet Firewall products and its RecoverKey technology during September 1996.
The Company offers a full range of consulting in information security planning
and product support. The Company's commercial consulting practice offers expert
technology research services, consultation on security issues associated with
products and services, corporate information security policy development,
architectural and diagnostic security analysis services, firewall configuration
and maintenance support, and training for corporate network and security
administration personnel. These services are carried out by a staff of 12
persons who average more than 15 years of information security experience in
both commercial and government organizations.
The Advanced Research and Engineering Division
The Advanced Research and Engineering Division consists primarily of research,
development and consulting in computer and related security systems, currently
including major contracts with three agencies of the U.S. government: the
National Security Agency ("NSA"), Air Force Rome Laboratories ("RL") and Defense
Advanced Research Projects Agency ("DARPA"), formerly the Advanced Research
Projects Agency ("ARPA"). Revenues from the AR&E Division increased consistently
through 1995, but decreased in the nine months ended September 27, 1996. The
aggregate award value of the Company's nine major active government contracts is
approximately $36,135,000. In October 1993, the Company began providing services
under the largest of these current contracts, with the NSA, which is valued at
$14,823,000 and is expected to expire in early 1997. Of the five contracts with
ARPA, which range in value from $741,000 to $9,114,000 and have all commenced in
the preceding four years, one expires during 1997 and four expire during 1998.
While the Company expects to continue to obtain government contracts for its
AR&E Division, it does not anticipate that revenues from such contracts will
attain the levels realized in 1995.
Most of the Company's government contracts provide for compensation to the
Company in the form of reimbursement of costs plus a fee. Gross profit under
government contracts generally represents the fee plus recovered operating
expenses. Under these government contracts, the Company is entitled to recover
associated direct labor costs, overhead and selling, general and administrative
expenses, including allowable research and development expenses. Selling,
general and administrative expenses allowable under government contracts include
salaries and
<PAGE>
benefits, marketing, bid and proposal costs, management, accounting, legal and
contract administration and certain other administrative expenses.
Under its government contracts, the Company bears the risk that recoverable
expenses billed by the Company are subject to review and audit by the Defense
Contract Audit Agency (the "DCAA"). The DCAA has audited the Company's cost
accounting system through 1990 without any significant disallowances and is
currently performing a similar audit of the Company's cost accounting system for
the years 1991 through 1994. Pursuant to their terms, these contracts are also
subject to termination at the convenience of the applicable governmental agency.
If the contract is terminated, the Company would typically be reimbursed for its
costs to the date of termination plus the cost of any orderly termination and
would be paid a portion of the fee.
<PAGE>
<TABLE>
<CAPTION>
Results of Operations
The following table presents for the periods indicated certain unaudited
statement of operations data as a percentage of the Company's revenues:
<S> <C> <C> <C> <C>
Three months Three months Nine months Nine months
ended ended ended ended
September 29, September 27, September 29, September 27,
Consolidated Statement of 1995 1996 1995 1996
Operations (unaudited) (unaudited) (unaudited) (unaudited)
as a Percentage of Revenues:
----------------- ------------------ ------------------- -----------------
Revenues:
Government contracts......... 69.5% 39.2% 71.6% 48.6%
Commercial products.......... 24.7% 53.9% 19.9% 45.3%
Commercial consulting services... 5.8% 6.9% 8.5% 6.1%
----------------- ------------------ ------------------- -----------------
Total Revenues 100.0% 100.0% 100.0% 100.0%
----------------- ------------------ ------------------- -----------------
Cost of Revenues:
Government contracts......... 50.9% 26.9% 53.2% 34.5%
Commercial products.......... 5.6% 12.7% 5.2% 12.5%
Commercial consulting services... 4.1% 3.6% 4.8% 3.5%
----------------- ------------------ ------------------- -----------------
Total Costs of revenues 60.6% 43.2% 63.1% 50.5%
----------------- ------------------ ------------------- -----------------
Gross profit.................. 39.4% 56.8% 36.9% 49.5%
Operating expenses:
Selling, general and administrative.. 16.9% 50.0% 18.2% 49.2%
Research and development.......... 5.0% 16.0% 6.2% 12.9%
----------------- ------------------ ------------------- -----------------
Total Operating expenses 21.9% 66.0% 24.4% 62.1%
----------------- ------------------ ------------------- -----------------
Income (loss) from operations....... 17.5% -9.2% 12.5% -12.6%
Interest and other income and expense.. -0.4% -2.2% -0.6% -1.8%
----------------- ------------------ ------------------- -----------------
Income (loss) before income taxes 17.1% -11.4% 11.9% -14.4%
Income tax provision (benefit)....... 7.2% -4.8% 4.6% -6.1%
----------------- ------------------ ------------------- -----------------
Net income (loss)................. 9.9% -6.6% 7.3% -8.3%
----------------- ------------------ ------------------- -----------------
Selected Information as a
Percentage of Related Revenues:
Gross profit by product line:
Government contracts............ 26.8% 31.3% 25.8% 29.0%
Commercial products............. 77.2% 76.5% 73.9% 72.3%
Commercial consulting services... 29.3% 47.2% 43.9% 42.6%
----------------- ------------------ ------------------- -----------------
Total Gross profit 39.4% 56.8% 36.9% 49.5%
----------------- ------------------ ------------------- -----------------
</TABLE>
<PAGE>
Three Months Ended September 27, 1996 Compared to Three Months Ended September
29, 1995
Revenues. The Company's total revenues increased 49.0% to $7,344,905 in the
three months ended September 27, 1996 ("the third quarter of 1996") from
$4,928,456 in the three months ended September 29, 1995 ( "the third quarter of
1995" ). Commercial product revenues increased 224.9% to $3,958,852 in the third
quarter of 1996 from $1,218,569 in the third quarter of 1995, because of an
increase in shipments of the Company's Gauntlet firewall products and sales of
licenses of Gauntlet Internet Firewalls directly to customers and through the
Company's resellers. Commercial consulting services revenues increased 77.1% to
$504,935 in the third quarter of 1996 from $285,081 in the third quarter of
1995, primarily because of the Company's increased efforts in commercial
consulting and the completion of a substantial number of commercial consulting
contracts in the third quarter of 1996. Government contract revenues decreased
15.9% to $2,881,138 in the third quarter of 1996 from $3,424,806 in the third
quarter of 1995, primarily because of the Company's reallocation of personnel,
including government contract research personnel, to its commercial activities.
Gross Profit. Gross profit increased 114.6% to $4,169,590 in the third quarter
of 1996 from $1,943,346 in the third quarter of 1995, due to the increase in the
Company's commercial product sales. The gross profit on commercial products
increased 222.2% to $3,029,393 in the third quarter of 1996 from $940,748 in the
third quarter of 1995 because of the increase in shipments of Gauntlet firewall
products. Gross profit from the Company's commercial consulting services
increased 185.4% to $238,151 in the third quarter of 1996 from $83,431 in the
third quarter of 1995, because of both increased revenues and an increase in
opportunities for contracts with higher margins, and gross profit from the
Company's government contracts decreased 1.9% to $902,046 in the third quarter
of 1996 from $919,167 in the third quarter of 1995, primarily because of lower
related revenues.
As a percentage of related revenues, gross profit on commercial products
remained virtually unchanged at 76.5% in the third quarter of 1996 from 77.2% in
the third quarter of 1995. As a percentage of related revenues, gross profit on
commercial consulting services increased to 47.2% in the third quarter of 1996
from 29.3% in the third quarter of 1995, because of the substantially higher
margin on a number of contracts in the third quarter of 1996. As a percentage of
related revenues, gross profit on government contracts increased to 31.3% in the
third quarter of 1996 from 26.8% in the third quarter of 1995, because of
greater revenues received in 1996 from contracts with proportionately higher
fees.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 338.9% to $3,667,763 in the third quarter of
1996 from $835,641 in the third quarter of 1995, due primarily to the
substantial increase in personnel and related operating costs associated with
the increase in the Company's commercial products sales, as well as the
Company's efforts towards developing the infrastructure to support future
commercial product revenue growth.
<PAGE>
Research and Development Expenses. The Company's research and development
expenses, which do not include such expenses directly reimbursed under
government contracts, increased 381.8% to $1,177,944 in the third quarter of
1996 from $244,503 in the third quarter of 1995. This increase primarily
resulted from the Company's efforts in developing new members of the Gauntlet
family of firewall products announced in April 1996, the development of its
Microsoft Windows NT and Sun Microsystems' Solaris firewall product versions and
its RecoverKey exportable cryptography enabling products.
Other Income and Expense. Other income and expense increased 732.9% to $163,818
in expense in the third quarter of 1996 from $19,669 in the third quarter of
1995, due primarily to the increase in interest expense from increased
borrowings under the Company's revolving and other credit lines, which the
Company used to finance its operating growth while it sought public equity
funding.
Nine Months Ended September 27, 1996 Compared to Nine Months Ended September 29,
1995
Revenues. The Company's total revenues increased 28.3% to $16,962,600 in the
nine months ended September 27, 1996 from $13,216,968 in the nine months ended
September 29, 1995. Commercial product revenues increased 192.4% to $7,690,874
in the nine months ended September 27, 1996 from $2,630,280 in the nine months
ended September 29, 1995, because of an increase in shipments of the Company's
Gauntlet firewall products and sales of licenses of Gauntlet Internet Firewalls
directly to customers and through the Company's resellers. Commercial consulting
revenues decreased 7.2% to $1,038,912 in the nine months ended September 27,
1996 from $1,120,085 in the nine months ended September 29, 1995, primarily
because of the Company's completion of a substantial number of commercial
consulting contracts in the nine months ended September 29, 1995. Government
contract revenues decreased 13.0% to $8,232,814 in the nine months ended
September 27, 1996 from $9,466,603 in the nine months ended September 29, 1995,
primarily because of the Company's reallocation of personnel, including
government contract research personnel, to its commercial activities.
Gross Profit. Gross profit increased 72.2% to $8,395,375 in the nine months
ended September 27, 1996 from $4,874,520 in the nine months ended September 29,
1995, due to the increase in the Company's commercial product sales. The gross
profit on commercial products increased 186.3% to $5,563,558 in the nine months
ended September 27, 1996 from $1,942,970 in the nine months ended September 29,
1995 because of the increase in shipments of Gauntlet firewall products. Gross
profit from the Company's commercial consulting services decreased 9.9% to
$442,478 in the nine months ended September 27, 1996 from $491,336 in the nine
months ended September 29, 1995, and gross profit from the Company's government
contracts decreased 2.1% to $2,389,339 in the nine months ended September 27,
1996 from $2,440,214 in the nine months ended September 29, 1995, in each case
primarily because of lower related revenues.
As a percentage of related revenues, gross profit on commercial products
decreased slightly to 72.3% in the nine months ended
<PAGE>
September 27, 1996 from 73.9% in the nine months ended September 29, 1995. As a
percentage of related revenues, gross profit on commercial consulting services
decreased to 42.6% in the nine months ended September 27, 1996 from 43.9% in the
nine months ended September 29, 1995, because of the lower revenues in the nine
months ended September 29, 1995. As a percentage of related revenues, gross
profit on government contracts increased to 29.0% in the nine months ended
September 27, 1996 from 25.8% in the nine months ended September 29, 1995,
because of greater revenues received in 1996 from contracts with proportionately
higher fees.
Selling General and Administrative Expenses. Selling, general and administrative
expenses increased 247.3% to $8,345,411 in the nine months ended September 27,
1996 from $2,403,219 in the nine months ended September 29, 1995, due primarily
to the substantial increase in personnel and related operating costs associated
with the increase in the Company's commercial products sales, as well as the
Company's efforts towards developing the infrastructure to support future
commercial product revenue growth.
Research and Development Expenses. The Company's research and development
expenses, which do not include such expenses directly reimbursed under
government contracts, increased 166.2% to $2,184,696 in the nine months ended
September 27, 1996 from $820,581 in the nine months ended September 29, 1995,
due primarily to the Company's efforts in developing the new members of the
Gauntlet family of firewall products announced in April 1996, the development of
its Microsoft Windows NT and Sun Microsystems' Solaris firewall product
versions, its RecoverKey exportable cryptography enabling products, the
Company's reallocation of government contract research personnel to its
commercial activities, and the further development and evaluation of its Trusted
Mach(TM) technology.
Other Income and Expense. Other income and expense increased 327.0% to $313,013
in expense in the nine months ended September 27, 1996 from $73,302 in the nine
months ended September 29, 1995, due primarily to the increase in interest
expense from increased borrowings under the Company's revolving and other credit
lines, which the Company used to finance its operating growth while it sought
public equity funding.
Liquidity and Capital Resources
Since its inception, the Company has financed its operations and the purchase of
property and equipment through the issuance of common stock, borrowings under
short-term lines of credit, secured notes payable and stockholder loans and the
generation of cash from operations. Cash and cash equivalents were $53,859 at
December 29, 1995 and $239,955 at September 27, 1996. The Company used cash in
operating activities of $581,182 for the nine months ended September 27, 1996,
as compared to a use of cash in operating activities for the nine months ended
September 29, 1995, but provided cash from operating activities of $575,470 for
the three months ended September 27, 1996, as compared to a provision of cash by
operating activities for the three months ended September 29, 1995 of $35,841.
Net cash provided by or used in
<PAGE>
operations for the three month periods ended September 29, 1995 and September
27, 1996 consisted primarily of net income, plus growth in the Company's net
working capital components. For the nine month periods ended September 29, 1995
and September 27, 1996, the Company used cash to fund its net losses, offset by
increases in its working capital components.
During the three and nine month periods ended September 29, 1995 and September
27, 1996, the Company used cash in investing activities of $383,288, $717,278,
$500,524, and $3,055,859, respectively, to purchase property and equipment. The
Company used cash in financing activities in the three months ended September
29, 1995 of $15,252 primarily to repurchase stock from a former officer offset
by an increase in net borrowings. The Company generated cash from financing
activities for the three month period ending September 27, 1996 of $63,099 and
for the nine month periods ending September 29, 1995 and September 27, 1996 of
$632,072 and $3,824,947, respectively, primarily through short term borrowings
and long term debt related to the construction of its Glenwood, Maryland
facilities.
At December 29, 1995 and September 27, 1996 the Company had various short-term
line of credit arrangements with Mercantile-Safe Deposit and Trust Company
("Mercantile Bank") aggregating $2,000,000 and $5,500,000, respectively, of
which $477,000 and $2,076,300, respectively, were available for further
borrowing. As of September 27, 1996, the Company's bank borrowings were secured
by substantially all of the Company's tangible assets. Subsequent to September
27, 1996, in conjunction with the Company's initial public offering, the Company
paid off and terminated these line of credit arrangements.
In 1995 the Company negotiated a construction loan in the amount of $1.8 million
to provide for the expansion of its facilities at its Glenwood, Maryland
locations. At the end of May 1996, the Company had completed its expansion and
substantially drawn down the total amount of its construction loan.
The Company intends from time to time to evaluate potential acquisitions of
businesses, products and technologies that could complement or expand the
Company's business. At the current time, the Company has no plans, agreements or
commitments for any such acquisitions and is not engaged in any negotiations
with respect thereto.
The Company has not engaged in any hedging activities to date.
While the Company may require additional financing to fund development of new
products and expansion of its domestic and international operations, it believes
that the net proceeds from its initial public offering, together with existing
cash and cash equivalents, cash generated from operations and cash available
through its credit and note payable arrangements, will be sufficient to finance
its product development and operating needs through December 1997.
<PAGE>
TRUSTED INFORMATION SYSTEMS, INC.
FORM 10 - Q
PART II. OTHER INFORMATION
<TABLE>
<CAPTION>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
<S> <C>
3.1* Certificate of Incorporation of the Company.
3.1.1* Certificate of Amendment to Certificate of Incorporation, as
filed with the Delaware Secretary of State on October 2, 1996.
3.2* Amended and Restated Bylaws of the Company.
4.1* Specimen stock certificate for shares of Common Stock of the Company.
10.1* Amended and Restated Employee Stock Option Plan.
10.2* Amended and Restated 1996 Stock Option Plan.
10.2.1* Form of Incentive Stock Option Agreement pursuant to 1996 Stock Option Plan.
10.2.2* Form of Non-Qualified Stock Option Agreement pursuant to 1996 Stock Option
Plan.
10.3* Amended and Restated 1996 Directors' Stock Option Plan.
10.4* Form of Employee Agreement Regarding Confidentiality and Inventions.
10.5* Form of Software License and Reseller Agreement.
10.6* Form of Consulting Services Agreement.
10.7* Form of Indemnification Agreement by and between the Company and its
directors and officers.
10.8* Construction Loan Agreement dated July 26, 1995, by and between the Company
and Mercantile-Safe Deposit and Trust Company.
10.9* Construction Loan Promissory Note dated July 26, 1995, by and between the
Company and Mercantile-Safe Deposit and Trust Company.
10.10* Deed of Trust and Security Agreement dated July 26, 1995, by and between the
Company and Mercantile-Safe Deposit and Trust Company.
10.11* Security Agreement, dated July 26, 1995, by and among the Company,
Mercantile-Safe Deposit and Trust Company and Stephen T. Walker.
10.12* Personal Guaranty Agreement dated July 26, 1995, by and between Stephen T.
Walker and Mercantile-Safe Deposit and Trust Company.
10.13* Revolving Note issued by the Company on April 4, 1996, to Mercantile-Safe
Deposit and Trust Company.
10.14* Security Agreement dated April 4, 1996, by and between the Company and
Mercantile-Safe Deposit and Trust Company.
10.15* Revolving Note issued by the Company on April 4, 1996, to Mercantile-Safe
Deposit and Trust Company.
10.16.1* Security Agreement as of August 27, 1996, by and between the Company and
Mercantile-Safe Deposit and Trust Company.
10.16.2* Revolving Note issued by the Company as of August 27, 1996, to Mercantile-Safe
Deposit and Trust Company.
10.17* Office Building Lease dated February 1, 1990, by and between the Company and
Perini Investment Properties, Inc.
10.18* Lease Amendment I dated May 26, 1994, by and between the Company and
<PAGE>
Robert R. Walker, Jr., Receiver (relating to exhibit 10.17).
10.19* Standard Lease dated April 12, 1989, by and between the Company and R&B
Property Holding Company.
10.20* Amendment to Lease effective November 1, 1992, by and between
the Company and R&B Property Holding Company (relating to
exhibit 10.19).
10.21* Lease Agreement dated as of October 3, 1995, by and between
Trusted Information Systems (UK) Limited and Theale Estates
Limited.
10.22* Deed dated July 17, 1996, by and between the Company and Glenwood
Associates Limited Partnership.
10.22.1* Promissory Note issued by the Company on July 17, 1996, to Glenwood
Associates Limited Partnership.
10.22.2* Deed of Trust and Security Agreement dated December 1, 1993, by and between
Glenwood Associates Limited Partnership and Mercantile-Safe Deposit and Trust
Company.
10.22.3* Promissory Note issued by Glenwood Associates Limited Partnership on
December 1, 1993 to Mercantile-Safe Deposit and Trust Company.
10.23* Deed and Confirmatory Deed dated July 26, 1995, by and between the Company
and Stephen T. Walker.
10.24* Agreement and Plan of Merger dated May 30, 1996.
11.1** Statement of computation of earnings per share.
27** Financial Data Schedule.
- -------------------
* Previously filed as an exhibit to the Company's Registration Statement Number 333-5419 on Form
S-1 and incorporated herein by reference.
** Filed herewith.
(b) Reports on Form 8-K
Not applicable.
</TABLE>
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
TRUSTED INFORMATION SYSTEMS, INC.
Date: November 20, 1996 By: /s/ Stephen T. Walker
--------------------------
Stephen T. Walker,
President and CEO
Date: November 20, 1996 /s/ Ronald W. Kaiser
----------------------------
Ronald W. Kaiser,
Chief Financial Officer
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT INDEX
<S> <C>
Exhibit No. Description Page
3.1* Certificate of Incorporation of the Company.
3.1.1* Certificate of Amendment to Certificate of Incorporation, as
filed with the Delaware Secretary of State on October 2, 1996.
3.2* Amended and Restated Bylaws of the Company.
4.1* Specimen stock certificate for shares of Common Stock of the Company.
10.1* Amended and Restated Employee Stock Option Plan.
10.2* Amended and Restated 1996 Stock Option Plan.
10.2.1* Form of Incentive Stock Option Agreement pursuant to 1996 Stock Option Plan.
10.2.2* Form of Non-Qualified Stock Option Agreement pursuant to 1996 Stock Option
Plan.
10.3* Amended and Restated 1996 Directors' Stock Option Plan.
10.4* Form of Employee Agreement Regarding Confidentiality and Inventions.
10.5* Form of Software License and Reseller Agreement.
10.6* Form of Consulting Services Agreement.
10.7* Form of Indemnification Agreement by and between the Company and its
directors and officers.
10.8* Construction Loan Agreement dated July 26, 1995, by and between the Company
and Mercantile-Safe Deposit and Trust Company.
10.9* Construction Loan Promissory Note dated July 26, 1995, by and between the
Company and Mercantile-Safe Deposit and Trust Company.
10.10* Deed of Trust and Security Agreement dated July 26, 1995, by and between the
Company and Mercantile-Safe Deposit and Trust Company.
10.11* Security Agreement, dated July 26, 1995, by and among the Company,
Mercantile-Safe Deposit and Trust Company and Stephen T. Walker.
10.12* Personal Guaranty Agreement dated July 26, 1995, by and between Stephen T.
Walker and Mercantile-Safe Deposit and Trust Company.
10.13* Revolving Note issued by the Company on April 4, 1996, to Mercantile-Safe
Deposit and Trust Company.
10.14* Security Agreement dated April 4, 1996, by and between the Company and
Mercantile-Safe Deposit and Trust Company.
10.15* Revolving Note issued by the Company on April 4, 1996, to Mercantile-Safe
Deposit and Trust Company.
10.16.1* Security Agreement as of August 27, 1996, by and between the Company and
Mercantile-Safe Deposit and Trust Company.
10.16.2* Revolving Note issued by the Company as of August 27, 1996, to Mercantile-Safe
Deposit and Trust Company.
10.17* Office Building Lease dated February 1, 1990, by and between the Company and
Perini Investment Properties, Inc.
10.18* Lease Amendment I dated May 26, 1994, by and between the Company and
Robert R. Walker, Jr., Receiver (relating to exhibit 10.17).
10.19* Standard Lease dated April 12, 1989, by and between the Company and R&B
Property Holding Company.
10.20* Amendment to Lease effective November 1, 1992, by and between
the Company and R&B Property Holding Company (relating to
exhibit 10.19).
10.21* Lease Agreement dated as of October 3, 1995, by and between
Trusted Information Systems (UK) Limited and Theale Estates
Limited.
10.22* Deed dated July 17, 1996, by and between the Company and Glenwood
<PAGE>
Associates Limited Partnership.
10.22.1* Promissory Note issued by the Company on July 17, 1996, to Glenwood
Associates Limited Partnership.
10.22.2* Deed of Trust and Security Agreement dated December 1, 1993, by and between
Glenwood Associates Limited Partnership and Mercantile-Safe Deposit and Trust
Company.
10.22.3* Promissory Note issued by Glenwood Associates Limited Partnership on
December 1, 1993 to Mercantile-Safe Deposit and Trust Company.
10.23* Deed and Confirmatory Deed dated July 26, 1995, by and between the Company
and Stephen T. Walker.
10.24* Agreement and Plan of Merger dated May 30, 1996.
11.1** Statement of computation of earnings per share.
27** Financial Data Schedule.
- -------------------
* Previously filed as an exhibit to the Company's Registration Statement Number 333-5419 on Form
S-1 and incorporated herein by reference.
** Filed herewith.
</TABLE>
Exhibit 11.1
Trusted Information Systems, Inc.
Statement of Computation of Earnings (Loss) Per Share
For the Nine Months Ended
September 29, September 27,
1995 1996
---------------------------------------
Common Stock Outstanding 7,467,451 7,343,885
Dilutive effects of Stock Options 674,441 ---
Issuance of Cheap Stock 866,176 571,676
------- -------
Weighted average shares
outstanding 9,008,068 7,915,561
========= =========
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE NINE MONTH PERIOD
ENDED SEPTEMBER 28, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-29-1995
<PERIOD-START> DEC-30-1995
<PERIOD-END> SEP-27-1996
<CASH> 239,955
<SECURITIES> 3,000,000
<RECEIVABLES> 3,750,521
<ALLOWANCES> 144,000
<INVENTORY> 0
<CURRENT-ASSETS> 11,284,074
<PP&E> 8,077,709
<DEPRECIATION> 1,657,811
<TOTAL-ASSETS> 17,760,760
<CURRENT-LIABILITIES> 11,750,332
<BONDS> 2,815,619
0
0
<COMMON> 75,523
<OTHER-SE> 3,119,286
<TOTAL-LIABILITY-AND-EQUITY> 17,760,760
<SALES> 16,962,600
<TOTAL-REVENUES> 16,962,600
<CGS> 8,567,225
<TOTAL-COSTS> 8,567,225
<OTHER-EXPENSES> 10,530,107
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 334,880
<INCOME-PRETAX> (2,447,745)
<INCOME-TAX> (1,041,077)
<INCOME-CONTINUING> (1,046,668)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,046,668)
<EPS-PRIMARY> (.18)
<EPS-DILUTED> (.18)
</TABLE>
