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 26, 1997
( ) 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 52-1281786
(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 X No
Indicate the Number of shares of the issuer's classes of common stock
outstanding as of the latest practicable date: 13,759,705 shares of common stock
were outstanding as of November 4, 1997.
1
<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 27, 1996 and September 26, 1997 3
Condensed Consolidated Statements of Operations
for the three months and nine months ended
September 27, 1996 and September 26, 1997 4
Condensed Consolidated Statements of Cash Flows
for the nine months ended September 27, 1996 and
September 26, 1997 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 and Reports on Form 8-K 16
SIGNATURES 18
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
Trusted Information Systems, Inc.
Condensed Consolidated Balance Sheets
<CAPTION>
<S> <C> <C>
December 27, September 26,
1996 1997
(unaudited)
------------------ --------------
Assets
Current assets:
Cash and cash equivalents $ 1,838,787 $864,185
Marketable securities 39,127,069 32,997,374
Accounts receivable, net of allowance of $174,592
and $512,140 for December 27, 1996 and September 26,
1997, respectively 5,803,361 8,854,161
Unbilled receivables 1,746,370 2,085,473
Prepaid expenses and other current assets 952,822 1,624,998
Refundable income taxes 1,507,121 2,204,926
Deferred income taxes 528,634
----------------- ------------
Total current assets 50,975,530 49,159,751
Property and equipment, net 6,695,524 7,691,785
Other assets 332,539 373,818
------------ ------------
Total assets $ 58,003,593 $ 57,225,354
============== ============
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 906,706 $ 537,025
Other accrued expenses 4,332,077 6,595,544
Deferred income taxes 403,324 --
Deferred revenue 2,072,266 3,118,529
Notes payable, current portion 150,857 150,857
------------ ------------
Total current liabilities 7,865,230 10,401,955
Notes payable, net of current portion 2,424,355 2,316,602
Other non-current liabilities 47,365 43,894
------------ ------------
Total liabilities 10,336,950 12,762,451
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;
11,489,704, and 11,653,210 shares issued and outstanding
as of December 27, 1996 and September 26, 1997,
respectively 114,897 116,532
Additional paid-in capital 46,809,343 47,036,156
Unrealized gains, net of income taxes of $932,838 at
December 27, 1996 1,495,162 --
Foreign currency translation adjustment 12,663 (62,799)
Retained earnings (deficit) 178,861 (1,889,983)
Deferred stock compensation (944,283) (737,003)
Total shareholders' equity 47,666,643 44,462,903
------------- ------------
Total liabilities and shareholders' equity $ 58,003,593 $ 57,225,354
============ =============
</TABLE>
See notes to unaudited condensed consolidated financial statements.
3
<PAGE>
<TABLE>
<CAPTION>
Trusted Information Systems, Inc.
Condensed Consolidated Statements of Operations
(unaudited)
<CAPTION>
For the Three Months Ended For the Nine Months Ended
<S> <C> <C> <C> <C>
September 27, September 26, September 27, September 26,
1996 1997 1996 1997
------------------------------------------------------------------
Revenues:
Government contracts $ 2,881,138 $ 2,402,128 $ 8,232,814 $ 7,168,416
Commercial products 3,958,832 7,656,439 7,690,874 18,671,033
Commercial consulting services 504,935 930,116 1,038,912 2,641,821
----------------- -------------- --------------- -------------
7,344,905 10,988,683 16,962,600 28,481,270
Cost of revenues:
Government contracts 1,979,092 1,684,975 5,843,475 4,964,520
Commercial products 929,439 1,057,629 2,127,316 2,920,945
Commercial consulting services 266,784 512,472 596,434 1,458,957
---------------- --------------- --------------- -------------
3,175,315 3,255,076 8,567,225 9,344,422
--------------- --------------- --------------- -------------
Gross profit 4,169,590 7,733,607 8,395,375 19,136,848
Operating expenses:
Selling, general and administrative 3,667,763 6,090,669 8,345,411 19,115,685
Research and development 1,177,944 1,984,884 2,184,696 5,873,295
---------------- -------------- --------------- -------------
4,845,707 8,075,553 10,530,107 24,988,980
---------------- -------------- --------------- -------------
Loss from operations (676,117) (341,946) (2,134,732) (5,852,132)
Other income (expense):
Interest and other income 8,152 447,248 21,867 1,452,856
Interest expense (171,970) (55,872) (334,880) (162,188)
Non-recurring gain on sale of marketable
securities -- 1,670,377 -- 1,670,377
---------------- --------------- --------------- -------------
(163,818) 2,061,753 (313,013) 2,961,045
---------------- --------------- --------------- -------------
Income (loss) before income taxes (839,935) 1,719,807 (2,447,745) (2,891,087)
Income tax provision (benefit) (353,484) 657,481 (1,041,077) (822,243)
---------------- --------------- --------------- --------------
Net income (loss) $ (486,451) $ 1,062,326 $ (1,406,668) $ (2,068,844)
================ =============== =============== ==============
Net income (loss) per share $ (0.06) $ .09 $ (0.18) $ (0.18)
================ =============== =============== ==============
Weighted average shares
outstanding 7,540,849 12,309,565 7,915,561 11,569,109
=============== ================ =============== ==============
</TABLE>
See notes to unaudited condensed consolidated financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
Trusted Information Systems, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited)
<CAPTION>
For the Nine Months Ended
<S> <C> <C>
September 27, September 26,
1996 1997
------------------ ---------------
Operating Activities
Net Loss $ (1,406,668) $ (2,068,844)
Adjustments:
Depreciation 340,171 642,229
Deferred income taxes (26,141) --
Amortization of stock compensation 92,124 207,280
Gain on sale of marketable securities -- (1,670,377)
Changes in operating assets and liabilities:
Accounts receivable and unbilled receivables 1,169,514 (3,389,903)
Prepaid expenses and other current assets (993,869) (672,176)
Other Assets (1,016,178) (41,279)
Accounts payable (59,163) (369,681)
Other accrued expenses 2,429,342 2,263,467
Other non-current liabilities -- (3,471)
Income taxes refundable (1,356,084) (697,805)
Deferred revenue
245,770 1,046,263
-------- ---------
Net cash used in operating activities (581,182) (4,754,297)
---------- -----------
Investing Activities
Purchases of property and equipment (3,044,979) (1,638,490)
Sale of marketable securities -- 1,681,258
(Purchase) redemption of marketable securities (10,880) 3,691,695
--------- ---------
Cash provided by (used in)
investing activities (3,055,859) 3,734,463
----------- ---------
Financing Activities
Proceeds from exercise of stock options 310,412 228,447
Net short-term borrowings 1,900,700 --
Proceeds from issuance of notes payable 1,757,219 --
Repayments of notes payable (143,384) (107,753)
----------- -----------
Net cash provided by financing activities 3,824,947 120,694
---------- --------
Effect of exchange rate changes on cash (1,810) (75,462)
-------- --------
Net change in cash and cash equivalents 186,096 (974,602)
Cash and cash equivalents at
beginning of period 53,859 1,838,787
------- ---------
Cash and cash equivalents at
end of period $ 239,955 $ 864,185
============= ============
Supplemental disclosures of
cash flow information
Interest paid during the period $ 334,880 $ 166,949
============ ============
Income taxes paid during the period $ 325,537 --
============ ============
</TABLE>
See notes to unaudited condensed consolidated financial statements.
5
<PAGE>
Trusted Information Systems, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements
September 26, 1997
Basis of Presentation and Subsequent Events
Trusted Information Systems, Inc. (the "Company" or "TIS") provides
comprehensive security solutions for the protection of computer networks,
including global Internet-based systems, internal networks and individual
workstations and laptops. The Company develops, markets, licenses, and supports
the Gauntlet[R] family of firewall products and other network security products
as well as TIS' patented RecoverKey[TM] technology which is the first and only
key recovery system to meet current U.S. government requirements for exporting
of strong cryptography with key recovery technology. In addition to providing
leading edge information security products, TIS performs an array of services in
the areas of cryptography, security consulting, training, and advanced research
and engineering for commercial and government customers on a worldwide basis.
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 27, 1996, 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.
In February 1997, the Financial Accounting Standards Board issued Statement No.
128, Earnings per Share, which is required to be adopted on December 31, 1997.
At that time, the Company will be required to change the method currently used
to compute earnings per share and to restate all prior periods. Under the new
requirements for calculating primary earnings per share, the dilutive effect of
stock options will be excluded. The impact of Statement No. 128 on the
calculation of basic earnings per share and fully diluted earnings per share for
these quarters is not expected to be material.
These unaudited condensed consolidated financial statements should be read in
conjunction with the Company's audited financial statements and footnotes
thereto which are included in the Company's report on Form 10-K that was filed
with the SEC on March 27, 1997. The accompanying unaudited condensed
consolidated financial statements reflect all the adjustments that, in the
opinion of management, are necessary for a fair presentation of results for the
interim periods presented. The results for interim periods are not necessarily
indicative of the results for the full year.
6
<PAGE>
On October 16, 1997, the Company completed a merger with Haystack Laboratories,
Inc. ("Haystack"). Haystack is a developer of information security intrusion
detection and monitoring products. In connection with the merger, the Company
issued approximately 2.1 million shares of its common stock to Haystack
shareholders. Pending completion of a registration statement and declaration of
its effectiveness by the SEC, the shares issued in connection with the
transaction will be restricted shares. The merger will be accounted for under
the pooling of interest method, and accordingly, historical financial data in
future reports will be restated to include Haystack.
In the third quarter of 1997, TIS sold all if its common stock in CyberCash,
Inc. acquired in connection with the formation of CyberCash, Inc. at a gain of
approximately $1.7 million before income taxes.
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 enterprise-wide networks. Focusing on
full-service security that enables organizations to take advantage of secure
networking, the Company develops, markets and licenses and supports the
Gauntlet[R] family of network security solutions and RecoverKey[TM]
user-controlled key recovery systems. The Company intends to integrate the
Stalker[R] and WebStalker[TM] software technology, acquired in its October 1997
merger with Haystack Laboratories, Inc. with the Company's Gauntlet family of
products to provide customers with a single firm for multi-dimensional solutions
that prevent, detect and respond to threats from both outside and inside a
company's network.
The Company also performs comprehensive services in the areas of cryptography,
security policy management, penetration testing, training, and custom
engineering for commercial and government customers.
The Company currently has two operating divisions: the Commercial Division
and the Advanced Research and Engineering ("AR&E") Division.
7
<PAGE>
The Commercial Division
The Commercial Division derives revenues from the Company's Gauntlet family of
firewall products, from its commercial consulting services and from its
RecoverKey exportable cryptography enabling products. Revenues from the
Commercial Division accounted for approximately 75% of total Company revenues
for the nine months ended September 26, 1997 versus 51% of total Company
revenues for the nine months ended September 27, 1996. The Company expects that
the Commercial Division will continue to 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 exclusively through resellers and a sales
administration staff. The Company presently employs 115 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.
During 1996 the Company began to incur and has continued 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: the Gauntlet Intranet
Firewall, the Gauntlet Net Extender[TM], the Gauntlet PC Extender[TM], the
Gauntlet Internet Firewall for Solaris, the Gauntlet Internet Firewall for
Windows NT, the Gauntlet ForceField[TM], and certain of its RecoverKey[TM]
exportable cryptography enabling products for multiple platforms such as
Windows, NT and Unix. In addition, the Company expects to continue to expand its
research and development organization and efforts, particularly with regard to
its RecoverKey exportable cryptography enabling products, including key recovery
centers ("KRC's") and cryptographic service providers ("CSP") tool kits. 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 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 28
persons with extensive information security experience in both commercial and
government organizations.
8
<PAGE>
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. Revenues
for the AR&E Division accounted for 25% of total Company revenues for the nine
months ended September 26, 1997 versus 49% for the nine months ended September
27, 1996. The Division currently has major contracts that are funded through
programs 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 decreased 13% in the first nine months
of 1997 versus the same period in 1996, primarily due to completion of a major
contract with the NSA on March 31, 1997. The completed NSA contract had an
aggregate initial award value of approximately $14.8 million. Total revenues
from this contract were $.9 million and $3.6 million for the nine months ending
September 26, 1997 and September 27, 1996, respectively.
In the third quarter of 1997, the Company was awarded ten new contracts with an
aggregate award value of $12.9 million. The aggregate award value of the
Company's sixteen major active government contracts is approximately $35 million
as of September 26, 1997. Thirteen of these contracts are funded by DARPA and
range in value from $.8 million to $8.2 million. Three of these contracts will
expire during 1998, eight will expire in 1999 and two will expire in 2000. The
Company expects to continue to obtain government contracts for its AR&E
Division. Excluding the major NSA contract which ended on March 31, 1997, the
Company anticipates revenues from such new contracts will attain the level
realized in 1996.
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 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 1995 without any significant disallowances. 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 an orderly termination and would be paid a
portion of the fee.
9
<PAGE>
Results of Operations
The following table presents for the periods indicated certain unaudited
Statements of Operations' data as a percentage of the Company's revenues:
<TABLE>
<S> <C> <C> <C> <C>
Three months Three months Nine months Nine months
ended ended ended ended
September 27, September 26, September 27, September 26,
Consolidated Statements of Operations 1996 1997 1996 1997
as a Percentage of Revenues: (unaudited) (unaudited) (unaudited) (unaudited)
Revenues:
Government contracts 39.2% 21.9% 48.6% 25.2%
Commercial products 53.9% 69.7% 45.3% 65.5%
Commercial consulting services 6.9% 8.4% 6.1% 9.3%
------- ------- ------- -------
Total Revenues 100.0% 100.0% 100.0% 100.0%
------- ------- ------- -------
Total Costs of revenues 43.2% 29.6% 50.5% 32.8%
------- ------- ------- -------
Gross profit 56.8% 70.4% 49.5% 67.2%
Operating expenses:
Selling, general and administrative 50.0% 55.4% 49.2% 67.1%
Research and development 16.0% 18.1% 12.9% 20.6%
------- ------- ------- -------
Total Operating expenses 66.0% 73.5% 62.1% 87.7%
------- ------- ------- -------
Loss from operations -9.2% -3.1% -12.6% -20.5%
Interest and other income and expense -2.2% 3.6% -1.8% 4.5%
Non-recurring gain on sale of
marketable securities -- 15.2% -- 5.9%
------- ------- ------- -------
Income (loss) before income taxes -11.4% 15.7% -14.4% -10.1%
Income tax provision (benefit) - 4.8% 6.0% - 6.1% -2.8%
------- ------- ------- -------
Net income (loss) -6.6% 9.7% -8.3% -7.3%
------- ------- ------- -------
Selected Information as a
Percentage of Related Revenues:
Cost of revenues:
Government contracts 68.7% 70.1% 71.0% 69.3%
Commercial products 23.5% 13.8% 27.7% 15.6%
Commercial consulting services 52.8% 55.1% 57.4% 55.2%
Gross profit:
Government contracts 31.3% 29.9% 29.0% 30.7%
Commercial products 76.5% 86.2% 72.3% 84.4%
Commercial consulting services 47.2% 44.9% 42.6% 44.8%
</TABLE>
10
<PAGE>
Three Months Ended September 26, 1997 Compared to Three Months Ended
September 27, 1996
Net Income. The Company reported net income of $1,062,326, or $.09 per share, in
the third quarter of 1997. Net income included the effect of a gain of
approximately $1,032,000 on the sale of shares the Company acquired upon the
formation of CyberCash, Inc. Excluding the one time gain, net income was
approximately $30,000, or break-even on a per share basis, representing the
Company's first profitable quarter since going public in October 1996. The
profit compares to a loss of $486,451, or $.06 per share, in the third quarter
of 1996.
Revenues. The Company's total revenues increased 50% to $10,988,683 in the three
months ended September 26, 1997 ("the third quarter of 1997") from $7,344,905 in
the three months ended September 27, 1996 ( "the third quarter of 1996" ),
primarily due to strong performance by the Company's Commercial Division.
Commercial product revenues increased 93% to $7,656,439 in the third quarter of
1997 from $3,958,832 in the third quarter of 1996 as a result of a 48% increase
in sales to direct customers and a 251% increase in reseller revenues.
Commercial consulting services revenues increased 84% to $930,116 in the third
quarter of 1997 from $504,935 in the third quarter of 1996, primarily because of
the Company's increased dedication of resources to its commercial consulting
business and the completion of a substantial number of commercial consulting
contracts in the third quarter of 1997. Government contract revenues decreased
17% to $2,402,128 in the third quarter of 1997 from $2,881,138 in the third
quarter of 1996, primarily because 1996 results included $1.3 million in revenue
from a major contract with the NSA, which was completed on March 31, 1997.
Gross Profit. Gross profit increased 85% to $7,733,607 in the third quarter of
1997 from $4,169,590 in the third quarter of 1996 primarily due to increased
commercial product and commercial consulting service revenues. The gross profit
on commercial products increased 118% to $6,598,810 in the third quarter of 1997
from $3,029,393 in the third quarter of 1996 reflecting the Company's higher
sales as well as an increase in gross profit margins. As a percentage of related
revenues, gross profit on commercial products increased to 86.2% in the third
quarter of 1997 from 76.5% in the same period in 1996 primarily due to a higher
percentage of 1997 third quarter revenues resulting from higher margin license
products from reseller sources.
Gross profit from the Company's commercial consulting services increased 75% to
$417,644 in the third quarter of 1997 from $238,151 in the third quarter of 1996
reflecting higher commercial consulting revenues. As a percentage of related
revenues, gross profit on commercial consulting services decreased to 44.9% in
the third quarter of 1997 from 47.2 % in the third quarter of 1996 because of
slightly higher contract costs in the third quarter of 1997.
11
<PAGE>
Gross profit from the Company's government contracts decreased 21% to $717,153
in the third quarter of 1997 from $902,046 in the third quarter of 1996,
primarily due to lower revenues associated with completion of a major contract.
As a percentage of related revenues, gross profit on government contracts
decreased to 29.9% in the third quarter of 1997 from 31.3% in the third quarter
of 1996 because of greater revenues received in 1996 from contracts with
proportionately higher fees.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 66% to $6,090,669 in the third quarter of 1997
from $3,667,763 in the third quarter of 1996. Increased costs reflect 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 and expansion of the Company's international
operations.
Research and Development Expenses. The Company's research and development
expenses, which do not include such expenses directly reimbursed under
government contracts, increased 69% to $1,984,884 in the third quarter of 1997
from $1,177,944 in the third quarter of 1996. This increase reflects costs
associated with development of the next generation of the Gauntlet Firewall,
Gauntlet Firewall Version 4.0, the Gauntlet Internet for Firewalls on NT version
1.1, RecoverKey exportable cryptography enabling products and technology, and
additional members of the Gauntlet family of firewall products.
Other Income and Expense. In the third quarter of 1997, the Company realized a
gain of $1,670,377 on the sale of its 100,000 shares of CyberCash, Inc. common
stock. Excluding the gain on CyberCash, Inc. stock, other income totaled
$391,376 in the third quarter of 1997 and consists of interest income generated
from the proceeds of the Company's initial public offering, offset by interest
expense on the Company's long-term debt associated with its Glenwood, Maryland
headquarters facilities. The Company's other expense totaled $163,818 in 1996
and consisted primarily of interest expense from borrowings under the Company's
revolving and other credit lines prior to the Company's initial public offering.
Nine Months Ended September 26, 1997 Compared to Nine Months Ended
September 27, 1996
Net Loss. In the nine months ended September 26, 1997, the Company reported a
net loss of $2,068,844, or $.18 per share. Excluding the non-recurring gain on
the sale of CyberCash, Inc., stock, the Company's loss was approximately
$3,100,000, or $.27 per share, compared to a loss of $1,406,668, or $.18 per
share for the nine months ended September 27, 1996.
12
<PAGE>
Revenues. The Company's total revenues increased 68% to $28,481,270 in the nine
months ended September 26, 1997 from $16,962,600 in the nine months ended
September 27, 1996 primarily due to strong performance by the Company's
Commercial Division. Commercial product revenues increased 143% to $18,671,033
in the nine months ended September 26, 1997 from $7,690,874 in the nine months
ended September 27, 1996 primarily because product revenues from direct
customers nearly doubled and reseller revenues grew by approximately 350%.
Commercial consulting revenues increased 154% to $2,641,821 in the nine months
ended September 26, 1997 from $1,038,912 in the nine months ended September 27,
1996, primarily because of the Company's completion of a substantial number of
commercial consulting contracts in the nine months ended September 27, 1997.
Government contract revenues decreased 13% to $7,168,416 in the nine months
ended September 26, 1997 from $8,232,814 in the same period last year primarily
because of the Company's reallocation of government research personnel to its
Commercial Division activities and completion of a major contract with the NSA
on March 31, 1997.
Gross Profit. Gross profit increased 128% to $19,136,848 in the nine months
ended September 26, 1997 from $8,395,375 in the nine months ended September 27,
1996 primarily due to increased commercial product sales. The gross profit on
commercial products increased 183% to $15,750,088 in the nine months ended
September 26, 1997 from $5,563,558 in the nine months ended September 27, 1996
because of the increase in shipments of Gauntlet firewall products. As a
percentage of related revenues, gross profit on commercial products increased to
84.4% in the nine months ended September 26, 1997 from 72.3% in the nine months
ended September 27, 1996 because of a higher percentage of sales in 1997 coming
from higher margin reseller revenues.
Gross profit from the Company's commercial consulting services increased 167% to
$1,182,864 in the nine months ended September 26, 1997 from $442,478 in the nine
months ended September 27, 1996. As a percentage of related revenues, gross
profit on commercial consulting services increased to 44.8% in the nine months
ended September 26, 1997 from 42.6% in the nine months ended September 27, 1996
because of increased revenues from higher margin consulting business in the nine
months ended September 26, 1997.
Gross profit from the Company's government contracts decreased 8% to $2,203,896
in the nine months ended September 26, 1997 from $2,389,339 in the nine months
ended September 27, 1996. As a percentage of related revenues, gross profit on
government contracts increased to 30.7% in the nine months ended September 26,
1997 from 29.0% in the nine months ended September 27, 1996 because of greater
revenues received in 1997 from contracts with proportionately higher fees.
Selling General and Administrative Expenses. Selling, general and administrative
expenses increased 129% to $19,115,685 in the nine months ended September 26,
1997 from $8,345,411 in the nine months ended September 27, 1996 primarily due
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.
13
<PAGE>
Research and Development Expenses. The Company's research and development
expenses, which do not include such expenses directly reimbursed under
government contracts, increased 169% to $5,873,295 in the nine months ended
September 26, 1997 from $2,184,696 in the nine months ended September 27, 1996,
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, Sun Microsystems' Solaris firewall product versions,
and its RecoverKey exportable cryptography enabling products, and the Company's
reallocation of government contract research personnel to its commercial
activities.
Other Income and Expense. Results for the nine months ended September 26, 1997
include a $1,670,377 gain on the sale of CyberCash, Inc. common stock which had
been purchased in connection with the formation of CyberCash, Inc. Excluding the
gain on the sale of CyberCash Inc. stock, other income totaled $1,290,668 in the
nine months ended September 26, 1997 and consisted primarily of interest income
on cash generated in the Company's initial public offering. Other expense
totaled $313,013 in the nine months ended September 27, 1996 and consisted
primarily of interest expense from borrowings under the Company's revolving and
other credit lines prior to the Company's initial public offering.
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 $864,185 at
September 26, 1997 and $1,838,787 at December 27, 1996 and marketable securities
were $32,997,374 at September 26, 1997 and $39,127,069 at December 27, 1996. The
Company used cash in operating activities of $4,754,297 and $581,182 in the nine
months ended September 26, 1997 and September 27, 1996, respectively. The
increase in cash used in operating activities in 1997 is primarily due to the
use of funds for selling, general and administrative expenses associated with
the Company's expansion of commercial activities and the introduction of new
products. The Company financed these operating activities primarily through the
redemption of marketable securities. In the nine months ended September 27,
1996, operating activities were financed primarily by proceeds from short-term
borrowings and notes payable.
Capital expenditures totaled $1,638,490 and $3,044,979 in the nine months ended
September 26, 1997 and September 27, 1996, respectively. Higher expenditures in
1996 were due to construction costs associated with expansion of the Company's
Glenwood, Maryland headquarters facility.
At December 29, 1995, the Company had various short-term line of credit
arrangements with Mercantile-Safe Deposit and Trust Company ("Mercantile Bank")
aggregating $2,000,000. During 1996, the Company arranged for additional credit
agreements and modified existing credit agreements with Mercantile Bank to
provide for additional borrowings to fund the Company prior to its initial
public offering. 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.
14
<PAGE>
As of September 26, 1997, the Company had no material commitments for capital
expenditures.
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
location. At the end of May 1996, the Company had completed its expansion and
substantially drawn down the total amount of its construction loan. The
construction loan was converted into mortgage notes payable to Mercantile Bank
with a fixed interest rate in December, 1996. In conjunction with these mortgage
notes, the Company is required to meet a minimum liquidity level of $5 million
and a minimum tangible net worth of $20 million.
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. On October 16, 1997, the Company completed a merger with
Haystack Laboratories, Inc. ("Haystack"). In connection with the merger, the
Company issued approximately 2.1 million shares of its common stock to Haystack
shareholders. Pending completion of an effective registration statement with the
SEC, the shares issued in connection with the transaction will be restricted
shares.
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 at least through December 31, 1998.
15
<PAGE>
TRUSTED INFORMATION SYSTEMS, INC.
FORM 10 - Q
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
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).
16
<PAGE>
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.
10.25** Agreement and Plan of Merger among Trusted Information
Systems, Inc., Trusted Acquisitions, Inc. and Haystack
Laboratories, Inc., dated as of October 3, 1997.
11.1*** Statement of computation of earnings (loss) 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.
** Previously filed as Exhibit 2 to the Company's Current Report on Form 8-K,
submitted October 24, 1997 and incorporated herein by reference.
*** Filed herewith.
(b) On October 24, 1997, the Company filed a report on Form 8-K
regarding its merger with Haystack Laboratories, Inc. on
October 16, 1997.
17
<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 10, 1997 By: Stephen T. Walker
----------------------
Stephen T. Walker,
President and CEO
Date: November 10, 1997 Ronald W. Kaiser
------------------------
Ronald W. Kaiser,
Chief Financial Officer
18
<PAGE>
EXHIBIT INDEX
Exhibit No. Description
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).
19
<PAGE>
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.
10.25** Agreement and Plan of Merger among Trusted Information
Systems, Inc., Trusted Acquisitions, Inc. and Haystack
Laboratories, Inc., dated as of October 3, 1997.
11.1*** Statement of computation of earnings (loss) 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.
** Previously filed as Exhibit 2 to the Company's Current Report on Form 8-K,
submitted October 24, 1997 and incorporated herein by reference.
*** Filed herewith.
20
<PAGE>
Exhibit 11.1
<TABLE>
<CAPTION>
Trusted Information Systems, Inc.
Statement of Computation of Earnings (Loss) Per Share
For the Three Months Ended For the Nine Months Ended
<S> <C> <C> <C> <C>
September 27, September 26, September 27, September 26,
1996 1997 1996 1997
------------------------------------------------------------------------
Common Stock Outstanding 7,540,849 11,634,583 7,343,885 11,569,109
Dilutive effects of Stock
Options -- 674,982 -- --
Issuance of Cheap Stock -- -- 571,676 --
---------- ---------- ---------- ----------
Weighted average shares
outstanding 7,540,849 12,309,565 7,915,561 11,569,109
========== ========== ========== ==========
</TABLE>
21
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
Exhibit 27
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE NINE MONTH PERIOD
ENDED SEPTEMBER 26, 1997 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-27-1997
<PERIOD-END> SEP-26-1997
<CASH> 864,185
<SECURITIES> 32,997,374
<RECEIVABLES> 9,366,301
<ALLOWANCES> 512,140
<INVENTORY> 0
<CURRENT-ASSETS> 49,159,751
<PP&E> 9,999,209
<DEPRECIATION> 2,307,424
<TOTAL-ASSETS> 57,225,354
<CURRENT-LIABILITIES> 10,401,955
<BONDS> 2,316,602
0
0
<COMMON> 116,532
<OTHER-SE> 44,346,371
<TOTAL-LIABILITY-AND-EQUITY> 57,225,354
<SALES> 28,481,270
<TOTAL-REVENUES> 28,481,270
<CGS> 9,344,422
<TOTAL-COSTS> 9,344,422
<OTHER-EXPENSES> 24,988,980
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 162,188
<INCOME-PRETAX> (2,891,087)
<INCOME-TAX> (822,243)
<INCOME-CONTINUING> (2,068,844)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,068,844)
<EPS-PRIMARY> (.18)
<EPS-DILUTED> (.18)
</TABLE>
