U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
X Annual Report Pursuant to Section 13 or 15(d) of the
_____ Securities Exchange Act of 1934
For the Fiscal Year Ended December 27, 1996
or
____ Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from __________ to __________
Commission File Number: 0-21067
TRUSTED INFORMATION SYSTEMS, INC.
(Exact Name of Registrant as specified in its charter)
Delaware 51-0375640
(State or other jurisdiction of (IRS employer
incorporation or organization) identification No.)
3060 Washington Road 21738
Glenwood, Maryland (Zip Code)
(Address of principal executive office)
Registrant's telephone number, including area code: (301) 854-6889
Securities Registered Pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class: on which Registered:
Common Stock, par value Nasdaq National Market
$0.01 per share
Securities Registered Pursuant to Section 12 (g) of the Act:
None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No __
<PAGE>
Documents incorporated by reference: Specified portions of the
Definitive Proxy Statement to be filed with the Commission pursuant to
Regulation 14A in connection with the 1997 Annual Meeting are incorporated
herein by reference into Part III of this Report. Such proxy statement will be
filed with the Securities and Exchange Commission not later than 120 days after
the Registrant's fiscal year ended December 27, 1996.
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K [X ].
The aggregate market value of the voting stock held by non-affiliates
of the Registrant as of March 14, 1997 was approximately $169,918,000.
The number of shares outstanding of the Registrant's Common Stock, as
of March 14, 1997 was 11,519,865 shares of Common Stock.
<PAGE>
TRUSTED INFORMATION SYSTEMS, INC.
FORM 10-K
TABLE OF CONTENTS
Part I
Item 1. Business............................................................1
Overview
Industry Background
TIS Strategy
TIS Solution
Advanced Research and Engineering
Sales and Marketing
Customer Service and Support
Research and Development
Competition
Proprietary Information and Intellectual Property
Employees
Regulatory Matters
Item 2. Properties..........................................................
Item 3. Legal Proceedings...................................................
Item 4. Submission of Matters to a Vote of Security Holders.................
Part II
Item 5. Market for the Company's Common Equity and Related
Stockholder Matters.................................................
Item 6. Selected Financial Data..............................................
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................
Item 8. Financial Statements and Supplementary Data..........................
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..................................
Part III
Item 10. Directors and Executive Officers of the Registrant...................
Item 11. Executive Compensation...............................................
Item 12 Security Ownership of Certain Beneficial Owners and Management.......
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Item 13. Certain Relationships and Related Transactions.......................
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......
Exhibit Index .................................................................
Signatures.....................................................................
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FORWARD-LOOKING STATEMENTS
IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT ON FORM 10-K
CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY. FACTORS THAT MIGHT CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED
IN THE SECTION ENTITLED "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--FACTORS THAT MAY AFFECT FUTURE RESULTS OF
OPERATIONS." READERS SHOULD CAREFULLY REVIEW THE RISKS DESCRIBED IN OTHER
DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE
COMMISSION, INCLUDING THE QUARTERLY REPORTS ON FORM 10-Q TO BE FILED BY THE
COMPANY IN 1997. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THE
FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE OF THIS ANNUAL
REPORT ON FORM 10-K. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY RELEASE
ANY REVISIONS TO THE FORWARD-LOOKING STATEMENTS OR REFLECT EVENTS OR
CIRCUMSTANCES AFTER THE DATE OF THIS DOCUMENT.
PART I
Item 1. Business.
Overview
Trusted Information Systems, Inc. ("TIS", or the "Company") 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. TIS, which was founded
in 1983 to engage in computer security consulting, draws upon the expertise of a
senior management team with an average of more than 20 years of experience in
computer security and networking issues in industry and government. The Company
emphasizes the robustness of its security solutions, its long experience with
computer security and cryptography issues and its ability to provide
comprehensive solutions to customers. The Company also emphasizes its strong
reputation with corporate and government computer security professionals in the
United States and abroad as a pioneer in the field of computer network security.
The Company's customers include the following or subsidiaries thereof: Chrysler
Corporation, E.I. duPont de Nemours and Company (DuPont), Microsoft Corporation,
NationsBank Corporation, Royal Dutch Shell Company (Shell International B.V.),
and Swiss Bank Corporation.
The Company develops, markets, licenses and supports the Gauntlet(R)
family of firewall products. These products allow customers to create "trusted"
networks that are protected from access, theft and damage by unauthorized users
from "untrusted" networks such as the Internet and also enable the creation of
virtual private networks ("VPNs") through the encrypted transmission of
information across untrusted networks. The Company's Gauntlet Internet Firewall,
introduced in 1994, was derived from the TIS Internet Firewall Toolkit which has
been available on the Internet since 1993 and has been downloaded more than
50,000 times to more than 35,000 discrete locations worldwide. Through December
1996, more than 4,000 Gauntlet Internet Firewalls have been licensed to
customers. In January 1996, the Company initiated a telemarketing program to
upgrade TIS Internet Firewall Toolkit users to the Gauntlet family of firewall
products. To build, maintain and enhance customer relationships, TIS also offers
a full range of consulting in information security policies and planning to its
customers. The Company further provides research and development and consulting
to government agencies, including the National Security Agency ("NSA") and
Defense Advanced Research Projects Agency ("DARPA"), in areas such as next
generation firewalls, distributed trusted operating systems, Internet domain
name services, international cryptography and advanced cryptographic key
handling and recovery techniques.
Prior to founding the Company in 1983, Stephen T. Walker, Chairman and
Chief Executive Officer, spent over 20 years working on computer security issues
for the U.S. government at the NSA and the Advanced Research Projects Agency
("ARPA"), the predecessor agency of DARPA.
<PAGE>
Industry Background
The Internet
The Internet, derived from ARPA research in the 1970s, is a global web
of inter-connected computer networks which enables commercial organizations,
educational institutions, government agencies and individuals to freely
communicate, access and share information and conduct business remotely. The
networks that constitute the Internet are connected in a variety of ways,
including by the public switched telephone network and by high speed, dedicated
leased lines.
While there has been significant media interest in the consumer
potential of the Internet, business and professional organizations also account
for a significant percentage of Internet usage. The recent growth in the
Internet has been driven primarily by the increasing popularity of two
applications: the World Wide Web and e-mail. The emergence of the World Wide Web
allows commercial organizations a new medium in which to publish multi-media
documents and other information for public access and to advertise or provide
products and services to users. Many such commercial enterprises have
established a "home page" to enhance these new market opportunities. Customer
service, electronic commerce, advertising and market data generation are all
being conducted across the World Wide Web. The growth of e-mail usage on the
Internet is being driven by ease-of-use and standardization. Today, there are a
number of commercially available e-mail programs that an organization or
individual may use to facilitate Internet communications.
The Company believes that full commercial utilization of the Internet
has been hampered by lack of security and the vulnerability of the Internet and
private networks directly connected to the Internet. The very openness of the
Internet means that transmitted information and data stored in connected hosts
are exposed to other users who are able, in the absence of effective security
measures, to gain access to, manipulate and divert the data. This fundamental
weakness mandates that organizations and individuals weigh security concerns
against the perceived commercial opportunities presented by millions of Internet
users.
Private Networks and Intranets
As network technology has advanced, enterprise computing has evolved
from mainframe computers supporting a number of terminals toward networks of
inter-connected personal computers. Organizations have developed local area
networks ("LANs") to share data and applications within work groups.
Increasingly, businesses are using the Internet's non-proprietary TCP/IP
protocol for internal network communications which facilitates corporate
communications using Internet tools and applications. Internal networks that
employ TCP/IP as a network protocol are known as "Intranets."
Organizations are increasingly dependent on electronic communications
among geographically dispersed internal operations, customers, suppliers and
other partners. Many organizations have connected together LANS, including
geographically dispersed networks, into wide-area networks ("WANs"), and further
connect multiple LANs and WANs, including remote networks and mobile PCs, over
dedicated leased lines or other costly telecommunication links. Private networks
can support remote access from other private networks to provide customer
support bulletin board services, electronic data interchange ("EDI") and
database sharing. Organizations can use the Internet as a low-cost, if less
secure, communications "backbone" for a WAN, thereby extending internal
information systems and enterprise applications to geographically dispersed
facilities, remote offices and mobile employees.
The increasing number of authorized users having direct access to
expanding networks and the data contained on such networks has increased the
need to provide protection for sensitive data on such networks from unauthorized
users with general access to a system. Network administrators face the challenge
of creating
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accessible, shared LANs and Intranets while protecting the integrity and
confidentiality of the information being shared.
Network Security
As a result of the increased use of the Internet and Intranets,
unauthorized access to organization networks and corporate data is an
increasingly costly business problem. Sensitive data that require protection
from unauthorized use include financial results, medical records, personnel
files, research and development projects, marketing plans, customer lists and
other business information. Unauthorized access to this information may go
undetected by the computer user or network administrator, especially if the
information is read but not altered by the unauthorized party. Organizations are
vulnerable not only to unauthorized access to information resources by
outsiders, but also to abuse by employees within their own organizations.
TIS believes the requirements for information security in these complex
communications systems can be described in terms of three major requirements:
Confidentiality: controlling who gets to read information
Integrity: assuring that information is changed only in a
specified and authorized manner, and
Availability: assuring that authorized users have continued access
to information and resources.
The relative importance of these requirements differs depending upon
the application. For example, funds transfer systems require strong integrity
controls, while product design or mineral exploration systems may focus chiefly
on confidentiality.
These information security requirements typically are stated in a
security policy--a concise statement of information sensitivities, protection
responsibilities and organizational commitment. The Company believes that a
strong security policy must state specific security needs in terms which balance
the system's risk and vulnerabilities with the need to operate. An organization
must consider following in establishing a system security policy:
the value of the asset being protected;
the vulnerabilities of the system--what damage can insiders/outsiders
do to the system; the threats to the system--can adversaries exploit
these vulnerabilities; and the risks to the system--what are the costs
of recovery if an adversary exploits a system's vulnerability.
These policies then need to be implemented by the organization at a number of
levels, for example, (a) between sections or particular groups within a site,
(b) for each site, (c) throughout the organization with its many sites and (d)
between the organization, its customers and suppliers. Each level of
communications requires the implementation of information security technology to
carry out these security policies.
Firewalls
Without any firewall protection, a computer on an untrusted network can
easily exploit any weaknesses in the software on a computer on a trusted
network.
Firewalls have developed as key elements in implementing different
security policies at the different levels within networks. The growth in
Internet users and Intranets, as well as the growing concerns about network
security, are fueling increasing demand for firewalls. A report released in
February 1996 by International Data Corporation projects that firewall product
licenses will grow from 10,000 units in 1995 to 1,500,000 units in 2000, while
revenue from such licenses will grow from approximately $160 million to
approximately $980 million over the same period.
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Firewalls provide strong points of defense and controlled, audited
access to services at all levels of communications -- both from within and
without an organization's private network. A firewall is a computer system that
is interposed between two networks, generally an organization's internal or
private computer network and a more public or untrusted network. The private, or
trusted, network can be as large as the internal network of a Fortune 500
company, or as small as a network serving a single department at a single site.
The public or untrusted network can be as specific as the enterprise's network
or as general and open as the Internet. One "firewalled" private network can
exist inside another. A firewall can restrict the access to a trusted network by
user, by application and by location. A firewall can also require users to
provide authentication based on cryptography that is much less vulnerable than
the simple passwords that have been historically used in computer systems. Thus,
any organization linking a trusted network to an untrusted network, either
internal or external, will generally and increasingly require a firewall to
enforce network security and protect the trusted network.
The two major types of firewalls are filtering gateways and application
gateways. Both gateway types work to enforce a network security policy without
adversely limiting flexibility or affecting performance. However, each design
strikes a different balance between these three goals: filtering gateways
sacrifice aspects of security in order to be more flexible and generally provide
for performance, and application gateways provide higher security at the expense
of some flexibility and performance.
Filtering Gateway Firewalls. Filtering gateway firewalls are either
"static" or "dynamic" packet filters. Dynamic filtering is sometimes referred to
as "Stateful Multi-Layer Inspection." All filtering gateways make routing
decisions based on information contained in each network "packet." If a
packet's content meets the security policy criteria, it is forwarded to the
destination. Otherwise, it is blocked at the gateways. Static filters, which are
typically implemented in routers, examine each packet as it arrives at the
gateway and make a routing decision based on the packet's header (information
such as source and destination address, protocols, and port numbers) and
sometimes on portions of the packet's contents. Dynamic filters can make
forwarding decisions based on the application protocols contained within the
packets, by maintaining the state of the application program. All filtering
gateways are limited in the amount of content filtering that may be done for a
given session.
Since filtering gateways operate by routing traffic, they provide
direct connectivity between untrusted and trusted networks. This direct
connection places a large burden for the network's security policy on internal
systems because they are directly exposed for all services the firewall lets
through. A typical example is electronic mail: if the filtering gateway is
configured to permit inbound e-mail, the security of the e-mail server become
critical--if it is running an insecure mail service such as the UNIX "sendmail"
program, history has shown that the system will be vulnerable to penetration,
and could then be used as a starting place to attack the rest of the computers
on the network intended to be protected by the firewall.
Application Gateway Firewalls. Application gateways, also known as
proxy gateways, control network connections rather than individual packets. At
the point where a connection is requested, the proxy for the given protocol will
check the firewall's security policy and decide whether the connection is
permitted. If it is, the proxy will than mediate all future traffic for that
connection and verify that it conforms to the given protocol and security
policy. Application gateways permit or deny connections with mediate traffic
based on security policy considerations such as user name, addresses, protocols,
and protocol-specific functions (e.g., download data but not upload, e-mail
scanning, Java filtering).
Virtual Private Networks (VPNs) Once firewalls are in place at multiple
sites on a WAN, the ability to establish encrypted communications links over
WANs becomes practical. These VPNs provide the most complete protection among
networks, whether among a corporation's internal information systems at
different locations or among those locations and widely dispersed customers and
suppliers. VPNs permit the safe commercial use of the Internet, thereby
providing significant cost savings by reducing reliance on more costly dedicated
telecommunications alternatives. A report prepared by an industry consultant
indicates that for the set of applications covered, such cost savings could
provide a full payback of the VPN investment within the first year of its
operation.
Export controls imposed by most governments are a significant
impediment to the establishment of Global VPNs ("GVPNs"). Recent initiatives and
interim regulations by the U.S. and other governments to allow export of
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cryptography when combined with some form of key recovery system offer an
excellent opportunity to realize the full potential of GVPNs on an international
basis. The Company believes that as appropriate government policies are put in
place, the combination of application gateway firewalls and key recovery enabled
encryption (such as the Company's RecoverKey/KRT technology) will serve to
radically alter the landscape of today's private networks, providing reliable,
protected communications through public networks such as the Internet. See "--
Commercial Products and Services -- Cryptographic Products/RecoverKey/Key
Recovery Technology (KRT) System."
TIS Strategy
The Company's objective is to be the leading provider of comprehensive
security products and services for corporate and government information systems.
Essential elements of the Company's strategy include:
Provide Comprehensive Security Solutions. The Company's approach is to
develop, market and support a broad range of network security software
products for the protection of computer networks, including global
Internet-based systems, internal networks and individual workstations and
laptops. The Company believes that its integrated approach to network
security products and services provides a more comprehensive security
solution than the single product offerings marketed by many of its
competitors. The Gauntlet family of firewall products currently includes
the Gauntlet Internet Firewall, the Gauntlet Intranet Firewall, the
Gauntlet Net Extender and the Gauntlet PC Extender. Additionally, the
Company offers a full range of expert consulting services in information
security policies and planning to commercial enterprises and governments.
With the support of government-funded and independent research and
development, the Company is developing extensions and enhancements to
current firewall technology and applications of cryptography to maintain
its position as a leader in providing comprehensive security solutions.
The Company has developed enhancements to the Gauntlet family of firewall
products, including an enhanced graphical user interface ("GUI"), and has
shipped initial versions of its Gauntlet products which support Sun
Microsystems' Solaris Version 2 and Microsoft's Windows NT Server Version
4.0. The Company intends to extend its leading positions in network
firewalls and encryption technology, including RecoverKey(TM), to enable
companies to establish GVPNs.
Increase Market Penetration Through Multiple Channels. The Company's
marketing strategy for TIS network security products and services focuses
on utilizing both a direct sales force and resellers channels to target
large corporations and organizations. The Company intends to continue to
expand its current direct sales force to both increase its market
penetration and to pursue follow-on sales for TIS network security
products and services. The Company intends to continue to focus its direct
sales efforts on Fortune 500 companies, particularly those which have a
strong need for secure communications within workgroups and among
geographically dispersed networks through the Internet. For example, the
Company has targeted companies in the telecommunications, finance and
banking, petrochemicals and pharmaceuticals industries as those most
likely to require network security solutions. The Company intends to
emphasize the use by such organizations of the Gauntlet family of firewall
products and related services together with cryptography, for enhanced
security for sensitive communications. The Company has established
customer relationships with the following or subsidiaries thereof:
Chrysler Corporation, DuPont, Microsoft Corporation, NationsBank
Corporation, Royal Dutch Shell Co., and Swiss Bank Corporation.
The Company has established a significant global resellers channel
consisting of over 75 Internet service providers, value added resellers
and hardware vendors, system integrators and security product vendors. The
Company's resellers are primarily located in the United States, Europe and
the Pacific Rim. The Company intends to greatly expand these channels for
its network security products and for its cryptographic products,
particularly in Europe and the Pacific Rim.
A significant portion of the Company's Gauntlet firewall products
customers consist of organizations which have sought upgrades to and
support for the TIS Internet Firewall Toolkit available on the Internet.
The Company has established a program to identify and pursue entities
which have installed firewalls based on the TIS Internet Firewall Toolkit
for follow-on sales of Gauntlet firewall products and related services.
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Expand Consulting Services. The Company intends to focus on expanding its
provision of consulting services to large organizations with respect to
the establishment of information security policies and of trusted
communications systems, including GVPNs. The Company believes these
consulting services will assist companies in enhancing security while
reducing communication costs through the effective deployment of the
Company's products. In building its consulting services, the Company
intends to emphasize the reputation and experience of its senior
management and technical staff. The Company also intends to utilize the
relationships it establishes through its expanding consulting efforts to
generate additional customers for TIS network security products and
services.
Leverage Government Research and Engineering. The Company believes its
extensive U.S. government-funded research activities can yield major short
and long-term product concepts as well as enhance current network security
product offerings. Government funding contributes to the Company's ability
to maintain a research and engineering staff of over 130 scientists and
engineers. With the Gauntlet family of firewall products, the Company has
demonstrated its ability to create and market commercial products based on
government-funded research results and believes that similar efforts will
enable it to implement new advanced products in the future.
TIS Solution
TIS offers a comprehensive set of products and services for the
protection of computer networks, including global Internet-based systems,
internal networks and individual workstations and laptops. As part of this
complete solution, TIS provides consulting services to evaluate and design
information security policies and firewall and other network security products
that address the major requirements of confidentiality, integrity and
availability.
The TIS Trusted System Design Principles, derived from decades of
computer security experience, include:
Simplicity in mechanisms and services provided.
Simplicity in software design, development and implementation.
A "Crystal Box" approach, in which source code is made available to
allow for assurance reviews by the Company's customers, resellers and
other experts.
Logging every event that can be logged; the customer can then customize
a complete and appropriate security audit trail.
Supporting all forms of user authentication methods and mechanisms.
Enforcing an organization's security policy, instead of imposing one of
its own.
Management believes that the integrity of the Company's security
solutions, the simplicity and brevity of its Gauntlet code, the transparency of
its "Crystal Box" approach and the experience and expertise of its management
team and consultants attract customers to purchase the Company's products and
services. In addition, the Company believes that the encryption technology of
its firewall products, which allows organizations to establish secure
communication between geographically dispersed sites through VPNs and GVPNs,
further attracts customers due to the potential cost savings which may be
achieved by communicating over the Internet rather than over more expensive,
private lines.
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Commercial Products and Services
Gauntlet Firewall Products
The following table sets forth certain information regarding certain of the
current TIS product offerings.
<TABLE>
<CAPTION>
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Environment Product Name Description Date of
Introduction
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Internet Internet Firewall A research-based collection of Q4 1993
Toolkit modules, available free on the
Internet for use but not for
resale, from which one can build a
firewall and served as the
foundation for the initial version
of the Company's Gauntlet family of
firewall products.
Internet Gauntlet Internet Application gateway firewall that Q2 1994
Firewall protects internal networks from
external intrusion.
Intranets Gauntlet Intranet Distributed firewall technology Q2 1996
Firewall that protects departmental
Intranets from unauthorized
access by internal users.
Remote Sites Gauntlet Net Distributed firewall technology Q2 1996
Extender that provides secure communications
over the Internet and WANs to and
from remote networks through the use
of encryption.
Mobile PC Gauntlet PC Provides secure communications over Q2 1996
Users Extender the Internet and other public
networks to and from mobile PC
users.
Gauntlet Internet Application gateway firewall that Q4 1996
Internet Firewall for Solaris protects internal networks which
run on Sun Microsystems Solaris
from external intrusion.
Internet Gaunlet Internet Application gateway firewall that Q4 1996
Firewall for protects internal NT networks from
Windows NT external intrusion.
Internet Gauntlet Web server security product which Q4 1996
ForceField(TM) protects server platform from
unauthorized tampering while
allowing performance and web server
access.
</TABLE>
Internet Firewall Toolkit. The Company introduced its Internet Firewall
Toolkit on the Internet in 1993, free for use but not for resale. The TIS
Internet Firewall Toolkit, which has been downloaded more than 50,000 times to
more than 35,000 discrete locations worldwide, is a collection of computer
programs from which a skilled programmer can build an application gateway
firewall to secure communications over public networks such as the Internet. To
build a firewall from the TIS Internet Firewall Toolkit, the toolkit programs
must be compiled on the programmer's hardware and operating systems and the user
must configure the operating system on which the firewall is housed to be a
suitably secure base for the firewall software. A firewall compiled from the TIS
Internet Firewall Toolkit provides basic protection for common Internet
applications including e-mail and the World Wide Web browsers and supports user
authentication. Compared to the Gauntlet family of firewall products, such a
firewall will provide limited management features and lacks firewall-to-firewall
encryption that allows the construction of a VPN. Additionally, a firewall built
from the TIS Internet Firewall Toolkit generally must be maintained and enhanced
by the programmer who constructed it. The Company has initiated a program to
upgrade TIS Internet Firewall Toolkit users to the Gauntlet family of firewall
products.
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Gauntlet Internet Firewall. The Gauntlet Internet Firewall is an
application gateway firewall which is the corner-stone of the Company's
comprehensive security solution. The Gauntlet Internet Firewall functions as a
barrier between the user's trusted network and untrusted networks such as the
Internet and was initially based on the TIS Internet Firewall Toolkit. The
Gauntlet Internet Firewall enables secure communications over public networks
such as the Internet, including firewall-to-firewall encryption that allows a
firewall owner to construct a VPN. In addition to standard encryption and VPN
capabilities, authentication and proxy services, the Gauntlet Internet Firewall
includes a secure GUI for management and includes audit and alert capabilities
and tools. The Company introduced the GUI for the Gauntlet Internet Firewall in
January 1996 and continues to develop additional enhancements for ease of use
and administration. The Gauntlet Internet Firewall software operates on a number
of popular versions of the UNIX operating system. The Company has developed and
packages as part of the Gauntlet Internet Firewall selective modifications to
the operating systems to increase the Gauntlet Internet Firewall's usability and
to harden the operating systems to make them more resistant to attack. Because
of these modifications, the Gauntlet Internet Firewall is "transparent" and
supports network services without requiring action by individual end users or
modifications to their client software. Also because of these modifications, the
Gauntlet Internet Firewall prevents "spoofing" attacks in which a computer on
the untrusted network pretends to be on the trusted network, and it detects
attempts from either network to probe for unprotected services or points of
access. To date, more than 4,000 Gauntlet Internet Firewall products have been
installed.
Gauntlet Intranet Firewall. The Gauntlet Intranet Firewall was designed
for improving the internal security of a LAN or Intranet. The Gauntlet Intranet
Firewall provides protection against unauthorized access to network resources by
internal users, and protects communications among individual PCs within and
across workgroups. The Gauntlet Intranet Firewall also currently supports Sun,
Hewlett-Packard and BSDI operating systems. The Company introduced its Gauntlet
Intranet Firewall product supporting Sun Microsystems' Solaris Versions 2.4.1
and 2.5.1 in the fourth quarter of 1996.
Gauntlet Net Extender. Extending the capabilities of the Gauntlet
firewall, the Gauntlet Net Extender is a remote Gauntlet Internet Firewall that
network administrators can manage from another Gauntlet Internet Firewall. The
Gauntlet Net Extender is marketed to customers which are enterprises with
multiple divisions and remote locations. Using encryption, the Gauntlet Net
Extender works in conjunction with a Gauntlet Internet Firewall to provide
remote site network security and remote management and control from a
centralized location. The Gauntlet Net Extender also currently supports Sun,
Hewlett-Packard and BSDI operating systems. The Company's Gauntlet Net Extender
product supporting Sun Microsystem Solaris Versions 2.4.1 and 2.5.1 was made
available in the fourth quarter of 1996.
Gauntlet PC Extender. The Gauntlet PC Extender provides multiple levels
of security for remote users utilizing a PC running on Microsoft Windows 3.1 or
Microsoft Windows for Workgroups 3.11 to connect to an internal network or
communicate within an Intranet. The encryption provided by the Gauntlet PC
Extender protects passwords, provides user authentication to prevent
unauthorized access to internal network resources and provides data encryption
to protect the confidentiality and integrity of information transmitted over the
Internet or other public or privacy networks. Gauntlet PC Extender product for
PCs supporting Microsoft Windows 95 was made available in the first quarter of
1997.
Gauntlet Internet Firewall for Solaris. The Gauntlet Internet Firewall
for Sun's Solaris Operating System is a reimplementation of the Gauntlet
Internet Firewall for Solaris, including kernel level changes to support the
full range of Gauntlet Internet Firewall features and security. The Company
introduced its Gauntlet Internet Firewall for Solaris in the fourth quarter of
1996.
Gauntlet Internet Firewall for Windows NT. The Gauntlet Internet
Firewall for Microsoft Windows NT is a complete reimplementation of a Gauntlet
Firewall whose internal structure and user interface are adapted to the unique
functional and performance attributes of the Windows NT operating system
environment. The Company introduced Gauntlet Internet Firewall for Windows NT in
the fourth quarter of 1996.
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Gauntlet ForceField(TM). Gauntlet ForceField is a World Wide Web
security product which protects server platforms from unauthorized tampering
while allowing performance and web server access. The Company introduced
Gauntlet ForceField(TM) in the fourth quarter of 1996.
The specific uses and applications of the Company's network security
products vary significantly among market sectors and business organizations.
Examples of actual uses by customers of the Company's products include:
o A U.S. company that is a provider of software solutions for
electronic commerce has installed multiple Gauntlet Internet
Firewalls at the organization's sites in the United States and
abroad to create a GVPN utilizing encryption. This enables
personnel at the various domestic and overseas sites to share
proprietary software product development and business
information securely over the Internet.
o A multi-national banking institution has installed multiple
Gauntlet Internet Firewalls on corporate Intranets to enforce
the bank's security policies that require isolation of
different organizations within the bank located throughout the
world. Each Gauntlet Internet Firewall is configured to allow
only selected applications to pass financial and other
important information onto the appropriate internal system.
The Company's "Crystal Box" approach and the ability to log
all Internet Firewall activities are essential to enforcement
of bank security policy.
o A software industry leader uses a number of Gauntlet Internet
Firewalls in a parallel configuration which enables responsive
Internet access for internal and external users of its major
World Wide Web site. The Gauntlet Internet Firewalls enforce
the company's security policies and procedures and protect the
company's internal systems and networks, which process over
100,000 e-mail messages a day.
The Gauntlet Internet Firewall is offered by the Company at a U.S. list
price of approximately $11,500 for software only and approximately $16,500 for a
software/hardware bundle. The Company's U.S. list price for the Gauntlet Net
Extender is approximately $10,000, for the Gauntlet Intranet Firewall is
approximately $7,500, for the Gauntlet PC Extender is approximately $100, and
for the Gauntlet ForceField web security product is approximately $500. Volume
discounts are generally available. The Company provides initial on-site
installation, testing and training and offers a variety of continuing
maintenance and support options to customers of the Gauntlet family of firewall
products.
The Company plans to extend its firewall products to include new
proxies for new services and to defend against new threats. Customer input will
be an important part of the Company's continued development of improvements in
ease of use and management functions. In addition, the Company is developing
products which will be compatible with Microsoft's Internet Security Framework.
This framework provides an open, interoperable and cross-platform set of
technologies and enables the effective interface of products developed and
marketed by a variety of software companies which will allow individuals to
exchange information securely, control access to their systems and conduct
secure financial transactions across public networks.
Cryptographic Products/RecoverKey/Key Recovery Technology (KRT) System.
The Company's cryptographic products are currently under development and the
Company is in negotiations with a number of companies regarding licensing of the
RecoverKey/KRT toolkit and the Key Recovery Centers ("KRCs"). The Company has
signed licenses for its RecoverKey/KRT products and technology with IBM and
Atalla.
RecoverKey/KRT Toolkit. The RecoverKey/KRT toolkit consists of software
and a license to the Company's RecoverKey/KRT technology to enable companies to
incorporate key recovery technology into their products either to enable their
cryptographic functions to satisfy U.S. (and possibly other) government
requirements for general export to foreign markets (RecoverKey-International,
formerly known as Commercial Key Escrow or CKE). This also enables companies to
provide emergency access to encrypted data in case an encryption key is lost or
unavailable for any reason (RecoverKey, formerly known as Commercial Key
Recovery or CKR). Using the
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RecoverKey/KRT toolkit, the vendor can encrypt any user secret (e.g., a key used
to encrypt a file) using the public key of a KRC and storing it in a Key
Recovery Field ("KRF'). This KRF permits future access to that secret for any
reason through the designated KRC.
Key Recovery Centers. KRCs are an essential part of the Company's
RecoverKey/KRT. A KRC is a system (hardware and software) with a set of public
and private keys for the recovery of encrypted data. A KRC receives and records
user registrations which include the access information required for future
recovery requests. Upon registration, the user's RecoverKey/KRT-enabled
application can create a KRF which will be recognized by the KRC. If a user
needs to recover an encrypted file or message, the KRF is sent to the KRC, the
user's identity is authenticated and the KRC provides the user with a decrypted
version of the key located in the KRF to decrypt the file or message.
Microsoft CAPI Compliant Cryptographic Service Provider (CSP). The
Company is developing a Microsoft Cryptographic Application Programming
Interface (CAPI) compliant CSP with a domestic version, and an exportable
version which has been approved for export by the U.S. government. Both versions
will be based on RSA's BSAFE version 3.0 toolkit technology. An exportable
version will use the Data Encryption Standard ("DES") algorithm (56 bit) at a
112 bit equivalent key length (TRIPLE-qqDES) in conjunction with
RecoverKey-International. The domestic version will use triple DES as its
standard mode of operation, but will also be able to interoperate with the
exportable version. Both versions will use the Company's RecoverKey/KRT
technology and will have optional, user selected, key recovery features.
The Company has been a leader in developing a key recovery solution to
enable the interests of national security and law enforcement agencies to be
addressed while permitting the export of products with strong cryptography. The
U.S. government, both in the context of executive branch decision-making and
pending legislation in the U.S. Congress, is actively considering a variety of
options regarding cryptography export policy. The Clinton administration's
current policy on exportable strong cryptography links the relaxation of export
controls to systems that include the use of key recovery. However, certain
parties, including companies in the computer industry and members of the U.S.
Congress, call for removing export controls on products that use the industry
standard DES algorithm. Those options could have an adverse impact on the
development of a market for the RecoverKey-International products the Company
plans to introduce in the future.
In January 1996, the U.S. government granted the Company an export
license for a particular transaction involving the Gauntlet Internet Firewall
using the DES algorithm. This is the first export license granted because the
encryption is combined with a key recovery system. In June 1996, the U.S.
government granted the Company several export licenses to sell the Gauntlet
Internet Firewall in order to provide GVPN services. In February 1997, the U.S.
government granted the Company an export license exception for the general
purpose export of the RecoverKey-International(TM) enabled Gauntlet Internet
Firewall and in March 1997, the Company received an export license exception for
a version of the CSP incorporating multiple modes of operations including
TRIPLE-DES and 128 bit RC2/RC4.
On October 2, 1996, the Company, along with ten other companies
including IBM, announced the formation of an alliance to develop an exportable,
worldwide approach to strong encryption, using key recovery. This alliance now
includes over 50 corporations which meet periodically to help establish a
worldwide standard for key recovery, which will promote worldwide
interoperability while enabling secure international electronic commerce.
On January 24, 1997, the Company and International Business Machines
Corporation ("IBM") entered into a patent and software license agreement.
Pursuant to the terms and conditions of the agreement, IBM has been granted the
right to use, sell, sublicense and distribute the Company's RecoverKey(TM)
technology and IBM is permitted to bundle the Company's technology in IBM
products for resale. IBM received a license to make, use, sublicense and sell
the Company's Toolkits. IBM also received a license to make and sell key
recovery centers that incorporate the Company's proprietary technologies and to
operate and sublicense the Company's Key Recovery Centers(TM). Generally, the
licenses granted under the agreement terminate upon the expiration of the
underlying patents.
Under the terms of the license agreement, the Company will receive fees
and royalty revenue from IBM based upon IBM's sale of products that incorporate
the Company's technology. At IBM's election, the Company
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will perform certain ancillary services and provide maintenance and support, for
which the Company also receives revenue.
Commercial Consulting
TIS offers a full range of consulting in information security policies
and planning. TIS's Commercial Consulting Practice grew out of the Company's
original consulting practice founded by Stephen T. Walker. It is currently led
by members of senior management and carried out by TIS's staff of experts who
average more than 15 years of information security experience in both commercial
and government communities. TIS offers the following commercial consulting
services: technology research services; consultation on security issues
associated with products and services; corporate information security policy
development; architectural and diagnostic security analysis and firewall
configuration; and training for corporate network and security administration
personnel. TIS's consulting customer base includes a wide range of institutions
from financial, industrial, regulatory, entertainment, research, information
systems and telecommunications organizations.
Management believes that the Commercial Consulting Practice has and
will continue to play a key role in generating follow-on sales of the Company's
security products. Corporations with the most complete information security
needs, such as those in industries targeted the Company, often look to outside
consultants to assist them in designing, maintaining and improving network
security systems and policies. The Company believes that its reputation in the
field of computer security along with its team of experienced consultants
attracts customers to engage TIS's services in solving their complex security
needs.
The Commercial Consulting Practice continuously evaluates emerging
network services and technologies, the security vulnerabilities inherent in new
offerings and evolving methods employed by hackers and professional system
penetrators to exploit system vulnerabilities. The findings from this effort not
only enable more effective consultation and the development of automated
analysis tools, but also feed into the ongoing network security product
development and enhancement activities of TIS.
Advanced Research and Engineering
The Company engages in research and development of computer and
communications security technology under contracts with departments and agencies
of the U.S. government. The Company provides security technology analysis and
consulting under contracts both directly and indirectly with the U.S. government
and the governments of other countries. Prior to 1996, the principal source of
the Company's revenues was from government contracts. In 1994 and 1995,
approximately 86% and 68% respectively, of the Company's total revenues were
derived directly or indirectly from government contracts. In 1996 the percentage
of the Company's total revenue derived from government contracts was 42%. These
revenues, along with the Company's reputation as a pioneer in the field of
computer and network security, have permitted the Company to assemble a group of
renowned scientists and engineers.
The government research and development efforts include Trusted Mach
technology, a high assurance operating system base that controls access to all
system resources and enforces security policies based upon labels associated
with the sensitivity of the resources and access privileges of the users.
High-Assurance Firewalls, World Wide Web servers and file servers built on the
Trusted Mach(R) technology will provide strong protection for data that is to be
shared, either within an organization or externally, but which must also be
protected from unauthorized reading or writing. Another operating system
security technology derived from government-funded research enforces a broad
spectrum of security policies, including those tailored to the user's individual
role in an organization. This technology can greatly improve the security of
existing operating systems by partitioning their capabilities into various
domains. The Company has demonstrated significant improvements to UNIX systems
security using this technology.
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Other government research and development efforts include the
development of prototype secure distributed systems, the incorporation of
cryptographic services into various applications and the enhancement and broader
application of access control techniques. Under government contracts, the
Company has incorporated cryptography into e-mail to provide the ability to
digitally sign e-mail in addition to protecting the contents from change or
perusal. The Company is developing techniques to improve the security of the
Internet infrastructure, such as Domain Name Service and routing, by digitally
signing communications between cooperating elements. Security services are being
incorporated into distributed systems using access control techniques that work
with Common Object Request Broker Architecture (CORBA), an emerging
international standard.
Government-related consulting has focused primarily upon security
assessment and design assistance for security features and attributes of the
systems and applications of the U.S. Department of Defense. The Company's
consulting has helped to discover approaches that provide both the security and
functionality that is needed to support the defense mission. Many of the
security issues and architectures have commercial counterparts, and the Company
has generally reserved the rights to develop such related technologies for
commercial uses.
The Company's backlog for direct and indirect U.S. government contracts
as of December 27, 1996 was approximately $11 million. The government-related
backlog represents firm orders or contracts for research, development and
consulting analysis with performance and delivery schedules that extend up to 30
months. Funded backlog represents the portion of the backlog for which agencies,
departments or companies have actually obligated payment. As of December 27,
1996, approximately $4.7 million of the government-related backlog is funded.
The Company's U.S. government contracts are subject to audit by the DCAA. The
DCAA has audited the Company's cost accounting system through 1993 without
material cost disallowances and is currently performing a similar audit of the
Company's cost accounting system for 1994.
Most of the Company's government-related contracts require the Company
to perform specified services for which the Company is paid its costs incurred
and a negotiated fee. Two contracts for the development of the Trusted Mach
technology accounted for approximately 33% of the Company's total revenues
during 1995. The smaller contract ended in December 1995. The larger contract,
with the NSA, accounted for approximately 25% of the Company's total revenues
during 1995 and is currently scheduled to complete in early 1997. Security
technology research and development contracts with ARPA accounted for
approximately 17% and 15% of the Company's 1995 and 1996 revenues, respectively.
During 1995 and 1996, 8% and 1% of the Company's total revenues, respectively,
came from security technology research and development contracts with the Air
Force Rome Laboratories ("RL").
Sales and Marketing
The Company intends to pursue a focused marketing strategy to achieve
greater market penetration for TIS network security products and services by
utilizing complementary domestic and international distribution channels,
including direct sales, resellers and telesales. The Company believes these
channels will provide broad customer coverage while maintaining a highly
cost-effective effort. The Company has organized its direct sales, resellers and
telesales teams, currently consisting of over 30 employees, on a regional basis
in order to approach the market in a coordinated manner. The Company has
initiated a strategy of directly marketing to its current base of users who have
downloaded the TIS Internet Firewall Toolkit and seeks to convert them into
users of Gauntlet products. In addition, the Company's Fortune 500 marketing
strategy with large organizations is to establish relationships through
consulting assistance in the architectural design, installation and operational
phases of their major security initiatives. The Company has attended and plans
to continue to attend popular Internet and network shows, advertise in trade
journals and submit articles that will deliver its message to decision makers
and to the people who make information security recommendations.
Direct Sales. The Company's direct sales force markets its products and
services to large corporations and organizations with complex information
security needs, such as telecommunications companies, finance and banking
institutions, petrochemical companies and pharmaceutical companies. The
Company's direct sales staff solicits these customers and provides strategy and
solutions as well as insights into security architecture alternatives while
gathering insight into customers' future requirements.
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Resellers. The Company currently maintains a worldwide network of
approximately 75 resellers which can be categorized into four areas based on
business segmentation and end user focus: Internet service providers, value
added resellers and hardware vendors, system integrators and security product
vendors. The Company views these reseller partners as an extension of its direct
sales force and supports these relationships with on-going training in security
planning, installation and maintenance as well as by providing such resellers
with updated information, software enhancements and advance notice of
announcements of future products through a TIS World Wide Web site designed
specifically for that purpose. The following are some of the Company's resellers
in each of the designated categories:
o Internet Service Providers: In the United States, these
include BBN Internet Service Corp., PSINet, Inc. and UUNet
Technologies, Inc. Unipalm Limited is the Company's Internet
service provider reseller in Europe. Internet Initiative Japan
is one of the Company's Internet service provider resellers in
the Pacific Rim.
o Value Added Resellers and Hardware Vendors: In the United
States, these include Data General Corporation and Silicon
Graphics, Inc. In Europe and the Pacific Rim, these include
Bull Enterprise Systems, HITACHI Ltd. and Sumitomo Electric
Systems Company, Ltd.
o System Integrators: These include AvantComp Oy, Conjungi
Corporation, Fujitsu Systems Business of Canada, Inc. and
Media Communications STM AB.
o Security Product Vendors: These include Hanil Telecom Co.,
Ltd. in the Pacific Rim and Mergent International, Inc. and
V-One in the United States.
The Company's agreements with its resellers generally provide the
reseller with a limited license to market, distribute and install the Company's
Gauntlet family of firewall products in a particular territory and to make such
modifications to the Company's Gauntlet family of firewall products as may be
required to serve the customer's needs. The agreements obligate the Company to
provide its resellers with updates to the licensed Gauntlet family of firewall
products and with ongoing maintenance and support. The reseller is required to
provide the Company with periodic reports regarding its activities in connection
with such products and to pay related license fees to the Company. The
agreements also contain confidentiality, indemnification and warranty disclaimer
provisions.
Telesales. The TIS Telesales Team maintains frequent and open
communications with customers. The TIS Telesales Team is geographically focused
to develop, service and transact business. The 1993 decision to make the
Company's firewall technology available via the Company's World Wide Web page
proved very successful and of strategic importance. It is currently estimated
that there have been more than 50,000 downloads of the TIS Internet Firewall
Toolkit to more than 35,000 discrete locations worldwide. The Telesales Team
targets members of this user community as potential customers for the Gauntlet
family of firewall products. TIS also provides these prospects with information
through a Firewall Toolkit user group and Birds of a Feather sessions at
conferences. Other leads for the Telesales Team are generated through trade
shows, an 800 number, e-mail and direct mailings.
For information regarding the Company's revenues from outside North
America, see Note 1 of Notes to Consolidated Financial Statements.
Customer Service and Support
The Company offers extensive training to customers and resellers for
firewall installation and management. As part of the training program, the
Company provides onsite or offsite classroom instruction and related
instructional materials which enable customer and reseller personnel to deliver
the first level of support and to tailor a support scenario for a client's
unique requirements.
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The Company offers support services by e-mail and telephone for its
Gauntlet family of firewall products. These services encompass diagnosing
problems in the network associated with the firewall and answering questions
about configuration and operation alternatives. Most customers purchase support
services in the form of a support contract covering a single firewall or in the
form of a corporate support agreement. The Company offers a variety of support
contracts, including one offering support seven days a week, 24 hours per day (7
x 24).
Research and Development
The Company's research and development efforts are focused on core
information security technologies, enhancements to existing technologies and
products and development of new products. The Company's information security
products research and development program has focused primarily on feature and
performance enhancements, expansion of the family of scaleable firewall and
cryptographic security products and development of applications of cryptography,
in particular those associated with cryptographic key recovery. The Company's
government research and development program focuses on extensions and
enhancements to current firewall technology, access control techniques for
operational systems and networks, the application of cryptography within
operating systems, network components and network infrastructure and security
for distributed systems. See " -- Advanced Research and Engineering." Through a
combination of independent and government-funded research and development
efforts, the Company is able to maintain a broad base of computer and network
security technology expertise and to remain a leader in information security
technology development.
As of December 27, 1996, the Company's research and development staff
included more than 140 scientists and engineers. Of these, nine have PhDs, 63
have master's degrees and 70 have bachelor's degrees. The Company believes that
its ability to attract and retain a highly qualified technical staff will
continue to be essential to the success of its research and development
programs. The market for such personnel is highly competitive and the Company's
research and development activities could be adversely affected if the Company
is unable to attract and retain skilled technical personnel.
In addition to amounts directly funded by the U.S. Government, the
Company spent approximately $0.6 million, $1.14 million, and $3.9 million on
research and development during fiscal years 1994, 1995 and 1996, respectively.
The Company expects to continue to fund research and development efforts
independently, through internally generated funds. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources." The Company believes that the continued scope and
progressiveness of its security technology research and development are
essential in ensuring the Company's future success in the information security
field.
Competition
Competition in the information security market is intense and
constantly evolving, and the Company expects such competition to increase in the
future. The Company believes that significant competitive factors affecting this
market are depth of product functionality, product quality and performance,
product price, customer support, conformance to protocols and industry standards
and breadth of platform support. In addition, the Company believes that the
ability to rapidly develop and implement new products and features for the
market is critical. There can be no assurance that the Company can maintain or
enhance its competitive position against current and future competitors.
Significant factors such as the emergence of new products, fundamental changes
in computing technology and aggressive pricing and marketing strategies may also
affect the Company's competitive position. Many of these factors are out of the
Company's control.
The principal competitors for the Company's government-funded research
and development are BBN Corporation, The Open Group (formerly known as "Open
Software Foundation"), Secure Computing Corporation and SRI International.
The Company's principal current competitors for its network security
products include America Online, Inc.'s Advanced Network and Services
subsidiary, Bay Networks Inc., Check Point Software Technologies Ltd., Cisco
Systems, Inc., Digital Equipment Corporation, Harris Computer Systems
Corporation, International Business
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Machines Corporation, Microsoft Corporation, Milkyway Networks Corporation,
Morningstar Technologies, Inc., Network Systems Corporation, Raptor Systems,
Inc., Secure Computing Corporation, Sun Microsystems, Inc. and V-One. Due to the
rapid expansion of the network security market, the Company may face competition
from new entrants in the network security industry, possibly including the
Company's resellers.
The Company and other entities, including IBM, have received approval from
the U.S. Department of Commerce to export products using the DES algorithm
without key recovery features under the government's current cryptography export
regulations. The Company is currently the only entity that has received approval
from the U.S. Department of Commerce to export products using cryptography
substantially stronger than the 56 bit DES algorithm (eg. TRIPLE-DES and 128 bit
RC2/RC4) provided they incorporate RecoverKey-International(TM) features.
Proprietary Information and Intellectual Property
The Company's success is dependent in part on its proprietary
technology. TIS relies on a combination of patent, trade secret, copyright and
trademark laws, non-disclosure agreements and contractual provisions to
establish and protect its proprietary rights. The Company has received three
patents and has three pending domestic patent applications and two pending
international patent applications pursuant to the Patent Cooperation Treaty
(PCT) on its KRT and computer security technology. The Company has filed foreign
applications under the European Patent Convention for the countries of Austria,
Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Liechtenstein,
Luxembourg, Monaco, Netherlands, Portugal, Spain, Sweden, and United Kingdom.
Foreign patent applications are also pending in Australia, Brazil, Canada,
China, Japan, S. Korea, Mexico, and the Russian Federation. The Company uses a
printed "shrink-wrap" license for users of its products in order to protect
certain of its copyrights and trade secrets. The Company attempts to protect its
trade secrets and other proprietary information through agreements with
suppliers and non-disclosure agreements with employees and consultants and other
security measures.
Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or to
obtain and use information that the Company regards as proprietary. Policing
unauthorized use of the Company's products is difficult, and, while the Company
is unable to determine the extent to which piracy of its software products
exists, such piracy can be expected to be a persistent problem, particularly in
international markets and as a result of the growing use of the Internet. Some
courts have held that shrink-wrap licenses, because they are not signed by the
licensee, are not enforceable. The laws of Maryland, which the shrink-wrap
licenses purport to make the governing law, are unclear on this subject. In
addition, there can be no assurance that patent applications filed by the
Company will result in patents being issued or that its existing patents, and
any patents that may be issued to it in the future, will afford protection
against competitors with similar technology; nor can there be any assurance that
patents issued to the Company will not be infringed upon or designed around by
others or that others will not obtain patents that the Company would need to
license or design around.
The Company licenses encryption and other portions of the software
included in its products from third parties and its success will depend in part
on its continued ability to use technology that is important to the
functionality of its products licensed from these or other parties. If its
licenses were to be terminated and the Company were unable to obtain licenses to
similar software from others there could be a material adverse effect on its
financial condition or results of operations.
Employees
As of December 27, 1996, the Company employed 235 people on a full-time
basis and 28 people on a temporary or part-time basis. Although the Company has
no employment agreement with any of its employees, all employees are required to
sign agreements containing confidentiality and non-disclosure provisions.
Additionally, the Company hires independent contractors and temporary employees
on an as-needed basis to assist with specialized assignments in certain areas,
including commercial product development, advanced research and engineering,
customer support and installations.
None of the Company's employees is represented by a labor union or is
subject to a collective bargaining agreement. The Company considers its
relations with its employees to be good.
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Regulatory Matters
Certain of the Company's information security products are subject to
the export restrictions administered by the U.S. Department of State and the
U.S. Department of Commerce, which permit the export of encryption products only
with the required level of export license. In addition, these U.S. export laws
prohibit the export of encryption products to a number of hostile countries.
U.S. export regulations regarding the export of encryption technology require
either a transactional export license or the granting of Department of Commerce
classification determination. To date, the Company has been able to secure all
required U.S. export licenses, including the first two export licenses for
transactions involving a network security product using the industry standard
DES algorithm (56 bits) and the first classification determination permitting
the export of a general purpose cryptographic product containing TRIPLE-DES,
which were granted because they included a key recovery system. Additionally,
the Company has received several export licenses and favorable classification
determinations and has a number of export license and classification
determination applications pending before the U.S. government with respect to
the export of products utilizing RecoverKey/KRT. There can be no assurance that
the Company will continue to be able to secure such licenses in a timely manner
in the future, or at all. The Company does not expect that such RecoverKey/KRT
products will generate significant revenues prior to 1997. See "-- Commercial
Products and Services -- Cryptographic Products/RecoverKey/Key Recovery
Technology (KRT) System." In certain foreign countries, the Company's
distributors are required to secure licenses or formal permission before
encryption products can be imported.
Item 2. Properties.
The Company's principal administrative, research, sales, marketing and
consulting facility is located in 44,681 square feet of office space in
Glenwood, Maryland which is owned by the Company. The Company leases other
domestic research, sales, marketing and consulting offices, including
approximately 27,000 square feet in Rockville, Maryland and 1,371 square feet in
Lisbon, Maryland. The Company has also entered into a lease for 6,271 square
feet in McLean, Virginia. Additional domestic offices are located in Mountain
View and Los Angeles, California where the Company leases 4,472 and 3,874 square
feet, respectively. The Company also maintains a sales, marketing and consulting
office located in 2,675 square feet of leased space in the United Kingdom and a
similar facility of approximately 1,000 square feet in Germany. The Company also
owns a 1,700 square foot building adjacent to its main facility in Glenwood,
Maryland which is currently leased to a local small business. The Company
believes that its existing facilities are adequate for its needs and the
alternative or additional space will be available as needed.
Item 3. Legal Proceedings.
The Company is not currently engaged in any legal proceedings and is
not aware of any pending or threatened litigation that could have a material
adverse effect on the Company's business, financial condition or results of
operations.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
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PART II
Item 5. Market for the Company's Common Equity and Related Stockholder Matters.
The Common Stock of Trusted Information Systems, Inc. is traded on the
Nasdaq National Market under the symbol "TISX." Prior to October 10, 1996, there
was no established public trading market for any of the Company's securities.
The following table sets forth, for the periods indicated, the range of
high and low closing sales price for the Common Stock as reported on the Nasdaq
National Market.
Fiscal 1996 High Low
---- ---
Fourth Quarter (from October 10, 1996) 17 3/4 10
Fiscal 1997 High Low
---- ---
First Quarter (through March 14, 1997) 18 3/8 10
On March 14, 1997, the last reported sale price of the Common Stock was
$14.75 per share. As of March 14, 1997, the Company had approximately 200
shareholders of record.
The Company has never declared or paid any cash dividends on its common
stock. In addition, the agreements relating to certain of the Company's
borrowings from Mercantile-Safe Deposit & Trust Company ("Mercantile Bank")
restrict the Company's ability to pay cash dividends without Mercantile Bank's
consent. The Company intends to retain its earnings to fund development of its
business and does not anticipate paying cash dividends in the foreseeable
future.
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Item 6. Selected Consolidated Financial Data.
The consolidated statement of operations data set forth below for the
fiscal years ended December 30, 1994, December 29, 1995 and December 27, 1996
and the consolidated balance sheet data at December 29, 1995 and December 27,
1996 are derived from, and should be read in conjunction with, the audited
consolidated financial statements of the Company. The consolidated statements of
operations data for the fiscal years ended December 25, 1992 and December 31,
1993, and the consolidated balance sheet data at December 25, 1992, December 31,
1993 and December 30, 1994 are derived from audited or unaudited consolidated
financial statement of the Company not included herein. The unaudited
consolidated financial statements include all adjustments (consisting only of
normal recurring adjustments and accruals) that in the opinion of management are
necessary for a fair presentation of the financial information set forth
therein. The selected financial data set forth below are qualified in their
entirety by, and should be read in conjunction with, the consolidated financial
statements, the related notes thereto and "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
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Fiscal Year
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In thousands, except per share data 1992 1993 1994 1995 1996
Statement of Operations Data: ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenues:
Government contracts..................... $6,262 $8,343 $11,258 $12,327 $11,095
Commercial products...................... __ __ 1,003 4,271 13,598
Commercial consulting services........... 568 448 856 1,492 1,677
6,830 8,791 13,117 18,090 26,370
Cost of revenues:
Government contracts..................... 4,108 5,512 7,377 8,845 7,865
Commercial products...................... __ __ 333 1,142 3,341
Commercial consulting services........... 268 307 493 878 987
4,376 5,819 8,203 10,865 12,193
Gross profit.................................. 2,454 2,972 4,914 7,225 14,177
Operating expenses:
Selling, general and administrative...... 1,612 2,198 2,997 3,727 13,842
Research and development................. 580 582 646 1,145 3,937
2,192 2,780 3,643 4,872 17,779
Income (loss) from operations................. 262 192 1,271 2,353 (3,602)
Other income (expense):
Interest income.......................... 7 8 44 50 456
Interest expense......................... (145) (128) (134) (159) (415)
(138) (120) (90) (109) 41
Income (loss) before income taxes............. 124 72 1,181 2,244 (3,561)
Income tax provision (benefit)................ 50 37 506 900 (1,397)
Net income (loss)............................. $ 74 $ 35 $ 675 $ 1,344 $ (2,164)
Net income (loss) per share................... $ .01 $ -- $ .08 $ .15 $ (0.25)
Weighted average shares outstanding........... 8,419 8,369 8,526 8,885 8,645
Fiscal Year End
-------------------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
Balance Sheet Data:
Cash, cash equivalents and marketable securities $ 29 $ 37 $ 262 $ 54 $40,966
Working capital................................ 100 (68) 400 210 43,110
Total assets................................... 3,852 4,412 5,229 10,222 58,004
Total debt..................................... 1,970 1,835 973 3,264 2,575
Shareholders' equity........................... 755 793 1,467 2,407 47,667
</TABLE>
-18-
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Management's Discussion and Analysis of Financial Condition and Results of
Operations and other parts of this Annual Report contain 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 family of
firewall products, its commercial consulting services, and from its
RecoverKey(TM) exportable cryptography enabling products. The Commercial
Division accounted for 14.2%, 31.9%, and 57.9% of the Company's total revenues
in 1994, 1995 and 1996, respectively. The Company expects that the Commercial
Division will account for an increased percentage of total revenues 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
100 persons to develop, promote, sell and deliver its network security products
and services, including the Gauntlet family of firewall products. Prior to 1996,
the Company's Gauntlet Internet Firewall was licensed as software or as software
and hardware on one platform, 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 began to incur and expects to continue to incur
substantial increases in its selling, general and administrative expenses as it
builds its 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, the
Gauntlet Internet Firewall for Solaris, the Gauntlet Firewall for Windows NT,
the Gauntlet ForceField, and certain of its RecoverKey(TM) exportable
cryptography products. In addition, the Company expects to further expand its
research and development organization, particularly with regards to its
RecoverKey(TM) technology, and make additional investment in its general and
administrative infrastructure. As a result, the Company expects operating
margins to decrease from historical levels. 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 20
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 NSA,
Air Force Rome Laboratories ("RL") and Defense Advanced Research Projects Agency
("DARPA"), formerly ARPA. Revenues from the AR&E Division increased consistently
through 1995, but
-19-
<PAGE>
decreased in 1996. The aggregate award value of the Company's nine major active
government contracts is approximately $37.1 million. In October 1993, the
Company began providing services under the largest of these current contracts,
with the NSA, which is valued at $14.8 million and is expected to expire in
early 1997. Of the five contracts with DARPA, which range in value from $0.7
million to $9.1 million 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 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 1993 without any significant disallowances and is
currently performing a similar audit of the Company's cost accounting system for
1994. Pursuant to their terms, these contracts are also subject to termination
at the convenience of the applicable government 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.
Results of Operations
Fiscal 1996 Compared to Fiscal 1995
Revenues. The Company's total revenues increased 45.8% to $26,370,081 in 1996
from $18,090,087 in 1995. Commercial product revenues increased 218.4% to
$13,597,549 in 1996 from $4,270,294 in 1995, primarily because of increased
sales of licenses of Gauntlet Internet Firewalls directly to customers and
through the Company's resellers. Commercial consulting services revenues
increased 12.4% to $1,677,285 in 1996 from $1,491,661 in 1995, primarily because
of the Company's completion of a substantial number of commercial consulting
contracts during the third and fourth quarters of 1996. Government contract
revenues decreased 10.0% to $11,095,247 in 1996 from $12,327,502 in 1995,
primarily because of the Company's reallocation of personnel to its commercial
activities.
Gross Profit. Gross profit increased 96.2% to $14,176,628 in 1996 from
$7,225,140 in 1995 primarily due to the increase in the Company's commercial
product sales. The gross profit associated with commercial products increased
227.8% to $10,256,652 in 1996 from $3,128,642 in 1995, primarily because of
increased shipments of Gauntlet firewall products. The gross profit on
commercial consulting services increased 12.4% to $689,591 in 1996 from $613,715
in fiscal 1995, primarily because of increased revenues. Gross profit from the
Company's government contracts decreased 7.3% to $3,230,385 in 1996 from
$3,482,783 in 1995, primarily because of lower related revenues.
As a percentage of related revenues, gross profit on commercial products
increased to 75% in 1996 from 73% in 1995, primarily due to increased margins on
sales through the Company's resellers. As a percentage of related revenues,
gross profit on commercial consulting and government contracts remained
virtually unchanged at 41% and 29%, respectively, for fiscal years 1996 and
1995.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 271.3% to $13,841,618 in 1996 from $3,727,701
in 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 the current and future commercial revenue growth.
-20-
<PAGE>
Research and Development Expenses. Research and development expenses, which do
not include such expenses directly reimbursed under government contracts,
increased 243.9% to $3,936,825 in 1996 from $1,144,737 in 1995. This increase
primarily resulted from the Company's efforts in developing the new members of
the Gauntlet family of firewall products announced in April of 1996. These
efforts included developing new members of the Gauntlet family of firewall
products, the Microsoft Windows NT and Sun Microsystems' Solaris firewall
product versions and its RecoverKey(TM) exportable cryptography enabling
products.
Interest and Other Expense. Interest expense increased 161.5% to $415,243 in
1996 from $158,778 in 1995 due to the Company's increased borrowings under its
short term lines of credit and its construction credit line. Interest income
increased by 807.7% to $456,345 in 1996 from $50,276 in 1995 due to interest
earned on cash and marketable securities generated by the proceeds from the
Company's initial public offering, which occurred in October, 1996.
Fiscal 1995 Compared to Fiscal 1994
Revenues. The Company's total revenues increased 37.9% to $18,090,087 in 1995
from $13,117,152 in 1994. Commercial product revenues increased 325.6% to
$4,270,924 in 1995 from $1,003,498 in 1994, primarily because of increased sales
of licenses of Gauntlet Internet Firewalls directly to customers and through the
Company's resellers. Commercial consulting services revenues increased 74.3% to
$1,491,661 in 1995 from $855,638 in 1994 primarily because of the Company's
completion of a substantial number of commercial consulting contracts during
1995. Government contract revenues increased 9.5% to $12,327,502 in 1995 from
$11,258,016 in 1994.
Gross Profit. Gross profit increased 47.0% to $7,225,140 in 1995 from $4,914,495
in 1994. This increase was primarily the result of higher gross profit
associated with the Gauntlet Internet Firewall, which increased 366.3% to
$3,128,642 in 1995 from $670,994 in 1994. The gross profit on commercial
products as a percentage of related revenues increased to 73.3% in 1995 from
66.9% in 1994 because of increased margins on the Gauntlet Internet Firewall
overall and an increase in the percentage of sales through resellers at higher
margins than for direct sales. The gross profit on commercial consulting
services decreased slightly to 41.1% in fiscal 1995 from 42.4% in fiscal 1994.
Gross profit from the Company's government contracts decreased 10.3% to
$3,482,783 in 1995 from $3,881,084 in 1994, primarily because the Company
shifted resources to its commercial products. As a percentage of related
revenues, the gross profit for government contract revenues decreased to 28.3%
in 1995 from 34.5% in 1994 because certain of the Company's government contracts
provided for higher fees on the earlier installments under those contracts,
generating higher margins in 1994.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 24.3% to $3,727,701 in 1995 from $2,997,806 in
1994, primarily due to the Company's overall increase in operations and to the
Company's efforts in late 1995 to initiate dedicated commercial marketing and
sales efforts.
Research and Development Expenses. Research and development expenses increased
77.2% to $1,144,737 in 1995 from $646,001 in 1994, primarily because the Company
increased its budget for funding research and development efforts and began to
commit substantial resources to developing its commercial products, including
activities in encryption and additional platform applications for the Gauntlet
Internet Firewall.
Interest Expense. Interest expense increased 18.3% to $158,778 in 1995 from
$134,236 in 1994, due primarily to an increase of approximately $2.2 million
during 1995 in the Company's borrowings under its revolving and construction
credit lines.
-21-
<PAGE>
Quarterly Results of Operations
The following tables set forth certain unaudited consolidated statement of
operations data for each of the four quarters in 1995 and 1996, as well as the
percentage of the Company's revenues represented by each item. The unaudited
consolidated financial statements have been prepared on the same basis as the
audited consolidated financial statements contained herein and include all
adjustments (consisting only of normal recurring adjustments) that the Company
considers necessary for a fair presentation of such information when read in
conjunction with the Company's Consolidated Financial Statements and
accompanying notes. The Company believes that quarter-to-quarter comparisons of
its financial results are not necessarily meaningful and should not be relied
upon as an indication of future performance.
<TABLE>
<CAPTION>
Fiscal Quarter Ended
-----------------------------------------------------------------------------------------------------
March 31, June 30, September 29, December 29, March 29, June 28, September 27, December 27,
1995 1995 1995 1995 1996 1996 1996 1996
---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Government contracts........ $ 3,041 $ 3,001 $ 3,425 $ 2,860 $ 2,432 $ 2,920 $ 2,881 $ 2,862
Commercial products......... 424 988 1,219 1,640 1,497 2,235 3,959 5,907
Commercial consulting
services................... 481 354 284 373 247 287 505 638
--- --- --- --- --- --- --- ---
3,946 4,343 4,928 4,873 4,176 5,442 7,345 9,407
Cost of revenues:
Government contracts........ 2,119 2,402 2,506 1,818 1,774 2,090 1,979 2,021
Commercial products......... 187 223 277 455 472 726 929 1,214
Commercial consulting
services................... 178 249 202 249 166 164 267 391
--- --- --- --- --- --- --- ---
2,484 2,874 2,985 2,522 2,412 2,980 3,175 3,626
Gross profit:
Government contracts........ 922 599 919 1,042 658 830 902 841
Commercial products......... 237 765 942 1,185 1,025 1,509 3,030 4,693
Commercial consulting
services................... 303 105 82 124 81 123 238 247
--- --- -- --- -- --- --- ---
1,462 1,469 1,943 2,351 1,764 2,462 4,170 5,781
Operating expenses:
Selling, general and
administrative............ 988 580 836 1,323 2,044 2,634 3,668 5,496
Research and
development............... 295 281 244 325 375 632 1,178 1,752
--- --- --- --- --- --- ----- -----
. 1,283 861 1,080 1,648 2,419 3,266 4,846 7,248
----- --- ----- ----- ----- ----- ----- -----
Income (loss) from
operations............... 179 608 863 703 (655) (804) (676) (1,467)
Other income expense):
Interest income........... 8 4 13 25 6 8 8 434
Interest expense.......... (23) (43) (33) (60) (89) (74) (172) (80)
--- --- --- --- --- --- ---- ---
(15) (39) (20) (35) (83) (66) (164) 354
--- --- --- --- --- --- ---- ---
Income (loss) before
income taxes............. 164 569 843 668 (738) (870) (840) (1,113)
Income tax provision
(benefit)................ 66 196 355 283 (315) (373) (354) (355)
-- --- --- --- ---- ---- ---- ----
Net income (loss)........... $98 $373 $488 $385 $(423) $(497) $(486) $(758)
=== ==== ==== ==== ===== ===== ===== =====
</TABLE>
-22-
<PAGE>
<TABLE>
<CAPTION>
Fiscal Quarter Ended
-----------------------------------------------------------------------------------------------------
March 31, June 30, September 29, December 29, March 29, June 28, September 27, December 27,
1995 1995 1995 1995 1996 1996 1996 1996
---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Consolidated Statement of
Operations as a Percentage of
Revenues:
Revenues:
Government contracts 77.1% 69.1% 69.5% 58.7% 58.2% 53.7% 39.2% 30.4%
Commercial products 10.7 22.7 24.7 33.7 35.9 41.1 53.9 62.8
Commercial consulting
services 12.2 8.2 5.8 7.6 5.9 5.2 6.9 6.8
----- ----- ----- ----- ----- ----- ----- -----
100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Cost of revenues:
Government contracts 53.7 55.4 50.9 37.3 42.5 38.5 26.9 21.4
Commercial products 4.7 5.1 5.6 9.4 11.3 13.3 12.7 12.9
Commercial consulting
services 4.5 5.7 4.1 5.1 4.0 3.0 3.6 4.2
----- ----- ----- ----- ----- ----- ----- -----
62.9 66.2 60.6 51.8 57.8 54.8 43.2 38.5
----- ----- ----- ----- ----- ----- ----- -----
Gross profit 37.1 33.8 39.4 48.2 42.2 45.2 56.8 61.5
----- ----- ----- ----- ----- ----- ----- -----
Operating expenses:
Selling, general and
administrative 25.0 13.3 17.0 27.1 48.9 48.4 50.0 58.4
Research and
development 7.6 6.5 4.9 6.7 9.0 11.6 16.0 18.6
----- ----- ----- ----- ----- ----- ----- -----
32.6 19.8 21.9 33.8 57.9 60.0 66.0 77.0
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) from
operations 4.5 14.0 17.5 14.4 (15.7) (14.8) (9.2) (15.5)
Other income (expense):
Interest income 0.2 0.1 0.3 0.5 0.1 0.1 0.1 4.6
Interest expense (0.6) (1.0) (0.7) (1.2) (2.1) (1.3) (2.3) (0.9)
----- ----- ----- ----- ----- ----- ----- -----
(0.4) (0.9) (0.4) (0.7) (2.0) (1.2) (2.2) 3.7
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) before
income taxes 4.1 13.1 17.1 13.7 (17.7) (16.0) (11.4) (11.8)
Income tax provision
(benefit) 1.6 4.5 7.2 5.8 (7.6) (6.9) (4.8) (3.7)
----- ----- ----- ----- ----- ----- ----- -----
Net income (loss) 2.5% 8.6% 9.9% 7.9% (10.1)% (9.1)% (6.6)% (8.1)%
===== ===== ===== ===== ===== ===== ===== =====
Selected Information as
a Percentage of Related
Revenues:
Gross profit by product
line:
Government contracts 30.3 20.0 26.8 36.5 27.1 28.4 31.3 29.4
Commercial products 55.9 77.4 77.3 72.2 68.5 67.5 76.5 79.5
Commercial consulting
services 63.0 29.7 28.9 33.3 32.8 42.9 47.2 38.7
----- ----- ----- ----- ----- ----- ----- -----
37.1 33.8 39.4 48.2 42.2 45.2 56.8 61.5
----- ----- ----- ----- ----- ----- ----- -----
</TABLE>
-23-
<PAGE>
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 $1,838,787 at
December 27, 1996 and $53,859 at December 29, 1995, and marketable securities
were $39,127,069 at December 27, 1996, as compared to no marketable securities
at December 29, 1995. The Company provided cash from operations of $1,279,505
and $1,237 respectively, for fiscal years 1994 and 1995, but used cash in
operations of ($3,265,886) for fiscal year 1996. Net cash provided by or used in
operations for the fiscal years 1994 and 1995 consisted primarily of net income,
plus growth in the Company's accounts payable, accrued expenses and deferred
revenues, offset by growth in the Company's accounts receivable. For the year
ended December 27, 1996, the Company used cash to fund its net loss of
$2,164,203, which were the primary components of the net cash used in operating
activities for the period, and to fund the growth in its accounts receivable and
unbilled receivables of $1,843,777, offset by cash provided from increasing
various accrued expenses. The decline in cash provided by operations in 1996 as
compared to previous years was primarily the result of funds consumed as the
Company began to expand its commercial activities and introduce new products.
During fiscal years 1994, 1995 and 1996, the Company used cash in investing
activities of $192,165, $2,095,829 and $3,327,988, respectively, to purchase
property and equipment. Of these amounts, approximately $1,340,000 and
$1,520,000 in 1995 and 1996, respectively, were spent in connection with the
purchase or construction of the Company's Glenwood, MD facilities. The Company
also used cash in investing activities during the three months ended December
27, 1996 of $36,699,949 to purchase marketable securities.
The Company provided cash in financing activities for fiscal year 1995 of
$1,885,931 primarily through net borrowings offset by cash used to repurchase
stock from a former officer. The Company generated cash from financing
activities for fiscal year 1996 of $45,060,967, primarily from net proceeds from
the issuance of 3,910,000 shares of common stock in October, 1996 in an initial
public offering.
At December 29, 1995, the Company had various short-term line of credit
arrangements with Mercantile Bank aggregating $2 million. 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.
As of December 27, 1996, 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 which was
converted in December, 1996 into mortgage notes payable to Mercantile Bank with
a fixed interest rate. 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. 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. Exposure to
currency risk is not significant.
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 the 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.
-24-
<PAGE>
Certain Factors that May Affect Future Results of Operations
Except for the historical information contained in this report, the
matters discussed and the statements made in this Annual Report concerning the
Company's future prospects are "forward-looking statements" under the Federal
securities laws that involve risks and uncertainties. There can be no assurance
that future results will be achieved, and actual results could differ materially
from forecasts and estimates. Important factors that could cause actual results
to differ materially include, but are not limited to, the Company's transition
to commercial product vendor, its ability to manage growth, the potential
significant fluctuations in quarterly operating results and lengthy sales cycle,
certain sales and distribution risks, risks associated with information security
market, new product introductions, changes in technology, dependence on the
Internet, risks of doing business with the U.S. Government, risks of error or
failures, risks associated with international sales, the effect of government
regulation on technology exports and dependence on key personnel.
The Company is currently devoting significant resources toward the
development of versions of Gauntlet Internet firewall products, RecoverKey/KRT
products, and enhancements to these families of products. There can be no
assurance that the Company will successfully complete the development of these
products in a timely fashion, or that the Company's current or future products
will achieve market acceptance. Any inability of the Company to develop products
on a timely basis that address changing customer requirements may have an
adverse effect on the Company's results of operations. In addition, the Company
anticipates significant quarterly fluctuations in its operating results in the
future. Any shortfall in revenue or earnings from levels expected by securities
analysts could have an immediate and significant adverse effect on the trading
price of the Company's common stock in any given period. In addition to factors
specific to the Company, changes in analysts' earnings estimates for the Company
or its industry and factors affecting the securities market in general will
often result in significant volatility of the Company's common stock.
Item 8. Financial Statements and Supplementary Data.
The information required by Item 8 of Part II is incorporated herein by
reference to the Consolidated Financial Statements filed with this report; see
Item 14 of Part IV.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
-25-
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Company.
The information required by Item 10 is hereby incorporated by
reference from the Proxy Statement of Trusted Information Systems, Inc.
Item 11. Executive Compensation.
The information required by Item 11 is hereby incorporated by
reference from the Proxy Statement of Trusted Information Systems, Inc.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by Item 12 is hereby incorporated by
reference from the Proxy Statement of Trusted Information Systems, Inc.
Item 13. Certain Relationships and Related Transactions.
The information required by Item 13 is hereby incorporated by
reference from the Proxy Statement of Trusted Information Systems, Inc.
-26-
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
<TABLE>
<CAPTION>
Page Number
-----------
<S> <C> <C>
(a) Documents filed as part of the report:
(1) Report of Independent Auditors F-2
Consolidated Balance Sheets at December 29, 1995
and December 27, 1996 F-3
Consolidated Statements of Operations for the years ended
December 30, 1994, December 29, 1995
and December 27, 1996 F-4
Consolidated Statements of Shareholders' Equity for the
years ended December 30, 1994, December 29, 1995 and
December 27, 1996 F-5
Consolidated Statements of Cash Flows for the years ended
December 30, 1994, December 29, 1995
and December 27, 1996 F-6
Notes to Consolidated Financial Statements F-7
(2) Financial Statement Schedules
Financial Statement Schedules are omitted because they are
not required
(3) Exhibits
</TABLE>
<TABLE>
<CAPTION>
Exhibit Number Description
-------------- -----------
<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.
-27-
<PAGE>
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
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**+ Patent and Software License Agreement dated January 24, 1997,
by and between the Company and International Business Machines
Corporation.
11.1** Statement of computation of earnings per share.
21.1* Subsidiaries of the Registrant.
23.1** Consent of Ernst & Young LLP, Independent Auditors.
24.1** Power of Attorney (included in signature pages).
27** Financial Data Schedule.
</TABLE>
- -------------------
* 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.
+ Portions of this Exhibit were omitted and have been filed separately with the
Secretary of the Commission pursuant to the Registrant's Application
Requesting Confidential Treatment under Rule 24b-2 of the Securities
Exchange Act of 1934, as amended, filed on March 27, 1997.
- ---------------------------
-28-
<PAGE>
(b) Reports on Form 8-K
None.
(c) Exhibits
The exhibits required by this Item are listed under Item
14(a)(3).
(d) Financial Statement Schedule
Financial statement schedules are omitted because they are
not required.
-29-
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Trusted Information Systems, Inc.
Index to Financial Statements
Report of Independent Auditors F-2
Consolidated Balance Sheets at December 29, 1995
and December 27, 1996 F-3
Consolidated Statements of Operations for the years ended
December 30, 1994, December 29, 1995
and December 27, 1996 F-4
Consolidated Statements of Shareholders' Equity for the
years ended December 30, 1994, December 29, 1995 and
December 27, 1996 F-5
Consolidated Statements of Cash Flows for the years ended
December 30, 1994, December 29, 1995
and December 27, 1996 F-6
Notes to Consolidated Financial Statements F-7
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Trusted Information Systems, Inc.
We have audited the accompanying consolidated balance sheets of Trusted
Information Systems, Inc. as of December 29, 1995 and December 27, 1996 and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the three years in the period ended December 27, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Trusted Information
Systems, Inc. at December 29, 1995 and December 27, 1996, and the consolidated
results of its operations and its cash flows for the three years in the period
ended December 27, 1996, in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
Vienna, Virginia
February 28, 1996
F-2
<PAGE>
Trusted Information Systems, Inc.
Consolidated Balance Sheets
December 29, December 27,
1995 1996
------------ ------------
Assets
Current assets:
Cash and cash equivalents.................. $ 53,859 $ 1,838,787
Marketable securities...................... -- 39,127,069
Accounts receivable, net of allowance of
$44,000 and $174,592 for 1995 and 1996,
respectively............................ 4,304,536 5,803,361
Unbilled receivables....................... 1,401,418 1,746,370
Prepaid expenses and other current assets.. 258,438 952,822
Refundable income taxes.................... -- 1,507,121
Deferred income taxes...................... 426,390 --
------------ ------------
Total current assets......................... 6,444,641 50,975,530
Property and equipment, net.................. 3,715,090 6,695,524
Other assets................................. 62,072 332,539
------------ ------------
Total assets................................. $ 10,221,803 $ 58,003,593
============ ============
Liabilities and shareholders' equity
Current liabilities:
Accounts payable........................... $ 689,537 $ 906,706
Accrued payroll and related expenses....... 1,384,738 2,470,429
Accrued expenses........................... 1,342,421 1,861,648
Income taxes payable....................... 122,174 --
Deferred income taxes...................... -- 403,324
Deferred revenue........................... 1,011,992 2,072,266
Short-term borrowings...................... 1,523,000 --
Notes payable, current portion............. 160,662 150,857
------------ ------------
Total current liabilities.................... 6,234,524 7,865,230
Notes payable, net of current portion........ 1,580,000 2,424,355
Other non-current liabilities................ -- 47,365
------------ ------------
Total liabilities............................ 7,814,524 10,336,950
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 and
11,489,704 shares issued and outstanding
at December 29, 1995 and December 27,
1996, respectively........................ 69,336 114,897
Additional paid-in capital................. -- 46,809,343
Unrealized gains, net of income taxes of
$932,838................................... -- 1,495,162
Foreign currency translation adjustment.... (5,121) 12,663
Retained earnings.......................... 2,343,064 178,861
Deferred stock compensation................ -- (944,283)
------------ ------------
Total shareholders' equity................... 2,407,279 47,666,643
------------ ------------
Total liabilities and shareholders' equity... $ 10,221,803 $ 58,003,593
============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
<PAGE>
Trusted Information Systems, Inc.
Consolidated Statements of Operations
Year Ended Year Ended Year Ended
December 30, December 29, December 27,
1994 1995 1996
---- ---- ----
Revenues:
Government contracts... $11,258,016 $ 12,327,502 $ 11,095,247
Commercial products.... 1,003,498 4,270,924 13,597,549
Commercial consulting
services............. 855,638 1,491,661 1,677,285
----------- ------------- ----------------
13,117,152 18,090,087 26,370,081
Cost of revenues:
Government contracts... 7,376,932 8,844,719 7,864,862
Commercial products.... 332,504 1,142,282 3,340,897
Commercial consulting
services............. 493,221 877,946 987,694
----------- ------------- ----------------
8,202,657 10,864,947 12,193,453
----------- ------------- ----------------
Gross profit............. 4,914,495 7,225,140 14,176,628
Operating expenses:
Selling, general and
administrative....... 2,997,806 3,727,701 13,841,618
Research and development 646,001 1,144,737 3,936,825
----------- ------------- ---------------
3,643,807 4,872,438 17,778,443
--------- --------- ---------------
Income (loss) from
operations............. 1,270,688 2,352,702 (3,601,815)
Other income (expense):
Interest income........ 44,635 50,276 456,345
Interest expense....... (134,236) (158,778) (415,243)
----------- ------------- ----------------
(89,601) (108,502) 41,102
Income (loss) before income --------- --------- ----------
taxes.................. 1,181,087 2,244,200 (3,560,713)
Income tax provision
(benefit).............. 505,646 900,137 (1,396,510)
------- ------- ----------
Net income (loss)........ $ 675,441 $ 1,344,063 $ (2,164,203)
=========== ============= =================
Net income (loss) per
share.................... $ .08 $ .15 $ (.25)
=========== ============= =================
Weighted average shares
outstanding............ 8,525,910 8,884,755 8,645,862
========= ========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
<PAGE>
Trusted Information Systems, Inc.
Consolidated Statements of Shareholders' Equity
<TABLE>
<CAPTION>
Common Stock
---------------------
Foreign
Additional Currency Deferred
Number Paid-in Unrealized Translation Retained Stock
of Shares Amount Capital Gains Adjustment Earnings Compensation Total
--------- ------ ------- ----- ---------- -------- ------------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1993 $7,504,276 $75,043 $352,938 $1,702 $362,822 $-- $792,505
Net income for 1994 -- -- -- -- -- 675,441 -- 675,441
Exercise of stock options 11,803 118 6,262 -- -- -- -- 6,380
Translation adjustment -- -- -- -- (7,805) -- (7,805)
--------- ------ ------- -------- ------ --------- ---------- -----------
Balance at December 30,
1994 7,516,079 75,161 359,200 -- (6,103) 1,038,263 -- 1,466,521
Net income for 1995 -- -- -- -- -- 1,344,063 -- 1,344,063
Exercise of stock options 6,453 64 3,169 -- -- -- -- 3,233
Repurchase of common
Stock (588,921) (5,889) (362,369) -- -- (39,262) -- (407,520)
Translation adjustment -- -- -- -- 982 -- -- 982
--------- ------ ------- -------- ------ --------- ---------- -----------
Balance at December 29,
1995 6,933,611 69,336 -- -- (5,121) 2,343,064 -- 2,407,279
Net loss for 1996 -- -- -- -- -- (2,164,203) -- (2,164,203)
Sale of common stock, net
of related costs of
$1,869,250 3,910,000 39,100 45,363,550 -- -- -- -- 45,402,650
Exercise of stock
options 646,093 6,461 340,293 -- -- -- -- 346,754
Unrealized gain on
available-for-sale
securities, net of tax -- -- -- 1,495,162 -- -- -- 1,495,162
Deferred stock
compensation -- -- 1,105,500 -- -- -- (1,105,500) --
Amortization of deferred
stock compensation -- -- -- -- -- -- 161,217 161,217
Translation adjustment -- -- -- -- 17,784 -- 17,784
Balance at December 27, ----------- -------- ----------- ---------- ------- -------- --------- -----------
1996 $11,489,704 $114,897 $46,809,343 $1,495,162 $12,663 $178,861 ($944,283) $47,666,643
=========== ======== =========== ========== ======= ======== ========= ===========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
<PAGE>
Trusted Information Systems, Inc.
Consolidated Statements of Cash Flows
Year Ended Year Ended Year Ended
December 30, December 29, December 27,
1994 1995 1996
---- ---- ----
Operating activities
Net income (loss)............... $ 675,441 $ 1,344,063 $(2,164,203)
Adjustments:
Depreciation.................. 191,615 261,020 347,552
Deferred income taxes......... (102,456) (136,386) (133,244)
Amortization of deferred stock
compensation................ -- -- 161,217
Changes in operating assets and
liabilities:
Accounts receivable and
unbilled receivables...... (383,461) (3,131,057) (1,843,777)
Prepaid expenses and other
current assets............ (53,857) (119,829) (694,384)
Other assets................ (52,218) 22,065 (270,467)
Accounts payable............ 172,593 219,099 217,156
Accrued payroll and related
expenses.................. 272,096 332,770 1,085,691
Other accrued expenses...... 185,500 486,332 519,227
Other non-current liabilities -- -- 47,365
Income taxes
payable/refundable........ 378,835 (276,546) (1,598,295)
Deferred revenue............ (4,583) 999,706 1,060,274
--------- --------- ----------
Net cash provided by (used in)
operating activities.......... 1,279,505 1,237 (3,265,888)
Investing activities
Purchases of property and
equipment..................... (192,165) (2,095,829) (3,327,986)
Purchase of marketable
securities.................... -- -- (36,699,949)
-------- ---------- -----------
Net cash used in investing
activities.................... (192,165) (2,095,829) (40,027,935)
Financing activities
Proceeds from issuance of common
stock, net of related costs... -- -- 45,402,650
Proceeds from exercise of stock
options....................... 6,380 3,233 346,754
Repurchase of common stock...... -- (407,520) --
Net borrowings (repayments) of
short-term borrowings......... (390,000) 1,523,000 (1,523,000)
Proceeds from issuance of notes
payable....................... -- 1,036,299 1,801,777
Repayments of notes payable..... (471,269) (269,081) (967,214)
-------- ---------- -----------
Net cash (used in) provided by
financing activities.......... (854,889) 1,885,931 45,060,967
-------- ---------- -----------
Effect of exchange rate changes on
cash.......................... (7,805) 982 17,784
-------- ---------- -----------
Net change in cash and cash
equivalents................... 224,646 (207,679) 1,784,928
Cash and cash equivalents at
beginning of period........... 36,892 261,538 53,859
-------- ---------- -----------
Cash and cash equivalents at end of
period........................ $ 261,538 $ 53,859 $ 1,838,787
========== =========== ============
Supplemental disclosures of cash
flow information
Interest paid during the period. $ 129,119 $ 162,724 $ 497,398
========== =========== ============
Income taxes paid during the
period........................ $ 126,811 $ 1,176,683 $ 325,537
========== =========== ============
The accompanying notes are an integral part of these consolidated
financial statements.
F-6
<PAGE>
Trusted Information Systems, Inc.
Notes to Consolidated Financial Statements
(Information as of December 27, 1996 and for the years ended
December 30, 1994, December 29, 1995 and December 27, 1996)
1. Basis of Presentation and Significant Accounting Policies
Basis of Presentation of Financial Statements
Description of Business
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 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
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.
Fiscal Periods
The Company's fiscal year is based on a 52-53 week year ending on the last
Friday in December. The years ended December 30, 1994, December 29, 1995 and
December 27, 1996 were 52-week years. Each of the Company's fiscal quarters
consists of a 13-week period.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries, Trusted Information Systems (U.K.)
Limited ("TIS UK") and Trusted Information Systems GmbH ("TIS GmbH"). The TIS UK
subsidiary was established in 1992 to conduct the Company's activities in the
United Kingdom and the TIS GmbH subsidiary was established in 1996 to conduct
the Company's activities in Germany. All material intercompany accounts and
transactions have been eliminated upon consolidation.
Revenues from the Company's European subsidiaries amounted to 3.1% and 4.0% of
total revenues for the years ended December 29, 1995 and December 27, 1996,
respectively. Translation adjustments from foreign operations are not
significant in the current year nor is the risk associated with foreign
operations considered to be significant.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Initial Public Offering and Related Matters
Effective May 31, 1996, the Company consummated a tax-free reorganization for
the purposes of becoming a Delaware corporation by issuing 40 shares of a new
class of $.01 par value common stock in exchange for each share of the then
outstanding no par value Class A (voting) and Class B (non-voting) common stock.
The effect of this reorganization is reflected as if it had occurred at the
beginning of the earliest period presented.
F-7
<PAGE>
On August 30, 1996, the Board of Directors approved a 1-for-1.6301 reverse stock
split of the Company's common stock, which with stockholder approval became
effective on September 28, 1996. All references in the accompanying financial
statements to the number of shares of common stock and per share amounts have
been restated to reflect the reverse stock split.
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. Pursuant to the
registration statement, the Company completed its initial public offering (IPO)
on October 10, 1996. The initial public offering resulted in proceeds to the
Company of approximately $45.4 million, net of approximately $1.9 million in
underwriting fees and offering expenses. The Company repaid approximately $4.9
million of its short-term borrowings and notes payable out of the proceeds.
Other Information Regarding Basis of Presentation
The Company performs periodic credit evaluations of the financial condition of
its customers and typically does not require collateral from its customers.
Amounts receivable, directly and indirectly, from government agencies
approximated 54% and 17% of total accounts receivable at December 29, 1995 and
December 27, 1996, respectively. Sales to these agencies accounted for
approximately 68% and 42% of total revenues for the years ended December 29,
1995 and December 27, 1996, respectively.
Export sales, primarily to Europe, were 4.8% and 7.6% of total revenues for the
years ended December 29, 1995 and December 27, 1996, respectively. Export sales
were insignificant in all other periods.
Significant Accounting Policies
Marketable Securities
Marketable securities are classified as available-for-sale and are carried at
fair market value with unrealized gains and losses, net of taxes reported in a
separate component of shareholders' equity. At December 27, 1996, marketable
securities consisted of an investment in 100,000 shares of Cybercash, Inc. and
approximately $36.7 million in U.S. Government and U.S. Government-sponsored
securities, all with maturities of less than three months. At December 27, 1996,
government-sponsored securities are carried at cost, which approximates its fair
value.
Realized gains in value judged to be other-than-temporary are included in
investment income. Interest and dividends are included in investment income. At
December 27, 1996, the common stock of Cybercash, Inc., which the Company
purchased in connection with the formation of the company, had a cost basis of
approximately $10,000 and an unrealized gain and estimated fair value of
approximately $1.5 million (net of taxes of $932,838). The Company may sell such
shares subject to the limitations of Rule 144 under the Securities Act of 1933.
Property and Equipment
In 1995, the Company adopted the provisions of Financial Accounting Standards
Board Statement No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. Adoption of
this Statement did not have a material impact on the reported results of
operations of the Company.
Property and equipment is stated at cost. Additions prior to fiscal 1996 were
depreciated on an accelerated basis using estimated useful lives of 20-31 years
for buildings and improvements and 5-7 years for furniture and equipment, and
additions for fiscal year 1996 were depreciated on a straight line basis over
similar lives.
F-8
<PAGE>
Stock Options Granted to Employees
The Company records compensation expense for all stock-based compensation plans
using the intrinsic value method prescribed by APB Opinion No. 25, Accounting
for Stock Issued to Employees. In October 1995, the Financial Accounting
Standards Board issued Statement No. 123, Accounting for Stock-Based
Compensation, which encourages companies to recognize expense for stock-based
awards based on their estimated fair value on the date of grant. Statement No.
123, effective for 1996, does not require companies to change their existing
accounting for stock-based awards, but if the new fair value method is not
adopted, pro forma income and earnings per share data should be provided in the
footnotes to the financial statements. The Company's 1996 annual financial
statements supplementally disclose the required pro forma information as if the
fair value method had been adopted for 1996.
(See footnote 5.)
Revenue Recognition
Commercial Products and Services -- Revenues from the sale of goods, including
software products, are recognized upon shipment, when collection of the
receivable is probable and the Company has no significant remaining obligations.
In instances where the Company directly installs its products, related
installation revenues are recognized upon completion of installation. Commercial
consulting services are provided primarily on a time and materials basis. The
Company accounts for obligations under customer service, support and maintenance
agreements by deferring a pro rata portion of revenue and recognizing it either
ratably as the obligations are fulfilled or upon completion of performance.
Government Contracts -- The Company enters into research and development
contracts with government agencies under various pricing arrangements. Revenue
from "cost-plus-fixed-fee" contracts is recognized on the basis of reimbursable
contract costs incurred during the period, plus a percentage of the fixed fee.
Revenue from "time and material" contracts is recognized on the basis of hours
utilized, plus other reimbursable contract costs incurred during the period.
Revenue from "firm-fixed-price" contracts is recognized on the percentage of
completion method. Under this method, individual contract revenues are recorded
based on the percentage relationship that contract costs incurred bear to
management's estimate of total contract costs. Losses, if any, are accrued when
their occurrence becomes known and the amount of the loss is reasonably
determined.
Under its government contracts, the Company is subject to audit by the Defense
Contract Audit Agency (DCAA) which could result in the renegotiation of amounts
previously billed. The DCAA has performed audits of the Company's costs through
1993. Management believes that the results of such audits will not have a
material adverse effect on the Company's financial position or results of
operations.
Revenues recognized in excess of amounts billed to government agencies and
retainage related to long-term contracts have been recorded as unbilled
receivables in the accompanying balance sheets.
Research and Development
Research and development expenditures are charged to operations as incurred.
Statement of Financial Accounting Standard No. 86, Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed, requires
capitalization of certain software development costs subsequent to the
establishment of technological feasibility. Based on the Company's product
development process, technological feasibility is established upon completion of
a working model. Costs incurred by the Company between completion of the working
model and the point at which the product is ready for general release have been
insignificant. The distribution of products incorporating encryption technology
may be subject to U.S. government export restrictions.
Advertising Costs
All advertising costs are expensed when incurred. Costs which are included in
expense for the years ended December 30, 1994, December 29, 1995 and December
27, 1996 were approximately $11,800, $28,700 and $105,372, respectively.
F-9
<PAGE>
Earnings (Loss) Per Share
The Company's net income (loss) per share calculations are based upon the
weighted average number of shares of common stock outstanding during each
period, adjusted for the dilutive effect of common stock equivalents.
Pursuant to the requirements of the Securities and Exchange Commission, common
stock and options to purchase common stock issued at prices below the IPO price
during the twelve months immediately preceding the contemplated initial filing
of the registration statement in connection with the IPO have been included in
the computation of net income per share as if they were outstanding for all
periods presented in the Company's registration statement (using the treasury
method and assuming repurchase of common stock at the estimated IPO price with
the proceeds of assumed exercise of the options), even if antidilutive. For all
subsequent periods, such common stock and options have not been included in the
computation of net income (loss) per share, as they are considered to be
antidilutive.
2. Property and Equipment
Property and equipment consists of:
December 29, December 27,
1995 1996
---- ----
Land...................................... $ 232,926 $ 322,926
Buildings and building improvements....... 1,762,738 4,657,585
Furniture and equipment................... 1,656,097 3,264,082
Leasehold improvements.................... 45,211 116,123
Construction-in-progress.................. 1,335,758 --
---------- ----------
5,032,730 8,360,716
Less: accumulated depreciation and
amortization.............................. (1,317,640) (1,665,192)
---------- ----------
$3,715,090 $6,695,524
========== ==========
3. Short-term Borrowings
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 million. During 1996, the Company arranged for additional credit
agreements and modified existing credit agreements with Mercantile Bank that
provided for additional borrowings to fund the Company's growth prior to its
initial public offering. These credit facilities were paid off in conjunction
with the Company's initial public offering.
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. During 1996, the Company had completed its expansion and had
substantially drawn down the total amount of its construction loan which was
converted in December into a mortgage note which bears interest at a three year
fixed rate of 8.46%.
F-10
<PAGE>
4. Notes Payable
Notes payable to banks and others consist of the following:
December 29, December 27,
1995 1996
---- ----
Small Business Administration mortgage note due in
monthly principal and interest (10.1% per annum)
installments of approximately $5,000............. $ 420,962 $ 405,052
Notes payable to a bank:
Mortgage note; principal due in monthly
installments of $10,000 and interest payable
monthly at a three year fixed rate of 8.46% ... 684,170 1,750,000
Mortgage note; due in monthly principal and
interest (8.46% per annum) installments of
$4,128; balance due December 2011 ............. 481,694 420,160
Furniture and equipment notes; principal due in
monthly installments of $3,583 in 1995 and
$5,667 in 1996 ................................ 153,836 --
------------ ------------
1,740,662 2,575,212
Less: current portion.............................. 160,662 150,857
------------ ------------
$ 1,580,000 $ 2,424,355
============ ============
All of the notes payable to a bank described above are payable to the same bank
and are collateralized by the underlying properties. The furniture and equipment
notes were fully paid in 1996.
Other than amounts due under the Small Business Administration note, the Company
believes that the carrying amount reported in the balance sheet of its other
financial assets and liabilities approximates their fair value. Using discounted
cash flow analyses, the fair value of the Small Business Administration note at
December 27, 1996 is estimated to be approximately $466,000.
Aggregate maturities of all notes payable at December 27, 1996 are as follows:
1997........... $150,857
1998........... 155,288
1999........... 158,746
2000........... 162,547
2001........... 166,723
Thereafter..... 1,781,051
-----------
Total.......... $ 2,575,212
===========
5. Stock Options
The Company has adopted the Amended and Restated Employee Stock Option Plan
(Employee Option Plan) and the 1996 Stock Option Plan (1996 Option Plan) which
provide for the grant of incentive stock options and non-statutory stock options
to executives, employees and consultants. The Employee Option Plan authorizes
the issuance of options to acquire 6,134,593 shares of common stock and at
December 27, 1996, options to acquire 111,391 shares of common stock under the
plan were outstanding; no further options will be granted under this plan. The
1996 Option Plan authorizes the issuance of options to acquire 1,625,667 shares
of common stock, and, at December 27, 1996, options to acquire 1,152,891 shares
of common stock under the plan were outstanding.
F-11
<PAGE>
The vesting period, contractual life, and the exercise price of each option
shall be determined by the respective plan administration committee. However,
for incentive stock options, the exercise price shall not be less than the fair
market value of the common stock on the date of the grant.
Upon a change in control of the Company, as defined by the plans, 50% of any
outstanding unvested options under the 1996 Option Plan or the Director Plan
prior to the date of such change in control shall vest and be immediately
exercisable.
In connection with the initial public offering, the Company recorded deferred
compensation of $1,105,500 as a separate component of shareholders' equity
related to the issuance in June 1996 of options for 92,018 shares of the
Company's common stock. This deferred compensation is being amortized evenly
over the four-year vesting period of the options. At December 27, 1996, none of
these options were exercisable.
Option activity under the plans is as follows:
Options Weighted
Outstanding Price Average
Under the Per Price Per
Stock Plans Share Share
----------- ----- -----
Balance at December 31, 1993 907,920 $ .50 $ .50
Options granted.......... 1,091,958 .50-.69 .54
Options exercised........ (11,803) .50 .50
Options canceled......... (870,033) .50-.69 .54
--------- -------- ------
Balance at December 30, 1994 1,118,042 .50-.69 .54
Options granted.......... -- -- --
Options exercised........ (6,453) .50 .50
Options canceled......... (122,693) .50-.69 .54
--------- -------- ------
Balance at December 29, 1995 988,896 .50-.69 .53
Options granted.......... 1,175,316 2.66-7.04 3.21
Options exercised........ (646,093) .50-7.04 .54
Options canceled......... (253,837) .50-7.04 .65
--------- -------- ------
Balance at December 27, 1996 1,264,282 $.69-7.04 $ 3.00
========= ========= ======
Options exercisable at December 27, 1996 totaled 111,391 at a per share price
of $0.69.
The Company has also adopted the 1996 Directors' Stock Option Plan (Director
Plan) which provides for the grant of non-statutory stock options to
non-employee directors of the Company. The Director Plan authorizes the issuance
of options to acquire 200,000 shares of common stock. On August 15, 1996 each of
the Company's two existing outside directors were granted options to purchase
9,202 shares of common stock at an exercise price of $7.04 per share, and
options to purchase 6,000 shares of common stock will be granted to each future
director upon initial election to the board of directors. The options vest
ratably over three years. Additionally, commencing in 1997, each director will
annually be granted options to purchase 1,250 shares of common stock. Such
annual options will vest in full at the earlier of (i) the first anniversary of
the date of the grant or (ii) the date of the next annual meeting of
stockholders. The exercise price of options granted under the Director Plan will
equal the closing price per share of the common stock on the date of grant. As
of December 27, 1996, a total of 18,404 options were granted under the Director
Plan.
The Company adopted Financial Accounting Standard No. 123 entitled "Accounting
for Stock-Based Compensation" ("FAS 123") as of December 27, 1996. The
provisions of FAS 123 allow companies to either expense the estimated fair value
of stock options or to continue their current practice but disclose the pro
forma effects on net income and earnings per share had the fair value of the
options been expensed. TIS has elected to continue its practice of recognizing
compensation expense for its stock option incentive plans using the intrinsic
value based method of accounting (see note 1) and to provide the required pro
forma information for stock options granted after December 29, 1995.
Accordingly, TIS recognizes compensation expense for its stock option incentive
plans using the intrinsic value method of accounting. Under the terms of the
intrinsic value method, compensation cost is the excess, if any, of the quoted
market price of the stock at the grant date, or other measurement date, over
F-12
<PAGE>
the amount an employee must pay to acquire the stock.
Pro Forma Disclosure
Had compensation expense for TIS' stock option incentive plans for options
granted after December 29, 1995 been determined based on the estimated fair
value at the grant dates for awards under those plans, TIS' pro forma net loss
and earnings per share for 1996 would have been $2,605,484 and ($.30),
respectively, (a decrease of $441,281 and $.05, respectively). Since no options
were granted by the Company, there is no pro forma effect for the year ended
December 29, 1995. The effects on 1996 pro forma net income and earnings per
share of expensing the estimated fair value of stock options are not necessarily
representative of the effects on reported net income for future years due to
such things as the vesting period of the stock options and the potential for
issuance of additional stock options in future years.
The fair value of options granted after December 29, 1995, used as a basis for
the above pro forma disclosures, was estimated as of the date of grant using a
Black-Scholes option pricing model. The option pricing assumptions include a
dividend yield of 0%; an expected volatility of 1.414; a risk-free interest rate
of 6.13%; and an expected life of 4 years.
Weighted-average fair value and exercise price per option granted during 1996
was $2.87 and $2.86, respectively for options whose exercise price was equal to
the fair value of the options on the date of the grant. For options whose
exercise price was less than the fair value on the date of the grant, the
weighted average fair value and exercise price per option granted during 1996
was $13.92 and $2.66, respectively. The weighted average contractual life
for all options outstanding at December 27, 1996 was 4.0 years.
The following table summarizes information regarding stock options outstanding
at December 27, 1996:
Number of Weighted Average
Exercise Price Options Outstanding Contractual Life
$0.69 111,391 0.42
$2.66 1,005,660 4.26
$7.04 147,231 4.44
6. Income Taxes
Significant components of the Company's deferred tax assets and liabilities are
as follows:
December 29, December 27,
1995 1996
---- ----
Deferred tax assets:
Allowance for doubtful accounts.... $16,905 $ 70,718
Other accrued expenses............. 343,877 69,668
Accrued vacation................... 172,231 208,454
Deferred Revenues.................. -- 342,266
Deferred Compensation.............. -- 65,212
------- -------
Total deferred tax assets.......... 533,013 756,318
Deferred tax liabilities:..........
Unbilled receivables............... 86,257 49,154
Property and equipment............. 6,929 144,240
Unrealized gain on marketable
securities......................... -- 936,728
Other.............................. 13,437 29,520
------- -------
Total deferred tax liabilities..... 106,623 1,159,642
------- -------
Net deferred tax asset (liability). $426,390 $(403,324)
======== =========
At December 30, 1994, December 29, 1995 and December 27, 1996, no valuation
allowance was required for the deferred tax assets.
F-13
<PAGE>
The provision (benefit) for income taxes consists of the following:
Year Ended Year Ended Year Ended
December 30, December 29, December 27,
1994 1995 1996
---- ---- ----
Current:
Federal............... $ 475,575 $ 855,775 $(1,169,020)
State................. 132,526 180,748 (246,909)
------- ------- --------
608,101 1,036,523 (1,415,929)
Deferred:
Federal............... (80,026) (125,518) 18,118
State................. (22,429) (10,868) 1,301
------- ------- -----
(102,455) (136,386) 19,419
-------- -------- ------
Total income tax
provision (benefit)..... $ 505,646 $ 900,137 $(1,396,510)
=========== =========== ===========
The Company's provision for income taxes resulted in effective tax rates that
varied from the statutory federal income tax rate as follows:
Year Ended Year Ended Year Ended
December 30, December 29, December 27,
1994 1995 1996
---- ---- ----
Expected federal income tax
provision at 34%.......... $ 401,570 $ 763,028 $(1,210,642)
Expenses not deductible for
tax purposes............... 14,748 13,336 26,111
State income taxes, net of
federal benefit........... 72,664 112,121 (162,101)
Other....................... 16,664 11,652 (49,878)
--------- --------- -----------
$ 505,646 $ 900,137 $(1,396,510)
========= ========= ===========
7. Profit Sharing Plan
The Company has a 401(k) profit sharing plan covering all permanent U.S.
employees who work at least 20 hours per week and similar pension plans for
non-U.S. employees. Participants may make voluntary contributions to the plans
and the Company matches these contributions, up to 5% of the employee's salary.
In addition, the Company may make discretionary contributions to the plans.
Participants contributions vest immediately and Company contributions vest over
a six-year period. Contributions to the plan charged to operations for the years
ended December 30, 1994, December 29, 1995 and December 27, 1996 totaled
$410,629, $532,170, and $880,478, respectively.
8. Commitments
The Company leases certain office space in California, Maryland, and Virginia,
and sales satellite offices, under non-cancelable operating lease agreements.
Certain leases contain escalation clauses and require the Company to pay its
share of any increases in operating expenses and real estate taxes. Rent expense
was $220,615, $281,381 and $555,019 for the years ended December 30, 1994,
December 29, 1995 and December 27, 1996, respectively. Future minimum lease
payments under all non-cancelable operating lease arrangements are approximately
as follows:
1997.............................. $ 853,013
1998.............................. 794,974
1999.............................. 766,794
2000.............................. 210,937
2001.............................. 94,980
Thereafter........................ --
----------
Total............................. $2,720,698
==========
The Company maintains self-insurance programs for health care and short-term
disability costs with stop-loss insurance. Expense incurred for group medical
claims, program premiums and stop-loss limit charged to operations
F-14
<PAGE>
for the years ended December 30, 1994, December 29, 1995 and December 27, 1996
totaled $497,090, $621,378 and $780,888, respectively.
9. Related Party Transactions
In 1994, the Company entered into an oral agreement to lease real property
located adjacent to the Company's Glenwood, Maryland headquarters from Glenwood
Associates Limited Partnership (Glenwood Associates), a limited partnership
controlled by certain shareholders of the Company. The lease provided for
monthly rent of $3,929 plus payment of operating expenses. The Company purchased
the aforementioned property from Glenwood Associates on June 28, 1996 for
$360,000 by assuming a mortgage note payable (see Note 4) and the elimination of
a receivable. Rent expense under the lease agreement for the years ended
December 30, 1994, December 29, 1995, and December 27, 1996 totaled
approximately $44,000, $47,000, and $24,000 respectively.
In August 1995, the Company issued a promissory note for the benefit of a
shareholder and former officer (Mr. Crocker) in the principal amount of $307,520
representing the balance of monies due to Mr. Crocker in connection with the
repurchase by the Company of 588,921 shares of common stock from Mr. Crocker.
This promissory note was paid in full in September 1995.
10. Subsequent Events
On January 24, 1997 Trusted Information Systems and International Business
Machines (IBM) announced a patent and software license agreement. Under the
terms of the agreement, IBM acquired the right to license and distribute TIS'
patented RecoverKey(TM) technology within the IBM Secure Way Key Management
Framework, as well as in IBM products, which will need key recovery technology,
which provides revenues to TIS from IBM sale of products, which include
RecoverKey(TM) technology, the operations of recovery key centers and periodic
renewals for maintenance and updates.
As of February 28, 1997, the fair value of the Company's shares of Cybercash,
Inc. common stock was approximately $2.0 million.
F-15
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Company has duly caused this Report to be
signed on its behalf by the undersigned, thereunto duly authorized, in Glenwood,
Maryland, on the 27th of March, 1997.
TRUSTED INFORMATION SYSTEMS, INC.
By: /s/ Stephen T. Walker
-----------------------------------
Stephen T. Walker
President, Chief Executive Officer,
Chairman of the Board
and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report has been signed below by the following persons on behalf of
the Company in the capacities and on the date indicated.
Each person whose signature appears below in so signing also makes,
constitutes and appoints Stephen T. Walker and Edwin M. Martin, Jr., and each of
them acting alone, his true and lawful attorney-in-fact, with full power of
substitution, for him in any and all capacities, to execute and cause to be
filed with the Securities and Exchange Commission any and all amendments and
post-effective amendments to this Report, with exhibits thereto and other
documents in connection therewith, and hereby ratifies and confirms all that
said attorney-in-fact or his substitute or substitutes may do or cause to be
done by virtue hereof.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Stephen T. Walker President, Chief Executive March 27, 1997
- ---------------------------- Officer, Chairman of the
Stephen T. Walker Board and Director
/s/ Martha A. Branstad Executive Vice President and March 27, 1997
- ---------------------------- Chief Operating Officer
Martha A. Branstad President of Advanced Research
and Engineering Division and Director
/s/ Harvey L. Weiss Executive Vice President, President March 27, 1997
- ---------------------------- of the Commercial Division, Secretary
Harvey L. Weiss and Director
/s/ Ronald W. Kaiser Executive Vice President and Chief March 27, 1997
- ---------------------------- Financial Officer
Ronald W. Kaiser
/s/ Gerald J. Popek Director March 27, 1997
- ----------------------------
Gerald J. Popek
/s/ Charles W. Stein Director March 27, 1997
- ----------------------------
Charles W. Stein
</TABLE>
F-16
<PAGE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
TRUSTED INFORMATION SYSTEMS, INC.
FORM 10-K
EXHIBIT INDEX
Exhibit Description Sequential Page No.
- ------- ----------- -------------------
<S> <C> <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
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.
<PAGE>
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**+ Patent and Software License Agreement dated January 24, 1997,
by and between the Company and International Business Machines
Corporation.
11.1** Statement of computation of earnings per share.
21.1* Subsidiaries of the Registrant.
23.1** Consent of Ernst & Young LLP, Independent Auditors.
24.1** Power of Attorney (included in signature pages).
27** Financial Data Schedule.
</TABLE>
- -------------------
* 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.
+ Portions of this Exhibit were omitted and have been filed separately with
the Secretary of the Commission pursuant to the Registrant's Application
Requesting Confidential Treatment under Rule 24b-2 of the Securities
Exchange Act of 1934, as amended, filed on March 27, 1997.
- ---------------------------
PATENT AND SOFTWARE LICENSE AGREEMENT
THIS PATENT AND SOFTWARE LICENSE AGREEMENT ("Agreement") is made, entered into
and effective as of the latter date of execution ("Effective Date") at Glenwood,
Maryland, between Trusted Information Systems, Inc. a Delaware corporation
("TIS"), having its principal mailing address at 3060 Washington Road (Rt. 97),
Glenwood, Maryland 21738, and International Business Machines Corporation, a New
York corporation ("IBM"), having a mailing address at 500 Columbus Avenue,
Thornwood, New York 10594.
RECITALS
A. TIS is the owner of and holds exclusive rights to certain technology that
is the subject of certain copyrights and pending and issued U.S. and
foreign patent applications relating to cryptographic information recovery.
B. IBM desires to have access to use such technology and/or patents and/or
copyrights to develop and distribute Licensed Products and TIS is prepared
to grant IBM such access and license in accordance with the terms and
subject to the conditions hereinafter set forth.
AGREEMENT
NOW, THEREFORE, in reliance on the foregoing recitals and in consideration of
the premises and mutual promises and covenants set forth herein, TIS and IBM
agree as follows:
1. DEFINITIONS
The following terms when used in this Agreement, and in the exhibits hereto
shall have the following meanings:
1.1. "Bundled Product" means the series or group of specific
computer programs, software, derivative works thereof,
firmware, or equivalent hardware functionality, identified in
Exhibit "A" which, on a non-exclusive basis, incorporates
either (a) any portion of the TIS Object Code or (b) any New
Software. The term Bundled Product excludes Toolkit, Toolkit
Derivative, KRC, and IBM Recovery Facility.
1.2. "Cryptographic Information Recovery Technology" means all
means, methods and processes related to the recovery of
encrypted information through key recovery and key escrow or
similar or replacement means and any functionality
incorporated into or practiced by RecoverKey,
RecoverKey-International, any derivative work thereof, or any
Key Recovery Center.
1.3. "Default Certificate" means a cryptographic certificate
provided by a KRC or IBM Recovery Facility that is the
property of the KRC or IBM Recovery Facility and licensed by
the KRC or IBM Recovery Facility to the End-User Customer. A
Default Certificate may be required before a Bundled Product's
or Toolkit Derivative's cryptographic capabilities will
function and such Default Certificate expires after a
specified period of time not to exceed one year.
<PAGE>
1.4. "Distributor" means a person or entity in the business of
distributing and sublicensing Licensed Products by authority
granted by IBM, including, but not limited to OEMs, resellers,
value added remarketers, dealers, and sales representatives.
1.5. "Documentation" means hardcopy and/or softcopy versions of
printed materials and any updates thereto which TIS provides
for use with any TIS Software licensed under this Agreement.
1.6. "End-User Customer" means a person or entity having license
rights to a Bundled Product or a Toolkit Derivative, KRC, or
IBM Recovery Facility from IBM, its Subsidiaries,
Distributors, or Toolkit Licensees
1.7. "IBM Recovery Facility" means a facility designed or
manufactured, other than by TIS, by or for IBM or its
Subsidiaries and identified in Exhibit "A" that may: (i)
provide a series or group of specific computer programs,
software, derivative works thereof, firmware, or equivalent
hardware functionality, which, on a non-exclusive basis,
incorporates either (a) any TIS Software or (b) any New
Software to permit users of Licensed Products to register,
receive KRC Certificates, or obtain information in various
contingencies; and (ii) provide consulting and support
services ancillary thereto. It is contemplated that this
Agreement may encompass additional IBM Recovery Facilities at
some future date. IBM may add or delete IBM Recovery
Facilities to or from Exhibit "A" by providing written notice
to TIS of such additions and such additional IBM Recovery
Facilities shall be automatically licensed pursuant to the
terms and conditions of this Agreement.
1.8. "IBM Recovery Facility Licensee" means any third party which
licenses an IBM Recovery Facility from IBM, its Subsidiaries,
or Distributors.
1.9. "IBM Recovery Field Format" means a field in a Bundled Product
or Toolkit Derivative to store recovery information that is
used by a Toolkit Licensee or IBM Recovery Facility.
1.10. "Interface Modifications" shall have the meaning set forth in
Section 2.4.1.
1.11. "Key Recovery Center(TM)" or "KRC(TM)" means: a recovery
facility that is either manufactured by TIS or a licensee of
TIS and: (i) provides software, hardware and/or other
technology resources to permit users to register their use of
RecoverKey(TM) and/or RecoverKey-International(TM), as defined
in Exhibit "H", to receive KRC Certificates and to obtain
information in various contingencies, and (ii) may provide
consulting and support services ancillary thereto.
1.12. "KRC Certificate" means a cryptographic public key certificate
provided by a Key Recovery Center or an IBM Recovery Facility,
including but not limited to a Default Certificate, that
permits key recovery by End-User Customers or other authorized
users.
1.13. "Key Recovery Center Licensee" means any third party that
sublicenses a KRC from IBM, its Subsidiaries, or Distributors.
1.14. "Key Recovery Field" or "KRF" or "Key Recovery Field Format"
means the technical means by which Bundled Products or Toolkit
Derivatives will generate a field containing information
described in Exhibit "B". At a minimum, such field would
contain information or an encryption key encrypted using a
public key that was issued by a KRC or an IBM Recovery
Facility.
1.15. "KRF Requirement Mechanism" means a technical method for
requiring the inclusion of KRF(s) upon encryption of
information.
1.16. "KRF Tamper-Detection Mechanism" means a technical method
which prevents the encryption of encrypted information upon
detection of an altered or missing KRF.
1.17. "Key Recovery Technology(TM) " or "KRT(TM) " means technology
comprising RecoverKey(TM) and/or RecoverKey-International(TM)
implementations that permits End-Users Customers to register
their use of KRTenabled Licensed products and receive KRC
Certificates, and also permits users, their organizations and
government agencies to recover a user information in the event
the user's normal means of obtaining such user information are
unavailable. It includes the TIS Software, TIS Object Code,
TIS Source Code, the Patent Rights, and/or the TIS Key
Recovery Field Format.
<PAGE>
1.18. "License Fees" shall have the meaning set forth in Section
3.1.
1.19. "Licensed Product" means: a Bundled Product, Toolkit, Toolkit
Derivative, KRC, and/or IBM Recovery Facility.
1.20. "Net Revenue" for Bundled Products, Toolkits, KRCs and IBM
Recovery Facilities means the gross revenue amount recorded by
IBM or its Subsidiaries (except as otherwise provided in
Exhibit "D") at any time in consideration of the licensing or
other permitted transfer of Bundled Product Toolkits, KRCs,
and IBM Recovery Facilities excluding any amounts received by
IBM or its Subsidiaries for sales and use taxes, shipping,
insurance and duties, and reduced by all discounts, rebates,
refunds or allowances granted to Distributors, or End-User
Customers in the ordinary course of IBM's or its Subsidiaries'
business.
Net Revenue for Toolkit Derivatives means the gross revenue
amount recorded by Toolkit Licensees at any time in
consideration of the licensing or other permitted transfer of
the Toolkit Derivatives, respectively, excluding any amounts
received by Toolkit Licensees for sales and use taxes,
shipping, insurance and duties, and reduced by all discounts,
rebates, refunds or allowances granted to Distributors, or
End-User Customers in the ordinary course of any Toolkit
Licensee's business.
Net Revenue for KRC's and IBM Recovery Facilities, for the
purpose of Section III(B) of Exhibit "D" hereto means the
gross revenue amount recorded by KRC or IBM Recovery Facility
Licensees, as applicable, at any time in consideration of the
issuance of Default Certificates, the collection of User
Registration Fees and User Recovery Fees, excluding any
amounts received by KRC or IBM Recovery Facility Licensees, as
applicable, for sales and use taxes, shipping, insurance and
duties, and reduced by all discounts, rebates, refunds or
allowances granted to Distributors, or End-User Customers in
the ordinary course of any KRC or IBM Recovery Facility
Licensees, as applicable, business.
In computing Net Revenue in any of the forgoing situations,
credit for returns actually made or allowed to End-User
Customers, or Distributors may be deducted but no such
deductions shall be permitted for estimates or amounts
accumulated for future settlement with purchasers. With
respect to a Licensed Product that is licensed or otherwise
distributed by IBM, a Subsidiary, a Distributor or Toolkit
Licensee as part of a larger group of products, a License Fee
shall be due as set forth above as though the Licensed Product
had been licensed or distributed separately by IBM, a
Subsidiary, a Distributor or Toolkit Licensee; provided,
however, that the amount used by IBM, a Subsidiary, a
Distributor or Toolkit Licensee as the base net revenue for
the Licensed Product when licensed or distributed in this
manner shall not be less than the pro rata proportion of the
sum of each component's price if sold separately.
1.21. "New Software" means any computer program, software, firmware
or equivalent hardware functionality, developed by or for IBM
or its Subsidiaries which is covered by any claim of the
Patent Rights or which is manufactured using or incorporating
a process which is covered by any of the Patent Rights.
1.22. "Other Products" means a product manufactured by or for IBM,
its Subsidiaries, Toolkit Licensees and sublicensees that
incorporates a Key Recovery Field Format but does not include
TIS Software and is not otherwise covered by the Patent
Rights.
1.23. "Patent Rights" means all of the following intellectual
property owned, licensable to IBM by TIS, or controlled by
TIS, or its Subsidiaries for so long as the term of such
intellectual property, if any, has not expired by its terms or
been rendered invalid or unenforceable by a tribunal of
competent jurisdiction from which no further appeal was or can
be taken:
a) All patents having claims covering Cryptographic
Information Recovery Technology issued or issuing on
patent applications entitled to an effective filing date
prior to ***, under which patents or the applications
therefor TIS or any of its Subsidiaries now has, or
hereafter obtains, the right to grant licenses to IBM
including, but not limited to the patents identified in
Exhibit "I" and any patents issuing from patent
applications identified in Exhibit "I"; and
_______
*** Confidential Information has been omitted and filed
separately with the Commission.
<PAGE>
b) Any divisionals, continuations or continuation in parts or
extensions of any of the aforesaid applications and any
patent reissuing of any of the aforesaid patents.
1.24. "RecoverKey(TM)" means TIS's implementation of KRT which
permits the decryption of an encrypted user information by a
KRC, which does not include KRF Tamper-Detection or KRF
Requirement Mechanisms.
1.25. "RecoverKey-International(TM)" means TIS's implementation of
KRT incorporating: (i) a KRF Requirement Mechanism which
permits a KRF Tamper-Detection Mechanism to function; and/or
(ii) a KRF Tamper Detection Mechanism which enables the
decryption of user information encrypted by TIS Software or
derivative work thereof containing a KRF Requirement
Mechanism.
1.26. "Subsidiary" means a corporation, company or other entity:
more than fifty percent (50%) of whose outstanding shares or
securities (representing the right to vote for the election of
directors or other managing authority) are, now or hereafter,
owned or controlled, directly or indirectly, by a party
hereto, but such corporation, company or other entity shall be
deemed to be a Subsidiary only so long as such ownership or
control exits; or which does not have outstanding shares or
securities, as may be the case in a partnership, joint venture
or unincorporated association, but more than fifty percent
(50%) of whose ownership interest representing the right to
make the decisions for such corporation, company or other
entity is now or hereafter, owned or controlled, directly or
indirectly, by a party hereto, but such corporation, company
or other entity shall be deemed to be a Subsidiary only so
long as such ownership or control exists.
1.27. "TIS Object Code" means the TIS Software in machine-readable
object code form, either in the form provided to IBM by TIS,
or in the form that results from recompiling in whole or in
part of the TIS Source Code after modification thereof.
1.28. "TIS Software" means the software computer program(s)
described as such in Exhibit "H" and the TIS Documentation
associated therewith, if any, including both the TIS Object
Code and TIS Source Code. "TIS Software" shall also include
any modifications, upgrades, and enhancements to such programs
as may be provided by TIS to IBM pursuant to the Maintenance
and Support terms (attached hereto as Exhibit "C"), and
Exhibit "H" shall be updated to reflect such modifications,
upgrades and enhancements.
1.29. "TIS Source Code" means the human-readable, high level
statement versions of the TIS Software written in a source
language used by programmers.
1.30. "Toolkit" means the series or group of specific computer
programs, software, firmware, or equivalent hardware
functionality, identified in Exhibit "A" which, on a
non-exclusive basis, incorporates either (a) TIS Software or
(b) any New Software either of which performs key or
information recovery functions and which is packaged, marketed
and licensed to be used by product developers who incorporate
the key or information recovery functions into such product
developer's products for redistribution, which Toolkit is not
itself permitted or intended for use by End-User Customers. It
is contemplated that this Agreement may encompass additional
Toolkits at some future date. IBM may add or delete Toolkits
to or from Exhibit "A" by providing written notice to TIS and
such additional Toolkits shall be automatically licensed
pursuant to the terms and conditions of this Agreement.
1.31. "Toolkit Derivative" means a derivative work of a Toolkit
compiled into object code that incorporates either (a) any
portion of the TIS Object Code or (b) any New Software.
1.32. "Toolkit Licensee" means any third party which licenses a
Toolkit from IBM, its Subsidiaries, or its Distributors.
2. GRANT OF LICENSES
2.1. Bundled Product Licenses. Without limiting IBM's rights to
bundle its products with software provided by any other
vendor, TIS hereby grants IBM, a non-exclusive,
non-transferable, perpetual and irrevocable (each except and
IBM hereby accepts as provided in Section 10), non-assignable
(except as provided in Section 10.4), worldwide license under
the copyrights and other intellectual property rights related
to the TIS Software, and under all Patent Rights to make, have
made modify, use, import, lease, sell, offer for sale,
license, sublicense and otherwise transfer Bundled Products
and execute, copy, reproduce, have reproduced, perform, and
display Bundled Products and distribute and transmit Bundled
Products, and to practice any method or process involved in
the use or manufacture of such Bundled Products.
2.2 TIS grants to IBM a non-exclusive, non-transferable, perpetual
and irrevocable (each except as provided in Section 10),
nonassignable (except as provided in Section 10.4), worldwide,
royalty free right and license to use and incorporate Key
Recovery Field Formats in any Licensed Products or Other
Products and to distribute and transmit such Licensed
Products, or Other Products and sublicense others to do any of
the foregoing all subject to the limitations on sublicensing
set forth in this Section 2.2 and for Toolkit Licensees,
subject to the limitations in Section 2.11 including the right
of Toolkit Licensees to use and incorporate such Key Recovery
Field Formats in Toolkit Derivatives and to distribute and
transfer such Toolkit Derivatives. Such Key Recovery Field
Formats shall not be considered to be TIS Object Code even if
such TIS Object Code incorporates or uses such formats and
mere use, reproduction and distribution of such Key Recovery
Field Formats does not create a Licensed Product and,
therefore, does not create a corresponding royalty obligation.
2.3. ***
2.4 TIS Source Code License. Subject to the restrictions specified
in Sections 11.13, 2.10 and 2.11, TIS hereby grants IBM, and
IBM hereby accepts for the purpose of creating Licensed
Products, a non-exclusive, perpetual and irrevocable (each
except as provided in Section 10), non-transferable, and
non-assignable (each except as provided in Section 10.4),
worldwide license under the copyrights and other intellectual
property rights (including patents) related to the TIS Source
Code to:
2.4.1. Access, make, have made, execute, modify, use,
reproduce, display, perform, prepare and have
prepared derivative works of TIS Source Code and to
a) compile, and b) develop interfaces and other
software (all such modifications to the TIS Source
Code, interfaces and such other software are referred
to collectively as "Interface Modifications");
2.4.2. Access and review the TIS Source Code in support of
End-User Customers, Distributors, Toolkit Licensees,
KRC Licensees and IBM Recovery Facility Licensees;
2.4.3. Compile the TIS Source Code to create Licensed
Products; and
2.4.4. Maintain Licensed Products and support Distributors,
Toolkit Licensees, KRC Licensees, IBM Recovery
Facility Licensees and End-User Customers.
2.5. Limitations On Source Code Licenses. The limitations set forth
in Section 2.3 shall also be limitations of the license rights
granted in Section 2.4, and IBM shall have no right to use the
TIS Source Code except as expressly set forth under this
Agreement; provided further that IBM, its Subsidiaries and
Distributors are not permitted to sublicense TIS Source Code
to End-User Customers.
2.6. Documentation Licenses. TIS hereby grants to IBM, a worldwide,
non-exclusive, non-transferable, perpetual and irrevocable
(each except as provided for in Section 10), fully paid up
license with respect to the Licensed Products: (i) to use,
display, access, perform, transmit, distribute, execute and
reproduce copies of Documentation, (ii) to prepare or have
prepared derivative works thereof and (iii) to distribute
copies of such unmodified and modified Documentation.
2.7. Title.
2.7.1. Subject to the license rights granted herein, TIS
shall at all times retain full and exclusive right,
title and ownership interest in and to the Patent
Rights and the TIS Software, including in and to any
and all of its patent, trademark, copyright, trade
secret or other proprietary rights therein.
2.7.2. Subject to the license rights granted by TIS herein,
IBM shall retain full and exclusive right, title and
ownership interest in and to any New Software and any
Interface Modifications developed by IBM and any
other products of IBM and in and to any and all of
its patent, trademark, copyright, trade secret or
other proprietary rights therein.
_______
*** Confidential Information has been omitted and filed
separately with the Commission.
<PAGE>
2.8. Retained Rights. All rights of TIS not expressly granted to
IBM herein are retained by TIS. There are no implied rights of
TIS related to the New Software or the products owned by IBM.
TIS shall have no implied rights to any portion of the New
Software, a Licensed Product or any other product
independently developed by IBM or licensed by IBM from a
source other than TIS, rights in which are not otherwise
retained by TIS through its ownership of the Patent Rights
and/or the TIS Software.
2.9. Immunity from Suit. TIS hereby grants to End-User Customers
and Distributors of any Bundled Products or any derivative
work thereof and Toolkits a non-exclusive, worldwide,
non-transferable, perpetual and irrevocable (each except as
provided in Section 10), non-assignable (except as provided in
Section 10.4), immunity from suit, and freedom from
infringement liability under the Patent Rights for making,
having made, using, selling, offering for sale, licensing,
leasing or otherwise transferring Bundled Products and
Toolkits either alone or in combination with other products or
apparatus and to practice any method or process involved in
the use of such Bundled Products and derivative works thereof
and Toolkits provided; however that the foregoing rights are
exercised in accordance with the applicable terms of this
Agreement or any applicable sublicense agreement.
2.10. Toolkit Licenses and Immunity.
2.10.1. TIS hereby grants IBM a non-exclusive, perpetual
and irrevocable (each except as in Section 10),
non-transferable, non-assignable (except as provided
in Section 10.4), worldwide license under copyrights
and other intellectual property rights related to TIS
Software and under all Patent Rights to:
a) Access, make, have made, modify, and use Toolkits
and execute, copy, reproduce, have reproduced,
perform, and display Toolkits and prepare and
have prepared derivative works thereof, and to
practice any method or process involved in the
use or manufacture of such Toolkits and
derivative works thereof;
b) Lease, sell, offer for sale, import, license,
sublicense (only as provided in Subsection C
below), distribute, transmit, and otherwise
transfer Toolkits and derivative works thereof;
and
c) Sublicense Toolkit Licensees to access, modify,
and use Toolkits and execute, copy, reproduce,
have reproduced, perform, and display Toolkits
and prepare and have prepared derivative works
including Toolkit Derivatives, and to practice
any method or process involved in the use or
manufacture of such Toolkits and Toolkit
Derivatives; and lease, sell, offer for sale,
import, license, sublicense, distribute,
transmit, and otherwise transfer Toolkit
Derivatives. Any sublicense rights granted to
Toolkit Licensees, whether directly by IBM or
indirectly by an IBM Subsidiary or Distributor,
pursuant to this Section; (i) shall be made
subject to the terms and conditions of Section
6.3 (confidentiality); (ii) shall be made subject
to the limitation that Toolkit Licensees cannot
further sublicense or distribute the Toolkits;
(iii) shall include the right of Toolkit
Licensees to execute, copy, reproduce, have
reproduced, perform, distribute, transmit and
display Toolkit Derivatives and prepare and have
prepared derivative works of such Toolkit
Derivatives and further sublicense to End-User
Customers directly or through Distributors any of
the foregoing; and (iv) shall contain provisions
similar to those set forth in Exhibit "E".
2.10.2. Toolkit Immunity. TIS hereby grants to any Toolkit
Licensees and to any customers, mediate or immediate
of Toolkit Licensees, a non-exclusive,
non-transferable, perpetual and irrevocable (except
as provided in Section 10), non-assignable (except as
provided in Section 10.4.), worldwide immunity from
suit, and freedom from infringement liability under
the Patent Rights for making, having made, using,
selling, offering for sale, licensing, leasing and
otherwise transferring any Toolkit Derivatives, alone
or in combination with any other product or
apparatus, and to practice any method or process
involved in the use of any Toolkit Derivatives,
provided, however, that the foregoing rights are
exercised in accordance with the applicable terms of
this Agreement or any applicable sublicense
agreement.
2.11. KRC and IBM Recovery Facility Licenses. TIS hereby grants IBM
a non-exclusive, perpetual and irrevocable (each except as
provided in Section 10), non-transferable, non-assignable
(except as provided in Section 10.4), worldwide license under
copyrights and other intellectual property rights related to
TIS Software and under all Patent Rights tomake, have made,
modify, and use KRCs and IBM Recovery Facilities and execute,
copy, reproduce, have reproduced, perform, and display KRCs
and IBM Recovery Facilities, lease, sell, offer for sale,
import, license, sublicense, distribute, transmit, and
otherwise transfer KRCs and IBM Recovery Facilities, and to
practice any method or process involved in the use or
manufacture of such KRCs and IBM Recovery Facilities. With
respect to a KRC or an IBM Recovery Facility operated by IBM,
IBM shall be bound by the terms set forth in Exhibit "F". Each
sublicense agreement of a KRC or IBM Recovery Facility,
respectively, whether entered into directly by IBM or
indirectly by an IBM Subsidiary or Distributor, shall contain
similar provisions to those set forth in Exhibit "G".
2.12. KRC and IBM Recovery Facility Immunity. TIS hereby grants to
any KRC Licensees and IBM Recovery Facility Licensees, and to
any customers thereof, mediate or immediate, a non-exclusive,
non-transferable, perpetual and irrevocable (each except as
provided in Section 10), non-assignable (except as provided in
Section 10.4), worldwide immunity from suit, and freedom from
infringement liability under the Patent Rights for using KRCs
or IBM Recovery Facilities, alone or in combination with any
other product or apparatus, and to practice any method or
process involved in the use or manufacture of any KRC and IBM
Recovery Facilities provided however the foregoing rights are
exercised in accordance with the applicable terms of in this
Agreement or any applicable sublicense agreement.
2.13. IBM Recovery Field Formats. IBM agrees to disclose to TIS the
IBM Recovery Field Formats. IBM grants to TIS, a
non-exclusive, non-transferable, perpetual and irrevocable
(each except as provided in Section 10), non-assignable
(except as provided in Section 10.4), worldwide license under
copyrights in the IBM Recovery Field Formats to copy,
reproduce, distribute, and transmit such formats.
Notwithstanding the foregoing, nothing contained in this
Agreement shall be construed as conferring by IBM to TIS any
rights by implication, estoppel or otherwise, to or under
copyrights (other than those granted in this Section 2.13),
patents, trade secrets, know-how, trademarks, or trade names.
2.14. Extension of Licenses to Subsidiaries and Distributors. All
licenses herein granted under Section 2 shall include the
right of IBM to grant sublicenses, of or within the scope of
the licenses granted to it herein, to its Subsidiaries and
Distributors and each such sublicensed Subsidiary and
Distributor shall have the corresponding right to grant
sublicenses limited by the terms of the licenses contained
herein, of or within such scope, to other Subsidiaries and
Distributors of IBM. Each such sublicensee shall be subject to
the terms and conditions of this Agreement.
2.13. Additions to Exhibits. It is contemplated that this Agreement
may encompass additional Licensed Products at some future
dates. IBM may add or delete Licensed Products to or from
Exhibit "A" at any time during the term of this Agreement by
providing written notice to TIS and such additional Licensed
Products shall automatically be subject to the licenses and
other rights granted under the terms and conditions of this
Agreement..
3. LICENSE FEES
3.1. License Fees.
3.1.1. Upfront License Fee. Upon execution of this
Agreement, IBM shall be obligated to pay TIS the
amount up front set forth in Exhibit "D".
3.1.2. Royalty Rate. In consideration of the license,
immunities, and other rights granted by TIS under
this Agreement, IBM shall pay TIS the fees and
royalties set forth in Exhibit "D". There shall be no
minimum royalty payments except for the fees and
royalties set forth in Exhibit "D", and IBM shall
have no obligation to market any Licensed Products.
3.1.3. Exceptions. IBM shall have no fees or royalty
obligation for copies of Licensed Products that: (i)
are used for IBM, its Subsidiaries', or Distributors'
internal use, development (other than Distributors),
maintenance/support activities, marketing
demonstrations, field testing, customer trial
periods, training, unsold inventory, education, or
backup/archival purposes; or (ii) contains only TIS
Software which becomes generally available by TIS to
third parties without a royalty or payment
obligation; or (iii) are used on a secondary or
backup machine provided that the Licensed Product is
not in active use on both a primary and a secondary
machine at the same time.
3.1.4. ***. IBM may request *** for any or all Licensed
Products when a licensing transaction requires a ***.
If TIS agrees, both parties will sign a letter
specifying the licensing transaction and its ***.
3.1.5. Maintenance Fee. IBM agrees to pay TIS the Annual TIS
Software Maintenance fee set forth in the applicable
Exhibit "D".
______
*** Confidential Information has been omitted and filed
separately with the Commission.
<PAGE>
3.1.6. Quarterly Report and Remittance. Within sixty (60)
days of the end of each calendar quarter, IBM shall
furnish to TIS a complete and accurate statement,
indicating the quantity and Net Revenue of Licensed
Products licensed or otherwise transferred or
returned, if any, during such calendar quarter, and
shall accompany such statement with payment of the
amount of fees and royalties due. Outside of the
U.S., a royalty payment quarter is defined according
to IBM's then current administrative practices.
Should the administration of IBM's worldwide revenue
recording systems and processes materially change
from the system and processes described in Section
I.B of Exhibit "D", IBM will advise TIS as to whether
the time period for delivering such Quarterly Report
and the associated remittance may be modified to be
submitted in a shorter time period than is specified
in this Section 3.1.6.
3.1.7. Annual Reporting. Within sixty (60) days of the end
of each calendar year, IBM shall provide TIS with a
cumulative statement of the Net Revenue of all
Licensed Products for such calendar year with the
same detail as required by the preceding subsection.
Within sixty (60) days after the expiration or
termination of the rights licensed herein, IBM shall
provide TIS with a cumulative statement of the Net
Revenue of all Licensed Products for the year in
which such termination or expiration occurs. Such
statements shall be accompanied by a remittance of
any additional payment due TIS, or a statement of
credit due IBM.
3.1.8. Audit Provisions. IBM shall keep records in
accordance with generally accepted accounting
principles and in sufficient detail to permit the
determination of which products are subject to
royalty payments under this Agreement, the royalties
due TIS, and the accuracy of the information on IBM's
written reports. Such records shall include detailed
records supporting transaction relating to Licensed
Products. Such records shall be kept for three (3)
years following the due date for the report relating
to the reporting period to which such records
pertain.
Upon TIS's written request for an audit, IBM shall
permit independent auditors designated by TIS,
compensated (other than on a contingency basis) by
TIS, and approved by IBM, to examine, during ordinary
business hours, records, and materials of IBM for the
purpose of determining royalties due TIS and in such
a manner as not to interfere with normal business
activities. The auditor will sign a confidentiality
agreement and will only disclose to TIS any amounts
overpaid or underpaid for the period examined. TIS's
request for an audit will be provided to IBM in
writing and will be made at least sixty (60) days
prior to any audit. Such request will not occur more
than once each year.
Such audit shall be restricted to an audit of those
records and materials related to Licensed Products.
Such records and materials shall be deemed to include
general financial information to provide a
cross-check for the amount of royalties reported.
In the event an audit identifies an underpayment of
royalties by IBM, IBM shall pay an amount equal to
the sum of such underpayment.
3.1.9. IBM will pay TIS the reasonable cost of the
independent auditors in the event that the audit
results in a finding that any statement submitted by
IBM has understated the royalties due TIS for the
period in question by ten percent (10%) or more.
3.1.10. Currency. Net Revenue invoiced in a currency other
than United States Dollars shall, for purposes of
this Agreement, be converted into United States
Dollars on the basis of the United States Dollar
equivalent exchange rates according to IBM's standard
practices.
3.1.11. Taxes. All taxes, duties, fees and other governmental
charges of any kind (except United States or state
taxes based on the net income of TIS) which are
levied, assessed or otherwise imposed by or under the
authority of any government or political subdivision
on any royalties payable hereunder, or any aspect of
this Agreement, shall be borne by IBM and shall not
be considered a part of, a deduction from, or an
offset against such royalties.
3.1.12. ***
4. MAINTENANCE AND SUPPORT
4.1. Maintenance. IBM will receive from TIS Maintenance and support
services pursuant to the terms contained in Exhibit "C", which
terms are incorporated herein by reference as though repeated
here.
4.2. Support. TIS shall not be responsible for providing level one
support to Distributors or End-User Customers for the Bundled
Products or Toolkit Derivatives, but TIS shall provide level
one support to IBM and its Subsidiaries.
4.3. New Release. New releases and new versions of TIS Software
will be provided by TIS at no additional charge during the
term of this Agreement.
5. MASTER COPY
5.1. Within thirty (30) days after the execution of this Agreement,
TIS shall deliver to IBM copies, in electronic or magnetic
form, of the TIS Software, and such other information,
Documentation and instructions reasonably deemed necessary by
TIS to enable IBM to utilize the licenses granted under this
Agreement (collectively, the "Master Copy"). TIS shall provide
additional Master Copies of revisions, updates and/or
enhancements, if any, to the TIS Software from time to time.
6. ADDITIONAL OBLIGATIONS OF LICENSEE
6.1. Licensed Product Marketing. IBM is authorized to represent to
its customers such facts about the TIS Software as TIS states
in its product descriptions, advertising and Promotional
materials.
6.2. License Agreement. IBM or its Subsidiaries or Distributors
shall provide to each End-User Customer of a Licensed Product,
a license agreement which is substantially similar to IBM's or
its Subsidiaries' then current license agreement. A copy of
IBM's current license agreement is attached hereto as Exhibit
"J".
6.3. Confidentiality and Marking
6.3.1. Information. From time to time during the course of
performance of the terms and conditions of this
Agreement, the parties may find it necessary or
useful to exchange confidential information
("Information"). TIS and IBM agree that all
disclosures of Information shall be made in
accordance with this Section 6.3.
6.3.2. Non-disclosure. The recipient's obligations regarding
Information expire two (2) years after the date of
disclosure, except for Source Code provided
hereunder, for which the recipient's obligations
shall expire five (5) years after the date of
disclosure. Information shall be used only in
accordance with the terms of this Agreement and shall
not be disclosed to a third party unless such third
party has entered into a written confidentiality
agreement at least as restrictive as the terms of
this Section. The recipient shall protect Information
using the same degree of care as it uses to protect
its own information of a like nature and in no event
exercise no less than reasonable care.
6.3.3. Identification. The recipient shall be obligated to
protect only Information: (a) disclosed in tangible
form clearly labeled as confidential or proprietary
at the time of disclosure; or (b) disclosed in
non-tangible form, identified as confidential or
proprietary at the time of disclosure, summarized in
_______
*** Confidential Information has been omitted and filed separately with
the Commission.
<PAGE>
a writing, designated as confidential or proprietary,
delivered to the recipient within thirty (30) days
after the disclosure.
6.3.4. Exceptions. This Agreement imposes no obligation upon
the recipient with respect to Information which: (a)
was in the possession of, or was known by, the
recipient prior to its receipt from the discloser,
without an obligation to maintain its
confidentiality; (b) is or becomes generally known to
the public without violation of this Agreement; (c)
is obtained by the recipient from a third party,
without an obligation to keep such information
confidential; or (d) is independently developed by
the recipient without use of Information. Disclosure
of Information is not prohibited if reasonable prior
notice is given to the discloser and such disclosure
is: (a) compelled pursuant to a legal proceeding or
(b) otherwise required by law.
6.3.5. Disclaimer. Information is delivered "AS IS", and all
representations and warranties, express or implied,
including fitness for a particular purpose,
merchantability, and non-infringement are hereby
disclaimed. Neither party has an obligation under
this Agreement to sell or purchase any item from the
other party. The recipient does not acquire any
rights in Information, except the limited right to
use Information as described above.
6.3.6. Residual Knowledge. Nothing in this Agreement is
intended to impose any obligations on the recipient
with respect to its use of Residual Knowledge.
"Residual Knowledge" means Information, including
concepts, know-how or techniques, that is retained in
the memories of recipient's employees who have had
access to Information consistent with the terms of
this Agreement. Recipient's use of Residual Knowledge
is subject to valid patents, copyrights, and
semiconductor mask work rights of the discloser.
6.3.7. Source Code. Source Code shall only be available to
the employees of the recipient, its agents,
Subsidiaries, subcontractors or others authorized to
receive Source Code pursuant to this Agreement on a
"need to know" basis.
6.4. Quality and Marking Standards. Except as provided under this
Agreement, IBM shall not display or use in any other way any
TIS trademark or tradename or other copyright, patent,
trademark, or other TIS marking or legend. IBM will not remove
or receive any TIS copyright notice in TIS Source Code. IBM
shall comply with IBM's quality standards when making and
distributing Licensed Products. IBM agrees to insert within
the splash screen of the Licensed Product an appropriate TIS
marking unless such Licensed Product does not have a splash
screen.
7. PUBLICITY
7.1. Cooperation. Where both parties deem appropriate, IBM and TIS
may engage in the following activities: joint publicity
releases, joint marketing materials, joint marketing calls,
joint trade show efforts, joint KRT lead processing, and
strategy coordination concerned with promoting KRT in the
commercial marketplace and to various domestic and foreign
government agencies.
7.2. Agreement Announcement. The parties agree that upon execution
of this Agreement, both parties may announce and/or confirm
the existence of this Agreement to the business, trade and
general press, or to any other person or entity provided that
the parties agree on the content, and date of the
announcement, and venue and vehicle for the announcement.
7.3. Approval. Neither party may publish any press release or other
public document which contains quotes from or any information
about the other party or its products without obtaining the
prior written consent of the other party. Notwithstanding any
of the foregoing, TIS may make factually accurate statements
about the compatibility of TIS products with IBM products.
7.4. Confidentiality of Agreement. The terms and conditions of this
Agreement shall be maintained in confidence as Information in
accordance with Section 6.3 hereof. Notwithstanding the
foregoing, the parties agree that TIS may file this Agreement
with appropriate governmental authorities subject to
appropriate confidentiality provisions to the extent
available.
8. LIMITED WARRANTY AND DISCLAIMER
8.1 Both parties represent and warrant that they have the
authority to enter into this Agreement and perform the
obligations hereunder.
8.1.1. TIS represents and warrants that to the best of its
knowledge the TIS Software does not contain any
Harmful Code. For the purposes of this Agreement,
"Harmful Code" means computer programming code that
is intentionally constructed with the ability to
damage, interfere with or otherwise adversely affect
computer programs, data files, or hardware without
the consent or intent of IBM, or any other authorized
licensee, which includes, but is not limited to,
self-replicating and self-propagating programming
such as viruses, worms and Trojan horses.
8.1.2. TIS represents and warrants that the media on which
the TIS Software is recorded will be free from
defects in materials and workmanship for a period of
ninety (90) days after delivery. TIS's sole liability
with respect to breach of this warranty is to replace
the defective media. Except as expressly provided in
this Section 8.1 and Section 9.0, TIS licenses the
TIS Software and Documentation to IBM on an "AS IS"
basis.
8.2. Disclaimer.
EXCEPT AS SPECIFIED IN THIS AGREEMENT, ALL EXPRESS OR IMPLIED
REPRESENTATIONS AND WARRANTIES, INCLUDING ANY IMPLIED WARRANTY
OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE OR
INFRINGEMENT ARE HEREBY DISCLAIMED.
9. LIMITED INDEMNITY AND LIMITATION OF LIABILITY
9.1. Representation. TIS represents and warrants that: (i) TIS has
sufficient rights to grant the rights and/or licenses granted
to IBM herein; (ii) the TIS Software does not infringe any
copyright, patent, trademark, or misappropriate any trade
secret; and (iii) no claim of patent, copyright, trade secret
or trademark infringement has been threatened or asserted, in
writing, or is in litigation relating to any of the
intellectual property provided by TIS under this Agreement.
TIS shall notify IBM of written claims and litigation which
arise during the term of this Agreement related to the
foregoing on a reasonable schedule.
9.2. Indemnity by TIS. TIS will defend or, at its option settle, at
its expense, any legal proceeding brought against: (i) IBM,
(ii) its Subsidiaries, and (iii) at IBM's request, its
Distributors, Toolkit Licensees, KRC Licensees, IBM Recovery
Facility Licensees, and End-Users Customers by a third party
to the extent it is based on a claim that: (a) TIS Software or
any portion thereof misappropriates a third party trade
secret, or infringes a copyright, patent, or other
intellectual property right of a third party; and/or (b) that
TIS has no right to license the TIS Software, Patent Rights,
or other intellectual property rights licensed hereunder. TIS
will pay all damages awarded by a court of competent
jurisdiction attributable to such claim, provided that IBM (i)
provides notice of the claim promptly to TIS, (ii) gives TIS
control of the defense and settlement of the claim; and (iii)
provides at TIS' expense reasonable assistance in the defense
or settlement thereof; provided, that if any settlement
results in any ongoing liability to, or prejudices or
detrimentally impacts IBM, and such obligation, liability,
prejudice or impact can reasonably be expected to be material,
then such settlement shall require IBM's written consent,
which consent shall not be unreasonably be withheld. IBM shall
be permitted to participate in such defense and settlement
proceedings at its own expense.
9.3. Election. Should any TIS Software or any portion thereof
become the subject of a claim of infringement for which
indemnity is provided under Section 9, TIS may elect to: (i)
obtain for IBM the right to use such TIS Software; or (ii)
replace or modify the TIS Software so that it becomes
non-infringing while substantially retaining its previous
functionality.
9.4. Exception. TIS shall have no indemnification obligation for
any infringement or claim which results solely from: (i) use
of other than an unaltered version of the TIS Software, if the
infringement is avoided by using the unaltered version; (ii)
TIS's compliance with designs or specifications of IBM as
required by IBM; (iii) distribution of products by IBM which
are not distributed pursuant to, or which are distributed in
violation of, the terms of this Agreement; (iv) use of the
Patent Rights or the TIS Software in combination with software
not licensed hereunder where the Patent Rights or the TIS
Software would not itself be infringing other than in an
operating environment specified or contemplated by TIS; or (v)
any matter for which IBM has an obligation to indemnify TIS
hereunder.
9.5. Entire Liability. SECTION 9 STATES THE ENTIRE LIABILITY OF TIS
WITH RESPECT TO INFRINGEMENT OF ANY THIRD PARTY INTELLECTUAL
PROPERTY RIGHTS BY THE TIS SOFTWARE AND PATENT RIGHTS.
9.6. Indemnity by IBM. IBM will defend or, at its option settle, at
its expense any legal proceeding brought against TIS or its
Subsidiaries by a third party to the extent it is based on a
claim that portions of a Bundled Product, Toolkit or IBM
Recovery Facility, other than those licensed to IBM by TIS,
infringes a patent, copyright or other intellectual property
right of a third party or misappropriates a third party trade
secret. IBM will pay all damages awarded by a court of
competent jurisdiction attributable to such claim, provided
that TIS: (i) provides notice of the claim promptly to IBM,
(ii) gives IBM control of the defense and settlement of the
claim; (iii) provides at IBM's expense reasonable assistance
in the defense or settlement thereof; provided, that if any
settlement results in any ongoing liability to, or prejudices
or detrimentally impacts TIS, and such obligation, liability,
prejudice or impact can reasonably be expected to be material,
then such settlement shall require TIS's written consent,
which consent shall not be unreasonably be withheld. TIS shall
be permitted to participate in such defense and settlement
proceedings at its own expense.
9.7. Election. Should any IBM Recovery Field Formats become the
subject of a claim of infringement for which indemnity is
provided under Section 9, IBM may elect to (i) obtain for TIS
the right to use such IBM Recovery Field Formats; or (ii)
replace or modify any such IBM Recovery Field Format so that
it becomes non-infringing while substantially retaining its
previous functionality.
9.8. Exclusive Remedy for Infringement. TIS and IBM hereby
acknowledge and agree that the Limited Indemnity set forth in
this Section 9 sets forth the total liability and the sole and
exclusive remedy of each party with respect to the other party
relating to claims of infringement of any third party
intellectual property by any materials, information, or
intellectual property licenses pursuant to this Agreement, as
well as for any breaches of this Agreement by a party of the
intellectual property-related representations and warranties
contained in Sections 8 and 9 hereof.
9.9. Limitation of Liability. Except for express undertakings to
indemnify under this Agreement:
9.9.1. Cumulative Payments. Each party's liability to the
other for claims relating to this Agreement whether
for breach or in tort, or otherwise, shall be limited
to the cumulative payments required to be made by IBM
to TIS during the term of this Agreement for the
Licensed Products related to the claims.
9.9.2. Mutual Waiver of Damages. IN NO EVENT WILL EITHER
PARTY BE LIABLE FOR ANY INDIRECT, INCIDENTAL,
SPECIAL, CONSEQUENTIAL OR PUNITIVE DAMAGES IN
CONNECTION WITH OR ARISING OUT OF THIS AGREEMENT
(INCLUDING LOSS OF PROFITS, USE, DATA, OR OTHER
ECONOMIC ADVANTAGE).
Except for KRC's that TIS operates, TIS is not liable
for the acts of any KRC or its operators.
10. TERM AND TERMINATION
10.1. Term. This Agreement shall be effective as of the Effective
Date and shall continue in full force and effect until the
expiration of the last to expire of the Patent Rights licensed
hereunder, unless sooner terminated pursuant to the provisions
of this Agreement. All licenses granted in this Agreement
shall be perpetual.
10.2. Termination. IBM may terminate the licenses of copyright and
patents granted hereunder pursuant to this Agreement at any
time by delivering written notice to TIS at least *** prior to
the Effective Date of termination. After *** TIS may terminate
this Agreement by delivering six (6) months prior written
notice to IBM in the event that IBM during the immediately
preceding ***. In addition, either party shall be entitled to
terminate any of the license rights granted pursuant to this
Agreement at any ***.
_______
*** Confidential Information has been omitted and filed separately with
the Commission.
<PAGE>
10.3. Insolvency. In the event that any party be adjudged insolvent
or bankrupt, or upon the institution of any proceedings by or
against it seeking relief, or arrangement under any laws
relating to insolvency, or upon any assignment for the benefit
of creditors, or upon the appointment of a receiver,
liquidator or trustee of any of its property or assets, or
upon the liquidation, dissolution or winding up of its
business, then and in any such event the license rights
granted pursuant to this Agreement may forthwith be terminated
by the other party upon giving written notice thereof at any
time after such event, and upon the giving of such notice the
license rights granted pursuant to this Agreement shall
terminate forthwith.
10.4. Assignment. The Agreement may not be assigned by operation of
law or otherwise, to any entity except to a Subsidiary or a
successor entity of a party without the prior written consent
of the other party. Such consent shall not be unreasonably
withheld by the other party. Any such purported assignment
without the other party's prior written consent shall be void
and of no effect. Neither TIS or any subsequent assignee or
exclusive licensee of the Patent Rights shall assign any of
the Patent Rights or grant any exclusive licenses thereunder
unless such assignment or license grant preserves the licenses
and other rights granted to IBM and its sublicensees under
this Agreement.
10.5. Effect of Termination. Upon the expiration or termination of
the license rights granted pursuant to this Agreement, the
license rights granted pursuant to this Agreement shall cease
and terminate within *** of such termination (except as
provided below) and the remaining provisions hereof (including
without limitation the obligations to pay outstanding royalty
obligations to TIS of Section 3.1.2, the confidentiality
provisions of Section 6.3 and the obligations under Sections
2.9 and 2.10.2) shall remain in full force and effect. All
licenses and immunities granted to IBM and its Subsidiaries
for internal use, End-User Customers, Distributors, Toolkit
Licensees, KRC Licensees, and IBM Recovery Facility Licensees
and any customers thereof prior to termination shall remain in
all force and effect. When the copyright license rights
granted pursuant to this Agreement are terminated for any
reason within a period of *** from such termination, IBM shall
cease making copies of, using in any way, distributing or
licensing the TIS Software and the Licensed Products
incorporating TIS Software, excepting as to sublicenses
previously granted which have not expired and excepting as to
such copies of Licensed Products necessary to fill orders
placed with IBM prior to such expiration or termination and
IBM shall be obligated for royalty payments for such period.
IBM shall return the Master Copy to TIS as soon as practicable
after such expiration or termination and shall destroy or
deliver to TIS all copies of the TIS Software and all written
materials relating thereto.
11. MISCELLANEOUS PROVISIONS
11.1. Governing Laws; Resolution of Problems; Suits.
11.1.1. The laws of the State of N.Y. (irrespective of its
choice of law principles) shall govern the
enforceability and validity of this Agreement, the
construction of its terms, and the interpretation and
enforcement of the rights and duties of the parties
hereto.
_______
*** Confidential Information has been omitted and filed separately with
the Commission.
<PAGE>
11.1.2. Representative. Within 30 days of the Effective Date,
each party shall designate one or more
representatives to act as liaison and agreement
coordinator ("Agreement Coordinator") for the
purposes of this Agreement. Such representatives may
change upon written notice to the other party.
11.1.3. Internal Dispute Resolution. In the event of any
problem, claim, or dispute arising from, out of, or
based upon this Agreement, except as expressly
provided for in Section 10.2, or the business
relationship between the parties, the aggrieved party
shall promptly notify the other party of the
existence of the problem, claim, or dispute, and such
other party shall promptly undertake all reasonable
efforts, including but not limited to, submitting
such problem, claim or dispute for resolution to a
Manager (as defined below) of each Agreement
Coordinator. For the purposes of this Section
"Manager" shall mean someone in the management chain
of the applicable Agreement Coordinator who is senior
to such Agreement Coordinator in terms of
responsibility, and who is familiar with the
administration of this Agreement. The Managers shall
make a good faith effort to resolve the dispute as
quickly as possible. In the event that the managers
cannot resolve such dispute within *** the matter may
at the option of either party, be submitted for
resolution to each party's executive with overall
responsibility for the subject matter in dispute.
Except as provided in Section 10.2, if the matter is
not resolved at the executive level, the parties may
then pursue any remedies available to them in law or
equity.
11.1.4. Each party agrees to *** concerning this Agreement.
11.2. Binding upon Successor and Assigns. Each and all of the
covenants, terms, provisions, and agreements contained herein
shall be binding upon, and inure to the benefit of, the
permitted successors, representatives, administrators and
permitted assigns of the parties hereto.
11.3. Severability. If any provision of this Agreement or the
application thereof to any person or circumstances shall, for
any reason and to any extent, be void or unenforceable, the
application of the remainder of this Agreement to such person
or circumstances and the application of such provision to
other persons or circumstances shall be interpreted so as best
to reasonably reflect the intent of the parties hereto. The
parties further agree to replace such void or unenforceable
provisions of this Agreement with valid and enforceable
provisions which will achieve, to the extent possible, the
economic, business and other purposes of the void or
unenforceable provisions.
11.4. Entire Agreement. This Agreement and the exhibits hereto
constitute the entire understanding and agreement of the
parties hereto with respect to the subject matter hereof and
supersede all prior and contemporaneous agreements or
understandings, inducements or conditions, express or implied,
written or oral, between the parties with respect hereto.
11.5. Counterparts. This Agreement may be executed in any number of
counterparts, each of which shall be an original as against
any party whose signature appears thereon and all of which
together shall constitute one and the same instrument. This
Agreement shall become binding when one or more counterparts
hereof, individually or taken together, shall bear the
signatures of all of the parties reflected hereon as
signatories.
11.6. Expenses. Each party shall pay its own costs and expenses
incurred with respect to the negotiation, execution and
delivery of this Agreement and the exhibits hereto. Except as
otherwise expressly provided in this Agreement, each party
shall be solely responsible for all of its costs, salaries and
other expenses incurred in connection with the performance of
its obligations hereunder, and the other party shall not have
any liability, obligation or responsibility whatsoever
therefor.
_______
*** Confidential Information has been omitted and filed separately with
the Commission.
<PAGE>
11.7. Amendment and Waivers. Any term or provision of this Agreement
may be amended, and the observance of any term of this
Agreement may be waived (either generally or in a particular
instance and either retroactively or prospectively), only by a
written agreement signed by both parties.
11.8. No Waiver. The failure of any party to enforce any of the
provisions hereof shall not be construed to be a waiver of the
right of such party thereafter to enforce such provisions.
11.9. Other Remedies. Any and all remedies herein expressly
conferred upon a party shall be deemed cumulative and not
exclusive of any other remedy conferred hereby or by law, and
the exercise of any one remedy shall not preclude the exercise
of any other.
11.10. Notices. Whenever any party hereto desires or is required to
give any notice, demand, or request with respect to this
Agreement, each such communication shall be in writing and
shall be effective only if it is delivered by personal service
or mailed, United States certified mail, postage prepaid,
return receipt requested, addressed to a party at its
respective address set forth on page 1 hereof. Such
communications shall be effective when they are received by
the addressee thereof; but if sent by certified mail in the
manner set forth above in this Section 11.10, they shall be
effective five (5) days after being deposited in the United
States mail. Any party may change its address for such
communications by giving notice thereof to the other party in
conformity with this Section.
11.11. Construction of Agreement. This Agreement has been negotiated
by the parties hereto, shall be deemed to have been drafted by
both parties, and the language hereof shall be construed
neutrally and not for or against any party. A reference in
this Agreement to any Section shall include a reference to
every subsection the number of which begins with the number of
the Section to which reference is specifically made (e.g., a
reference to Section 2.1 shall include a reference to Section
2.1.2).
11.12. No Joint Venture. Nothing contained in this Agreement shall be
deemed or construed as creating a joint venture or partnership
between any of the parties hereto. No party is by virtue of
this Agreement authorized as an agent, employee or legal
representative of any other party. No party shall have the
power to control the activities and operations of any other
and their status is, and at all times, will continue to be
that of licensor and licensee with respect to each other. No
party shall have any power or authority to bind or commit any
other. No party shall hold itself out as having any authority
or relationship in contravention of this Section.
11.13. No Competitive Restrictions. Each party agrees that nothing in
this Agreement is intended to prohibit IBM from developing or
acquiring technology that is the same or similar to KRT
provided that IBM does not do so in breach of this Agreement
or TIS' intellectual property rights not licensed hereunder.
IBM is not obligated to announce or sell any product. IBM does
not guarantee the success of its marketing efforts.
11.14. Export Restrictions. This Agreement is expressly made subject
to any laws, regulations, orders or other restrictions on the
export from the United States of America of the Patent Rights,
the TIS Software or the Licensed Products, or of information
about such TIS Software or Licensed Products, which may be
imposed from time to time by the government of the United
States of America ("Export Control Laws"). Notwithstanding
anything contained in this Agreement to the contrary, neither
party shall export or re-export, directly or indirectly, any
Patent Rights, TIS Software or Licensed Products or
information pertaining thereto to any country for which such
government or any agency thereof requires an export license or
other governmental approval at the time of export or re-export
without first obtaining such license or approval. IBM hereby
agrees that it solely shall be responsible for its compliance
with the Export Control Laws.
11.15. Absence of Third Party Beneficiary Rights. No provisions of
this Agreement are intended nor shall be interpreted to
provide or create any third party beneficiary rights or any
other rights of any kind in any client, customer, affiliate,
shareholder, partner of any party hereto or any other person
unless specifically provided otherwise herein, and, except as
so provided, all provisions hereof shall be personal solely
between the parties to this Agreement.
11.16. Performance of Acts in Furtherance of this Agreement. Each
party shall execute, acknowledge, and deliver all such further
documents and do and perform all such other acts as shall be
reasonably necessary or appropriate to enable the other party
hereto to enjoy the rights granted to it under this Agreement.
11.17. No Other Rights Granted. No express or implied rights of any
kind are granted by TIS to IBM or to anyone else except for
those rights that are expressly set forth herein.
11.18. Meeting. At least semi-annually, during the period
commencing on the Effective Date and ending on the fifth
anniversary thereof upon the written notice by either party,
the parties will meet, at a mutually agreeable time and
location, to confidentiality discuss product trends, Licensed
Products, and other related items. The parties recognize that
similar field formats are beneficial to both parties,
therefore, the parties may discuss descriptions of field
formats and royalty and fee adjustments. Each party will bear
its own expenses regarding such meetings.
11.19. Conflicting Terms. If there is a conflict among the terms in
the various agreement documents, those of this Agreement
prevail over those of an Exhibit.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the date
indicated below:
TRUSTED INFORMATION SYSTEMS, INC.
By: /s/ Stephen T. Walker
--------------------------
Name: Stephen T. Walker
Title: President and Chief Executive Officer
Date: January 22, 1997
INTERNATIONAL BUSINESS MACHINES CORPORATION
By: /s/ M.C. Phelps, Jr.
--------------------------
Name: M.C. Phelps, Jr.
Title: Vice President
Date: January 24, 1997
Exhibit 11.1
<TABLE>
<CAPTION>
Statement of Computation of Earnings (Loss) Per Share
For The Twelve Months Ended
-------------------------------
Dec. 30, 1994 Dec. 29, 1995 Dec. 27, 1996
---------------- ------------- -------------
<S> <C> <C> <C>
Common Stock Outstanding 7,507,748 7,333,676 8,212,774
Dilutive effect of Stock Options 151,986 684,903 --
Issuance of Cheap Stock 866,176 866,176 433,088
------- ------- -------
Weighted average shares outstanding 8,525,910 8,884,755 8,645,862
========= ========= =========
</TABLE>
Exhibit 23.1
Consent of Independent Auditors
Board of Directors
Trusted Information Systems, Inc.
We consent to incorporation by reference in the Registration Statements (Form
S-8) listed below of our report dated February 28, 1996, with respect to the
consolidated financial statements of Trusted Information Systems, Inc. included
in the Annual Report (Form 10-K) for the year ended December 27, 1996.
1) No. 333-20311 1994 Stock Option Plan
2) No. 333-20313 Amended and Restated 1996 Stock Option Plan
/s/ Ernst & Young LLP
Vienna, Virginia
March 27, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Company's financial statements as of December 27, 1996 and for the year ended
December 27, 1996 and is referenced to such financial statements.
</LEGEND>
<CIK> 0001013355
<NAME> Trusted Information Systems
<MULTIPLIER> 1
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> DEC-27-1996
<PERIOD-START> DEC-30-1995
<PERIOD-END> DEC-27-1996
<EXCHANGE-RATE> 1.000
<CASH> 1,838,787
<SECURITIES> 39,127,069
<RECEIVABLES> 5,977,953
<ALLOWANCES> 174,592
<INVENTORY> 0
<CURRENT-ASSETS> 50,975,530
<PP&E> 8,360,716
<DEPRECIATION> 1,665,192
<TOTAL-ASSETS> 58,003,593
<CURRENT-LIABILITIES> 7,865,230
<BONDS> 2,424,355
0
0
<COMMON> 114,897
<OTHER-SE> 47,551,746
<TOTAL-LIABILITY-AND-EQUITY> 58,003,593
<SALES> 26,370,081
<TOTAL-REVENUES> 26,370,081
<CGS> 12,193,453
<TOTAL-COSTS> 12,193,453
<OTHER-EXPENSES> 17,778,443
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 415,243
<INCOME-PRETAX> (3,560,713)
<INCOME-TAX> (1,396,510)
<INCOME-CONTINUING> (2,164,203)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,164,203)
<EPS-PRIMARY> (0.25)
<EPS-DILUTED> (0.25)
</TABLE>
